How cheap are US banks?

How cheap are US banks? Recent price action suggests that market's answer to this is "rather." Merrill reports worse than expected (albeit only slightly worse than leaked), and the stock rallies 4% on the day. Today, Citigroup disappointed the consensus and wrote down $15 billion or so. However, this amount was less than the $22 billion leaked yesterday, and de-emphasized in the headlines. (Citi must have bunged Bloomberg's headline writer a few bucks, as the only "red headline" showed a $6 billion writedown.)

The BKX has struggled to break new lows, and Macro Man's favourite technical analyst is lookinbg for a tasty (albeit corrective) bounce in the index.
Macro Man decided to do a crude study of bank valuation. The study was not meant to be exhaustive, and he is well aware of the limitations of his metrics. He constructed an evenly-weighted (i.e., not cap-weighted) basket of a number of US banks- Citigroup, BofA, Goldman, Merrill, Morgan Stanley, and Lehman. Using Bloomberg data, he had a look at how the equally-weighted index of their prices and price/book ratios have changed over the last dozen years:
On the face of it, these stocks look pretty darned cheap. The price index is back at the level of four years ago, and the price/book ratio is at its lowest in the dozen-year sample. On this basis, they look like a scoop, plain and simple. Of course, things are never that simple. Price/book estimates for banks are notoriously unreliable, and the wedge between price and price/book means that book value has spared over the years. Perhaps we'd better look at that.
Oh dear. Book value has risen in a pretty straight line for the entirety of the sample, albeit with a modest downturn recently. When you consider the utter implosion of most banks' assets, and that some are realizing the losses at 90c on the dollar, it's difficult to believe that these book values have troughed.
Indeed, book values have only retrenched back to the levels of last March....which was only three months before the onset of the financial crisis. Now, maybe this is accurate, and that somehow banks have managed to defend book values even as they de-leverage their balance sheets. Then again, maybe not......

Macro Man will let you be the judge....
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vlade
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April 18, 2008 at 12:38 PM ×

I was fascinated by ML going up 4% on the news that your newly bought shares will be diluted by 25% (IIRC) shortly.

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prophets
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April 18, 2008 at 1:55 PM ×

the biggest problem I have with looking at the recent past in financials is that many of them achieved returns on equity that were multiples of what the average non-financial company generates. it's hard to believe that any US financial should generate 20% ROE's (without taking extraordinary risk) and thus P/BV should be markedly lower going forward than it was compared to the past.

I can stomach something like RJF which only booked ROE's in the lower/mid teens and is basically priced for zero growth at this more modest ROE level.

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Eventhorizon
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April 18, 2008 at 5:21 PM ×

Interesting that your choice of banks mirrors Elliott Wave International's s0-called "Hedge Fund Enablers" Index (BAC, BSC, C, GS, JPM, LEH, MER, MS). JPM being the major difference. Not sure how they weight the components.

Great minds and all that. (Not sure if that's a compliment or an insult! LOL)

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Macro Man
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April 18, 2008 at 5:58 PM ×

Yeah, for some reason I forgot to put JPM in. I always thought of BSC as the best proxy for the global hedge fund business, what with their clearing and PB businesses....so I wonder what their demise says about the industry?

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Anonymous
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April 19, 2008 at 1:16 PM ×

Not sure about book value trend.

Losses cut book value. But if a bank recapitalizes at a price greater than book value, book value increases. Hasn't that slowed net book value decline?

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Macro Man
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April 19, 2008 at 1:28 PM ×

Anon, perhaps. But of the banks in the sample, C and MER had the 2 lowest price/book ratios, if memory serves, which suggests that that is "in the price", so to speak. Still, the sumes that have actually been raised by C, MER, MS, and LEH would seem to me at least to be pretty small in light of the likely value destruction to the highly-levered balance sheets of these institutions.

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S
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April 19, 2008 at 2:04 PM ×

ML book is understated by the hidden value of historical cost investments. So long as NPA at least on the banking side do not spike severely, banks will get the benefit of the fed cramdown and earn out of the losses. Plus they get better spreads on new business for some NIM expansion. Therefore, at least for the banks tradional lenders provided no total implosion should be able to ride it out albiet BV could be stagnat for few years - dead money with bear rally/. Plus tangible book is better metric. Tabngible and book were similiar in early 90s. today intangibles 50% of bv.

Ibanks totally different story. bisiness model broken.

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jest
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April 20, 2008 at 4:46 AM ×

i'm not expert by any means, but wasn't the book value argument used for the homebuilders awhile back?

the problem was their book value was all properties which were falling in value. ouch.

the banks seem to have the same problem, except isn't it worse since we don't know what they own *and* we don't know what the value is?

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Banker
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April 20, 2008 at 1:32 PM ×

I think this market snap's back more quickly then people think. The FedSpeak this week clearly signaled to me at least that there was no cut in rates coming at the end of the month. They are clearly concerned about inflation in addition to this slowdown. Not a good situation to be in.

Banker

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