Market Points to Banks in Need

Date: Thursday, May 7, 2009
Author: Anthony Currie & John Foley, The New York Times

Everyone seems to have taken a stab at predicting which banks will need more capital as a result of the government’s stress tests. Few have been on the money — witness the surprise of the public over Bank of America’s $34 billion shortfall. But most analysts ignore one simple, all-encompassing metric: where the banks’ shares are trading as a multiple of book value, or assets minus liabilities. This shows what investors think about banks’ prospects.

Sure, markets have been wrong about the accuracy of book value before. But it can still be a handy guide. After all, the stock market should be the best place to digest all the analysis, guesstimates, rumors and leaks with which investors are being bombarded. It indicates that investors reckon there are two tiers of banks in the group being tested — those that can withstand the economic downturn with little problem, and those whose health will need to be bolstered.

Seven banks in the lower tier traded at discounts ranging from a quarter to half of their per-share book value on Tuesday: Citigroup, Regions Financial, Capital One, Fifth Third, SunTrust, Bank of America and KeyCorp. Clearly shareholders are wary of how these banks value their assets, reckon losses will be overwhelming, are expecting a common equity issue that will dilute their stakes, or are expecting a mix of all three.

Eleven others are all trading around or above book value, implying investors feel they’re relatively safe, including those that some press reports say will need to raise more capital, like PNC and Wells Fargo. GMAC, the 19th institution subject to the stress tests, does not trade publicly.

Capital ratios don’t play much of a role in distinguishing between the two tiers. In fact, Bank of America and Citi aside, the lower-tier firms have some of the best tangible common equity ratios of the 19. Instead, the stock market seems to give a higher ranking to banks that have posted fewer losses and manage to earn money without the help of a boost from too many one-time items.

In short, the market seems to be doing its job of separating the wheat from the chaff.

Asian Funds Rise

Greenwich and Mayfair, the hedge fund capitals of the United States and Britain, may be shrinking. But a new hedge fund center is sprouting in Hong Kong. More funds opened than closed in the territory last year, according to the Alternative Investment Management Association.

Asia is rich and still growing, so it is little wonder hedge fund start-ups see it as fertile territory. The newcomers fall broadly into two camps — refugees from investment banks’ shrunken proprietary trading desks, and hedge fund managers from big firms whose funds are so far below water that they can earn fees only by starting anew.

The opportunity for those who get it right could be huge. Asia-based funds account for just 8 percent of global assets under management. There’s also appetite among investors for Asia-focused strategies in nonequity asset classes, like macro and distressed debt. The number of macro strategy start-ups tripled in the region between 2007 and 2008.

But raising capital is tough. The Madoff scandal means any new hedge fund faces an uphill struggle to convince investors of its trustworthiness. That may explain why the new Asian hedge funds are not looking to funds-of-hedge-funds for capital. Instead, they tend to be rich individuals who can afford to put in seed capital of their own. Most new funds are around the $20 million to $50 million mark, bankers say.

Some new firms have turned to specialist providers of seed capital. But the terms for this type of money are onerous. New managers have to offer favors such as a cut of profits or equity in the parent company, say some fund advisers. Some have even promised new investors “side letters,” which give them preferential terms over future investors, like the right to pull money out first while others are locked up tight.

That might be the only way to get ahead. But the more special treatment is granted to early investors, the harder it will be for new funds to outgrow their friends-and-family beginnings. Potential clients may be deterred by being given unequal rights. Meanwhile, Asia’s relatively shallow markets don’t favor big trading bets. This reduces the odds that new megafunds will rise in the East.

Still, there’s one consolation. Even if Hong Kong isn’t the new Mayfair, running a $50 million boutique hedge fund beats being jobless in London or New York.

ANTONY CURRIE and JOHN FOLEY