Summary

  • The TED Spread is a terrific gauge of financial system stress in the U.S. The TED (Treasury-EuroDollar rate) spread measures the difference between the 3-month U.S. Treasury bill and the 3-month LIBOR, in USD. It widens and remains high during periods of economic stress, and contracts and remains low during periods of lower perceived credit risk (expansions).
  • LIBOR is the market rate banks charge each other for overnight lending, so measuring the difference between the interest rate on U.S. government debt and the interest rate on interbank loans, market participants can assess the risk bankers see for their own industry.
  • TED Spread peaked at 3.14% in September 2008 with the Lehman bankruptcy and reached its 2020 high of 1.39% in March.
  • Bank stocks are sensitive to the TED Spread, more so than their sensitivity to interest rates. True to form, regional bank stocks bottomed April 3, 2020 as the TED Spread began its most recent downturn. U.S. banks are well-capitalized and well-prepared for the current downturn.
  • See page 4 for our bank stock valuation framework. Bottom line: U.S. banks are trading their way back to book value.

Source: Bloomberg, FlowPoint

In 2005, we adopted the bank stock valuation framework of the Hall-of-Fame analyst Gerard Cassidy (RBC):

– In a “Normal” market, banks trade relative to book value

– Bear market: tangible book value

– Bull mkt: P/E

– Crisis: capital ratios

Below are the top 50 U.S.-listed banks. They currently average 1.00% ROA, a 10.3% weighted average cost of capital (WACC) vs. a 7.3% return on equity, an average projected EPS decline of -36% for the year and an average dividend yield of 4.3%. On valuation, they trade on average and 15.2x EPS, 1.02x book value and 1.40x tangible book value.

The next table illustrates the top 50 banks average 87% loan-to-deposit ratio (they don’t make many loans these days), 0.28% loan loss provision (and rising), 0.25% net charge off rations (NCO/loans) and 12.3% Tier 1 capital ratios (well (over?)-capitalized). YTD the top 50 bank shares are down on average -31% though this quarter sport an average rebound of 14%.

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