BankThink

Why Banks Should Temper Their Growth Ambitions, in One Chart

How fast can banks grow over the long run? The data is sobering.

The chart below shows compounded growth in total assets and assets per share (A-PS) for the 15 largest U.S. banks by market capitalization, from the first quarter of 1996 through this year's second quarter.

Banks can increase earnings in only three ways: (1) increase ROA; (2) increase leverage (turn a given ROA into a higher ROE); and (3) grow assets. Only (3) is a viable long-term earnings growth strategy. Long-run improvements in ROA are difficult to achieve (cost savings from increased scale, the obvious low hanging fruit, are modest at best), and leverage can be increased only so far.

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What sort of growth numbers have banks posted? Many banks have delivered total asset growth well north of 10%, but growth in A-PS has been more modest — just under 7% on average for these 15 institutions.

Why such a big difference? Because while acquisitions can greatly increase total assets, they tend to boost A-PS only modestly, if at all. Most of the largest banks have been aggressive acquirers.

The 7% average A-PS growth rate masks a lot of variance in growth across institutions. Why do some grow so much faster than others? Higher-ROE means higher potential A-PS growth. But chasing growth proved to be calamitous for several large institutions.

What does the future hold? Many banks have achieved lackluster asset growth in recent years. This will eventually change for the better. And institutions that saw their historical A-PS growth rates crushed by dilutive equity issuances will enjoy prospective A-PS growth.

But if measured across decades, prospective A-PS growth over 7% is unlikely. If you believe M&A helped big banks grow A-PS, this help won't be there in the future; there simply aren't enough sizable targets. And the overall asset "pie" isn't likely to keep growing by 7% a year.

Modest A-PS growth needn't be a bad thing for bank stock prices. But operating strategies that try to fight this reality might be.

Harvard Winters, a former investment banker, writes research on banks.

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