US Banking Industry Analysis | Valuation and Performance | Aranca Articles and Publications

8/10/2019 US Banking Industry Analysis | Valuation and Performance | Aranca Articles and Publications

1/25

www.aranca.com

US Banks:Fundamentals Ahead of Valuations?

Aranca Views

A Research Note By

Subarna Poddar

January 15, 2015


2/25

2Aranca Views: US BanksFundamentals Ahead of the Valuations?

January 2015

US Banks Valuation01

Irrational caution on the part of investors


3/25


January 2015

0

500

1000

1500

2000

2500

Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Jan-13

Jan-14

Jan-15

S&P Banks Select Industry Index S&P 500 Index

US banking sector underperforming the market over last seven years

S&P Banks Select Industry Index vs. S&P 500 Index

US banks underperformed the broader

market after the onset of the global economic

crisis in early 2007.

The S&P Banks Select Industry Index

indicated negative return of 3.65% YoY in the

last 10 years compared with 7.67% YoY by

S&P 500.

In 2008, banks and financial institutions were

at the center of this crisis and accumulated

huge subprime assets, which led to significant

losses in their books.

Since 2009, banks have tried to restructure

their balance sheets and operations. Most

banks have almost returned to the pre-crisis

level, although they continue to underperform

the broader market indices.

Source: Bloomberg


4/25


January 2015

Valuations below pre-crisis level

PB band chart of top 10 US banks

Banking stocks are trading at a significant

discount to the pre-crisis level valuation.

While the US banks current PB of about 1.0x

is a significant improvement over the low of

0.3x during the economic crisis, it is below the

high of 2.1x during the pre-crisis period.

The difference in valuation is despite an

improvement in bank earnings to the pre-

crisis level.

Source: Bloomberg

0.9x

0.3x

1.5x

2.1x

0.0

0.5

1.0

1.5

2.0

2.5

3.0

Jan-0

4

May-0

4

Sep-0

4

Jan-0

5

May-0

5

Sep-0

5

Jan-0

6

May-0

6

Oct-06

Feb-0

7

Jun-0

7

Oct-07

Feb-0

8

Jun-0

8

Oct-08

Feb-0

9

Jun-0

9

Oct-09

Mar-10

Jul-10

Nov-1

0

Mar-11

Jul-11

Nov-1

1

Mar-12

Jul-12

Nov-1

2

Apr-13

Aug-1

3

Dec-1

3

Apr-14

Aug-1

4

Dec-1

4

NetProfit(million

s)

Following are the top 10 banks we used for analysis:

1.Barclays Group US, Inc.(BCS US)

2. Bank of America Corp. (BAC US)3. Bank of New York Mellon Corp. (BK US)

4. Citigroup Inc. (C US)

5. Goldman Sachs Group, Inc. (GS US)

6. HSBC North American Holdings Inc. (HSBC US)

7. JPMorgan Chase & Co. (JPM US)

8. Morgan Stanley (MS US)

9. US Bancorp (USB US)

10. Wells Fargo & Co. (WFC US)


5/25


January 2015

Current valuation appearing to suggest irrational caution on the part of investors

PB/RoE scatter chart of top US banks in 2007 vis--vis 2014

A comparison between the 2007 and 2014

PB/RoE ratios of the top US banks indicates

the RoE of the banks has not reached the

pre-crisis level.

Book value of the banks rose in the last two

years, as the banks increased their equity

base to comply with BASEL III norms, leading

to a fall in PB.

*Bubble size denotes Market Cap

Source: Company filings, Bloomberg

JPM

C

GS

USB

BAC

WFC

MS BK

-5%

0%

5%

10%

15%

20%

25%

30%

35%

40%

0.0x 0.5x 1.0x 1.5x 2.0x 2.5x 3.0x 3.5x

2007RoE

2007 PB

JPM

C GS

USB

BAC

WFC

MSBK

-5%

0%

5%

10%

15%

20%

25%

30%

35%

40%

0.0x 0.5x 1.0x 1.5x 2.0x 2.5x 3.0x 3.5x

CurrentRoE

Current PB


6/25


January 2015

Operational Performance02

Operational improvements to warrant re-rating?


7/25


January 2015

Is valuation pertinent given improvement in banking operations?

Operating margin of top US banks

In recent years, US banks revenues have

risen above the pre-crisis levels due to high

net interest income, trading income,

investment banking, asset management, and

fee income.

With regard to efficiency, US banks managed

to keep the cost-to-income ratio below 60%.

Operating margin improved considerably, but

is yet to reach the pre-crisis bars.


-40%

-20%

0%

20%

40%

60%

80%

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

BCS US BAC US BK US C US GS US

HSBC US JPM US MS US USB US WFC US


8/25


January 2015

Improvement in bottom line on low provisions

Net profit margin of top US banks

US banks earnings are growing as

improvement in asset quality and writing off

bad loans is leading to low provisions

The bottom line improved majorly due to a

decline in loan loss provisions, which reduced

to 4.4% of the total revenue of the top 10 US

banks in 2013 from 28.3% in 2008.

The average ROE of US banks trended

upward after 2009 to 7.7% in 2013 from just

0.3% in 2008. However, it has not touched

the 2007 level of 11.9%.


-80%

-60%

-40%

-20%

0%

20%

40%

60%

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013




9/25


January 2015

NIM consistently below pre-crisis level with sustained deterioration

Net interest margin of top US banks

The declining NIM barely supported

revenues, whereas capital gains, as a % of

total revenue, increased.

NIM remained much below the pre-crisis level

due to ultra-low FED rates.

The end of QE would lead to a rise in US

interest rates, which would help improve the

NIM of US banks.


-1%

0%

1%

2%

3%

4%

5%

6%

7%

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013




10/25


11/25


January 2015

Gradual improvement in lending growth

Lending growth of top US banks

Lending activity remained the key driver of

growth in interest income. Low FED rates

were not conducive for the NIM environment

of US banks.

Loans of the top 10 US banks increased at a

CAGR of 12.8% from 200407 compared with

2.3% from 200713.


-100%

-50%

0%

50%

100%

150%

200%

2005 2006 2007 2008 2009 2010 2011 2012 2013




12/25


January 2015

Lending growth in different sectors supported by US economic upturn

Commercial loans grew significantly on high private investments

Improvement in the US economy supported

the overall growth of the banking industry.

With advancement in public spending, the

real estate loan segment experienced stable

growth.

Increasing economic activities added to the

loan growth in private sectors, leading to a

boom in the commercial loan segment.

Loans to non-financial corporations grew

more than 5%.

Despite improvement in consumer sentiment,

consumer lending remained below the pre-

crisis levels due to corporate and household

de-leveraging.

Source: Company filings

-20.0%

-10.0%

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

2005 2006 2007 2008 2009 2010 2011 2012 2013

Real Estate Loans Commercial Loans Consumer Loans


13/25


January 2015

Decline in non-performing loans compared with those in pre-crisis level

Non-performing loans and coverage ratios of US banks

Non-performing loans (NPLs) declined

compared with those in the pre-crisis level.

The average non-performing asset (NPA)

level of the top 10 US banks fell to 2.2% in

2013 from 4.1% in 2009.

The coverage ratio of the top US banks

deteriorated consistently from 133% in 2004

to 85% in 2013. This highlights the extent of

under-provisioning to cushion profitability.

0%

20%

40%

60%

80%

100%

120%

140%

160%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

NPL % Coverage Ratio (%)



14/25


January 2015

Lending growth supported by stable rise in deposits

Deposit growth of top US banks

The per capita and disposable incomes of US

citizens increased, driven by an increase in

job creation. This supported the deposit

growth.

Loan growth was majorly funded by high

deposits. The CAGR of US banking deposits

stood at 9.1% from 200413, driven by highdisposable incomes of US citizens. Loans

increased at a CAGR of 5.7% during the

same period.

The combined loan-to-deposit (LTD) ratio

reduced to 71% in 2013 from 94% in 2004, as

banks restricted lending to risky portfolios and

implemented strict KYC norms.

The liquidity of banks improved with the LTD

ratio coming down significantly.


-60%

-40%

-20%

0%

20%

40%

60%

80%

100%

120%

140%

2005 2006 2007 2008 2009 2010 2011 2012 2013




15/25


January 2015

Regulatory Measures03

Eliminating risk factors


16/25


17/25


January 2015

Most top US banks are way above their BASEL III regulatory requirements

Basel III ComplianceUS Banking Sector

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

WFC USB MS JPM HSBC GS C BK BCS BAC

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

10.0%


0%

2%

4%

6%

8%

10%

12%

JPM BAC C WFC GS MS BCS BK USB HSBC

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%


Tangible Common Equity Ratio

Total Risk-Based Capital Ratio

Tier 1 Risk-Based Capital Ratio

Tier 1 Leverage Ratio

Regulatory

requirement as

per BASEL III Regulatory

requirement as

per BASEL III

Regulatory

requirement as

per BASEL III

Source: Company filings

Regulatory

requirement as

per BASEL III


18/25


January 2015

CAMEL analysis of top US banks indicating GS performed better than peers in maintaining high level

of capital adequacy

Capital Adequacy Ratios (2013)

Source: Bloomberg, Aranca Analysis

0%

5%

10%

15%

20%WFC

USB

MS

JPM

HSBC

GS

C

BK

BCS

BAC

0%

5%

10%

15%

20%WFC

USB

MS

JPM

HSBC

GS

C

BK

BCS

BAC

0%

3%

6%

9%

12%WFC

USB

MS

JPM

HSBC

GS

C

BK

BCS

BAC

0%

5%

10%

15%

20%WFC

USB

MS

JPM

HSBC

GS

C

BK

BCS

BAC

Tier 1 Risk-Based

Capital Ratio

Tangible

Common Equity

Ratio

Total Risk-Based

Capital Ratio

Tangible

Common Equity

to Risk-Weighted

Assets

C A M E L


19/25


January 2015

BK better placed among peers in terms of asset quality, with low NPL level; HSBC underperforming

with high NPLs and low coverage ratio

Asset Quality Ratios (2013)


Non-performing

Loans (NPLs)/

Total Loans

Coverage Ratio

Provisions/Net

Revenue

Cost of Risk (bps)

C A M E L

0%

1%

2%

3%

4%WFC

USB

JPM

HSBC

C

BK

BCS

BAC

-4%

0%

4%

8%

12%WFC

USB

JPM

HSBC

C

BK

BCS

BAC

0%

50%

100%

150%

200%

250%WFC

USB

JPM

HSBC

C

BK

BCS

BAC

-30

0

30

60

90

120WFC

USB

JPM

HSBC

C

BK

BCS

BAC


20/25


January 2015

Increase in headcount of GS in 2013; significant growth in sales and net income per employee

Management Quality Ratios (2013)


Actual Sales Per

Employee (USD

000)

Net Income/

Employee

(USD 000)

YoY growth in

Headcount

Efficiency Ratio

C A M E L

0

400

800

1,200

1,600WFC

USB

MS

JPM

HSBC

GS

C

BK

BCS

BAC

-12%

-8%

-4%

0%

4%WFC

USB

MS

JPM

HSBC

GS

C

BK

BCS

BAC

0

50

100

150

200

250WFC

USB

MS

JPM

HSBC

GS

C

BK

BCS

BAC

0%

20%

40%

60%

80%

100%WFC

USB

MS

JPM

HSBC

GS

C

BK

BCS

BAC


21/25


January 2015

WFC and USB relatively superior in converting assets to earnings; poor performance by BCS

Earnings Ability Ratios (2013)


Return on

(Average) Equity

Pre-tax Margin

Return on

(Average) Assets

Operating Margin

C A M E L

0%

5%

10%

15%

20%WFC

USB

MS

JPM

HSBC

GS

C

BK

BCS

BAC

0.0%

0.5%

1.0%

1.5%

2.0%WFC

USB

MS

JPM

HSBC

GS

C

BK

BCS

BAC

0%

10%

20%

30%

40%

50%WFC

USB

MS

JPM

HSBC

GS

C

BK

BCS

BAC

0%

10%

20%

30%

40%

50%WFC

USB

MS

JPM

HSBC

GS

C

BK

BCS

BAC


22/25


January 2015

BCS among most aggressive lenders in peer group; BAC and JPM with highest short-term deposits

in their books

Liquidity Ratios (2013)


Loan-to-Deposit

Ratio

Short-Term

Deposits/Total

Deposits

Customer

Deposits/Total

Assets

Deposit Growth

C A M E L

0%

30%

60%

90%

120%WFC

USB

MS

JPM

HSBC

GS

C

BK

BCS

BAC

0%

20%

40%

60%

80%WFC

USB

MS

JPM

HSBC

GS

C

BK

BCS

BAC

0%

20%

40%

60%

80%

100%WFC

USB

JPM

HSBCBK

BCS

BAC

-5%

5%

15%

25%

35%JPM

BAC

C

WFC

GS

MS

BCS

BK

USB

HSBC


23/25


January 2015

Conclusion04

Fundamentals ahead of valuations


24/25


January 2015

Fundamentals ahead of valuations; upside expected

Sector requiresre-rat ing

Sound

Fundamentals

After analyzing the fundamentals and valuations of big banks simultaneously, it can

be concluded that US banks have strengthened fundamentally over the last six

years. Loan and deposit growth improved from an almost bottomed-out scenario in

2008; operating metrics such as net interest income, fee income, and operating

income increased, but the NPL level reduced. Although NIM is below the pre-crisis

level, it is expected to improve with the hike in FED rates.

Although the stringent regulatory guidelines impacted the operating maneuverability

and limited the trading gains of banks, banks can operate under relatively strict

supervision to avert another crisis. The emphasis on the quality and quantity of

capital requirement is another effort to build relatively more robust banks to face an

economic downturn.

RegulatoryCompliance

In the current scenario, while US banks regained some lost ground, they appear to

be undervalued and have reasonable upside potential.

Yet, investors would do well to keep a close watch on evolving global economicscenario, exposure to problematic regions and any rate decision by the FED.

Rate Hike, Key

Event to Watch

for


25/25

New York

275 Madison Avenue, 6th Floor

New York, NY 10016

T: +1 212 878 8826

Palo Alto

530 Lytton Ave, Palo Alto,

CA 94301, United States

T: +1 650 666 3011

London

93-95 Gloucester Place

London W1U 6JQ

T: +44 (0) 207 487 8214

Mumbai

Floor 2, Wing-B, Supreme Business Park

Hiranandani Gardens, Powai, Mumbai 400076

T: +91 (22) 3937 9999

Delhi

Plot 308, Udyog Vihar Phase IV

Gurgaon Haryana 122 016

T: +91 124 668 9999

Global Client Support

+1 212 995 5890

[email protected]

US Banking Industry Analysis | Valuation and Performance | Aranca Articles and Publications

Documents

Transcript of US Banking Industry Analysis | Valuation and Performance | Aranca Articles and Publications