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 lets' look at what the new bank looks like. Gone (or significantly scaled back) are the sexy derivatives trades, highly leveraged asset backed financing & 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
