TMCnet News

ANALYSIS-Funds fear regulatory cosh will hit bank earnings
[October 17, 2008]

ANALYSIS-Funds fear regulatory cosh will hit bank earnings


LONDON, Oct 17, 2008 (Reuters via COMTEX) --
Governments may have stepped in to recapitalise
struggling banks, but asset managers are still struggling to see value in the
hard-hit sector.
Funds are fearful lower leverage and tough regulation will hit earnings
growth over the next decade, meaning the sector's prospects are significantly
less attractive than in the past.
"Banks have been broadly viewed as growth stocks, but with government
involvement they will look to control risk to a much greater degree," said Jeff
Munroe, chief investment officer of Newton Investment Management.
"And with interest rates so low, how will they get a big play on the
yield curve to replenish their profitability?" he asked, referring to banks'
ability to borrow cheap short-term funds and lend long-term at higher rates.
The European bank sector has plummeted to its lowest level since 1997,
having lost well over half its value since hitting a peak in the middle of last
year, and has lagged European blue chips as a whole by 17 percent so far this
year.
Blue chip casualties are not hard to find -- UBS AG
is down more than
80 percent.
The sector is also underperforming traditional defensives. The MSCI World
Banks Index is down 47.2 percent over 12 months while the MSCI World Healthcare
Index is down only 25.4 percent.
But some value managers -- the usual buyers of beaten up stocks -- are
not persuaded this is a buying opportunity. Adam Steiner, head of research at
SVG Investment Managers, said banks only look cheap if earnings rebound to
pre-credit crunch levels -- a prospect which looks unlikely any time soon.
TEN-YEAR BUBBLE
Sceptics argue bank earnings have been artificially inflated during the
10-year bubble in credit.
Klaus Wiener, head of research at Generali Investments, said the targeted
25 percent return on equity for banking was only possible due to cheap and ample
liquidity. "Those targets need to be more sensible. If you only have nominal GDP
of about 5 or 6 percent, how can you expect one sector to return 25 percent?"
Credit Suisse analysts have cut 2009 EPS estimates for European banks by
an average of about 20 percent and stress the need for more earnings visibility
before they can turn positive.
They say the European wholesale banking sector now trades on a ratio of
0.97 to tangible 2008 estimated net asset value, with Deutsche Bank on 0.80 and
UBS on 1.19. "At these valuations, the market is implying a significantly lower
structural ROE (return on equity) going forward, which we believe is correct,"
they said.
Nigel Jenkins, senior strategist at Payden & Rygel, noted all the
institutions in trouble were characterised by rapid growth on the back of
leverage. And the expected crackdown from regulators on excessive leverage will
make it harder for banks to generate the returns they made in the easy credit
years.
Banks are largely a play on the dynamism of the local economy, so in a
recessionary environment the attractiveness of banks as an investment
proposition falls, particularly if dividends are curtailed as looks likely in
the UK.
"We might see some sort of bounce in banks based on better optimism or


interest rate cuts, but are they really going to be great long-term investments?
Probably not. The best opportunities are likely to be in different areas,"
Munroe said.
DEAD IN THE WATER
Jeff Arricale, lead portfolio manager of the T Rowe Price Financial
Services Strategy, predicts a return to making money from traditional services,
reflecting a shift from risk-taking investment banks and brokers to
straight-laced commercial banks.
Others agree.
"The investment bank model is dead in the water," said Joan Payden,
president of U.S.-based asset manager Payden & Rygel, noting derivatives had
allowed the fixed income market to swell to twice the size of the equities
market globally.
"But if you take liquidity out of this system, you're looking at a
completely different structure," she said.
While regulators focus on preventing further collapses, investors are
wondering how the system may be overhauled.
"The problem at the moment is that banks take more risk when markets
rise, so there is an accelerator effect," said Schroders chief economist Keith
Wade. "If capital requirements increase automatically in line with market
increases, this won't happen."
He added shareholders also need to do more. "We are seeing the first
signs of that. The share prices of Goldman Sachs and Morgan Stanley fell sharply
because shareholders were saying that that business model doesn't work any
more."
Robert Talbut, chief investment officer of Royal London Asset Management,
believes banks will rely less on short-term financing and will seek the
stability of deposit bases. "The successful banks will be the ones with a strong
branch network and retail savings base, as wholesale funding will be harder to
come by and more expensive."
(Editing by Joel Dimmock and David Holmes) Keywords: FINANCIAL/BANKS
VALUATION

[email protected]
cmr
COPYRIGHT
Copyright Thomson Financial News Limited 2008. All rights reserved.
The copying, republication or redistribution of Thomson Financial News Content,
including by framing or similar means, is expressly prohibited without the prior
written consent of Thomson Financial News.
MMMM

[ Back To TMCnet.com's Homepage ]