The FDIC quarterly banking profile, which was released yesterday, showed that the US banking system generated its largest quarterly profit of all time in the first quarter of 2013. This is pretty amazing considering the state of the banking industry just four years ago, but it should be noted that even though profits have recovered, returns on capital haven’t. In the previous peak quarter, 2Q06, the banking system generated a 12.6% ROE. In the most recent quarter the ROE was only 9.95%
Unfortunately for bank bulls there are signs that this depressed ROE is as much structural as it is cyclical. ROA is actually much closer to its former peak levels, which implies that the lower ROE is more a symptom of lower leverage rather than an unfavorable yield curve. Given that post-crisis regulation has stressed de-risking through de-leveraging, it’s unlikely that banks will be able to lever to former levels and therefore may have structural difficulties reaching their prior heights of ROE. This is important to consider from a valuation standpoint, because if banks can’t post mid or high teen ROEs then it is difficult to justify paying much more than book value for an inherently unstable business model. Of course, in a bull market, value doesn’t have to mean a whole lot…until it does.
