By Maximilian Clarke
Bank valuations have declined since the financial crisis and will likely see a slow return to normal levels, PwC’s latest Valuation Index shows.
The key valuation metric for banks is the premium to book value that the market places on a bank and for the 15 years that preceded the financial crisis, UK banks traded an average premium of 150%, with those in continental Europe at around 40%.
Since the financial crisis this premium had been reversed into a discount to book such that UK banks were trading at 60% of book value and at 50% for those on the Continent as at 30 September 2011. This reversal has been partly due to the uncertainty around the sovereign debt crisis. Although the market has welcomed the announcement following this week’s euro summit, bank valuations remain below their long run average and it is unlikely that any return to the pre-crisis level of valuation multiples is imminent.
Other factors will continue to weigh upon the banks including the demands of regulatory and structural reform.
While uncertainty persists about the impact of these changes and the commitment of policymakers to resolve the current crisis, bank valuations will remain vulnerable to changes in sentiment and volatile market conditions.
“Regulatory reform will improve banks’ resilience but will also act to depress profitability across the sector over the medium term,” said Nick Rea, partner and head of the financial services valuations team at PwC. “Although in theory a more resilient sector should attract a lower cost of equity, the removal of explicit state guarantees for the sector means that the market should be wary of reflecting this in sector multiples. It therefore appears unlikely that any reduction in the cost of equity will be sufficient to offset lower profitability and, as a result, we are unlikely to see any return to the previously high valuation levels in the sector over the short to medium term.
“The euro summit has removed the threat of a seizure in the term funding market and banking share prices have responded positively. European banks must now meet an accelerated timetable for capital increases up to a level of 9% Core Tier 1. Although some of the concern over the solvency and viability of the sector has now been relieved, the dilutive capital and other demands of regulatory and structural change will continue to weigh on bank multiples.”
PwC’s quarterly Valuation Index, which looks at valuations for the overall UK equities market, fell sharply to 60 in the third quarter of 2011, its lowest point since the financial crisis and down from 75 at the half year. Price to earnings ratios across the UK market fell during the third quarter despite long term interest rates being at historic lows.
"It is clear from Thursday’s rally that market sentiment has been coloured by worries over sovereign debt across the eurozone and this is likely to result in continued high volatility in market prices. Concern remains that economic weakness will depress growth and this seems likely to restrict any full recovery to fundamental values in the near term, PwC says.
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