The global banking sector is at its cheapest ever P/B (price-to-book) ratio compared with the rest of the market – and was close to absolute lows on a variety of measures even before coronavirus fears sent equities tumbling.
Data from Bloomberg showed that to the end of January, 60 per cent of the banking sector by market cap was on a P/B ratio of less than 0.5x, the highest proportion of any sector, by far. The sector in second place, insurance, was on just 15 per cent.
And, speaking before the market sell-off – which saw the MSCI World/Financials index fall by 10 per cent in little over a week – Nick Brind, manager of the Polar Capital Global Financials Trust, said that the banking sector represents outstanding value whichever metric you use.
“You are on a P/E [price-to-earnings] ratio that's less than 10x versus about 16.5x in the market,” he said.
“It has only ever been cheaper 7.5 per cent of the time. And on a price/book, it has only ever been cheaper about 10 per cent of the time going back to the mid-1990s. It is similar for dividend yield.
“When you get down to a relative valuation, you then go off the charts. It has never been cheaper price/book. And it has only ever been cheaper 2 per cent of the time on a P/E.”
Brind said that these valuations fail to take into account the enormous progress made by the sector since the financial crisis. The era of fines and impairments that has acted as a huge drag on profits appears to be coming to an end, while a more stringent regulatory environment has ensured a greater focus on repairing balance sheets and building capital to protect against a repeat of 2008.
George Barrow, co-manager on the trust, said this is evident from the low level of loan growth, which is the best predictor of losses going into a downturn. Meanwhile, the proportion of Level Three assets (described by Brind as “leveraged loans, bridge financing and an alphabet soup of structured products”) on bank balance sheets is 85 per cent lower today than it was in 2008.
Brind added: “It's funny, going back to meeting with the chief financial officer of Northern Rock in 2006 and 2007, I asked him how he could justify lending 125 per cent of the value of a house. He said to me, ‘you don't understand’. I came out of the meeting and spoke to the other people in it and said, ‘I still don't understand’.
“I mean, that's the extreme, but it was so endemic at the time.”
Low interest rates in the developed world have acted as one of the biggest hurdles to a banking rebound since the financial crisis and there is no sign of monetary policy being tightened anytime soon. The Federal Reserve is even considering cutting rates further in the short term to help deal with the threat from the coronavirus.
However, Brind pointed out that despite this difficult backdrop, banks are still capable of making money.
“JP Morgan has a return on tangible equity of 18 or 19 per cent and the other US regionals are there in the mid-teens,” he explained. “Then you look at emerging markets, where there are very profitable businesses.
“In the extreme, in Sweden and Denmark, they’ve got negative rates, but they're still actually making very good money.
“For the vast majority of banks, return on equity has gone back to pre-2007 levels. And the banks that have suffered are those that tend to have big investment banking operations.”
Barrow added: “And crucially, it's in the consensus estimates already – the market is already valuing the businesses at low rates that remain low. So the opportunity is there if there is ever a change in the environment.”
The opportunity in financials is not only based around the value trade. Fintech (financial technology), which accounts for 9 to 10 per cent of the portfolio, is one of the fastest-growing areas of the market – one fund focused on the sector, Wellington FinTech, was the seventh best-performer in the entire IA universe last year with gains of 44.23 per cent.
With 85 per cent of global transactions still in cash, there is still plenty of room for further expansion in fintech, which is why the managers are spending more time looking at this area both in terms of new entrants and how the incumbents are reacting to it.
However, Brind said it is vital to take a pragmatic approach to this area of the market, using banking start-ups Revolut and Monzo as examples.
“They effectively provide forex – I use them, my kids use them and they are undoubtedly great,” he continued.
“But how do they monetise the opportunity? Both have been very successful at customer acquisition through different approaches, and part of that is obviously a great customer user experience. But with a start-up bank, you don't have any network benefits you do with other technologies like Google, where if you're going to advertise, you have to be on it.
“Then secondly, you’ve got the regulatory requirements, which are only going to get higher with the capital it requires to fund any balance sheet growth.”
He compared Monzo and Revolut with One Savings Bank and Close Brothers, which are also on valuations around the £2bn mark, yet have revenues of up to 50x higher and are generating significant profits rather than draining capital.
Valuations, revenues and profits of banks
“[Monzo and Revolut] are priced to perfection, to put it diplomatically, and the others are priced for a really difficult operating environment,” the manager said.
“So One Savings Bank is trading less than 7x P/E for nearly a 20 per cent return on equity.
“And I think the issue you have is what are the advantages that Monzo and Revolut bring?
“At the moment, Monzo is quite funky. It's orange. Thank you. That's great.”
Data from FE Analytics shows Polar Capital Global Financials Trust has made 49.14 per cent since launch in July 2013 compared with gains of 57.86 per cent from the IT Financials sector.
Performance of trust vs sector since launch
Source: FE Analytics
It is trading at a discount of 6.99 per cent to net asset value (NAV) compared with 4.4 and 4.78 per cent from its one- and three-year averages.
The trust is just 1 per cent geared and has ongoing charges of 0.99 per cent.
It originally had a fixed life until May 2020. However, shareholders are now expected to vote to keep it open.