NEW YORK (TheStreet) -- There are seven large-cap U.S. banks that "could reach" into the category of "best managed Banks," according to the equity analyst team at RBC Capital Markets.
"We maintain our contention that as the tailwind of credit improvement subsides, banks must renew their focus on core profitability to compensate for the persistent low interest rate environment, increased regulations and modest loan growth," the analysts wrote in a note to clients on Monday.
So it would appear that the "easy play" for investors on the banking industry recovery is coming to an end.
Most stock investors know that large-cap bank stocks have seen a major recovery over the past two years. The KBW Bank Index (I:BKX) rose 35% last year, following a 30% return during 2012.
But the bank stocks seeing the greatest returns over the past two years have not necessarily been the strongest overall performers. Much of the gain has been driven by the recovery of credit quality the continuing U.S. economic recovery, and expectations that the elevated legal expenses of major players including JPMorgan Chase (JPM - Get Report) and Bank of America (BAC) will subside.
Following a profitability analysis of the top 20 U.S. Banks, RBC Capital Markets listed Wells Fargo (WFC - Get Report) and U.S. Bancorp (USB - Get Report) as "the best managed banks," and the numbers bear this out if we look at returns on assets (ROA) and returns on tangible equity (ROTCE) over the past five years, using data supplied by Thomson Reuters Bank Insight.
U.S. Bancorp's annual ROA has averaged 1.36% over the past five full years, for the top ranking among the top 20 U.S. banks, while Wells Fargo's ROA has ranked second, at 1.23%. USB also has the top ranking for ROTCE, with an average of 20.36%, followed by 16.75% for Wells Fargo.
If we look back further, for the past 10 years, the U.S. Bancorp is again in the top spot, with ROA averaging 1.66%, followed by Capital One Financial (COF), with a 1.56% ROA and Wells Fargo in third place, with a 1.33% ROA.
USB is again the leader with an average ROTCE of 29.66% over the past 10 calendar years, but investors aren't likely to see that type of return in the new regulatory environment, with many banks having capital ratios that are twice as high as they were before the U.S. housing bubble burst in 2008. For Wells Fargo, the 10-year average ROTCE was 19.46%.
Over the past five years, the best stock performer among the top 20 banks -- as defined by RBC Capital Markets -- has been Fifth Third Bancorp (FITB - Get Report), which has risen nearly 13-fold since bank stocks bottomed in March 2009. This shows just how far the market had fallen, and that returns for the past five years haven't mirrored overall operating performance.
Looking back 10 years, however, the stock returns do correlate with operating performance. The best stock performer among the top 20 U.S. Banks over the past 10 years through Friday's close has been Wells Fargo, with a total return of 115%, followed by U.S. Bancorp, with a total return of 101%. Not too shabby, considering the epic bust, bailout and recovery cycle we've been through.
The worst performer among the index components over the past 10 years, by far, has been Citigroup C, with a negative return of 88% through Friday's close, reflecting not only its common-equity raises but the additional dilution caused by the U.S. Treasury's conversion of $37.7 billion in Troubled Assets Relief Program (TARP) preferred shares to common shares in 2009.
Who Might Join the Top Rank?
Looking ahead, RBC Capital Markets listed these seven banks as the "Up and Comers," who could join the U.S. Bancorp and Wells Fargo as "Best Managed Banks."
JPMorgan Chase. The company's 2013 ROA was 0.75% and its ROTCE was 10.20%, during a year that include a third-quarter net loss, as the bank raised its litigation reserves to prepare for $17.5 billion in residential mortgage-backed securities settlements with government authorities and private investors in the fourth quarter.
M&T Bank (MTB - Get Report) of Buffalo, N.Y., had a 2013 ROA of 1.36%, and its ROTCE was 16.67%. The company is going through a period of higher expenses, as it enhances its Bank Secrecy Act and anti-money laundering systems and compliance procedures, while it prepares for the expected (but long delayed) completion of its acquisition of Hudson City Bancorp (HCBK) of Paramus, N.J.
For SunTrust (STT - Get Report)of Atlanta, the 2013 ROA was 0.78%, while the ROTCE was 9.40%. The company had a weak third quarter, with earnings lowered by $179 million, or 33 cents a share, by charges related to mortgage settlements, and other mortgage-related items.
Generally speaking, what sets the best banks apart, according to RBC Capital Markets, is "an unwavering focus on credit quality, maintenance of low operating expenses, i.e., efficiency ratio, and ability to grow revenues consistently through a cycle." RBC Capital Markets also emphasizes deployment of capital, with Wells Fargo's year-end 2008 acquisition of Wachovia as a prime example, as well as the return of capital to investors through dividends and share buybacks.
Capital deployment will be the big story for bank stock investors next week, with the Federal Reserve set to announce on March 26 the results of its annual review of large banks' plans to raise dividends, repurchase shares and/or make acquisitions from the second quarter of 2014 through the first quarter of 2015.
Please see these articles for more on bank stress tests and capital returns: