JPMorgan and Wells Beat 12% ROE – And How Others Can, Too
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In the midst of a slow recovery and miserable returns, one bank has chalked up a decisive victory. JPMorgan (NYSE: JPM) announced excellent third quarter profits – but more importantly, it earned a 12% return on its equity.
For perspective, the world’s 300 largest lenders reported an average 7.6% ROE in 2011, according to a McKinsey survey. In contrast, banks often saw returns on their equity in excess of 15%, as looser regulations and riskier behavior allowed for more leveraged and profitable endeavors.
Despite hitting 12% in just four of the last 19 quarters since the beginning of 2008, JPMorgan’s results are impressive, and they mark JPMorgan’s move back into high-returning territory. According to The Wall Street Journal:
(Banks) aren’t earning enough to justify their existence. Twelve is something of a magic number because banks have to earn more on their capital than they pay for it. With capital costing somewhere between 8% and 12%, executives and analysts believe that a lender has to earn an ROE of around 12% to be a worthwhile investment.
How Others Compare
JPMorgan’s news was a sigh of relief for investors, but other banking stocks, with the exception of Wells Fargo (NYSE: WFC), haven’t hit the mark.
Wells Fargo announced that it earned $4.9 billion in net income on $21.2 billion in revenues, leading the bank to a 13.38% ROE, up .52% from last quarter. Also, the bank boosted its return on assets from 1.41% to 1.45%, another positive for investors. However, other banks did not fare as well.
Citi earned just 1% on its common equity, which was preceded by 6.5% in Q2 and an 8.4% return in Q1. Though its returns are low, it did boost its book value per share to $63.59, up from $62.61 last quarter. With Vikram Pandit gone, Citi’s new leader must quickly boost its returns to stay competitive with other banks.
B of A also performed poorly, earning just $340 million in net income last quarter. The earnings represent $0.00 per share, giving Bank of America a tiny return on equity. B of A did make improvements to its balance sheet and to being more customer-driven, but those moves over the past three months have not turned into tangible financial returns on this month’s earnings announcement.
Finally, Goldman posted a modest return on equity for shareholders. According to Goldman’s filing, “Annualized return on average common shareholders’ equity (ROE) was 8.6% for the third quarter of 2012 and 8.8% for the first nine months of 2012.” Goldman’s modest return is a step up from its loss in Q3 one year ago, but its returns still lag competitor JPMorgan and lender Wells Fargo.
How to Improve ROE
Slow markets, a bad world economy, and tough regulations have hurt the financial sector. However, the banks can take measures to improve their performance.
According to a McKinsey study, banks will have to trim their costs. Cost-to-income ratios in the U.S. are currently 68%, but must be reduced to 51% for the banks to earn a favorable ROE. Unless banking revenues pick up – which is not likely in the current environment – banks will have to lay off workers, outsource jobs, and automate other work.
Banks have conducted layoffs, but they have barely kept pace with the drop in profits. Costs still rest at 60% of income, holding steady since 2007. To become more profitable, the banks will have to slow hiring and increase layoffs.
These moves would be negative for the broader economy, but they would allow more banks to sport favorable returns on equity – and cover their costs of capital.
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ChrisMarasco has no positions in the stocks mentioned above. The Motley Fool owns shares of Bank of America, Citigroup Inc , JPMorgan Chase & Co., and Wells Fargo & Company. Motley Fool newsletter services recommend Goldman Sachs Group and Wells Fargo & Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.