Policy makers have spent the last five years setting rules to rein in risk-taking and reduce financial leverage. The 2010 Dodd-Frank Act, the biggest overhaul of market regulation since the Great Depression, and other rules require banks to curb trading for their own accounts, double capital for the biggest firms and use clearinghouses for derivatives trades.
Excess Capital
Even with tighter controls, faster earnings growth and a pickup in the economy may boost financial shares more than the rest of the market, according to Todd Wittgenstein, a Los Angeles-based fund manager at HighMark Capital Management Inc., which oversees about $19 billion. The enactment of regulation after years of negotiations will spur CEOs to deploy excess capital back to shareholders, he said.
“Right now they’re being priced as if it’s still Armageddon,” Wittgenstein said Sept. 12. “Financial services are like a coiled spring.”
Initial jobless claims reached the lowest level in seven years this month, manufacturing reached a two-year high and a report showed gross domestic product expanded faster in the second quarter. The U.S. economy will grow 2.7 percent next year and 3 percent in 2015, the most since 2005, according to the median of 81 forecasts compiled by Bloomberg.
The average ratio of tangible assets to tangible equity, a measure of leverage, is down to 12.8 for the six biggest American banks as of June 30, according to data compiled by Bloomberg. That compares with 27.5 at the end of 2007.
Restrained Valuation
That hasn’t translated into higher valuations.
Morgan Stanley has doubled equity and customer deposits to cut reliance on short-term borrowing, which accounted for more than half of its funding in 2008. The sixth-largest U.S. bank’s assets are 14 times its equity, as of the end of June, compared to 38 at the end of 2007. Shares of the New York-based company trade at 15.2 times reported profit, down from 24 times in 2008.
Goldman Sachs, based in New York, doubled earnings last quarter, beating analyst estimates for the seventh straight time, data compiled by Bloomberg show. The price-earnings ratio of 9.7 compares with 8.7 five years ago, even as Chief Financial Officer Harvey Schwartz said the firm is “very comfortable” with its ability to meet a proposed U.S. minimum ratio of capital to assets.