They're questioning whether the investment-banking model that fueled record profits in the middle of the decade can be repaired
Goldman Sachs Group (GS) was one of the best-performing financial shares in the past decade, beating the Standard & Poor's 500-stock index. That helps to explain Chief Executive Officer Lloyd C. Blankfein's $125 million in cash bonuses during the period. Now consider this: One-year certificates of deposit earned an average rate of 3.17 percent over the last 10 years, beating the 2.78 percent annual total return on Goldman Sachs. Buying a 10-year Treasury note in mid-September 2000 would have yielded a return of 5.8 percent annually.
Many investors may be skeptical of financial shares for some time. In the aftermath of the collapse of Lehman Brothers Holdings and the devastating economic slump that ensued, investors are questioning whether the investment-banking model that fueled record profits in the middle of the decade can be repaired. "The fundamentals of their businesses aren't going to be anywhere near as good as they were pre-Lehman," says Jon Fisher, a portfolio manager at Fifth Third Asset Management in Minneapolis, which handles more than $18 billion. "Every aspect of the business has been damaged."
Of 10 banks with large capital-markets business units, only Goldman and JPMorgan Chase (JPM) are trading close to their prices on Sept. 12, 2008, the last day of trading before Lehman filed for bankruptcy. Citigroup (C) has lost 78 percent, and Bank of America (BAC) is down 60 percent. The average is a 25 percent decline, almost triple the 8.9 percent drop in the S&P 500 over the same period.
The earnings outlook for Wall Street banks remains pallid compared with profits in 2006, the year before the credit crisis began. Estimates for 2011 earnings per share are lower than 2006 for all except JPMorgan, according to data compiled by Bloomberg. Citigroup's 2011 earnings-per-share forecast is 89 percent below 2006 earnings, while Bank of America and Zurich-based UBS (UBS) will probably fall more than 60 percent below 2006 levels on a per-share basis.
The financial crisis led to new regulations that set limits on banks' activities and will require them to hold more capital and liquid assets. "The rules of the business have all been changed," says Peter Sorrentino, senior portfolio manager at Huntington Asset Advisors in Cincinnati, which manages $13.3 billion and has reduced its holdings in large-bank stocks. "We see more pitfalls than we do potential profits in that group, and then there are so many question marks with regard to financial-services regulation."
Investors may be shunning large-bank stocks because they haven't recovered from the shock of Lehman's implosion, says Michael K. Farr, president and founder of Washington-based Farr, Miller & Washington, which manages about $650 million. "Valuations look very low to me, and I think there's opportunity there, but I think there's also ample reason for the abundant caution that investors are showing," says Farr, who recently bought shares of Bank of America. After Lehman, he says, "we all began to see that as we looked behind the curtain, the guy pulling the levers was not in very good shape at all."
The bottom line: The financial crisis changed investors' view of Wall Street banks as perpetual money-making machines.