By Guy de Blonay
Banks are getting more boring, and finally markets are getting excited about it. According to Bloomberg, the MSCI World Financials Index has risen more than 16% over the past 12 months, compared with a rise of less than 10% for the MSCI World Index. There are two fronts to this advance: first, global banks are beginning to allocate their resources more efficiently and become more focused. Second, there are the tentative signs of global economic recovery. While the latter is still uncertain, the former is a reality. So any broad economic growth would simply be a bonus to the improvement we are already seeing in the financial sector.
Many are aware of the positive developments in emerging market financials; however, in our view, many investors have not yet fully grasped the opportunities in the developed world. Large banks such as UBS, Barclays, and Citigroup are moving away from the more complicated world of big M&A deals and proprietary trading and returning to the more solid foundations of corporate banking and wealth management.
The move reflects a change of culture. Since the 2008 crisis, almost all the big banks have seen a change in senior management. Michael Corbat, Citigroup’s new CEO, has, for example, reversed the priorities set by former CEO Vikram Pandit. Corbat has announced significant cost cutting and is focusing on efficiency rather than growth. The bank’s share price almost doubled between April 2012 and January 2013, but it still trades at a discount to book value (the value of the tangible assets on its balance sheet). Our expectation is that Citigroup could eventually end up looking more like HSBC, which already has completed extensive restructuring, and currently trades significantly above its book value.
With so many institutions retreating from traditional investment banking activities, those that remain have a greater chance of operating successfully. Pre-tax profit margins from Morgan Stanley’s brokerage unit rose from 7% at the end of 2011 to 17% at the end of 2012.
Similarly, UBS has reviewed its remuneration policies. It recently announced that high-earning staff would receive deferred bonuses in the form of bonds that could be written down completely if certain capital adequacy levels were breached; thus aligning staff interests more closely with those of creditors and investors. While UBS made a loss in the last quarter of 2012, this was primarily attributed to one-off provisions for litigation and regulatory action. More importantly, UBS is already close to meeting its Basel III capital requirements, well ahead of the 2019 deadline, and is recommending a dividend increase.
At present, these banks are trading at levels that seem more appropriate for their riskier antecedents. These valuations do not fully reflect the reality that many large US banks recapitalised early on and were subject to rigorous stress tests. Even in Europe, many banks have taken the opportunity to make early repayment of funding received from the European Central Bank’s Long-term Refinancing Operation. Banks are positioning themselves for success by becoming more like utility companies; they are implementing stable business models and a focus on business-as-usual. Once they have built up their capital buffers, they should be able to increase dividend payments, potentially driving valuations higher amid increasing demand from income investors.
With the Basel III requirements now being phased in gradually over the next six years, banks are being given time to heal and could make significant progress over the medium to long term. Like with any hospital stay, the period of recuperation may be boring, but the outcome for the patient should be a return to health.
Guy de Blonay is manager of the Jupiter Financial Opportunities fund
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