Matein Khalid: Money Spinners

Matein Khalid, a global equities investor and advisor to regional family offices, builds a bullish case for global bank shares.

by Matein Khalid

May 11, 2014

International bank shares were gutted in the 2008 global financial crisis but have led impressive recoveries in the US, Europe, Japan and the GCC.

As Wall Street dumps high momentum biotech/internet shares, the world’s leading money centre banks offer the potential for lower risk capital appreciation and rising dividend payouts.

Citigroup, for instance, is trading at 20-year valuation lows. The Fed’s failure to approve its capital plan, Byzantine boardroom politics, an accounts receivable fraud at its Mexican subsidiary Banamex, weak internal control, a Wall Street rogue bond dealing scandal, LIBOR and foreign exchange rate manipulation scandal in London has devastated the valuation of the shares. Citigroup now trades at nine times earnings and almost a 20 per cent discount to book value at a time when California’s Wells Fargo trades at two times book value.

Regulatory restrictions like the Volcker Rule and Dodd Frank means money centre banks cannot deliver the 15 to 20 per cent return on equity during the pre-Lehman era. However, it is not unreasonable to expect Citigroup to trade at 1.5 times book value (J.P. Morgan Chase’s current valuation) sometime in 2015, a $75 price target is possible if global growth accelerates and CEO Mike Corbats engineers a credible turnaround.

In Europe, I believe Credit Suisse, HSBC and Banco Santander are all deeply undervalued, unloved and unowned banks.

Credit Suisse was not gutted by the 2008 crash, unlike UBS, which lost $50 billion in failed bets on toxic credit and mortgage derivatives on Wall Street. However, Credit Suisse, despite high levels of operating profitability and a 15 per cent Basel Tier One capital ratio, has been hit by a series of setbacks and scandals. The uber-strong Swiss franc, record low interest rates and the crisis in Russia and the Arab spring have hit the growth metrics of the private bank.

Credit Suisse bankers were sued by the Justice Department for its role in illegal tax avoidance by US citizens with offshore accounts. The investment bank has derisked its balance sheet and asset management growth has been less than stellar. Yet the bank, now trading at a mere nine times earnings, can rise 20 per cent in New York and Zurich.

HSBC, at 600 pence in London, offers a forward dividend yield above 6.4 per cent to investors with a credible possibility of 10 per cent capital return. Chairman Stuart Gulliver has slashed $4 million in operating costs, shrunk the world’s local bank’s US consumer banking footprint, built profitable new franchises in Asian capital markets and insurance. HSBC is arguably Britain’s most attractive and undervalued international bank.

While the Fed taper hits US momentum stock, any potential ECB “unorthodox monetary easing”, hinted at by both Dr. Mario Draghi and the Bundesbank’s Dr. Jens Weidmann, would be nirvana for Spanish banks. This means Banco Santander in Spain, with its six per cent dividend and Latin emerging market footprint, could well be undervalued in the Madrid Borsa.

The Bank of Japan’s failure to implement a “shock and awe” ease, fear about the new sales tax, foreign selling in Marounuchi and angst about the third arrow of Abenomics (structural reform) has led to Japan equities falling 10 per cent in 2014.

However, the Nikkei Dow is not expensive at 13 times earnings and 1.4 times book value. The Bank of Japan will be forced to expand its QE policy to meet its one per cent inflation target or Abenomics fails. This means a lower yen and outperformance by Japanese banks and brokers, even as a tsunami of retail/ trust funds switch from debt to the stock market.

Japanese banks are down 15 per cent in 2014 even though they are the greatest beneficiaries of reflation, Abenomics and Special Economic Zones. Bank loan growth can well rise four per cent and both mortgages/consumer loans and wealth management products are on a roll.

Japanese banks are also buying distressed banks all over Europe, the US and Southeast Asia. This means Sumitomo, Mitsui, Mitsubishi UFJ and Mizuhu could be the three Japanese banks that power the next stage of the bull market in the Empire of the Rising Sun.

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