Bank valuation in US mispriced by strength of fundamentals

21 May 2018

The financial crisis hit banks hard, particularly in developed countries. Recovery has been slow, as profitability went on the back-burner in favor of stability. New analysis shows that US banks are relatively profitable; however, concern around valuation is growing as both weak and strong performing banks are garnering high price-to-book ratios.

The global banking system hovered close to a full-scale meltdown during the financial crisis, with a domino effect spawned by a subprime mortgage crisis rippling through the sector. In the years since, regulators have sought to make the system more robust, and less liable to collapse completely if a strategic card were to fall out of place.

European banks have taken longer to recover from the crisis than US banks, though even weakly performing US banks are seeing high price-to-book ratios. For some analysts, this is a major cause for concern.

Components of the banking health check scoring modelLeading strategy consultancy Bain & Company has developed a ’health check’ scoring model, based on publicly available information, which it uses to assess the performance of hundreds of US and European banks. Bain’s evaluation includes insolvency override analysis, profitability and efficiency metrics, and breakdowns of assets and liabilities. The results are published in its recent report: “Are Investors Mispricing US Bank Risks?”

The consulting firm places the 601 banks assessed on a broad scale that runs from ‘at risk’ to ‘winner’. Overall, 141 banks fall into the ‘high concern’ category, exhibiting poor asset and liability scores, as well as weak profitability and efficiency performances. Both US and European banks are marked as ‘high concern,’ including some of the biggest 25 banks in each region. US banks are, however, more likely to fall into the extreme end of the high concern category.

US banks are resilient as their European counterpartsBanks with a weak business model – delivering little in the way of profitability and efficiency while boasting a healthy asset and liability score – are predominantly in Europe, where recovery has been slower and controls tighter. The large group of banks with weak balance sheets but strong business models – which translate to better profitability and efficiency scores – are more likely to be found in the US. 

While US banks tend to perform better in terms of their ability to turn a profit, there are concerns that overvaluation from investors is a problem, while in Europe investors are more modest in their expectations. Price-to-book ratios in 2016 were high in the US, even when asset and liability scores were poor.

Those in the ‘high-concern’ bracket were given a 1.46 price-to-book ratio, compared to 1.32 for those in the weaker business model bracket. To compare, banks in the ‘winners’ category have a price-to-book ratio of 1.70. In Europe the high-concern banks have a price-to-book ratio of just 0.31, substantially lower than banks in the winners category, which record a ratio of 1.31. Banks with weak balance sheets have a 0.72 ratio in Europe.

Investors are giving the least resilient US banks relatively high valuationsEvaluating the data, the authors of the Bain report express concern that investors are “disconnected from the realities of banks’ financial health.” One alarming parallel they cite is the situation before the financial crisis took hold, when investors similarly failed to draw essential distinctions between weak and strong banks while making their valuations. The report calls for a more “integrated view” to help banks identify weak points and work on a plan towards establishing robust health.


Payments market projected to see 6.6% annual growth to 2027

17 April 2019

Bank payment systems are big revenue generators for incumbent banks, and growth in the segment is projected to continue at a rapid 6.6% annual increase, from $1.3 trillion in 2018 to $2.4 trillion in 2027. Developing markets are set to see the fastest growth, increasing their total share from 52% to 61% in the same period.

The payments segment is set to see strong growth in the coming decades, particularly in developing countries. The long-time control of banking incumbents over the segment, however, faces various threats from the rise of fintechs leveraging a range of technological innovations.

To understand the changing market conditions, as well as the possible impact of new entrants, Boston Consulting Group (BCG) has released its “Global Payments 2018” report.Payments revenue is expected to grow by 1.1 trillion to 2027Payment revenue has seen a number of years of solid growth, particularly in line with developing global economies. Compound annual growth rate (CAGR) globally stood at 6.8% between 2010 and 2017, increasing from $805 billion to $1.27 trillion. Mature markets have been relatively stable, with growth of around $100 billion noted during the period, resulting in around $616 billion in revenue in 2017. Developing economies, meanwhile, saw total revenue more than double, from $268 billion to $657 billion.

While the disparity in growth between developing and mature economies is currently stark, the firm’s projections for the future will see developing markets up their growth while mature market growth slows, at 8.3% and 4.4% CAGR, respectively, between 2018 and 2027. Developing market revenue shares are overall set to continue to eat into mature market shares. The shift will see the 2027 mature market represent 39% of total revenues, compared to a 48% share 2018.Primary income set to close gap on secondary income in mature marketsThe study also examined the difference between primary and secondary revenue sources, and their respective growth rates. Primary sources represent transaction fees that come with making payments, while secondary sources represent account fee costs and related non-transaction costs. The study revealed a shift toward increased income from primary sources in mature markets, with the share between primary and secondary sources shifting from 43% and 57% in 2017, to 57% and 43% by 2027. In developing markets, however, secondary sources are and will continue to be the main source of revenue growth, at 27% (primary) and 73% (secondary) by 2027, with only a 4% increase in income from primary sources over the same period.Retail payments revenue is expected to growRetail growth is projected to represent the more lucrative growth market for payment revenues, with 7% growth between 2017 and 2027. Credit card revenue will see the strongest relative growth, up almost $462 billion, followed by account revenue and debit card revenue. The retail market, meanwhile, is set to top $1.85 trillion by 2027, with the wholesale market set to see growth of around 6%. Account revenue will see the strongest absolute growth, while credit card and debit card revenue growth is set to outpace the market as a whole, with around 7% growth during the period.

The firm notes, however, that customer sentiment is changing. Fintechs are sometimes able to provide more efficient and better tailored services – with uncertain outcomes for some incumbents. “In both the retail and wholesale payments business, customers are becoming impatient with clumsy interactions and inefficiencies,” Mohammed Badi, leader of the firm’s global payments and transaction banking segment, and the report's coauthor, said. “Consumers, treasurers, and merchants are looking for automated, integrated buying journeys and tailored service. They are being conditioned by their buying experiences in other industries. Banks, in order to stay relevant, must respond faster and more strategically to the altered payments environment by focusing on the pain points that matter most across the overall customer journey.”