Big U.S. Banks Had A Good Quarter. We Still Have No Plans to Invest in Them.
The collapse of Silicon Valley Bank and Signature Bank in March sent chills down the spine of an already anxious U.S. economy. It seemed very possible that the volatility within the banking sector might be the final factor to push the U.S. into–what seems like–its most-anticipated recession ever. But that recession has still not yet materialized, and U.S. banking behemoths just reported first quarter earnings that beat analyst expectations.
So, is the banking sector strong or troubled? The positive news out of large U.S. banks may quell the market’s concerns of a full-blown banking crisis reminiscent of 2008, but our team at Martin Currie sees plenty of reasons for investors to remain cautious of the sector over the long run. Despite strong earnings from the biggest banks in America, we see significant structural risks facing both large and small banks, and we view the sector as unappealing in terms of long-term investor value creation. Here are a few reasons why.
Why our Global Long-Term Unconstrained team does not invest in banks
There are several reasons why banks do not meet our criteria for sustainable growth, starting with the financials. In our assessment of potential investment opportunities, we look for companies that can generate returns that are superior to their cost of capital on a consistent basis, using a defined cost of capital assumption. If a company cannot generate a positive spread between its returns on invested capital and its cost of capital, it will, by definition, not create value for shareholders. If the spread is negative, the company will actually destroy value for shareholders. For companies in the financial sectors, the measure we use is the return on equity, which we compare to the cost of equity, using a higher threshold. Overall, in the financial sector, we struggle to find companies that will be able to sustainably generate a positive spread between the return on equity that they generate and the cost of equity that we assume.