A Necessary Evil?
Banks can not catch a break. Just as one embarrassing headline fades, another pops up to put banks back into the limelight. Over the past weeks, revelations of JP Morgan Chase's large trading loss have been eclipsed by the disclosure of Barclay's tweaking of LIBOR (the acronym for the London Inter-Bank Offer Rate, a key benchmark for setting loans and deposits). It is alleged the bank doctored submissions to make its health and funding appear rosier than perhaps was warranted. While these events transpired, in the background remains the public's general frustration with low deposit rates, ubiquitous bank fees, obscene executive compensation and the industry's non-stop lobbying to thwart further regulation.
No surprise then that banks ranked third from the bottom in Gallup's annual survey of confidence in key institutions. Of the sixteen institutions cited in the poll, banks beat only HMOs (health maintenance organizations) and Congress for last place. Just 21% of respondents expressed either a "Great deal" or "Quite a lot" of confidence in banks. This compares to 41% in Gallup's 2007 survey, the year before the mortgage debacle unfolded into the near collapse of the financial system. Looking further back in history, even at the height of the savings and loan crisis (in the late 1980s, early 1990s), public confidence in banks was not as dinged and dented as now.
To be fair to bankers, the general public has always been at best ambivalent to the industry. We suspect few will confess a fondness for the banker Mr. Potter, in Frank Capra's classic film, It's a Wonderful Life. Today, as in 1946, the audience's sympathy is with his everyman opponent, George Bailey. This ambivalence is reflected in the Gallup numbers. In the time Gallup has included the banking industry in its survey, in only 7 of the 32 years has confidence exceeded 50%.
Still the industry has its work cut out. We doubt few institutions can weather such low confidence levels for long without undertaking fundamental change or having such change thrust, involuntarily, upon it. Yes, with a few exceptions, banks appear to have come through the past proxy season unscathed, but we wonder if patience is not wearing thin.
Share prices — as measured by the S&P Banks Index — remain off almost 60% (as of Jul 12th, 2012) from levels five years ago. Certainly an acceleration in economic growth or a resolution, of sorts, to the European sovereign debt and banking crisis will take the pressure off, allowing bank share prices to float higher. But we doubt relief in either form will be forthcoming soon.
In the current environment, we believe banks that are focused are at an advantage. Our suspicion is, investors are levying a conglomerate discount on the share prices of the large, Wall Street or money center banks. We have long thought financial statements for many such institutions had become impenetrably opaque. Furthermore, we doubt there are few outsiders who fully comprehend the risks or who can judge the quality of assets on their balance sheets.
Second, investors are favoring regional over national banks. In part, this is because their range of business is less expansive. Over the past five years, regional bank share prices have held up better than the broader banking sector. Over the last twelve months, they have rallied further. The S&P Regional Bank Index is up 5.0% versus a 4.7% loss for the broader bank index as of July 12th. What investors appear to be saying is, size confers an advantage, but only to a point. Beyond that point investors worry that diseconomies of scale may proliferate.
For the man on the street small is perhaps beautiful. We suspect smaller, regionally focused banks are more likely to be seen as part of the community, and less like interlopers — in other words, they are more like institutions residents are inclined to do business with, and less like necessary evils.
Bank failure data obtained from the FDIC (Federal Deposit Insurance Corporation). Statistics for each year represent the number of financial institution taken over by the FDIC or allied insurance funds. Numbers for 2012 are year-to-date through Jul 6th.
Public confidence in banks sourced from Gallup, Inc. The statistic is the sum of respondents expressing a "Great Deal" or "Quite a lot" of confidence in banks. Gallup has regularly asked this question annually in its survey of confidence in selected institutions since 1983. The latest survey was conducted Jun 7 to 10, 2012.
Returns cited — for S&P Banks and S&P Regional Banks Indices — are total returns (including the reinvestment of dividends) stated in US Dollars. The S&P Banks Index is a market capitalization weighted, float adjusted index of U.S. chartered banks, money center or regional, trading on a U.S. exchange with market capitalizations of at least $400 Million. The S&P Regional Bank Index is similarly constructed but is constituted solely with banks with regionally focused operations.
(Sources: S&P, Gallup, FDIC.)
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