Which banks look cheap on
“new normal” returns?
In this note we set out what we think will be the
“new normal” earnings power for US and European
banks. We look at risks around the trajectory and
outcome, implied upside to valuations on a look-through
basis, and which stocks are best ways to play the theme.
In Europe, we think it increasingly likely that
provisions will plateau in 2H09 for many banks.
Those more geared to CRE and CEE may not see the
peak until 2010. Our top picks revolve around four
themes and are reinforced by our ‘look-through’ analysis.
1) We like banks where we think the market is still too
bearish on wholesale (CSG, BARC). 2) We think some
stocks offer under-priced EM growth and strong
profitability (BBVA, SAN, which we upgrade to OW).
3) We would hold a clutch of deeper-value stocks that
are supported by look-through valuations and offer good
upside potential (UCG, SEB). 4) Diversified financials
where inflection and optionality is not yet in the price
(Baer, SDR). We also upgrade Danske to Equal-weight.
In the US, we have an Attractive view on the large
cap and mid cap bank group. We see two steps to
normalized earnings: slowing NPL growth should reduce
reserve build in 2010, and stabilizing economic activity
late next year should drive lower losses in 2011-2012.
We see slightly lower ROAs and leverage driving
normalized ROEs of largely 12-20%, which in most
cases are above our estimated normalized COE of
10-12%. With a median P/B of 0.8x for the large caps
and 1.0x for mid-cap banks, we see upside to the stocks
as earnings power reemerges. We are long capital
market sensitive banks (JPM, BK and NTRS). Among
credit sensitive banks, we are long early-cycle card and
consumer lenders (BAC, JPM), banks with
acquisition-driven earnings accretion (WFC, PNC) and
banks that are far ahead of peers in credit loss
absorption or capital raising (FHN, WBS).