With a tough operating environment behind them, U.S. banks have put greater focus on resource optimization, risk mitigation and cost management. As a result, Societe Generale analysts anticipate that U.S. banks’ business models have significant earnings leverage embedded.
Murali Gopal and the team at Societe Generale, in their report dated June 2, 2014 on U.S. banks entitled “US Banks – Loan growth should lead the recovery; Buy BAC and JPM,” point out that the business models of banks within their coverage universe are capable of supporting mid-teen RoTEs.
US banks’ sustainable RoTEs
The analysts explain that the banks they follow fall in a relatively wide range of expected RoTE. Their bottom-up analysis is based on divisional profitability and their anticipation of returns through the cycle. They note that Morgan Stanley (NYSE:MS), Wells Fargo & Co (NYSE:WFC) and Bank of America Corp (NYSE:BAC) emerge as the top banks with sustainable RoTEs at the high end of the range.
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The following graph shows that, based on price to tangible book versus return on tangible equity, JPMorgan Chase & Co. (NYSE:JPM) looks attractive:
Uptrend in loan growth
The Societe Generale analysts are increasingly convinced that loan growth is set to pick up by Q414. Their expectations are based on evolving trends in several indicators, including senior loan officer surveys, anecdotal evidence gathered from earnings conference calls from the past two quarters, a pick-up in household debt, and the historical relationship of loan growth to GDP.
The following graph captures the loan growth relationship to GDP. The analysts note while there may be a lag in loan growth recovery, the relationship with GDP growth has held up reasonably well in the past.
The following table captures the ratings summary of U.S. Banks from the Societe Generale analysts.
The analysts assign a Buy rating on JPMorgan Chase & Co. (NYSE:JPM) and Bank of America Corp (NYSE:BAC) and a Sell rating on Goldman Sachs Group Inc (NYSE:GS).
Pick up in profitability
The analysts note that the profitability of U.S. banks is poised to pick up, aided by several factors, such as loan growth gaining momentum by Q414, NIM having mostly bottomed and higher interest-rate forecast for FY15. Moreover, they believe that a pickup in the macro-economy should boost M&A advisory and capital raising activities and asset management flows and that operating margins also will continue to improve.
The analysts point out that while themes across the U.S. and Europe are similar in many ways, the U.S. has been faster in terms of turning around profitability since the financial crisis. They note that even while revenue, expenses, and leverage trends have been broadly similar, the biggest divergence is the recovery in credit costs. The following graph sets this forth best.