Return To Normal Expense Ratios For Most Banks Predicted By Oppenheimer Bank Equity Expert Despite Durbin Debit Card Limits
August 7, 2011 - The Wall Street Transcript has just published US Banking Report: An Investor offering a timely review of the Banking sector. This Special Report contains expert industry commentary through in-depth interviews with public company CEOs, Equity Analysts and Money Managers. Please find an excerpt below.
Chris Kotowski is Managing Director and Senior Research Analyst at Oppenheimer & Co. Inc. covering large-cap banks and brokers, a position which he has held twice at the firm from 1987 to 1995 and currently, since 2009. Mr. Kotowski originally joined Oppenheimer in 1985 as a Research Associate in the bank's franchise and was promoted to Senior Bank Analyst two years later.
Over the next nine years, he led a team covering more than 45 stocks supporting large-cap institutional efforts and the firm's small-cap franchise. During this time, Mr. Kotowski often was represented in Institutional Investor's annual rankings and consistently was ranked among the firm's top analysts. He served as Associate Director of Research and then as Director of Research at Oppenheimer and CIBC World Markets Inc. In 2004, Mr. Kotowski joined Leerink Swann LLC, where he served as Director of Research and Head of Institutional Equities.
TWST: Why are the stocks cheap? Is it because of a lack of understanding by the market of what is going on?
Mr. Kotowski: Obviously, whenever you have a sector that is inexpensive, it's inexpensive for a reason. My read of that reason, in terms of the money center banks right now, is that there are still some people who don't believe that they have recovered from the difficulties of a couple years ago. Credit quality is here, but there are still some people who think that loan growth will be anemic forever. I'd say the predominant concern I hear is that with all these new regulations, the banks will never earn what they once earned.
TWST: Is that perception accurate?
Mr. Kotowski: I think it can take a while to adjust to a new regulatory environment, but in the end banks will manage themselves to earn a competitive return.
Let's take, for example, the Durbin amendment, which limits debit card fees. In the fourth quarter, they are going to put a limit on what banks can charge for debit card fees that's lower than what they are charging currently for the swipe fees. But ultimately, there is no such thing as free checking. Ultimately, consumers need these services and banks somehow need to find a way to charge for them. They'll charge for them with some combination of swipe fees, monthly fees or requirements to maintain certain balances or something else. There will be some way to make up the losses.
Whenever there is a new regulatory issue and the banks say, "Well, if nothing else happens, it would cost us a $100 million," then there are a lot of analysts who take that $100 million out of revenues, out of their pretax earnings, and drive on from there. The problem with that is that's ultimately not how banks are going to manage themselves. In the long run, banks manage themselves by the need to earn a competitive return on equity. That means they're going to need to tweak and fiddle with the pricing of the products and the cost of the delivery system. They will look at issues like whether they have too many branches or whether they don't have enough branches, but ultimately they need to come up with a business model that pencils out to a competitive return on equity for their shareholders. They can't just sit there and say, "Oh gee, 8% is all we can do."
In times of financial stress, when you have a recession and credit quality problems are mounting and bank CEOs are being hauled in front of Congress to be excoriated about foreclosure practices, you're going to have the banks just throwing money at the problem to try to make it go away. But once credit quality stabilizes and you get past all that, then banks are going to tweak and fiddle and say, "How do we make money doing this?"
We produced a report that includes a graph showing the long run trend in banks' operating expense ratio or efficiency ratio, and you can see generally the trend has been downward. But when you have recessions like in 1990 or in 2002, it tends to creep up for a little while because you're throwing money at the credit problems to try to clean them up. But then once things stabilize, then you're going to try to optimize your returns.
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