Will discount valuations on UK banks shield them from US storm?

• Irony that losses on allegedly safe US Treasuries have scuppered Silicon Valley Bank is not amusing investors
• Silvergate crypto liquidation and ongoing slump at Credit Suisse are also concerns as worries over contagion build
• UK banks remain much cheaper than their US counterparts - will premium US valuations now be a negative?

"Investors have spent the past few years worrying about contagion in the context of a global pandemic but now they are back to fretting about financial contagion as banking shares slide on both sides of the Atlantic," says AJ Bell investment director Russ Mould. "The Silicon Valley Bank is swallowing losses on its asset holdings, Silvergate is liquidating it crypto-currency focused bank, and everyone is wondering what on earth is going on at Credit Suisse as the Zurich-quoted lender's stock continues to plumb new all-time lows, with Swiss regulators taking a fresh look at the bank's public statements at the time of December's huge capital raising.

Source: Refinitiv data

"This leaves investors wondering who is exposed to whom and they are taking no chances as they sell banking stocks left, right and centre. America's Philadelphia KBW Banks index slumped 7.7% on Thursday night and the Big Five FTSE 100 banks are down sharply in sympathy, albeit by not quite as much.

"The irony that losses on allegedly safe holdings of US Treasuries, or US Government bonds, are forcing Silicon Valley Bank to raise fresh capital is not amusing anyone, especially as all banks will hold Government debt to varying degrees to help them meet their capital adequacy regulatory ratios.

"The Tier 1 Capital ratio is a key measure of a bank's financial strength, according to Basel III regulations and it is measured by a bank's core equity against its risk-weighted assets (RWAs). RWAs are weighted for their perceived credit risk and - wait for it - Government bonds are given a zero-risk weighting, the same as cash. For investors to belatedly remember that bond prices usually go down as interest rates (and therefore Government bond yields) go up is proving a nasty shock.

"Yields on benchmark US ten-year Treasuries have blown out and prices have fallen sharply as the US Federal Reserve has raised rates from almost zero in its fight against inflation. This has come home to roost at Silicon Valley Bank, which has suffered deposit withdrawals and had to raise liquidity by selling assets. That has included US Treasuries and it has now had to crystallise and swallow losses on those holdings, losses that have been so bad that SVB has had to turn to shareholders for fresh capital.

"This raises the issue of who else may be sat on unrealised losses on US Government bonds, or indeed other assets, such as mortgage or company loans or - at the more esoteric end of the risk spectrum - venture capital, or cryptocurrencies.

"The good news, if it can be called that, is that investors were already sceptical of the valuations attributed to the assets on the balance sheets of the five FTSE 100 banks. Only NatWest's shares trade at a premium to the last stated tangible net asset, or book, value per share figure, while Lloyds and HSBC trade at modest discounts and Standard Chartered and Barclays are really quite big discounts. The gap at Barclays doubtless reflects lingering concerns over what would happen at the investment banking arm in a major market downturn.

	2023E	Q4 2022	2023E	2023E
	P/E	Price/book	Dividend yield	Dividend cover
Barclays	4.7 x	0.52 x	5.8%	3.67 x
Standard Chartered	7.7 x	0.71 x	2.3%	5.52 x
HSBC	6.6 x	0.94 x	10.3%	1.46 x
Lloyds	7.0 x	0.95 x	5.6%	2.55 x
NatWest Group	6.7 x	1.07 x	5.7%	2.63 x

Source: Company accounts, Marketscreener, consensus analysts' estimates

"All of the quintet passes the Basel III requirements for both capital ratios (4.5% for CET1, 6% for Tier 1 and 8% for total capital) and also the accompanying leverage ratio (which divides Tier 1 capital by total assets and some off-balance sheet ones too, where the minimum accepted by regulators is 3%). Nevertheless, investors are getting nervy, for the moment at least, about the value of some of those assets used in those ratios, and, in some cases, derivative exposure thereto.

	Q4 2022
	Return on tangible equity	CET 1 ratio	Leverage ratio
Barclays	8.9%	13.9%	5.3%
Standard Chartered	(3.2%)	14.0%	4.8%
Lloyds	16.3%	14.1%	5.6%
NatWest Group	20.6%	14.2%	5.4%
HSBC	9.9%	14.2%	5.8%

Source: Company accounts, Marketscreener, consensus analysts' estimates

"By contrast, of the Big Four Main Street banks and the two Wall Street banks in the US, only Citigroup stock trades at a discount to its NAV per share. This puts a different spin on the debate over the relative valuation between the US and UK stock markets, since shares in the UK banks are down by less than their US equivalents, as perhaps you might expect given the lower valuation starting point.

	2023E	Q4 2022	2023E	2023E
	P/E	Price/book	Dividend yield	Dividend cover
Main Street
Citigroup	8.6 x	0.60 x	4.3%	2.70 x
Wells Fargo	8.6 x	1.18 x	3.2%	3.63 x
Bank of America	8.9 x	1.40 x	3.0%	3.71 x
JP Morgan	10.1 x	1.78 x	3.2%	3.10 x
Wall Street
Goldman Sachs	9.9 x	1.21 x	3.0%	3.33 x
Morgan Stanley	12.7 x	2.30 x	3.4%	2.30 x

Source: Company accounts, Marketscreener, consensus analysts' estimates

"All six US megabanks offer balance sheet ratios which please regulators, even if investors are having some doubts, at least for now.

	Q4 2022
	Return on tangible equity	CET 1 ratio	Leverage ratio
Main Street
Citigroup	15.8%	11.2%	7.0%
Wells Fargo	5.8%	13.0%	5.8%
Bank of America	20.0%	13.2%	5.6%
JP Morgan	7.6%	10.6%	6.9%
	15.8%	11.2%	7.0%
Wall Street
Goldman Sachs	4.8%	15.1%	5.8%
Morgan Stanley	12.6%	17.2%	5.5%

Source: Company accounts

"However, those premium ratings for the US banks have started to weigh. The KBW Banks index peaked in January 2022 and, barring a brief rally since December, has been on the slide ever since. This - added to the deeply inverted yield curve - may suggest that there is indeed bad news due from the US economy sooner rather than later, whether financial markets stumble or not."

Source: Refinitiv data