Bank shares have rallied strongly over the last week as investors react positively to president-elect Trump's promises to loosen restrictive regulations implemented in the aftermath of the economic downturn of 2008. This has helped prices across the financial sector as a whole. While the S&P 500 has gained about 1.5% since November 8th, the KBW Bank Index has jumped 13.2% over the same period. As a result, price-to-book (P/B) ratios for U.S. banks are currently at highs last seen in late 2014.
The P/B ratio compares the share price with the bank's underlying financial condition (captured by the book value per share), and can indicate whether the shares are being priced too cautiously or too aggressively. Marked differences between the price of a company's shares compared to its book value are often a sign of under- or over-valuation. At times, however, very low P/B ratios may actually be because of problems with the company's business model, whereas high P/B ratios could be due to optimism about the future potential of a company's business model.
Now, the shares of U.S. Bancorp and Wells Fargo have traded at sizable premiums to book value since the economic downturn of 2008 - indicating that investors believe in the business models and growth opportunities for these banks in the long run. In sharp contrast, Citigroup and Bank of America have traded at a marked discount to book value as investors remain skeptical about the quality of assets on their balance sheets - especially their legacy mortgage portfolio.
The table above summarizes the change in P/B ratios for these banks at the end of the last five quarters, with the color gradation along a row added to help understand the overall trend for a particular bank. As banks lost a chunk of their value over the first half of the year, there was a significant reduction in the P/B ratio figure for each bank for this period. A reversal in this trend over Q3 2016 helped P/B ratios recover marginally for the quarter before the recent rally pushed share prices for some of these banks to the highest level since the economic downturn. In fact, shares of U.S. Bancorp and JPMorgan are currently trading at an all-time high.
Notably, Wells Fargo's P/B ratio fell to 124% at the end of Q3 2016 - the lowest level for the banking giant since late 2012. This was due to the sell-off in Wells Fargo's shares in September when the bank's fraudulent account scandal came to light. Although the share price has recovered enough for P/B ratios to improve to almost 150%, the current figure is still well below the 165% P/B ratio Wells Fargo's shares traded at over 2014-15. We believe the difference comes from the loss in reputation Wells Fargo has suffered over recent months as a result of the scandal.
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