Banking Won't Be Fun for a While

I'm not a bank analyst but I'm interested in comments on some rough numbers. US banks were levered about 33:1, and as we all found out that number was clearly too high. Not surprisingly, since that means that only $3 in equity backed $97 in debt. Said differently, this allowed only a 3% "cushion" to absorb any extraneous losses, and as we know the write-downs were far greater than 3%.

Therefore, what is the "proper" leverage number for an average "new" bank? It's probably not zero, or even 1X. Maybe 10X? If we assume 10X leverage, the new capital base is $33. (assuming $3 in equity + $30 in debt).

Let's then say a bank made $1.00 per share in profits on an "old" capital base of $100. If we strip out $97 in debt and replace it with $30 instead (the "new" 10X leverage factor), and keep profit level the same (say 1% for simplicity, or $1.00 per $100), this implies $0.33 in earnings. Keeping P/E multiple the same, which we assume to be 10X for simplicity (arguably a stretch since the sector is now out of favor and is no longer considered a "growth" industry) and this implies a $3.30 stock price. (which is down from $10 previously (10X $1.00 EPS), which is a haircut of 67%)

Now let's look at what the new bank looks like. Gone (or significantly scaled back) are the sexy derivatives trades, highly leveraged asset backed financing and trading etc., and the new "in" thing is boring old retail and commercial banking. Even with aggressive fee hikes, I would suggest that a 10% y/y profit growth is aggressive. That means our new $0.33 in earnings grows to $0.36, and with a 10X P/E the new share price is $3.60.

Using these back-of-the-envelope numbers it appears that banking is not going to be much fun for a long time. Consequently, it seems like it will also be a long time until we see the September 2008 share prices again.

Disclosure: No positions at this time

Comments

[atavist.avatar:]

Almost trivially funny but not quite, just trivial. Why bother with this silliness when the big issue is the economy and its impact on the banks along with everyone else.

Apr 16 09:16 AM

[R0B50:]

This is so insightful, thanks.
I would like to add my own scenario:
Let's say the World GDP is equal to $1.
Then let's say that the World GDP is now found to be worth 30% of what we thought it was.
Now that means I can buy every Company for a 70% discount!
Wow, well who wants to sell me their business?
I mean I can make numbers up too and then start extrapolating out meaningless stats.
It doesn't make me right, or my analysis worth anything.
Please remember that we don't read these articles hoping to here what you dreamed up in a drunken haze.
We hope for some reliable and concrete information,
EVEN FROM SEEKING ALPHA.

Apr 16 09:29 AM

[Ranchr:]

Once the banks repay TARP and the world adjusts for the sins of the past, the back will start paying dividends again and the share values will move back toward historic levels. Which, in the case of BAC, since 1996 hasn't been below $20, until a short blip in July 2008 and then since November 2008. Bet on death and destruction if you like, but I bought at $7.28 and am planning on $20ish by the end of 09.

Apr 16 10:42 AM

[discov:]

The new banks have not been de-leveraged. They are just moving their assets off balance sheet through the PPIP. They are posing as the private investors, getting more leverage from the Treasury and Fed, then buying their assets under another subsidiary name.

America is being impoverished by their banking government, and we still can't short the market at least not until we get a technical break of the current trend
concisetrading.blogspo...

Apr 16 01:29 PM

[Nick Gogerty:]

Banking shouldn't be fun, it is risk management.

Apr 17 10:03 AM

[chux08:]

At least it shouldn't be fun for the banksters "playing the game"....
I mean, I'm no gold bug but why anyone in this kind of economic climate being hosted by this type of government approved economic scourge would rather buy paper from Mr. Bankster instead of good ol real money gold, is beyond me. And I believe over time, especially THIS TIME, the precious metals crowd will be proven right....again.
Now, if we could just get some of these bastards into jail where they belong, the world would be well on it's way to being a better place. Banksters belong on a short leash (or a long rope) and we're all witness to what happens when we let it stretch too long.

Apr 17 11:12 AM