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Winners in banking's new world order
03/23/2010 8:30 am EST
Tattered for rent signs hang in the windows of the building that once housed Bear Stearns. All that’s left of Lehman Bros. is a digital crawl that endlessly cycles news. American International Group keeps itself alive by selling body parts and hoping that the government vampires don’t demand their blood payment now. HSBC has retreated to its ancestral island fortress far away from the fields where it went down to defeat before the pitiless hordes of the mortgage-backed securities market. The ghosts of Wachovia and Washington Mutual flit through quarterly financial statements. Citibank branches offer promises to blasted survivors.
Everywhere you look you can see the ruins of the old financial order.
But in those ruins, like green grass sprouting in the shelter of the fallen stones of the Greek temples at Agrigento, you can see signs of the new financial order. Old players have been reborn. New leaders have risen to assume the mantle of the fallen. New opportunities beckon to the brave and unbloodied.
It’s still early. The green shoots are just shoots. The early leaders may falter. But this is also the time to start to stake out positions in the stocks that could, if things break right for these companies, be the leaders of the financial sector for the next cycle whether it’s just a few years or a few decades in length.
Here’s my thinking on what that new financial order will look like.
I divide the picture into five parts.
- The creatures that ate American International Group (AIG). Before the crisis, American International Group’s AIA Group subsidiary ran one of the most exciting financial businesses in the world. After 90 years in the region, the company had built up a network of 250,000 agents in 13 Asian markets. The company had 20 million customers, $60 billion in assets and was a life insurance powerhouse in a region projected by McKinsey & Co. to generate 40% of all growth in global life insurance premiums over the next five years. American International Group’s subsidiary American Life Insurance (of ALICO) did business in 50 countries. Its biggest developed market was Japan, where before the financial crisis the company was the country’s No. 4 insurer. ALICO’s business in the fast growing markets of the Middle East, Russia, and Latin America balanced the subsidiary’s presence in Japan’s mature life insurance market. After the crisis, these companies don’t belong to AIG anymore. Metropolitan Life (MET) bought ALICO and Prudential PLC (PUK) of London bought AIA.
- Ready to rumble in Asia. The sale of ALICO to Metropolitan Life and of AIA to Prudential PLC doesn’t restore the status quo in Asian financial markets by a long shot. The AIG brand took a big hit in Asian markets thanks to the company’s near run with bankruptcy and it’s going to take work by the new owners to rebrand that business. (Especially because the ALICO portfolio has some risky and illiquid assets in it that will need a lot of attention. There’s $5.3 billion in commercial mortgage-backed securities and $1.3 billion in Greek bonds, for example. I think Metropolitan Life has the balance sheet to handle the strain but it won’t be easy.) And it’s not just American International Group that saw its reputation tarnished. Australia’s Macquarie Group (MCQEF.PK), HSBC (HBC), Citigroup (C), and ING (ING), to name just a few, all took hits to their reputation in the crisis or retreated from these markets or both. That has opened the door for financial companies that escaped the worst of the crisis and that already have a presence in the region such as Canada’s Manulife Financial (MFC), Spain’s Banco Santander (STD), and the United Kingdom’s Standard Chartered (SCBFF.PK) to pick up share in the world’s fastest growing markets for financial products.
- It don’t all run one way, anymore. The crisis just accelerated a trend (or maybe just accelerated our awareness of a trend) that I’d call the rise of developing world financial powers. The biggest IPOs (initial public offerings) in 2009 were in China and Brazil—on Chinese and Brazilian financial markets. Through the end of November 2009, 72% of the money raised in IPOs for the year came from Asian and South American deals, according to Ernst & Young. By funds raised, the three top markets for IPOs were Hong Kong stock exchange (18.7%), New York Stock Exchange (17.9%), and the Shanghai stock exchange (17%). That trend in IPOs is just indicative of a larger trend in global capital markets: the developed world’s share of global capital is falling. In 2004 U.S. capital markets accounted for 53% of all the shares of stock in the world that were free to trade. By 2007—a year I picked because it was before capital markets everywhere felt the full effects of the global financial crisis—the U.S. share was down to 44%. So what financial companies are picking up the slack? Look to recent stock offerings in Brazil to see one cast of emerging players: The big offerings have included Banco Santander and Itau Unibanco (ITUB). One of the reasons that HSBC moved its CEO back to Hong Kong from London and is preparing to list on the Shanghai stock exchange is its desire to participate in China’s IPOs. China’s big banks and investment companies have the bulk of that business now. (Switzerland-headquartered UBS (UBS) was the top developed-economy investment bank in 2009 in the Chinese IPO market earning $728 million in fees on Hong Kong IPOs worth $26 billion, according to Bloomberg.) The mergers and acquisitions market, however, remained a stronghold for developed-economy financial companies. Morgan Stanley (MS) was the top advisor on deals worth $20.9 billion in the mainland and Hong Kong stock exchanges.
- Another tiny step in the consolidation of the U.S. banking sector. Since the beginning of 2008 the FDIC (Federal Deposit Insurance Corp.) has closed down a little more than 200 banks. (You can get the list, updated weekly, here http://www.fdic.gov/bank/individual/failed/banklist.html) That sounds like a lot but it’s actually a drop in the bucket in comparison to the more than 7,000 FDIC-insured banks in the United States. In reality what the crisis has produced is some significant consolidation among the country’s biggest banks but almost no consolidation below that level. At the top, the banks that got bigger in ways that I think will increase future profits for shareholders include JPMorgan Chase (JPM) and Wells Fargo (WFC). US Bancorp (USB) has done a good job at picking up pieces of smaller banks—and sometimes whole banks—to extend its footprint in new and existing markets.
- One financial revolution stalls and another keeps on chugging below the radar. By the second quarter of 2007—just before the financial crisis got really critical—the traditional banking sector accounted for less than half of the assets in the U.S. financial system, according to a 2009 report from the New York Federal Reserve. (See that report here http://www.newyorkfed.org/research/staff_reports/sr382.pdf ). The majority of the financial systems assets were in the hands of financial institutions that raised their capital—not from the traditional source of deposits—but by borrowing from the financial markets themselves (by issuing short-term commercial paper for example) or by selling securitized assets on the financial markets. Securitization allowed what has come to be called the shadow banking system to make mortgages, issue credit card debt, make loans for buyouts or private equity deals and then bundle those debt instruments together and resell them as securities backed by those assets. That enabled the institutions in the shadow banking system (and traditional banks too) to leverage their capital over and over again. (And because huge swathes of the shadow banking system escaped any effective regulation, it became the mechanism that turned a serious financial problem into a global financial crisis.) The financial crisis has closed down some of these securitized markets. Others are functioning only because the government—which means taxpayers in reality—is acting as buyer because no one else will. But I’m sure that this revolution has only been suspended. Securitization is simply too profitable and serves too big a market—every pension fund, endowment, etc. looking for a higher return, with safety of course, than Treasury notes and bonds offer—for it not to come back in some form. Exactly what form is impossible to tell right now. But I’d be willing to bet that companies like Goldman Sachs (GS) and BlackRock (BLK) will be at the front in the next stage of this revolution. I’d call the second revolution, especially in contrast to the securitization revolution, the poor people’s revolution. Thanks to the success of the microcredit movement in the last decade in bringing banking services to the world’s poorer people, it’s become clear that 1) people with very low incomes use financial services to save and borrow, and 2) that there’s potentially a good profit to be earned in serving this huge market if you can get the costs low enough. A study by McKinsey & Co. and the Financial Access Initiative (see www.financialaccess.org ) in October 2009 found that while 2.5 billion adults, just over half of the world’s adult population, don’t use formal financial services to save or borrow, 800 million of the people in Africa, Asia, and the Middle East who do use formal financial services live on less than $5 a day. Getting more services to that 800-million-adult market and expanding it to include some part of that 2.5 billion-unserved-person market will require the invention of new forms of banking whether it’s the cell phone banking model of Africa or something else. Companies that are worth keeping an eye on in this space include South Africa’s Standard Bank Group (SBGOY.PK), one of the first banks to partner with cell phone operators, India’s HDFC Bank (HDB), which is building out its ATM network into underserved areas of the country, Wal-Mart (WMT) in the United States and Mexico, which has expanded its financial service effort again, and Apple (AAPL). The iPhone and its apps store seems an ideal platform for new banking products—at least as soon as Apple solves its AT&T (T) network problems.
A few of these stocks—Itau Unibanco, Metropolitan Life, US Bancorp, and Wal-Mart are already on my Jim’s Watch List (http://jubakpicks.com/ ). With this post I’m going to add HDFC, Prudential PLC, Standard Bank Group, and Standard Chartered to that list. HBSC is already a member of my Jubak’s Picks portfolio.
Full disclosure: I own shares of HDFC, HSBC, Itau Unibanco, Standard Chartered, and US Bancorp in my personal portfolio.
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