Fitch: Equity Returns Still Falling Short for Some U.S. Banks
CHICAGO -- February 20, 2013
Returns on equity (ROE) for a number of large U.S. financial institutions
continued to fall short of the cost of equity capital in 2012, even though ROE
performance varied considerably among top banks, according to Fitch Ratings.
Particularly for those institutions with ROEs far below hurdle rates, weak
returns continue to point to the need to reduce legacy costs, including legal
and problem asset-related expenses that remained high in 2012.
On average, the 9.0% Fitch-adjusted ROE for the top six U.S. institutions
(JPMorgan Chase, Citigroup, Bank of America, Wells Fargo, Goldman Sachs, and
Morgan Stanley) during the fourth quarter of 2012 remained significantly below
the calculated average cost of common equity for that peer group (11.8%).
However, performance varied greatly with Wells Fargo, JPM, and Goldman all
reporting adjusted ROEs that exceeded our calculated cost of capital. The cost
of equity capital calculated for each bank represents a Fitch estimate, based
on market data.
Given the challenging revenue outlook, U.S. banks continue to focus on
improving customer-specific returns across a wide range of relationships and
services. The risk-adjusted profitability of various banking relationships is
measured relative to targeted customer hurdle rates in an effort to get paid
for the risks being taken. However, the measurement of relationship
profitability is challenging, especially for large corporate and institutional
customers where services are provided across a wide range of products and
We continue to expect many banks to reduce exposures to products and business
segments that do not offer risk-adjusted returns commensurate with a bank's
cost of capital, factoring in the impact of business improvement and operating
efficiency initiatives. In particular, certain trading products and positions,
such as structured and non-investment-grade exposures, as well as higher risk
lending and counterparty relationships, may no longer achieve profitability
targets on a risk-weighted basis.
Banks are emphasizing core strengths and actively downsizing businesses that
offer limited prospects for acceptable returns. For some, that means renewing
their focus on fixed income, while reducing the scope of their equities
business. For others, where the equities business is the traditional strength,
the opposite is taking place.
Laggards will likely continue to gradually narrow the gap between ROE and the
cost of equity capital in 2013, barring any unforeseen macro or risk issues.
Weaker earners will continue to reduce legacy costs and exposures,
de-emphasize lower return products, enhance customer profitability, and
continue to seek operational efficiencies.
However, returns exceeding the cost of equity capital may not be achievable in
the near term for some major U.S. banks, as legacy issues remain a large drag
on consolidated results. The higher rated U.S. banks will likely continue to
enjoy a significant advantage in ROE generation as 2013 progresses, allowing
them more flexibility to build capital internally while distributing
significant amounts to shareholders.
The above article originally appeared as a post on the Fitch Wire credit
market commentary page. The original article can be accessed at
www.fitchratings.com. All opinions expressed are those of Fitch Ratings.
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