Market Overview

Fitch: Equity Returns Still Falling Short for Some U.S. Banks

CHICAGO--(BUSINESS WIRE)--

Returns on equity (ROE) for a number of large U.S. financial institutions continued to fall short of the cost of equity capital in 2012, even though ROE performance varied considerably among top banks, according to Fitch Ratings. Particularly for those institutions with ROEs far below hurdle rates, weak returns continue to point to the need to reduce legacy costs, including legal and problem asset-related expenses that remained high in 2012.

On average, the 9.0% Fitch-adjusted ROE for the top six U.S. institutions (JPMorgan Chase, Citigroup, Bank of America, Wells Fargo, Goldman Sachs, and Morgan Stanley) during the fourth quarter of 2012 remained significantly below the calculated average cost of common equity for that peer group (11.8%). However, performance varied greatly with Wells Fargo, JPM, and Goldman all reporting adjusted ROEs that exceeded our calculated cost of capital. The cost of equity capital calculated for each bank represents a Fitch estimate, based on market data.

Given the challenging revenue outlook, U.S. banks continue to focus on improving customer-specific returns across a wide range of relationships and services. The risk-adjusted profitability of various banking relationships is measured relative to targeted customer hurdle rates in an effort to get paid for the risks being taken. However, the measurement of relationship profitability is challenging, especially for large corporate and institutional customers where services are provided across a wide range of products and legal entities.

We continue to expect many banks to reduce exposures to products and business segments that do not offer risk-adjusted returns commensurate with a bank's cost of capital, factoring in the impact of business improvement and operating efficiency initiatives. In particular, certain trading products and positions, such as structured and non-investment-grade exposures, as well as higher risk lending and counterparty relationships, may no longer achieve profitability targets on a risk-weighted basis.

Banks are emphasizing core strengths and actively downsizing businesses that offer limited prospects for acceptable returns. For some, that means renewing their focus on fixed income, while reducing the scope of their equities business. For others, where the equities business is the traditional strength, the opposite is taking place.

Laggards will likely continue to gradually narrow the gap between ROE and the cost of equity capital in 2013, barring any unforeseen macro or risk issues. Weaker earners will continue to reduce legacy costs and exposures, de-emphasize lower return products, enhance customer profitability, and continue to seek operational efficiencies.

However, returns exceeding the cost of equity capital may not be achievable in the near term for some major U.S. banks, as legacy issues remain a large drag on consolidated results. The higher rated U.S. banks will likely continue to enjoy a significant advantage in ROE generation as 2013 progresses, allowing them more flexibility to build capital internally while distributing significant amounts to shareholders.

The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.

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Fitch Ratings
Joseph Scott, +1-212-908-0624
Senior Director
Financial Institutions
or
Bill Warlick, +1-312-368-3141
Senior Director
Fitch Wire
70 W. Madison
Chicago, IL 60602
or
Media Relations:
Brian Bertsch, New York, +1 212-908-0549
brian.bertsch@fitchratings.com

 

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