Oppenheimer’s Chris Kotowski has keyed into a bullish argument for banks that he says no one else has mentioned. This makes U.S. banks “extraordinarily undervalued.”
Bank stocks have suffered due to concerns about margin pressure in a perpetual low rate environment. What the Bears ignore, however, is that even diminished bank returns will look competitive compared to a 2% 10-year bond rate.
More from Oppenheimer:
[W]e have seen no discussion around the fact that if 10 year UST rates stay at 1.93%, the banks current level of the banks’ profitability would be an extraordinarily attractive competitive return. Consider that during the period from 1Q 1992 to 4Q 2006 the average bank earned a ROE of 14.2% but that during this time the average yield on the 10-year treasury was 5.53% (see Exhibit 1).
In other words, the average bank earned 2.7x the yield of the 10-year treasury. Thus, if the 10-year treasury were to stay at 1.93% for the next 14 years, they would be earning a 10.00% historically competitive return on equity of about 5.21%. Clearly, banks should be able to earn that. We think that this is the correct way to look at the issue, but even if one were to focus on the “spread” (i.e. the 8.7% difference between the 14.2% and the 5.53%) it would put a competitive return at 10.6%, which is still well within the reach of most banks 4.7x 6.00% (although again, we believe in the multiplicative rather than additive relationship).
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