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23-03-2025 : ROE or ROTE ?

In addition to return on equity (ROE), banks are accustomed to calculating return on tangible equity (ROTE), which is calculated by dividing net income for the year by shareholders' equity less intangible assets, mainly goodwill.

In practice, ROTE is higher than ROE. For Citigroup, ROE 2024 is 6.1% and ROTE is 7%.

While it's understandable that banks are sensitive to the notion of tangible equity, since the European banking regulator's prudential ratios remove intangibles from book equity, it's a different story for shareholders. Continuing with the example of Citigroup, shareholders have contributed or left at the disposal of their company $190 billion in equity. In addition, Citigroup has goodwill of $19 billion, giving tangible equity of $171 billion.

Citigroup's shareholders have contributed, or decided not to pay out in dividends or share buybacks, $190 billion.  Logically, it is on this sum that they wish to obtain their required rate of return, not on $171 billion of tangible equity. In fact, just because management spent part of this $190 billion on acquisitions that resulted in the recognition of goodwill, doesn't mean that shareholders have given up all hope of receiving a return on the $19 billion that has fallen into a calculation hole.

If management now believes that this goodwill is worthless, it has a duty to write it off, to recognize a loss of $19 billion. But if they haven't done so, it's because they don't consider the goodwill to be worthless. There is therefore no reason to remove them from shareholders' equity when calculating profitability, even if this improves the quotient.

In our opinion, there is no reason to publish ROTEs other than to dress up the bride. It's worth noting that in the United States, banks communicate on these two returns, whereas in Europe, communication is focused on return on tangible equity.

In these times of a partial return to favor for banking stocks, isn't it time to simplify communication by publishing only return on equity (ROE)? Admittedly, they'll be a little less good, but this would stop the impression being created that shareholders are being taken for fools.

European banks will also benefit from the elimination of the correlative reference to tangible equity per share, which since 2011 has often been seen as an unsurpassable horizon for the share price, and to which a discount is applied. If a discount is to be applied, let it on the higher basis of equity per share.

28-12-2024 : Between American and European universal banks, there's much more than an ocean

In 2008, the leading American bank J.P. Morgan had a market capitalization of €75 bn, and the top 10 European banks 7 times more, at around €510 bn combined. Today, J.P. Morgan's market capitalization is €675 billion, a third more than the sum of the market capitalizations of the top 10 banks in the eurozone. BNP Paribas, Intesa Sanpaolo and Santander, the leading banks in the eurozone on any given day, each have a market capitalization of less than €70 billion. Finally, the Euro Stoxx index of European banks is at its early 1997 level.

Unlike non-financial companies, the equity multiple (PBR) is an important valuation tool for banks; the higher their return on equity, the higher the PBR.

When we take the 4 US universal banks and the 10 largest European universal banks and run a linear regression of their PBR against their return on equity, the R2 is mediocre: 37%. When we repeat the same exercise with two subsets, the correlation between PBR and ROE for US banks is almost perfect at 99%, and excellent for European banks at 80%. This results in the graph illustrated here, which shows that for the same return on equity, US universal banks are valued at around 2 times more than their European counterparts.

For example, Citigroup, the worst performer in America since the financial crisis, with a 4.2% return on equity in 2023, is valued at the same 0.7 PBR as Santander, which has almost three times the return on equity (11.2%). Or that UniCredit, which has the same return on equity as J.P. Morgan (16%), is valued at 1.1 compared with 2.2 for J.P. Morgan.

In terms of P/E ratios, the situation is similar: between 6 and 9 in Europe (with an average of 7) versus 13.5 to 16.5 in the United States (average of 15). Closely tied to their core market, European banks have, according to analyst consensus, zero growth prospects to 2028, compared with 7.3% for their American counterparts.

The composition of the samples alone (there are 4 universal banks in the USA, compared with over 10 in Europe) says it all in this business, where size is of major importance. In Europe, the national public authorities, by de facto refusing to allow the fungibility of prudential capital at European level, by giving tax advantages to investments in debt products rather than equities, by opposing cross-border mergers (UniCredit - Commerzbank AG) except in the event of bankruptcy (BNP Paribas - Fortis), and by doing little to revive securitization which, by taking loans off bank balance sheets as in the USA, would improve profitability, bear a crushing responsibility for this situation.