NEW YORK (TheStreet) -- Despite a spectacular sector run-up this year, stocks of major U.S. banks are trading at just half their historical average levels to tangible book value, according to Oppenheimer analyst Chris Kotowski.
The KBW Bank Index I:BKX closed at 67.29 Thursday, rising 31% this year. Here's a quick look at the valuations for the six large-cap banks covered by Kotowski:
- Shares of JPMorgan Chase (JPM) - Get JPMorgan Chase & Co. Report closed at $57.22 Thursday. The shares traded for 1.6 times tangible book value, according to Thomson Reuters Bank Insight, and for 9.5 times the consensus 2014 earnings estimate of $6.01 a share. The consensus 2015 EPS estimate is $6.37.
- Bank of America (BAC) - Get Bank of America Corp Report closed at $15.59 Thursday and traded for 1.2 times tangible book value and 11.6 times the consensus 2014 EPS estimate of $1.34. The consensus 2015 EPS estimate is $1.60.
- Citigroup (C) - Get Citigroup Inc. Report closed at $51.73 Thursday and traded for just below tangible book value and 9.5 times the consensus 2014 EPS estimate of $5.42. The consensus 2015 EPS estimate is $5.96.
- Wells Fargo (WFC) - Get Wells Fargo & Company Report closed at $44.08 Thursday and traded for 2.2 times tangible book value and 11.0 times the consensus 2014 EPS estimate of $4.01. The consensus 2015 EPS estimate is $4.22.
- U.S. Bancorp (USB) - Get U.S. Bancorp Report closed at $38.86 Thursday and traded for 3.2 times tangible book value (according to Kotowski) and 12.1 times the consensus 2014 EPS estimate of $3.20. The consensus 2015 EPS estimate is $3.45.
- Shares of Capital One Financial (COF) - Get Capital One Financial Corporation Report closed at $69.63 Thursday and traded for 1.6 times tangible book value and 10.0 times the consensus 2014 EPS estimate of $6.96. The consensus 2015 EPS estimate is $7.46.
In a note to clients on Thursday (based on his firm's figures and Wednesday's closing prices), Kowtoski wrote that the large-cap banks covered by his firm were "right in line" with the historical average, with an average forward price-to-earnings ratio of 10.6, which was 72% of the average forward P/E of 14.7 for the S&P 500undefined.
But the six big bank stocks stocks trade at just "half their historical level," with an average price-to-tangible-book ratio of 1.8, according to Kotowski. For the 12-year period through 2006, the year-end average price to TBV ratio for the group was 3.6.
"A lot of investors respond by saying 'Well that of course makes perfect sense: Between the higher capital requirements, Durbin, Volker and all the other regulations, ROEs will be lower in the future than in the past'," Kowtoski wrote. But the analyst disputed that notion by writing "Therefore I get a free option on the prospect that bank returns will trend towards normal over time."
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.
>Contact by Email.
Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.