Banking 2.0 & IFSR9

[JEast]

From about 1986 thru to 1992, US banks in general had a tough time with the S&L crisis where over 1,000 banks were closed and that also included a nice recession in ’90-‘91.  Near the end of this terrible period, you could buy banks for 60-80% of TBV and all paying a healthy dividend.  Then, coming out of that period the banks had a long runway for 10-15 years only culminating in the beginning of the ’07 crisis.  It took nearly six years to clean up the mess the first time and appears that it has taken about 8 years to clean up the mess second time.  What’s different now versus the ’86-’92 period?  A lot. 

• There were roughly 12,000 banks in the US in 1992 and today their are less than 4,900 due to consolidation and Dodd/Frank pushing smaller banks out, and
  
• Now, the top 10 banks capture the vast majority of all US deposits.
  
• The regulatory capture has also made the largest banks even in a more advantageous position with the ‘stickiness’ of IT, such as,
  
• Winner takes all effects with digital and ongoing with Fintech R&D (e.g. what small bank can afford an annual $500m spend on cybersecurity).
  
• Also, Buffett gave a big thumb up to banking last year with his BAC conversion and Dimon says it is just the sixth inning.
  

That is the US from a very cursory look, but what about Europe, the UK, and maybe Africa?  In essence, the UK is about two years behind the US and selective opportunities in Europe are a year or two behind the UK.  Also, the European regulators are forcing banks to up their IT game and only the bigger banks can afford this ongoing expense.  Again, the biggest banks appear to be locking in customers in a somewhat annuity type outcome, as the stickiness of IT will keep customers for a long time.  In addition, some big banks in the UK may even have better IT presently then in the US and are selling at only 70-90% of TBV.  In addition, with the ‘ring fencing’ in the UK is the financial risk reduced more due to a more centric domestic market?  Outside of the UK, there are some European banks with similar attributes and are selling for significantly less but maybe a little more political risk.

 

What makes some of these non-US banks seem interesting, along with the current low valuation with potentially annuity type returns going forward, is that they are actually cheaper than they appear due to the recently adopted IFSR9 (booking loan losses up front).  From a value perspective — this up front loss acts like additional margin of safety — does it not (e.g. many banks took 10-15% equity adjustments for anticipated loans losses)?  One could make an educated guess that loan-to-value-plus-collateral is better today than 10 years ago and this pro-cyclical accounting adoption should make the banks even more overcapitalized over the next few years, maybe longer.  As for the UK challenger banks, they have made good progress but its been easy pickings and their IT spend going forward will catch up to them eventually.  So and if we are in the sixth inning in the US as some have suggested, then Europe, the UK, and maybe Africa are only in the second or third inning.

 

What say our UK and European friends?

[HJ]

Not that I'm any expert at European banking.  But I think there's a general perception that Europe is over banked.  Each country has their own national champion bank(s), and often times, those national champions are disproportionately large compared to their domestic GDP, relative to the banks in the US.  The ultra competitive banking landscape also leads to a less developed euro bond market, and more willingness to finance activities in the emerging markets, which at different times can be a good or a bad thing. Spanish banks roam all over Latin America, HSBC and Standard Chartered feels more Asian than European, both Swiss banks are truly too big to fail for Switzerland.  Maybe the one bank that has similarity in geographic mix in the US is Citi.  But as noted in the Citi thread, they do seem to have a knack for getting disproportionately caught up in every financial crisis. 

 

These are obviously way too generalized statements, and each bank should be evaluated on its own merit.  But European banking seems to be a slightly different animal, and a more difficult business than the US counterpart, where JPM, BAC, Wells Fargo all have super-regional, deposit taking roots. 

 

 

[Spekulatius]

Europe isn’t necessarily overbanked. Germany for example has less than Hall the number of branches /100K of population than the US (14 in Germany vs 33 in the US)

https://fred.stlouisfed.org/series/DDAI02USA643NWDB

 

The problem for banks in Europe is that competition is higher and margins are lower. A lot of banks have lower NIM (~2% vs 3%+ in the US) and fee income is less too. There is little unsecured lending for example with credit cards in Europe. Mortgages aren’t sold off either, since the equivalent of Fannie/Freddie Mac does not exist. I think the lower profits are due to competition from semi state or federal owned saving banks (Sparkassen), Mutual banks (Raiffeisen) and the lower interest rates overall. The banks that are most similar to US banks are British banks. Those also generate better margins more equal to their US counterparts.

[Jurgis]

AFAIK, Scandinavian banks in Lithuania pretty much mint money. There's almost no competition and they can gouge customers as much as they want. But then Lithuania is a small market - and that's the reason there's no competition - so maybe it doesn't move the needle much.

[vinod1]

I am more worried about tail risks related to Euro currency breakup.

 

Assets could end up being in one currency and liabilities could end up being in another currency. How would that impact bank capital?

 

For example, say Italy exits Euro currency. Most of the Italian bank loans are local and they would be marked in Lira. Their funding is more likely going to be remain in Euro.

 

This mismatch brings a host of risks. European banks look cheap, but every time I try to look at them, this tail risk keeps me from going forward.

 

Vinod

[racemize]

One thing I hadn't thought of (and TBW mentioned this to me when I was talking about Eurobank) was that a bank was, to a large extent, a bet on the sovereign bonds of that country.  For U.S./Canadians, that wasn't something that we had to even think about.  For Italy/Greece/etc., it definitely is.

[Spekulatius]

One thing I hadn't thought of (and TBW mentioned this to me when I was talking about Eurobank) was that a bank was, to a large extent, a bet on the sovereign bonds of that country.  For U.S./Canadians, that wasn't something that we had to even think about.  For Italy/Greece/etc., it definitely is.

This is true in the US as well, it’s just that nobody is worried about US treasuries yet.

 

I do think that in some emerging markets, private credit ratings can be higher than the countries sovereign rating.

[JEast]

to a large extent, a bet on the sovereign bonds of that country.

 

Maybe my comments were too subtle and the above quote is more to the point.  As all banks have pulled their horns in and have become basically domestic franchises, then what is a UK bank worth that has captured 9% of the domestic market with annuity type returns?  TBV is maybe an archaic measurement these days, but TBV plus intangible franchise value makes some look very inexpensive with only recessionary risk.  In a few select European countries, there are some domestic banks that have 25-40% market shares presently with negligible to zero intangibles on the balance sheet.

[Spekulatius]

In a few select European countries, there are some domestic banks that have 25-40% market shares presently with negligible to zero intangibles on the balance sheet

 

Which banks are you looking at? So far, I think Lloyd’s (LYG)  and ING look reasonable to me.

[Spos]

I agree with most of the comments on this thread.  When I looked at American banks last year, the things that jumped out at me were the historically high capital ratios, low NIMs, high liquidity, low delinquency rates and the above mentioned consolidation and regulatory issues.

 

Some of these factors are present in some European markets.  The two I’ve looked at closer, the UK and Ireland, now look more like Canada in terms of concentration, yet their ROA’s are significantly lower.  I wonder what the chances of them moving towards Canada-like returns on capital are.

 

FWIW, the one I am liking is RBS.  It feels like BAC from 3-4 years ago: grew into a very complex organization before the financial crisis, endless fines, litigation and restructuring expenses masking a profitable core business, unsuccessful stress tests.  But it now has a strong capital position, a very nice core business -which is now mainly retail and commercial banking in the UK-, is winding down its “bad bank” and with the agreement with the DOJ on the RMBS issues, seems to be past most of its legal and restructuring costs.  A dividend is likely later this year when (if?) they pass the next stress test.  Nicer would be share repurchases.  The government owns a majority of RBS, not sure if they would be able to buy back some of the government’s holding.

 

[cubsfan]

The best looking bank in the UK is Metro Bank. It's growing like crazy in a no growth market.

There are structural reasons for this - but you need to dig into it to understand way.

The UK banking market is a cartel, run for the banks, not for the population.

Metro is cleaning up, and will continue to clean up for quite some time.

 

IMO

[LC]

We are in a giant bull market. And the banks have benefitted greatly from this. I don't think the next five years will look similar to the last.

[Viking]

We are in a giant bull market. And the banks have benefitted greatly from this. I don't think the next five years will look similar to the last.

 

LC, the last 5 years have not been all that kind to the big banks:

1.) tens of billions paid out in fines

2.) exceptionally stringent regulation were imposed by regulators; costs to comply were very large

3.) banks were required to build up/hoard capital (with minimal dividends and stock buybacks)

4.) interest rates in US fell to generational lows (grealy reducing net interest income)

5.) constant fear US was about to slip back into deflationary spiral

 

Since the Trump election, the last 20 months have been kind to the banks.

1.) no more massive fines (small ones, yes)

2.) we have passed peak regulation; will be reduced in coming years

3.) era of capital hoarding has passed; capital returns now are at or exceeding 100% of earnings

4.) interest rates are now on a solid path of increasing with benefits flowing through to net interest income

5.) US GDP growth is solid, with forecasts of 3-4% real growth for Q2.

 

Given how worried everyone is right now, I am guessing US growth will surprise to the upside in the 2H 18. As much as I may not like Trump the man, I think much lower taxes, much less regulation, solid GDP growth and a pro US trade message will result in a stronger US economy and job growth.

 

You are right, the nest 5 years will be different. My guess is what happens will likely be quite different from what people are talking about today. Inflation rising more quickly than expected may be the real threat that few people are talking about right now. What if the US economy continues to deliver solid growth for the next 4 or 5 years... many experts are predicting a recession in late 2019 or 2020.   

[sleepydragon]

Corporate profits are currently at 10% of GDP. The long term average is around 6%:

 

http://fortune.com/2017/12/07/corporate-earnings-profit-boom-end/

 

In 1998 (or 1999) annual meeting, Buffett has said 20% of GDP is definitely Not possible over the longer term (he was referring to the high PE and forward profits at the market at that time).

 

I guess we will be fine if GDP gets to 4%? But all these talks about trade wars is not helping..

[rb]

US GDP print for Q1 just go revised down. But let me spare everyone the suspense... The US won't grow at 4% GDP. In fact growth, unless something weird is going on, going forward we'll most likely see weaker growth than in the past years. There's nothing wrong with that, btw.

 

A bump in margins and profits to GDP can happen even from the levels we're at. But probably nothing too dramatic. Banks could do quite well as the US could be going into a credit cycle.

[Spos]

http://www.cityam.com/263414/rbs-talks-bank-england-over-share-buyback-plans-

 

Buying back shares from the government is the best thing they can do.  They've announced a small dividend, but they should focus on this and buy back as much as they can in shares if the government is willing to do it at these prices.  CET ratio is 16.1% and should keep increasing so there is a lot of excess capital.