Once upon a time there was a bank, run by wokies
I didn’t cover, now it’s brokies
A biased, ironic deposit base
It’s time to pass the hat
What a week. This time it’s different, but it sure feels like deja vu again. Big moves in the markets. Discount windows. I took up poetry to stay sane. My funds are bloody. Yours too, I suppose.
The temptation to “do something” is overwhelming. Sell. No purchase! Put your money in a suitcase. UK readers are also digesting an unusually stuffed budget of bits. More information next week.
The best approach is to keep an investor’s view. Link each event to asset price movements. Where are valuations now? What is reduced? Assess the risk and the reward. Keep calm and analyze the numbers.
Let’s start with Silicon Valley Bank. Personally, I wouldn’t have given a penny – preferring lenders with names like Morgan or Rothschild, or banks that look like countries. A group of West Coast bean bag fans who love start-ups? Certainly not.
Like many, including European regulators, I am surprised at the generosity of the US bailout, not to mention its irony. They were the troublemakers. They bragged about breaking things. A small crack, however, and they ran to Mom. In the UK too.
For investors, however, SVB and the resulting spasms are useful in my opinion. I wrote last week that policymakers would end up “bottling it up” when it comes to raising rates – too painful. But how do you do it without losing face? The European Central Bank gained 50 basis points on Thursday, but abandoned its hawkish stance. Others may follow.
The markets agree. For a brief moment on Monday, futures prices were priced within two 25 basis point cuts by the Federal Reserve this year. Only a few weeks ago, another increase was expected this month. No wonder bonds are flapping like geese in a gust of wind. Ten-year Treasury yields have made a round trip of more than 100 basis points this week alone.
Yields are now lower across the board, which, once the dust settles, will be a comfort to stock owners (wrongly, but there you go). And with inflation still present, real interest rates may have peaked for now. This helps traditional bonds and their inflation-protected cousins.
Meanwhile, bailouts, looser money and lifelines like Credit Suisse and First Republic will support banking stocks in the near term. But lower net interest margins are ultimately bad for bank earnings. The sector is cheap, however, at 1.1 times book value.
And there are quality banks with price-to-earnings ratios in the low double digits. A counter argument is that stricter regulations and capital requirements are surely coming. Maybe. There is no doubt that Wall Street was quick to deposit $30 billion with the First Republic in order to show that it can take care of itself.
As an investor, I would welcome a little more intrusion, if not from regulators. To understand why, join me a dozen years ago sitting across from Congressman Barney Frank at the White House Correspondents’ Dinner. We were swapping war stories of financial crisis while a senior banker showed us pictures of his new yacht (hint: it’s probably rigged and ready to sail).
If you had told Barney what banks would look like today, he would have laughed. His Dodd-Frank Wall Street Reform and Consumer Protection Act had recently revamped everything from consumer protection to derivatives trading. Change was coming. And yet, the banks are more or less the same today.
We knew there would be more crises. But at least everyone hoped that section 951 of the law would make a difference. He gave shareholders a “say on pay”. If banks were essentially guaranteed by the state, we thought, over time excessive wages would certainly be forced down.
That didn’t happen either. If you take the 10 largest U.S. lenders, for example, average employee compensation as a percentage of revenue is four percentage points higher since the financial crisis than in the boom years before it, according to data from CapitalIQ. .
Shameless. But it explains why the banks did their best to make us forget that we bailed them out. Yet bankers are still paid as if they were owners or entrepreneurs taking personal risks.
Hopefully the Fed’s $300 billion backstop this time around will remind everyone how nonsense that is. Especially shareholders, who have seen the employees of many banks line their pockets while suffering a return below the cost of equity.
But I see it as a glass half full. Bank earnings multiples are already tempting, as I have shown above. They would be even more attractive if bankers received salaries and bonuses more in line with other professions, such as accounting and law.
By my calculations – again for the US top 10 – cutting banker pay by just one-third would increase net income margins and returns on equity by 10 and 4 percentage points respectively. For an industry with middle office staff earning six-figure packages, a halving of pay is more the ballpark, I think.
Not only does this suggest a rise in stocks, but it would also help eliminate moral hazard. Lenders know they get paid like rock stars when things are going well, while dumb taxpayers foot the bill when the stage lights go off, setting everyone’s hair on fire.
All of this means that I am looking very seriously at ETFs in the banking sector at the moment. I wrote about them briefly in January when stocks were much higher than they are now. Does anyone have any fund suggestions to share? If not, a poem?
The author is a former portfolio manager. E-mail:stuart.kirk@ft.com; Twitter:@stuartkirk__
This article has been amended to correct the ECB interest rate hike
