Crisis-Related Shifts in the Market Valuation of Banking Activities

Abstract

We examine changes in banks’ market-to-book ratios over the last decade, focusing on the dramatic and persistent declines witnessed during the financial crisis. The extent of the decline and its persistence cannot be explained by the delayed recognition of losses. Rather, it is declines in the values of intangibles – including customer relationships and other intangibles related to business opportunities – along with unrecognized contingent obligations that account for most of the persistent decline in market-to-book ratios. Changes in the business environment since the financial crisis have led investors to associate little value with intangibles. Changing market perceptions of the consequences of leverage also affected the way investors value banks; prior to the crisis, higher leverage, ceteris paribus, was associated with greater value (reflecting the high relative cost of equity finance), but during and after the crisis, as default risk concerns came to the fore, lower leverage was associated with greater value. After controlling for other influences, dividend payments (a signal of management and regulatory perceptions of the persistence of financial strength) matter for market values, and this effect increases during and after the crisis. “Carry-trade” effects from taking on interest rate risk are also apparent. The flattening of the yield curve during and after the crisis is associated with reduced valuation effects from duration mismatch between assets and liabilities.

Keywords: bank holding companies, valuation, financial crisis

JEL Classification: G01, G21, E32, E43