Global Bank Equity Specialist, Creative Portfolios

Paul Hollingworth

Global Bank Equity Specialist

Creative Portfolios

Thematic (Sector/Industry)

United states Financials / Thematic (Sector/Industry)

<p>After yesterday's halted trading, US banks could be due a nice bounce today as a risk-on bounce takes shape -if it does at all, or fades.</p><p>US bank shares have been hit hard, not as badly as transportation and oil stocks, but meaningfully. The coronavirus has taken its toll on risk sentiment, because of the economic and profit implications of disruption, driving US yields on safe-haven status deeply into unknown territory- and into a zone where basic banking logic fails. A new normal of low-to-negative yields, as in the troubled Japanese and European banking systems, is having a ripple effect on US bank profitability despite the protestations that the US will eschew a similar fate. Low-rate regimes punish savers, pensioners, and anyone else relying on deposit-based income,  while proportionately benefiting equity and real estate investors. We are not so sanguine that the US will dodge the bullet or that US risk assets are out of the woods by any means: global dynamics are moving in one direction. This will not bother President Trump, who built his business model on cheap debt, as he seems to favour more "competitive" US rates much to the chagrin of bank executives. The greatest challenge for the US Banking System is to avoid low or negative rates: the Fed tried and failed to normalise the rate environment a few years ago (recall Dimon calling for 4% rates) and has succumbed to QE and repo infusions to keep the show on the road with consequences. </p><p>Negative real rates squeeze the net interest margins of banks that pay a penalty to store excess reserves but that are unable to pass on negative rates to depositors ; many European banks have lost more than a third of their market capitalization since January 2018 as a result. Some central banks have even reported that commercial depositors have asked to store cash in vaults to avoid being penalized by negative rates. Lowering rates further into negative territory only worsens this issue. In the corporate sector, negative rates can also create a moral hazard of sorts as companies confuse cheap financing with sound capital investment, or where marginally profitable companies remain in business due purely to the low cost of capital.</p><p>In an unprecedented event, US yields from 3 months to 30 years have fallen below 1%, paving the way for a period of unprofitable financial intermediation and margins in the US, especially given relatively high CIRs. US banks are generally higher inefficient and rely on fat net interest margins of say between 2.5-3.5%. Such a scenario may change - we expect a rally today in bank stocks and higher yields- but the risk exists that rates will remain lower-for-longer, underpinning US bank under performance. Why? Debt burdens (of all types) are elevated while globalisation, aging demographics, and technology-related price deflation exert a downward pull on rates, accentuated by cofid19 and the politics of oil.</p><div class="content-highlight">
<p>Lower yields are accompanied by a rise in credit risk. The oil price imploglio immediately raises the question: which US banks are exposed to potential distress and default in this space? Besides behemoths such as JP Morgan and Citi and the deeply troubled Wells Fargo, we highlight PNC Financial, US BankCorp, Regions Financial, BOK Financial Corp, Comerica, Texas-centric banks such as Texas Capital, Independent bank Group, Hancock Whitney, Cadence Bancorp, and KeyCorp.</p>
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<p>At Cadence, energy loans account for approximately 11% of the bank's total net loans. BOK Financial and Cullen/Frost carry about 10% of loans dedicated to energy sector. Legacy problem energy loans mark Texas Capital, Independent Bank, Cadence and Hancock Whitney. KeyCorp has supplied copious loans to fracking concerns. Comerica has quite a large Texas exposure.</p>
<p>Canadian and Australian banks are overexposed too, let alone oil exporter banks. Avoid.</p>
</div>
</div><p>So US banks will enjoy a bounce today. But the bigger picture of deeply low yields and oil-related credit risk, accompanied by beefed-up sub-prime auto loans, student indebtedness, and leveraged loans, indicate that the system is more vulnerable than many think as loan losses mount. Lending is soft. Products are marked by deflationary pressures. US bank shares have been pummeled for a reason, hovering on bear market classification. The risk of owning them has risen. Despite intermittent bounces, we believe the sector is in trouble from an investment perspective. Banks need a different type of yield curve and normalised rates and better quality credit growth to make money. The oil price debacle adds fuel to the fire. I wonder if the horse has bolted and the prospects of US banks are now grisly though better than the forlorn markets of Japan and Europe. If you want to hold bank shares, selective EM just got more valuable though rates trajectories need to be monitored carefully there too.</p><p>The oil price bear market, galvanised by supply and demand forces, is a kick in the teeth for -or a proverbial nail- to the US banking system. If energy prices remain at these low levels, we will see a sharp uptick in negative credit quality trends and losses at the most energy exposed banks.</p>

After yesterday's halted trading, US banks could be due a nice bounce today as a risk-on bounce takes shape -if it does at all, or fades.US bank shares have been hit hard, not as badly as transportation and oil stocks, but meaningfully. The coronavirus has taken its toll on risk sentiment, because of the economic and profit implications of disruption, driving US yields on safe-haven status deeply into unknown territory- and into a zone where basic banking logic fails. A new normal of low-to-negative yields, as in the troubled Japanese and European banking systems, is having a ripple effect on US bank profitability despite the protestations that the US will eschew a similar fate. Low-rate regimes punish savers, pensioners, and anyone else relying on deposit-based income,  while proportionately benefiting equity and real estate investors. We are not so sanguine that the US will dodge the bullet or that US risk assets are out of the woods by any means: global dynamics are moving in one direction. This will not bother President Trump, who built his business model on cheap debt, as he seems to favour more "competitive" US rates much to the chagrin of bank executives. The greatest challenge for the US Banking System is to avoid low or negative rates: the Fed tried and failed to normalise the rate environment a few years ago (recall Dimon calling for 4% rates) and has succumbed to QE and repo infusions to keep the show on the road with consequences. Negative real rates squeeze the net interest margins of banks that pay a penalty to store excess reserves but that are unable to pass on negative rates to depositors ; many European banks have lost more than a third of their market capitalization since January 2018 as a result. Some central banks have even reported that commercial depositors have asked to store cash in vaults to avoid being penalized by negative rates. Lowering rates further into negative territory only worsens this issue. In the corporate sector, negative rates can also create a moral hazard of sorts as companies confuse cheap financing with sound capital investment, or where marginally profitable companies remain in business due purely to the low cost of capital.In an unprecedented event, US yields from 3 months to 30 years have fallen below 1%, paving the way for a period of unprofitable financial intermediation and margins in the US, especially given relatively high CIRs. US banks are generally higher inefficient and rely on fat net interest margins of say between 2.5-3.5%. Such a scenario may change - we expect a rally today in bank stocks and higher yields- but the risk exists that rates will remain lower-for-longer, underpinning US bank under performance. Why? Debt burdens (of all types) are elevated while globalisation, aging demographics, and technology-related price deflation exert a downward pull on rates, accentuated by cofid19 and the politics of oil.
Lower yields are accompanied by a rise in credit risk. The oil price imploglio immediately raises the question: which US banks are exposed to potential distress and default in this space? Besides behemoths such as JP Morgan and Citi and the deeply troubled Wells Fargo, we highlight PNC Financial, US BankCorp, Regions Financial, BOK Financial Corp, Comerica, Texas-centric banks such as Texas Capital, Independent bank Group, Hancock Whitney, Cadence Bancorp, and KeyCorp.

At Cadence, energy loans account for approximately 11% of the bank's total net loans. BOK Financial and Cullen/Frost carry about 10% of loans dedicated to energy sector. Legacy problem energy loans mark Texas Capital, Independent Bank, Cadence and Hancock Whitney. KeyCorp has supplied copious loans to fracking concerns. Comerica has quite a large Texas exposure.
Canadian and Australian banks are overexposed too, let alone oil exporter banks. Avoid.

So US banks will enjoy a bounce today. But the bigger picture of deeply low yields and oil-related credit risk, accompanied by beefed-up sub-prime auto loans, student indebtedness, and leveraged loans, indicate that the system is more vulnerable than many think as loan losses mount. Lending is soft. Products are marked by deflationary pressures. US bank shares have been pummeled for a reason, hovering on bear market classification. The risk of owning them has risen. Despite intermittent bounces, we believe the sector is in trouble from an investment perspective. Banks need a different type of yield curve and normalised rates and better quality credit growth to make money. The oil price debacle adds fuel to the fire. I wonder if the horse has bolted and the prospects of US banks are now grisly though better than the forlorn markets of Japan and Europe. If you want to hold bank shares, selective EM just got more valuable though rates trajectories need to be monitored carefully there too.The oil price bear market, galvanised by supply and demand forces, is a kick in the teeth for -or a proverbial nail- to the US banking system. If energy prices remain at these low levels, we will see a sharp uptick in negative credit quality trends and losses at the most energy exposed banks.

US Financials: Energy Exposures Mean Boil, Boil, Toil and Trouble