Tony Shiret isn’t the only big name analyst heading out of the door at Credit Suisse.
UK banks analyst Jonathan Pierce, who made timely calls on The Crock, Alliance & Leicester and Bungle Bank before the crunch, is also leaving, albeit for different reasons.
Here’s the valedictory email he fired off to clients, which contains some interesting observations on credit portfolios, fantastical ROE targets (Diamond Bob take note) and what will it take to drive a re-rating of the sector.
Emphasis throughout ours.
As many of you know, I am finally trading in the offices of Canary Wharf for a portakabin classroom in Oxford. After 12 years as a UK banks analyst, I will start training as a secondary school Maths teacher in September. While I am looking forward to the change (15 weeks holiday) I will miss this job and the interaction and debate I have had with you all over the years – good preparation for the classroom.
A few people suggested I make a closing comment on on my exit. Basically I think I leave at a time of still considerable uncertainty. Aside from the obvious issues, tail risk in UK bank credit portfolios remains a particular concern of mine and I think the road to normalised returns will be longer and bumpier than most expect. If things are getting so much better, why did 71,000 people contact National Debtline in the first 4 months of 2011 – more than the same period of 2009?
Why are there £110bn MORE interest only mortgages today than in 2007 despite lower rates and tighter new lending criteria? Why are there three times as many CRE loans in breach of covenants than actual reported arrears? Potential problem loans are likely much larger than actual NPL, in my view.
Even when we get through this, I expect “normalised” ROE to be well below management and analyst expectations. The idea that the three domestic banks can simply “reverse engineer” a mid-teens return assumes there is no limit to asset margin expansion and if this were the case, Q1 2011 pre-provision profits of £34bn (annualised) would not have fallen 16% on a year earlier and would not be £16bn south of the £50bn I think is necessary to deliver 15% ROTE. As I wrote in 2008, UK banks were 7% ROTE businesses for the 70 years pre 1990 and the market should settle for 10-12% in the new world.
The subjectivity that remains in the setting of accounting provisions and regulatory risk weights also discomforts me. The 50% variance in the mortgage risk weight of the domestic banks, with seemingly little correlation between risk and weight, is a case in point. Pillar 2 requirements might adjust for this but the market deserves transparency through a more consistent Pillar 1. The calculation of capital ratios also feels a bit confused. We now have a system that requires banks to hold a total capital ratio well above 10%, applied to an RWA defined in relation to an 8% capital ratio, itself based on a set of statistical equations that have proved inadequate through the downturn. UK banks probably have enough capital but there is work to do on disclosure, comparability and the broader construct of the regime, and that doesn’t help the investment thesis.
HOWEVER, to leave on a brighter note, I believe the long-term outlook is better. Eventually, banks will become stable, low growth, tightly regulated businesses and dividends will be the single most important determinant of value. By the middle of the decade, payout ratios of 50-60% could emerge and this should drive up share prices, maybe substantially, from current levels. In essence, it is the emergence of dividends that will drive down the sector’s COE warranting, eventually, a premium to book value.
I thank all of my colleagues at Credit Suisse for their help over the last 8 years, particularly those in fixed income, money markets and capital structuring. Without you, I would not have understood the issues and complexities of the sector during the downturn. I also wish my successors the best – I am sure they will do a great job. Finally, I thank all of the salesforce and the external client base for their support. It’s been hugely enjoyable and I wish you all the best for the future.