Recent events impacting Deutsche Bank (DBK.GY) and Wells Fargo (WFC) underscore – yet again – that the mega-cap banks, particularly those with (1) global investment banks and/or (2) operating in the U.S., continue to face significant regulatory/litigation risk, irrespective of quality. In general, these two categories of banks, which overlap, are not growing very fast (in some instances shrinking), have mid-single digit ROEs, and/or continue to face significant regulatory risk.

Our investment stance for our U.S. bank holdings is to significantly limit our exposure to these two categories of banks, in favour of mid-cap banks (banks with assets less than $100 bln). In general, relative to their mega-cap peers, these banks continue to grow EPS faster (see “Four Largest U.S. Banks See Earnings Decline 9% Y/Y in a Tough Operating Environment (While Mid-Caps’ Earnings Rise 9%)”). U.S. mid-cap banks are also consolidating/merging and also more rate-sensitive (particularly those focused on commercial and industrial [C&I] lending), making them more likely to continue growing EPS faster when the Fed Funds rate begins to normalize. Importantly, this category of banks has immaterial regulatory/litigation risk.