Over the last five years, the KBW index of 24 large-cap bank stocks is down 61% while the S&P 500 has been flat. Year to date, BKX has lost 24% while the S&P has gained 0.3%.
This disparity between banks and the broader market isn't just about performance. Bank stocks also are more volatile, and many of the industry's leading companies trade well below book value.
Why is this happening? Let me count the ways — and then float some policy options.
First, let's acknowledge the factors affecting all publicly traded stocks: a slow economy, persistent unemployment, government deficits, the mess in Europe, political uncertainty.
Of course, these factors are a big drag on bank stocks, too, but something else must explain the huge divergence between the banking sector and the rest of the market.
Some people blame the media's fixation with all things financial.
In the 24-hour news cycle world we live in today, every misstep by a bank gets magnified. Just ask Brian Moynihan. Operating at the center of society's crosshairs breeds mistrust and scares investors away from bank stocks.
Others blame the industry's many and varied exposures, including sovereign debt, derivatives, underwater mortgages and litigation related to all of the above. The risks are obvious, but just how big and deep the losses will be is unknown.
Those are both important, legitimate forces weighing down bank stocks.
But the biggest reason bank stocks trade so much lower than the broader market is the uncertainty and cost of government oversight.
Capital and liquidity requirements, interchange limits, the Volcker Rule, risk retention, stress testing. The list goes on and on; American Banker readers are all too familiar with the jumble of rules being layered on the industry.
Concerns about regulation center on how banks will make money in the future and, when they do, whether regulators allow them to return earnings to shareholders via dividends.
"It's hard to say bank stocks are undervalued, because we really don't know what kind of returns they can produce in the future," says Fred Cannon, the director of research at Keefe, Bruyette & Woods, the investment bank that created the BKX. "They have turned into value traps."
That's because returning earnings to shareholders through dividend payments has become a whole lot harder since the crisis. In February 2009, the Federal Reserve Board clamped down on dividends and only started loosening up last March. Banks with more than $50 billion in assets must get the Fed's approval before paying or increasing a dividend, and can't pay out more than 30% of earnings. None of the big banks are paying anywhere near that ceiling today.
Bank stocks have traditionally paid a steady dividend that tended to attract individual investors and certain types of mutual funds. But the government's move to curb dividends is a big turnoff for investors who count on dividend income.
"It really affects investor appeal and that in turn will lead to lower share prices, making it even harder for banks to raise additional capital," says Bert Ely, an independent consultant in Alexandria, Va., with a keen eye for bad government policy. "It's a vicious cycle."
No one is arguing banks should not be well capitalized, but no one knows when or if banks will have enough capital to satisfy the regulators, because they keep proposing new surcharges for everything from being big to thwarting procyclicality.
Until regulators can agree on an amount of capital that makes sense and give the market some reason to believe that's the final number, it will continue to be difficult for banks to raise capital and keep investors.
Regulators "need to recognize we are at a 70-year high of capital in the banking industry and recognize that maybe we are pushing this too far," Cannon says.
He predicts the current path will lead to a "very concentrated industry with much higher prices to consumers." Ely sees business simply moving to the less-regulated providers in the industry's shadows as the banking sector shrinks.
The regulators' more-is-better approach is completely understandable. It's way easier to simply tell critics that you are jacking up capital and making the system safer than to explain the downside of going too far.
"I question whether they have the guts to educate important audiences, including Congress and even the political leaders within the administration, as to why such things as an adequate return on capital and steady dividend payments are essential to attract and retain capital," Ely says.
"I think a lot of them, quite frankly, don't."
The Fed recently unveiled its third round of stress testing for the largest banks. This one is the toughest of the three and it's a great opportunity for regulators to use what they learn to lighten up on the strongest, best-managed banks.
The entire sector can't be undercapitalized and run by losers. And regulation can't simply be a constant ratcheting up.
There's one other policy prescription we ought to consider: a tax on trading.
The idea, most often expressed as a financial transaction tax, has already gotten a lot of press but for the wrong reasons. Usually it's raised as a way to punish financial companies for the 2008 crisis. But I see it as a way to tame the market, which has become obsessed with "trading" at the expense of "investing."
It's possible the market is too liquid and trading is too cheap. Who benefits from all the things we did to "democratize" markets? It hasn't been retail investors.
"We do need retail investors to hold bank stocks so that they don't just get pushed around by hedge funds," says Nancy Bush, an independent bank analyst who runs NAB Research LLC in New Jersey. "I wonder if the Fed understands or cares about the traditional shareholder base of banks."
Bush does not favor raising taxes. And I get that there are plenty of reasons to oppose a tax on trading, but we need to find a way to curb the absurd get-in, get-out speculative trading that dominates today's market. Regular investors see the system as stacked against them, and so they stay away.
Critics claim the trades would simply move beyond our borders, but policymakers should be searching for a way to make the market attractive to retail investors again.
"I think there is a very good argument that a transaction tax would slow things down a little and could actually be good for the market," Cannon says. "High-frequency trading is justified because it makes the market more efficient, but at some point the efficiency push from all this trading has created more, rather than less, volatility, and more volatility ultimately reduces value."
Bush predicts bank stocks will remain "market pariahs until we get a clear acceleration of the economy and we do get some lending volume."
"I am very concerned that even that won't bring back the traditional bank investor," she says. "That's not a good thing for capital formation in this industry or in this country."
During a Senate Banking Committee hearing Tuesday, Chairman Tim Johnson neatly summed up the situation: "This is a time when tough decisions have to be made by our regulators."
Strong banks are key to a strong economy, and sooner or later regulators are going to have to have the courage to make decisions that, while politically unpopular, are the right moves for the industry's and the country's long-term health.
