Banks’ falling book value could invite activists

Pedestrians pass in front of a Bank of America branch in New York City.
Scott Mlyn | CNBC
Pedestrians pass in front of a Bank of America branch in New York City.

Trading below tangible book value was once considered a harbinger of doom for banks, even the stock market itself. Now, it could instead spell trouble for banks' management teams.

A group of U.S banks including Goldman Sachs, Morgan Stanley and Bank of America saw shares drop by at least 8 percent to begin this year. Each bank also trades below tangible book value, or the net value of the company less intangible assets and goodwill.

With the stocks' value dipping beneath book value and earnings reports from U.S. banks due this week and next, underperforming banks could see activist investors clamoring for leadership changes or for spinouts at firms posting disappointing returns.

"If valuations stay depressed as they are it creates incentive for banks to unlock value," CLSA banks analyst Mike Mayo said. "Shareholders have every right to push for a credible plan."

Disappointing share performance has invited activists at other large financial firms. This includes Ally Financial, currently under pressure from activist investor Lion Point Capital to sell itself. Ally shares have fallen by more than 20 percent over the last 12 months.

Ally is fighting the activist and said in a recent statement, "Our fundamental disagreement is with Lion Point's clear agenda to force a sale of Ally."

After the market close Tuesday, MetLife — where shares never fully recovered from losses suffered in the financial crisis — revealed plans to break its U.S. life insurance unit from the rest of its businesses. Although it wasn't spurred by an activist, the announcement sent MetLife stock up more than 6 percent at the market open on Wednesday. MetLife has also underperformed the market for the last 12 months and is down about 12 percent.

One analyst attributed the sharp drop in banks' share prices to expectations around the Federal Reserve, contrasted to the central bank's plans. This suggests more pain could be on the way for shareholders.

"There's growing concern the Federal Reserve won't follow through with projections in dots data," RBC Capital Markets managing director and banks analyst Gerard Cassidy said, referring to the chart on which Fed officials plot their rate expectations.

Many economists think the Fed will hike interest rates two times during — 2016; according to the central bank's projections, it aims for four rate hikes. If the Fed doesn't raise interest rates on that projected schedule, it will put pressure on banks' yield curves and potentially hamper profitability.

The Fed's decision to raise interest rates a quarter point from near-zero percent in December is in part responsible for creating greater turbulence in markets. But it was also expected to inject billions into banks' top lines via interest income — additional revenue earned from making loans.

The adjustment to the regulatory environment for banks is credited for defusing another potential market crisis, but analysts say it has also hampered bank profitability. Better-capitalized banks may let regulators sleep well at night, but not investors.

"The swashbuckling days swinging to hit the ball out of the park (are) over for this industry," Ken Leon, S&P Capital IQ global head of equity research, wrote in a recent note.

CLSA's Mayo suggested banks that have struggled for years in a slow-growth low-rate environment can and should see more activist pressure to spin out businesses if they continue to underperform.

The pain big banks are seeing in the market is even worse for private equity firms, all of which watched shares fall by 10 percent or more to start the year.

Private equity investors that took big hits to begin 2016 include KKR (-11 percent); Blackstone Group (-12 percent); the Carlyle Group (-14 percent) and Oaktree Capital (-10 percent), as of midday trading Wednesday.

The tumble of PE firms' stock so far hasn't been attributed to the same causes as big banks' pain in 2016. Instead, their inability to cobble together big deals with cheap debt in a market that has been far more receptive to investment-grade debt deals, compared with the high-yield debt that has fueled private equity, is being blamed.

"Many of the private equity firms have exposure to the high-yield market," Cassidy said.