Banks around the world will enjoy solid growth in 2017. These banks, lean from years of cost-cutting and flush with capital, are well positioned to take advantage of rising interest rates and steady economic growth while benefiting from a less onerous regulatory environment.
“Banks have had to adapt their business models to a very low top-line environment over the past five years,” says Bill Fitzpatrick, global equities analyst with Manulife Asset Management Ltd. in Chicago. “Now, all of a sudden, [their] operating leverage is enormous. If we get some loan growth; if we get economies to come back – and do so from a lower cost base – I think that bodes very well for the profitability of the banks.”
The stocks of large banks around the world, particularly shares of U.S.-based banks, received a boost in November based on expectations of higher interest rates, lower corporate taxes and reduced regulatory red tape under U.S. President Donald Trump’s administration.
However, Julie Thomas, senior portfolio manager with RBC Global Asset Management (U.K.) Ltd. in London, U.K., is quick to cautions that stock prices could correct if these and other rosy expectations don’t materialize: “I would be quite careful about the pace of change. The market is asking for something quite immediate, and we need to separate what Trump can do immediately and what will take time.”
Fitzpatrick, for one, anticipates a rise in real gross domestic product of 2.5%-3% in the U.S., 1.5%-2% in Europe and 3%-3.5% in emerging markets.
U.S. interest rates also are expected to rise in 2017, which would widen banks’ net interest margins and boost earnings. However, an increase in interest rates that’s too steep and too soon would do more harm than good to banks in general, Fitzpatrick says: “We could have a 100- to 150-basis-point (bps) increase in rates without major disruption to the global economy. Anything more than that and you’ll see a big blowup in the emerging markets’ economies. They have a lot of U.S. dollar-based funding, and a quick move [in rates] would hurt them.”
Sotiris Boutsis, portfolio manager with Fidelity International Ltd. in London, U.K., believes the trend toward governments imposing ever-stricter regulations on banks, which began in the aftermath of the global financial crisis of 2007-08, may have hit its peak. However, he adds, regulations are unlikely to be rolled back significantly.
“If this compliance burden is somewhat alleviated, not by relaxing the rules but by reducing somewhat the bureaucracy that ties down the banks, that would be a positive,” says Boutsis, who manages Fidelity Global Financial Services Fund.
U.S.-based banks are favoured by Thomas and other portfolio managers. Says Thomas: “The big [U.S.] banks can take share from the international banks, and the better run [U.S.] regional banks can take share within their own markets and benefit as well.”
U.S.-based banks could make some acquisitions this year, which also could be positive for earnings growth, she adds: “Strategic moves on investment plans that have been on hold [until now] can be taken out of the freezer and acted upon.”
As well, money-market centres’ banks, such as J.P. Morgan Chase & Co., Morgan Stanley and Goldman Sachs Group Inc., all based in New York, are expected to do well. Many of their clients are sitting on high levels of cash.
“As people become more confident about the stock market or bond yields, and [those investors] are willing to put money to work again, then, all of a sudden, transactional revenue starts to increase,” says Richard Nield, portfolio manager with Invesco Canada Ltd. in Austin, Tex. That optimism should benefit all of the banks’ operations: wholesale banking, brokerage, asset management and wealth management.
Several multinational banks also are in favour. For example, London, U.K.-based HSBC Bank PLC “is sitting on a huge deposit base that’s earning very little, and [the bank has] kept [its investments] on the short end of the curve so that when interest rates began moving upward by 25 bps to 50 bps, there was a huge amount of operating leverage,” Nield says.
Fitzpatrick agrees, noting that HSBC has a very low loan/deposit ratio, which means the bank is leveraged to interest rates more so than its peers. Another plus, he adds, is HSBC’s presence in some higher-growth markets in the Far East, which generates high returns and continues to perform well.
Another multinational Fitzpatrick favours is Standard Chartered PLC: “It’s doing a lot of restructuring. It has very good new management in there that has been very effective, and [the bank] has dodged many of the challenges in China and other parts of Asia. [This bank] is in high-growth markets [and is] a good franchise. [It] tripped up over the past years, but if the bank can begin to get its groove back a little bit – which it looks like it has, as the stock is grossly oversold – [the stock] is certainly a good value play.”
Fitzpatrick also gives a nod to another multinational, Mitsubishi UFJ Financial Group: “We’ve been very pleased with MUFJ, which does about 70% of [its]business in Japan, and 30% elsewhere.”
Marc McGovern, director, investment research, and portfolio manager with I.G. Investment Management (H.K.) Ltd. in Hong Kong, points to private-sector banks in India, such as HDFC Bank, as being interesting: “They’ve done very well over the past few years; it’s difficult to see why that would change,” he notes, adding that those banks “are run for the shareholders, [which] makes [these banks] unique, very disciplined – from a liquidity perspective; a balance sheet management perspective – and focused on profit generation.”
Among more domestically focused banks, Lloyds Bank PLC and Royal Bank of Scotland Group PLC (RBS) are two U.K.-based possibilities.
Lloyds, says Nield, is a “pure retail lender. Mortgages are its bread and butter, as [is its] commercial business, consumer finance [and] credit cards. [Lloyds is the] best capitalized bank in the U.K. [with] higher core T1 capital, which gives [Lloyds] the ability to pay a recurring dividend. [The bank] has been hit with regulation and litigation. We think those headwinds are going to begin to peter out over the next couple of years.”
RBS is a turnaround situation, McGovern says: “[RBS has] undergone a multi-layer transformation, [but has] a huge amount of litigation to come in the next year or two. What the management team is doing is impressive, so if [RBS] can get through the litigation, [that] could be an interesting story.”
Regarding European banks, McGovern favours ING Bank NV of the Netherlands and Swedbank AB of Sweden. They are among a “select bunch” of banks “with strong balance sheets and high profitability, with strong dividend capacity,” he says.
Fitzpatrick prefers Norway-based DNB ASA because it “has a lot of oil exposure. And now that the energy markets moving higher, [DNB’s stock] is beginning to recover.”
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