Sunday, November 25, 2012

US & Canadian Bank Valuations

Well, I have been pounding the tables on the US Large Cap Banks for a while so I thought I would explain once again why they are cheap but from another angle.  The below table, courtesy of TD Securities, gives a very quick and easy picture showing a comparison between the US and Canadian Banks. 

The average Price to Book Value Per Share (BVPS) for the six largest banks in Canada is 1.8 times.  The US Money Center Banks, which include Bank of America (BAC), Citigroup (C) and JP Morgan Chase (JPM), sell on average for 0.6 times book value.  Even the US Super Regional Banks, which includes US Bancorp (USB) and Wells Fargo (WFC), sell at an average of 1.5 times book value.

Now the table above clearly shows significant upside for the large US Money Centered Banks.  That said, lets look at little deeper at the individual valuations of the the five large US banks above.

Note: USB is technically the seventh largest bank in the US.  JPM, BAC, C, and WFC are the four largest banks in the US ranked by assets respectively.

US Large Cap Banks - Price to Book Value Per Share

So looking deeper, BAC sells for under the average and JPM for above average of 0.6 times BV.  Likewise for the Super Regional Banks, WFC sells for less than the average and USB sells for the about the same valuation as the large Canadian Banks. 

So this begs the questions.  What would the stock price be if the US Banks sold for the same valuation (P/BV) as comparable Canadian banks?  Now for this exercise I used the average P/BV of 1.8 times for large Money Centered Banks and 2 times for the Super Regional Banks.  I made this adjustment because WFC and USB are much stronger banks and earn higher returns on assets than the Money Centered Banks. 

Upside in US Large Cap Banks - Common Shares

So if US Money Centered Banks simply sold at the same average valuation they would be worth anywhere between 1-3 times higher.  That is quite a bit of upside.  For the US Super Regional Banks the upside for WFC and USB is 61% and 9%, respectively.  Perhaps this explains why Warren Buffett is still buying WFC every quarter.   He's buying a 60 cent dollar laying out in plain view for all to see. 

Can we do even better than the common shares?  Lets take a look a the TARP warrants sold off by the US treasury a couple years ago.  For this analysis I didn't include the Citigroup warrants because I have no interest in buying Citi common or warrants.  USB bought back the warrants directly from the treasury so they are not publically traded.

Upside in US Large Cap Banks - TARP Warrants

***BAC Class A Warrants shown in table above. 

Here I assumed the common shares were selling at the same P/BV as the Canadian banks and subtracted the strike price.  For example the BAC Class A warrants would be worth $26.01/warrant ($39.31 - $13.30 = $26.01).  Now that leaves quite a bit more upside in the warrants. 
Now I should also mention that these warrants are also adjusted for dividends beyond a certain price.  For the BAC Class A warrants the strike price is adjusted for any dividends above $0.01/share.  The JPM and WFC warrants are adjusted for dividends above $0.38/share and $0.34/share, respectively. 
Now I should mention that the dividend adjustment isn't as straight forward as first appears.  There is a formula in the prospectus that adjusts not only the warrant strike price but ALSO adjusts the number of shares per warrant.  This has been referred to the double racketing feature of these warrants.  I have modeled these adjustments in a spreadsheet and the reader will have to make their own assumptions to estimate the final strike price and the number of common shares that each warrant will purchase many years from now.
It should be noted by the readers that I have not included any upside in the above table for the aforementioned dividend adjustment.  You will have to make your own assumptions. 
The US Large Cap Banks are severely undervalued compared to Canadian Large Cap Banks.  I know this analysis is crude and high level but makes the point of my discussion here very clear.  One would have to look more closely at the price to tangible book value for each bank and determine what types of returns each bank is capable of.  
Lastly the riskiness of each bank should be examined based on the type of assets each hold.  The Level 3 assets should be considered.  I have discussed these factors in the past here on my blog. 
Clearly there is significant value among the US Large Cap Banks.  Once the smoke clears and the real earnings power of these large banks appear, they will trade much higher.  It should also be noted that a number of the US Large Cap Banks are very well capitalized.  For example BAC requires a minimum Basel III capital level of 8.5% and after the third quarter of 2012 their capital level stood at 9%.  I fully expect BAC and all of the US Banks mentioned above to increase the dividend next March.
Good Decisions. 
Best Regards,
Disclosure: Long WFC, JPM.WS, & BAC.WS.A


  1. Great article. To add more meat we should factor in expected ROE comparisons going forward. If we invert the analysis to allow Canadian bank ratios to match that of their U.S. peers we have a different story. I am not sure about returns Canadian banks are able to generate but if they are lower than their U.S. counterparts I find the ratios to be over estimated.

  2. Value investing is all about buying a stock for ten dollars when its really worth twenty dollars. Growth stock investing is all about buying the future propects of a company. Since one cannot predict the future propects of a company. I would much rather buy the stock thats trading at ten dollars that really worth twenty dollars.

  3. Interesting article.

    I noticed that for JPM you are including goodwill and intangibles in your book value. I think tangible book value is probably the number to look at. Goodwill and intangibles are just accounting entries and probably not relevant in this form of analysis. In JPM's case, there is 60B in goodwill & intangibles which drops the book value by 1/3. When you look at it from that perspective JPM is actually selling at a premium to book.

  4. Hi Anon,

    I mentioned at the end of the article that prospective investors should consider analyzing tangible book value instead of book.

    That said I would consider all of the facts instead of just your narrow look at JPM.

    For instance, TD Bank (TD) has the same ratio of tangible book value to book value as Bank of America (BAC). Thus their relative valuations on a book value basis should be similar, but that is clearly not the case. At the time I write the above article, TD's valuation was 3.4x larger than BAC on a book value or tangible book basis.

    Good Decisions,

  5. Canadian banks also operate in something closer to an oligopoly. Not sure any kind of comparison to American banks is warranted.