PwC: Potential 20% bounce back in bank valuations

By Rob Starr, Content Manager, Big4.com

According to a new PwC report, “Banking industry reform – A new equilibrium”, launched recently, banking industry reforms and weak growth will keep bank equity returns at around 10%, but reduced equity costs and renewed investor confidence could allow a steady return to economic profitability and a strong recovery in share prices.

The report envisages a post-crisis equilibrium in which bank equity costs fall to 8%-10% following reform-driven reductions in bank leverage and a gradual return to financial market normality. While capacity overhang, competitive pressures, subdued underlying economic growth and a substantial adjustment and compliance cost burden will continue to impact performance severely in the short term, and keep long run equity returns to no more than 1-2% over equity costs thereafter, even this expectation should support a substantial re-rating of bank stocks.

“While new capital ratios dilute returns to equity holders, they also dilute risks to equity holders and this has yet to be factored fully into equity cost calculations and forecasts. This has knock-on implications for investment criteria, product pricing, bank strategy and bank valuations,” said Miles Kennedy, financial services partner and author of the report, PwC.

Banks and bank investors need to re-set expectations: a return to return on equity in the mid-teens is unrealistic and unnecessary. We estimate that the cost of equity will subside to 8-10% as bank balance sheets are strengthened and the systemic riskiness of bank assets returns towards historical norms.