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.
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David,
It’s not just the BDA reinsurers who are priced so. Munich Re, Swiss Re, Scor, Hannover Re are all apparently and this is always a worthy caveat) as cheap.
Its worthy of mention that reinsurance markets (i.e rates and thus expected returns are softening aggressively), whereas IB spreads (call it investment intermediation and investment risk- warehousing opportunity) are opening up and improving aggressively (though admittedly others e.g. advisory and underwriting are softening dramatically).
Also noteworthy, is that a year ago hedge funds flush with capital were alll over the place placing bets with reinsurers in sidecar deals, whhere as today the tables have turned and the reinsurers have the excess capital, but seemingly little risk-appetite on the investment side. Go figure…