The financial health of banks and t r e n d s in national and regional systems is of paramount
importance for investment decisions. Global decisions too. The effects of the financial crash of 2008 are still painfully with us, including artificially low interest rates.
I devised the PH Score™ to identify signals and fundamental momentum across global financial systems. Inspired by Piotroski’s F Score for companies, it is a composite measure that takes into account signals on profitability, operating efficiency, asset quality, liquidity, capital adequacy, and coverage. It is a binary system and scores a bank from 0 to 9.
The PH Score™ is thus a useful tool for stock selection, corporate and sovereign bonds, as well as gauging the overall macro environment of a jurisdiction as a systemic proxy. The Score aims to mitigate risk as well as capturing key fundamental signals and momentum. The outcome is a model for risk-adjusted returns.
The Score works well in conjunction with the calculation of our own long-term ROEs as a numerator and the price to book ratio (P/Book) as a denominator to create an Earnings Yield. One sometimes hears analysts bemoaning a high P/Book or advocating a low P/Book. This is meaningless. A low P/Book can offer opportunity but it can be a testament of distress, growth of risk and risk of growth. A high P/Book for a bank may signal undervaluation or overvaluation. An assessment of value depends on the relationship between P/Book and ROE, captured by the earnings yield.
Latest data show that there are clear regional trends and investment winners. The Americas emerges as a relatively benign jurisdiction. In Canada, return on equity is high (higher than US). Capital adequacy and liquidity are satisfactory while asset quality is mostly positive. Provisioning levels could be higher. However, the fundamental momentum of the four main banks is encouraging.
Earnings yields are attractive, relative to the US, Europe and Asia, as the market may be under pricing the high ROEs.
In the US, profitability could be higher. Given the market pricing of that profitability, earnings yields are a lot lower. Liquidity and asset quality are robust. The PH Score™ of Comerica, JP Morgan and Bank of America are benign though the long-term ROEs - in certain cases - leave a lot to be desired. While capital adequacy and provisioning levels are relatively favourable, Citibank has a very low PH Score™.
With sky-high net interest margins and profitability, as well as elevated provisioning, LATAM stands out. Mexican and Colombian banks (mostly) show fundamental progression. The PH Score™ of BanColombia, Banco de Bogota, Grupo Financiero Inbursa, and Grupo Financiero Santander Mexico are strong. Valuations look relatively attractive too, with double-digit earnings yields across the region. Brazilian banks look cheap, but they are not investments without risk, which exerts a negative pull on their PH Score™.
PH Score™ results for Australia and China are the most disheartening. The scores are extremely low. This reflects a trend and a direction. To me, it is indicative of some stress in both systems.
Europe has been an epicentre of concern globally about the state of the banks for some time. And certain well-publicised jurisdictions still look fragile. Regional profitability and efficiency could be a lot better. But asset quality seems to be on the mend and capital adequacy is robust. While BBVA scores well, its long ROE is a concern. Scandinavian (mostly Swedish) banks exhibit the best fundamental signals. Valuations there are similar to Canadian counterparts in general. HSBC and RBS exhibit a subpar PH Score™ while UBS is extremely low.
In Japan, it is hard to find a bank trading even at book value and the PH Score™ results are uninspiring. Nomura is an exception. Some scores are very low though the biggest banks are mostly reasonable. There is clearly more work to be done here on my part regarding long-term ROEs, given the merits of Japan as an investment jurisdiction. This is a subject that I will be working on in forensic detail in due course.
In conclusion, Canadian, Swedish, Mexican, and Colombian banks in general command the best fundamental signals. Australia and China as well as some Japanese banks have some work to do with a low PH Score™. As one would expect, there are winners and losers in each market.
Paul Hollingworth is Director of Creative Portfolios Limited, a financial diagnostics consultancy serving global investors. Paul previously worked for 20 years as a Head of Research for a global investment bank.
