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Ten Years After Crisis, Investors Still Wary On Bank Stocks

Global banks stocks have been out of investors' favor since the onset of the financial crisis nearly a decade ago, but the prospect of rising interest rates, looser regulation, improved credit quality, and stronger global economic growth might put them back on investors' radar screens, observers say.

While most broad market indexes around the world have crawled back from the nosedive suffered during the crisis — in some cases well surpassing precrisis trading levels — the banking sector's recovery has not been nearly as robust.

10-years market performance of select indexes

According to data from S&P Global Market Intelligence, banking stocks globally have yet to return to pre-crisis trading levels. For example, in the U.S., the broad market S&P 500 has climbed 60.09% above its pre-crisis peak level in October 2007, while the SNL U.S. bank index is still 10.86% below its pre-crisis level. Sparked by the subprime mortgage crisis beginning in 2007, the financial crisis saw the collapse of Lehman Brothers Inc. in 2008 and almost brought the global financial system to a halt. The financial industry was bailed out with huge amounts of taxpayer money, and the effects are still being felt today in the banking sector.

In Europe, the difference is starker. While the STOXX Europe 600 has nearly returned to its October 2007 trading level, the SNL European bank index is down 53.69%.

Only in Asia and Latin America have bank indexes bounced back to trade at or above levels from a decade ago, although in Asia, the SNL Asia-Pacific Bank Index's performance has still lagged the broader-market S&P Asia 50 and Nikkei 225.

Banks have been a "neglected sector," largely due to balance sheet and credit quality problems during the crisis, Davide Marchesin, who manages Switzerland-based fund manager GAM Investment Management's financials fund, said in an interview, with negative perceptions of the banking sector remaining.

A 'neglected sector'

"On the fundamental side, and specifically on the balance sheet side, the major problems were sorted out so the perception that the sector still has some big problems to address is probably misplaced," he said.

To be sure, banks across the globe — particularly those in countries hit the hardest in the credit crisis — have locked up trillions of dollars in total equity over the past several years to add cushion to their loss-absorbing capacity, even as credit quality has mostly improved.

One of the problems is that banks no longer produce the returns investors are seeking. In the heady days before the subprime crisis, banks such as Countrywide Financial Corp., one of the major actors in the subprime crisis, beefed up its balance sheets with a huge production of loans. While that ultimately brought about their downfall, it also inflated earnings, said Christopher Whalen, Chairman of Whalen Global Advisors, a veteran bank analyst and the author of several publications on the financial markets.

"That volume drove earnings and now you don't have that," he said. "There is less risk on these banks today than there was 20 years ago, and that is going to affect returns and affects growth because they just don't have that much credit at risk."

'Globally they are still finalizing Basel III, and things should ease up in terms of capital requirements; so balance sheets will ease up', Haidar said, referring to global rules on bank capital buffers.
Tighter regulation such as the Volcker rule in the U.S, which prohibits proprietary trading to prevent risk-taking by banks, "has killed" banks' business model, Said Haidar, CEO of New York-based hedge fund investment firm Haidar Capital Management, told S&P Global Market Intelligence.

"Since the financial crisis, there is all this macro prudential regulation which has affected their ability to make money," he said.

Return to growth

However, market observers say they do not expect the underperformance of global banking stocks to become a permanent feature, with several different factors at play that will be positive for banking stocks, including tax reform in the U.S.

"This will give a direct positive impact to the profitability of the banking sector, but will also give a boost to the economy overall, which should eventually translate into an improvement of lending growth," Marchesin said.

The prospect of looser regulation, which some argue has been a stranglehold on bank profits, may also tempt investors back to banking stocks.

"Globally they are still finalizing Basel III, and things should ease up in terms of capital requirements; so balance sheets will ease up," Haidar said, referring to global rules on bank capital buffers.

In addition, the phasing out of quantitative easing measures by central banks, coupled with the prospect of higher interest rates, will also make banking stocks more attractive, observers said.

"The ECB's accommodating monetary policy has been the main driver of banks' lower profitability," said Alexandre Baradez, chief market analyst at IG in Paris.

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In addition, banks have improved nonperforming loan, or NPL, ratios in the wake of the crisis, and leverage ratios have fallen, Marchesin said, noting that European banks were behind the U.S. credit cycle by about four years.

"Opportunities are better in Europe because the banks are really cheap," Haidar said. More generally, signposts suggest that systemic risks are declining and the economy is growing across Europe, making banking stocks a good buy. According to S&P Global Market Intelligence data, the aggregate NPL ratio at EU banks stood at 4.22% at the end of 2016, down from 4.49% at the peak of the crisis, but still well above the 2.97% nine years earlier. In the U.S., the NPL ratio, at 1.47%, has nearly returned to pre-crisis levels after spiking to 5.70% in 2009.

Asia, Latin America

Investors have also shunned bank stocks in emerging markets in Asia and Latin America, as the impact of the financial crisis bit into those regions' economies and investors became more risk averse.

"Emerging markets did poorly from 2010/11 to 2016," Haidar said. "Everybody was pulling capital out of emerging markets. A lot of their economies contracted."

Several countries such as Brazil have undertaken reforms, and investors seeking yield have started putting their money back in those markets, he said.

In Asia, GAM's Marchesin said it was difficult to predict the direction of banking stocks because of the large geographical footprint.

"As a rule of thumb, the capital position looks okay in Asia," he said. "In China there is [the] biggest question mark. We have credit quality which is deteriorating; probably still poorer accounting, and so this reduces a lot of the visibility and the confidence the market could have in the Chinese financial sector."

Total equity, NPL ratio of select banking systems

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