U.S. Large Cap Banks: Initiation of Coverage

Overview:

• We believe the market has undervalued the dramatic reconstruction of the industry over the past 15 years and that large banks now have the wherewithal to work through a category 5 storm.
• We also see a new optimization era ahead unleashing a powerful decade of earnings growth, improved returns and a call for generalist investors to re-engage with the sector.
• While banks being early artificial intelligence (AI) implementers will create a flywheel, the ground for a valuation reset has already been laid. To position for this new era, however, a new playbook is needed.

The TD Cowen Insight

We're initiating coverage of the U.S. large cap banks with a very bullish outlook. Large cap banks are trading at the lowest relative valuation in decades, so we see the group as being at least 30% undervalued. While a new playbook is needed, we see the strongest decade ahead for earnings growth, improved returns and reduced risk as banks start a new chapter and enter an optimization age.

Optimization Era to Offer Positive Returns

While large cap banks have sold off recently given rising fears of a recession, the market incorrectly perceives banks as weak links in the economy. After nearly 15 years of rebuilding capital, liquidity and reserves, modern day large banks are now built with the wherewithal to work through a category 5 economic storm. In fact, we see a recession as a potential positive valuation catalyst. We also believe that a substantial further economic value unlock is at the industry's doorstep as the industry enters a new optimization age.

While a more normal level of interest rates as well as eventual deregulation are key factors, we also view large banks as poised to lead other sectors as early implementers of AI.

Large-cap Banks In Position for a Phase Shift

What Is Proprietary?

In the optimization age that we see ahead, low-cost deposits will replace loan growth as the key differentiator, an era of deregulation will begin and banks will lead as early adopters of AI. With our money-making framework revealing that the "money-makers" in the industry remain fully intact, in the optimization age we see the growth of revenue, earnings per share (EPS) and tangible book value (TBV) as shifting to a higher gear. What also differentiates our launch is the ability to leverage valuable regulatory insights from Washington Research Group (WRG) analyst, Jaret Seiberg.

Financial and Industry Model Implications

In the optimization age, we see net interest margins (NIMs) heading from the current 2.8% range back to the approximately 3.50% level and return on tangible common equity (ROTCE) heading from the current 14% level to 20%-plus over time. We also see AI as being used to further reduce credit and interest rate risk, which should lead to more predictable results and reduced equity risk premium.

What To Watch

While many large cap banks were historically turnarounds with (deservedly) tarnished reputations, a new set of large cap bank CEOs are emerging who are tech-savvy, customer focused and energized to win. We believe that modern day large banks are emerging as the new disrupters in the financial services arena.