Because of all their additional regulatory burdens, including the above items and the annual stress tests, Kowtowski sees the group facing a constrained growth environment as they "manage for market returns." For example, the "severely adverse scenario" being used in the tests and capital plan reviews, include rapid rises to double-digit unemployment rates in the U.S.
"The unmistakable message to banks of course is that they should not lend any money to the 6-7% of the population that would most likely to
become unemployed in a severe recession. Thus, the banking industry will be smaller in the future than it was in the past, but that doesn't mean they can squander capital unproductively in the business that remains," Kotowski wrote.
So the price to TBV discount reflects investors' suspicions that the banks can achieve stellar returns in the years ahead. But Kotowski sees the banks pulling four levers to improve their performance, but not necessarily their growth: Underwriting standards to limit credit losses, "higher rates on loans and lower rates on deposits," continued efficiency improvement, and "returning capital in the form of dividends and buybacks."
Kotowski cited data showing that banks' returns on equity (ROE) have matched the broad market over extended periods. "The average bank ROE of 10.2% in the first half of 2013 was still below the 12.5% long-term ROE of the market, but importantly bank ROEs are still rising," he wrote.
If the big banks -- especially Bank of America and Citigroup -- continue their efficiency improvements, and the large-cap banks as a group improve ROE to bring it in line with the broad market, investors may see quite a jump in stock valuations.
-- Written by Philip van Doorn in Jupiter, Fla.
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