Friday, December 21, 2012

BoE's Robert Jenkins: plan to increase bank share price

In his speech to the ABI Annual Investor Conference, the Bank of England Financial Policy Committee member Robert Jenkins laid out a plan for what he thinks it will take to a) increase bank share prices and b) reduce risk in the financial system.

Naturally, the starting point for his plan is transparency of the risks that are on and off the bank balance sheet.

He presented the plan in a hypothetical speech by a bank CEO.
As you know we have weathered the crisis reasonably well. Loss-making quarters have been few. Earnings are recovering. Our balance sheet is stronger. By the standards of the industry we have much of which to be proud. There is only one not-so-small problem. Loyal shareholders – you, have made no money. 
Why have you made no money? Because the dividend was cut by us and bank share prices were cut by the market. 
Why did we cut the dividend? Because we wished to re-build capital. 
Why were bank share prices“cut?” Because the market fears that the capital we have built is insufficient. 
Why might our capital be insufficient? Well there is concern about the past and worries about the years to come. Investors fear that losses from the past will drag down earnings in the future. And in thinking about the future they are more conscious of the risks that financial firms take and the leverage with which they take them. 
Finally, there is uncertainty over the regulatory playing field on which banks will compete. 
Are these perceptions likely to change soon? Not unless we change. 
What must such change accomplish? It must lay to rest worries of vulnerability. It must remove to the extent possible the threat of surprise. It must clarify the earnings we hope to achieve and the risks we must take in order to achieve them. 
It must prove to prospective shareholders that management will do what is necessary to create shareholder value. And it must convince investors that such value will include a dependable dividend. 
So what is the plan? 
1) we will invite independent specialists to review our holdings and confirm our valuations. They will publish the results. 
2) we will increase provisions to the extent permissible; 
3) where the accounting standards do not permit prudent provisioning, we will ensure that in capital excess to regulatory requirements is there to absorb the losses...
Investors no longer strive for high short term returns unadjusted for risk. They strive for attractive relative risk-adjusted returns. 
The market will reward balance sheet strength, greater transparency, lower volatility and a predictable dividend - with a higher earnings multiple
Why invite a select few independent specialists to review each bank's holdings and the bank's valuation when the market is, by definition, the entity best equipped to review and value the holdings?  After all, the market includes all the specialists plus the rest of the valuation experts.

Why should anyone trust a few independent specialists?

If there is anything that has been learned from having accounting firms and specialists like BlackRock Solutions review banks in Ireland, Greece and Spain, it is that markets do not trust their results.

In theory, after the specialists have done their review, the facts are suppose to be disclosed to the market.  Then why hide the underlying data and not let the market independently confirm their assessments?

The bottom line of using independent specialists in place of the market is that you are raising a very large red flag and saying that the banks have something to hide.

Regular readers know that Step 1 of Mr. Jenkins' plan should be to provide ultra transparency.  Step 1 should be rewritten as follows:
1) We will disclose on an ongoing basis all of our current global asset, liability and off-balance sheet exposure details so that all market participants can confirm our valuations and our conservative management of risk and see that we have nothing to hide.

No comments: