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Bank Stocks Ready to Compete: Oppenheimer

Tickers in this article: BAC C COF GS JPM MS

NEW YORK ( TheStreet) -- "Credit quality is a gift that keeps giving because stable and good credit quality allows management to focus on optimizing returns."

This is Oppenheimer analyst Chris Kotowski's assessment of the opportunity and necessity for banks at this point in the credit cycle. Despite the "headwind" from the prolonged period of historically low interest rates, the analyst's view for the big banks has been that "over time banks will manage themselves to earn a competitive return. It is simply not an option for them to accept a single-digit return when the rest of the market is earning, say, 14%. That is an unstable dynamic that would cause capital to leach out of the banking system."

The "three levers" that banks can pull to bring their returns in line with the broad market, according to Kotowski, include pricing, "expenses and scope of the delivery system," and capital deployment.

The analyst also emphasized that the banking industry is cyclical, and said that "we will never argue that the industry 'learned its lessons,' but on the other hand we are on the favorable side of the cycle where the managements have emerged from the fog of war and can now focus on the logistics of running a well-oiled machine."

Of course, investors are probably way too cynical to expect corporate executives to learn any lessons for the very long haul, with so much of their compensation still tied to relatively short-term results, however the investors themselves might have learned a key lesson, which is simply to avoid bank stocks whenever the U.S. economy shows clear signs of heading into a recession.

Fourth-quarter earnings results underlined the themes of cutting expenses and deploying capital. " Goldman Sachs (GS) , which through the first nine months had shown a return on tangible common equity, or ROTCE of just 9%, sharply dropped its full-year compensation ratio from 42% to 38% to bring the full-year ROTCE in at 11%," Kotowski said, adding that the company "has now kept its aggregate dollar amount of TCE flat at about $63B+/- for two and a half years and used any earnings above this level to repurchase shares."

Several of the largest banks also outlined new efforts to cut costs and make more efficient use of capital, in their fourth-quarter earnings announcements:

  • Citigroup (C) announced several moves to lower its expenses by $900 million during 2013, with cost savings increasing to $1.1 billion 2014, at the relatively meager cost of $300 million in annual revenue. The moves included the closure of 84 branches and the elimination of 11,000 positions, and new CEO Michael Corbat said all the right things during the company's fourth-quarter earnings conference call, including the company's need to "get to a point where we stop destroying our shareholders' capital, and the need to "run a smart and efficient business that's good at its allocation of its resources."
  • Morgan Stanley (MS) said it had already met its goal to reduce its fixed-income risk-weighted assets to $280 billion from $390 billion at the end of the third quarter of 2011, and was on track to lower the RWA to $255 billion by the end of 2013, and eventually to less than $200 billion by the end of 2014. The company also said it would accelerate its purchase of the remaining stake in its brokerage joint venture with Citigroup, to complete the purchase by the end of 2013, when its agreement with Citi last year called for Morgan Stanley to complete the acquisition by 2015. Having 100% ownership of the brokerage will enable "greater order flow capture," increase deposit funding and lower expenses by eliminating the joint venture agreements and expenses, according to the company. Morgan Stanley in 2012 reduced its work force by 7% and said it planned to cut staffing by another 10% in 2013.
  • Bank of America (BAC) said that its fourth-quarter noninterest expenses declined 6% year-over-year, and that it had reduced its staff levels by 1% sequentially and 5% year-over-year. The company's deals earlier this month to sell servicing rights on roughly $300 billion in mortgage loans will also help to lower its legacy assets servicing (LAS) expenses by $1 billion during 2013.