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Bank Valuations Stuck at 2009 Lows Showing No Crisis Recovery

Valuations for U.S. financial stocks have fallen so far, it’s like the rebound from the worst crisis since the 1930s never happened.

Banks, insurers and asset managers in the Standard & Poor’s 500 Index trade at 12.3 times estimated earnings, close to the lowest level since the bull market began in March 2009, according to data compiled by Bloomberg. The group is the second-cheapest among 10 industries in the gauge even as analysts say profits will rise 18 percent this year, exceeding the S&P 500, data compiled by Bloomberg show.

While the biggest equity rally in more than five decades has lifted the S&P 500 above its level when Lehman Brothers Holdings Inc. collapsed in September 2008, the failure of price- earnings ratios to widen is a sign to Pioneer Investments and Gamco Investors Inc. that gains in banks may end when government stimulus ends. Bulls such as OppenheimerFunds Inc. say forecasts for a three-year economic expansion mean the stocks will prove bargains as earnings and dividends increase.

“It may be awhile before investors feel comfortable paying above-average multiples for financial companies,” said John Carey, a Boston-based money manager at Pioneer Investments, which oversees about $250 billion. “What everyone is waiting for is a sign that the companies are really back, that they’re really on their feet again and can survive without continued government support and subsidy.”

Industrial Production

The biggest yearly increase in U.S. retail sales since 1999 and higher-than-estimated industrial production show the U.S. expansion is gaining momentum. The Commerce Department may say Jan. 28 that gross domestic product rose at an annual rate of 3.5 percent in the fourth quarter, based on the median estimate from 67 economists surveyed by Bloomberg.

That may not be enough to boost bank shares because investors are still trying to gauge how much profits will be reduced by last year’s financial reform law, Carey said. The last time the industry was this cheap, in March 2009, the economy had been in a recession for about 14 months, the S&P 500 was at a 12-year low and regulators were conducting stress tests to determine how much capital lenders needed to cover losses.

Earnings for S&P 500 companies rose 30 percent in 2010, the fastest growth since 1995, according to analyst estimates. Profits for financial companies almost doubled, aided by the Federal Reserve’s decision to keep benchmark interest rates near zero. The U.S. government and Fed have pledged about $12.8 trillion since 2008 to fix the financial system and prevent deflation, and policy makers committed $600 billion to buy Treasuries to stimulate economic growth, data compiled by Bloomberg show.

Weekly Retreat

The S&P 500 gained 0.6 percent to 1,290.84 today. The gauge fell 0.8 percent to 1,283.35 last week, halting the longest streak of increases since May 2007. Among the 25 financial institutions in the U.S. equity benchmark to report results since Jan. 10, the average company beat analyst estimates by 2.2 percent, data compiled by Bloomberg through last week show. Banks topped forecasts by an average 17 percent in the previous earnings season and 24 percent in the period that began in July, data compiled by Bloomberg show.

Investors will get more information on profits this week, with at least 128 companies in the S&P 500 scheduled to report results, according to Bloomberg data. Peoria, Illinois-based Caterpillar Inc., the world’s largest maker of construction and mining equipment, and Procter & Gamble Co. in Cincinnati, the maker of Tide detergent, are scheduled for Jan. 27.

Goldman, Citigroup

Goldman Sachs Group Inc. fell 5 percent and Citigroup Inc. lost 4.7 percent last week as earnings from the New York-based companies failed to exceed analysts’ estimates. New York-based American Express Co., the world’s biggest credit-card issuer by purchases, lost 0.5 percent after reporting lower-than-estimated profit and cutting 550 jobs.

Bank of America Corp. in Charlotte, North Carolina, fell 2 percent on Jan. 21 and 6.6 percent for the week. The largest U.S. bank by assets reported a $1.24 billion fourth-quarter loss as costs mounted for refunds, writedowns and litigation tied to faulty mortgages. The S&P 500 Financials Index declined 1.7 percent, the biggest weekly retreat in almost two months.

“Banks have lost the revenue stream from mortgage lending, and M&A activities and capital markets activities have been muted,” said Hayes Miller, the Boston-based head of asset allocation in North America at Baring Asset management Inc., which oversees about $51.4 billion. “All these things just add up to basically speculating on banking stocks as opposed to feeling really secure about the future.”

Estimated Profit

Goldman Sachs, JPMorgan Chase & Co. and Bank of America trade for less than 10 times estimated 2011 profit, making them among the 50 cheapest companies in the S&P 500, data compiled by Bloomberg show. Valuations have held steady even as the S&P 500 Financials Index gained 165 percent since March 9, 2009, leading the broader gauge’s 90 percent advance.

Financial institutions in the benchmark measure of U.S. equities are cheaper using estimated income than utilities, whose earnings are forecast to drop 0.9 percent in 2011 and 1.2 percent in 2012, according to data compiled by Bloomberg.

Banks and brokerages trade at 1.2 times book value, or assets minus liabilities, compared with the 18-year average multiple of 2. Still, that marks a recovery from right after Lehman Brothers collapsed in September 2008. Two months later, Goldman Sachs was valued as low as 0.5 times book, while Citigroup’s fell to 0.1 in March 2009 and the bank required a $45 billion taxpayer-funded bailout. The companies are now valued at multiples of 1.3 and 0.9.

Valuing Paper

For industrial companies, book value represents the liquidation value of plants and equipment. Financial firms’ valuations depend on prices for paper assets such as stocks, bonds, loans and contracts.

Starting in 2007, record declines in property values and rising mortgage defaults made it impossible for banks to value securities whose prices were derived from home loans, sparking the credit crisis that led to $1.98 trillion in losses and writedowns for financial institutions worldwide, according to data compiled by Bloomberg.

Even after the Fed took steps to reduce soured credit, financial companies in the U.S. have $378 billion in loans and leases that are 90 days or more past due, data from the Federal Deposit Insurance Corp. show. The ratio of so-called noncurrent assets and other foreclosed properties to total assets was 3.25 percent at the end of the third quarter, compared with 0.7 percent three years ago.

Book Value Calculations

“The issue here is how trustworthy are the book value calculations given all the asset quality issues banks have had the last couple of years,” said Howard Ward, a money manager at Mario Gabelli’s Gamco, which oversees about $30 billion in Rye, New York. “This is not an industry that is poised for a sharp return.”

The Dodd-Frank Act, passed in July, created the Consumer Financial Protection Bureau and requires most swap trades in the $583 trillion over-the-counter derivatives market to be processed by clearinghouses. The top five U.S. commercial banks generated an estimated $28 billion in revenue from privately negotiated swaps in 2009, according to company reports collected by the Fed and people familiar with banks’ income sources.

“Revenue growth is certainly an issue,” said Michael Levine, a money manager at OppenheimerFunds, which oversees about $180 billion. Levine remains bullish, with financial stocks representing the biggest share of the Oppenheimer Equity Income Fund, which has beaten 97 percent of its rivals in the past five years, according to data from the New York-based firm’s website and Bloomberg.

Dividend Increase

JPMorgan, the fund’s top holding, will quadruple its quarterly dividend to 20 cents a share in March, according to Bloomberg estimates that factor in criteria such as earnings and options prices. The New York-based bank, Wells Fargo & Co., Bank of America and Morgan Stanley are among at least 10 financial stocks in the S&P 500 likely to increase payouts by twofold or more this year, the data show.

The 19 biggest U.S. banks must show regulators they can withstand losses before boosting dividends or buying back shares, the Fed said in a Nov. 17 report. More companies may lift their payout in February than any other month, Howard Silverblatt, a New York-based analyst at S&P, wrote in an e-mail this month.

“The banks think they’re going to be allowed to start returning capital to shareholders sometime this year,” said David Honold, a fund manager and financial stock analyst for Turner Investment Partners Inc., which oversees about $18 billion in Berwyn, Pennsylvania. “That’s a very important inflection point.”

TARP Payments

Fifth Third Bancorp, Ohio’s largest lender, raised $2.7 billion through debt and equity sales last week to pay back borrowings under the Treasury Department’s Troubled Asset Relief Program, created in 2008 to prevent a collapse of the U.S. financial system. The Treasury has $118.5 billion of TARP borrowings outstanding, a 64 percent decline from $328.9 billion of funds received, according to data compiled by Bloomberg.

While companies may boost payouts in 2011, the biggest U.S. banks said the profitability of loans narrowed in the fourth quarter. JPMorgan’s net interest margin, the difference between what the bank pays for funds and what it charges borrowers, dropped to 2.88 percent from 3.01 percent in the third quarter. Citigroup’s fell to 2.97 percent from 3.09 percent, and San Francisco-based Wells Fargo’s narrowed to 4.16 percent from 4.25 percent.

“It’s going to take a return to significant profitability and resumption of meaningful dividends before people breathe a sigh of relief and think it’s safe to go back in the water here,” said Pioneer’s Carey. “It’s still a mixed picture. We’re still careful and cautious about the group, but getting more involved as the quarters go by.”

To contact the reporters on this story: Lynn Thomasson in Hong Kong at lthomasson@bloomberg.net; Inyoung Hwang in New York at ihwang7@bloomberg.net.

To contact the editor responsible for this story: Nick Baker at nbaker7@bloomberg.net.

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