Investment Banks Are Priced Like Bermuda Reinsuers

Late in the day, I looked at a table of valuations of the remaining major investment banks, and thought, “Huh, they’re priced like Bermuda Reinsurers.  Price-to-book near 1 or lower, and expected P/Es in the middle single digits.”  Well, that got me thinking… how are those two groups of companies alike?

  •  When losses come they can be severe.
  • Both have strong underwriting cycles where a lot of money is made in the boom phase, and a lot gets lost in the bear phase.
  • Earnings quality can be poor, unless management teams have a bias against meeting Street expectations, and allowing earnings to be ragged.
  • The opacity of the investment banks’ swap books is matched by that of the reinsurers’ reserving.
  • Both businesses are highly competitive, and global in scope.

Now, what’s different?

  • The reinsurers typically don’t have asset problems, only reserving problems.
  • The Bermuda reinsurers know that one day a change in their tax status may come (somehow forced to pay US tax rates — ask Bill Berkley), and that would lower earnings.
  • The financial leverage of the reinsurers is a lot lower.
  • The financing of reinsurers is a lot more secure.

The risk-reward seems balanced to me across the two groups.  The reinsurers are lower-risk/lower-reward, and the investment banks are higher on both scores.  Choose in accordance with your risk tolerance — as for me, I’ll look at the reinsurers.