Financial sector analysis

Анализ финансового сектора

We tell, as evaluate securities of banks and insurance companies.

The financial sector is one of the largest segments of the S index&P 500, according to market capitalization.

It includes industries:

— Banks

— Capital Markets

— Consumer Finance

— Diversified financial services

— Insurance

— Mortgage REITs

— Mortgage Finance

Let's take a look at the valuation of shares in the banking and insurance industries. The income generation models of such structures differ, but in general, their analysis obeys general rules. To determine the optimal zones for buying / selling, it is better to use technical analysis.

Income indicators

Locally they are considered in the moment, comparing with analysts' expectations, indicators of other financial institutions, median values ​​for the group of comparable enterprises. To determine long-term trends, it is worth evaluating them in dynamics..


1) EPS - earnings per share, a key metric for assessing company revenues. The ratio of net income to the number of shares outstanding. When there are one-time factors, it is useful to consider the adjusted EPS., that is, cleared of one-time income and expenses. American banks have many such factors, therefore, the refined EPS can be very different from the baseline version of the metric. Adjusted EPS is traditionally compared to the consensus forecast of analysts.

2) ROE - return on equity. Allows you to assess the efficiency of the enterprise. It is the ratio of net income to book value of equity (assets - liabilities). The higher the ROE, the more efficient the business. Attention: higher rates of return on equity may be due to higher debt burden (debt / equity ratio). For banks, high debt burden is the norm due to the structure of their balance sheets. Former investment banks (Goldman Sachs и Morgan Stanley) Debt / Equity is much higher, than their more traditional competitors.

Especially for banks

1) Loan to deposit ratio. Lending growth, usually, favored by a combination of a strong economy and fairly low interest rates FED. The effect is growing in anticipation of growth in rates, which is typical for the mortgage segment. The deposit mass increases to a greater extent in a strong economy, but higher interest rates. Bank rates in the USA depend on the prime rate - the rate for high-class borrowers, which in turn depends on the dynamics of the FRS key rate.

  Apex launched a service to raise capital

2) Net interest income (ЧПД) - a key metric for evaluating traditional banks - the difference between interest income and expenses. NPV depends on the bank's net interest margin - the difference between the aggregate rate on loans and deposits. American bank balance sheets are often designed like this, that with an increase in market interest rates, NPV increases. Bank stocks are often correlated with Treasury yields. Fed rate hike could weaken economy, which is reflected in the flatter or even inverted "yield curve" of Treasuries. This is already a negative factor for net interest margin and NPV..

3) FICC Revenue - Bonds, currencies, raw material. Depends on trade operations. Essential for evaluating former investment banks. These indicators are significantly influenced by volatility on trading floors., the level of stress in the financial system. At the same time, it can turn out to be negative as too volatile., the market is too calm.

4) Efficiency ratio (Efficiency Ratio) - the ratio of operating expenses and bank revenue. For US financial institutions, the value is considered normal 50% and less.

Especially for the insurance industry

Insurance companies make money by selling and reselling insurance policies. Money, received from the sale (prizes), they spend on insurance payments and invest in financial instruments.

1) Insurance premiums - total, paid for insurance policies.

2) Loss ratio (losses on insurance policies / amount of premiums) and expense ratio (administrative expenses / amount of premiums). Together, they form a total cost indicator..

Risk indicators

For banks, they arose, based on the regulations of the regulatory authorities. Basel III was developed in the wake of the mortgage crisis 2008 r. To replace the Basel II standard, it can come in 2023 r.

1) Capital Adequacy Level (Capital Adequacy Ratio, CAR) - the ratio of the amount of capital 1 and 2 level to assets, risk weighted. The higher the credit risk, so assets are taken with a large correction factor.

  Refund Chargeback | How to get money back on chargeback

Tier-1 Capital (1 level) represents the base capital - the amount of the share capital, intangible assets and audited reserves. This is a basic airbag, which can mitigate losses. Tier-2 Capital (2 level) - the amount of unaudited retained earnings, unaudited reserves and principal allowance for losses. Can be used to mitigate the consequences of more significant losses - in the event of a loss of capital 1 level.

Requirements of banking regulators to provide a financial institution with a minimum CAR level is necessary to reduce private and systemic financial risks. Basel II standard - not less 8%, Basel III - not less 10,5%.

2) Risk indicators in selected areas: delays in various segments, growth of low quality loans (subprime debt), excessive increase in the volume of loans with floating rate, possible bubbles.

3) Leverage Ratio - Equity Ratio 1 level and total amount at risk. Standard - not less 3% according to Basel III.

4) Liquidity indicator - the ratio of highly liquid assets and liquidity outflows for 30 days. Standard - not less 100% according to Basel III.

Dividends and baibeki

Dividend payments in the case of the largest American banks, usually, fairly moderate - dividend yield is about 2% annual. Regular dividend payments are usually quarterly. Besides, leading US financial institutions are implementing share buyback programs (buyback).

It makes sense to pay attention to the level of dividend payments from net profit. Ideally, for cyclical sectors, to which banks belong, it should not exceed 50-60%.

Fed annually conducts stress testing for leading financial institutions. Analyzed, to what extent banks can withstand adverse changes in economic conditions, including all sorts of shocks. FROM 2019 r. American banks with assets over $250 billion. Banks receive approval for dividend payout and share buyback programs upon passing stress tests.

  Short-term system # 4 for futures. US 30-year bond futures.

Investment appraisal approaches

The classical model within the cash flow discounting approach is the dividend discounting model (DDM). With its help, a certain conditionally fair price of a share is calculated. For this, the current dividend payments or the forecast for payments are used..

A simpler and rougher approach - multiplier estimation. For banks, two multipliers are traditionally used - P / E (price / net profit) and P / BV (price / net worth of balance sheet assets). More accurate indicator - P / TBV (price / net worth of tangible balance sheet assets).

Forward multiples - adjusted for income or balance sheet expectations. The PEG multiplier is P / E, adjusted for EPS dynamics expectations. All other things being equal, PEG value, equal 1 and below, testifies in favor of buying shares.

If the bank's multiples exceed the median values ​​for the group of peers, then this testifies in favor of the comparative "high cost" of his shares, and vice versa. This is true "ceteris paribus", that is, if the bank's income indicators do not exceed the average values ​​of competitors. Equally too low multiples may not indicate the "cheapness" of shares, but about the weak fundamentals of the financial institution.

BCS USA в Telegram

Simplified Analysis of American Bank Shares

A sample of the largest American banks was taken as an illustration., data on 02.11.2021.

1) We look at the values ​​of the multipliers. Looking for comparative "underestimation" or "overvaluation".

2) Compare ROE values. We estimate the dynamics of EPS and other income indicators, we compare them with the consensus forecasts of analysts. This will make it clear, where "cheapness" or "high cost" is really observed.

3) For a general understanding of the situation, we look at the discount or premium of shares to the median targets of analysts, assessing expectations regarding the dynamics of FRS rates and GDP.

4) We use technical analysis methods to determine the optimal points for the formation of positions and their fixation.

5) Additionally - adding the dividend factor.

An example of a practical analysis of the situation based on the results of the third quarter 2021 r. given in the review: US financial sector. Ideas in the largest banks ".

Scroll up