The divergence in the returns that banks can sustainably earn on their increased capital is remarkable. Looking at reported return on average equity for Q3 2015 compared to Q3 2014, seven of our sample banks improved profitability, while seven suffered falls. Deutsche Bank’s latest abysmal quarter, following a similarly poor result the prior year, makes comparison meaningless.
Market darling Goldman Sachs suffered the biggest year-on-year decline in ROE from 11.8% in Q3 2014 to 7% in Q3 2015, with Morgan Stanley also dropping from 9.9% to 5.6%, reflecting a pause in fee earnings from capital markets activity and completed M&A in the third quarter and low customer volumes in securities markets.
Ten out of the 15 biggest G-Sibs are still reporting ROEs measured in single digits. And while most have cut the target 15% returns they were aiming for a couple of years ago down to between 10% and 12%, that is much more than most are delivering, with bank stock risk premia keeping cost of equity at between 10% and 11%.
Those cursing regulators for requiring banks to run with an unnecessary surplus of capital might pause to note that UBS is the best performing developed market bank in terms of profitability (15.9% return on equity) and it also carries the highest common equity tier 1 ratio among its peers (14.3%). The only bank with a higher return on equity in our sample is China’s ICBC (18.6%).
The stock market seems to be coming round to the view that well capitalized banks are an acceptable investment even if they are returning less than 10%, as long as there is a credible path to that goal and no sign of excessive risk taking.
