Bank bail-outs, rate gearing and capital returns are the key themes for the global banking sector as raised by UBS analysts in a global conference call held on Friday.
Against a backdrop of an improving global growth outlook - and the prospect of less dovish monetary policy - the overall bank fundamentals outlook appears to be moving in the right direction – albeit gradually, and possibly not as fast as previously expected.
Loan growth appears to have bottomed out, while capital is building up and the prospect of central banks retreating from QE has pushed up margin expectations.
The outlook for bad debts also appears to be steadily improving – especially in emerging markets where asset quality is turning around after over four years of deterioration, and in parts of Europe, notably following banking resolutions in Italy and Spain, according to the wealth manager.
Another positive theme that is gaining more traction is higher capital deployment.
“Over the past decade, banks have rebuilt their core capital positions in preparation for new Basel III capital rules, but either weaker-than-expected risk weight asset growth and/or management focus on return-on equity /leverage have seen more banks returning more capital to shareholders, both in developed markets as well as increasingly in the emerging markets," said Jason Napier, UBS European analyst.
“The risk profile of European banks is improving. In recent weeks, we've had resolution of four weak banks in Italy and Spain without market turmoil, and capital increases from a number of others."
In Napier’s view, other reasons to be more upbeat include positive macro surprises, regulatory clarity and the resumption of earnings upgrades.
“At a time when more central banks are talking about retreating from QE, a more hawkish European Central Bank would also be positive for European banks, with a focus on how quickly and by how much rates could go up.”
European banks are up 12 per cent this year, outperforming the market by 5 per cent although Swiss and UK were down relatively speaking.
“Avoiding the UK and all the trappings of the volatility and fear around Brexit has been the best course of action," said Napier, noting that over the last two weeks the Bank of England has begun talking more about rate hikes.
“Sterling and the curve have gone up but investors are so worried about domestic finances that the banks haven’t moved.”
Turning to the US, the biggest driver of earnings-per-share upgrades this year has been higher rates, with net interest margins expected to expand further, although conversely, more recent dovish comments by the Federal Reserve appears to be supporting risk appetite towards emerging markets.
“In the US, capital deployment continues to exceed expectations, as illustrated by the latest stress testing results, while the appointment of the new head of bank supervision could facilitate more shareholder-friendly capital returns going forward," said US analyst, Saul Martinez.
“While, interest rates and NIMs should be a positive part of the earnings trajectory story. Now, offsetting that to a certain degree though is that you have seen sluggish loan growth. And that should accelerate, but when it starts to accelerate is a key question.”
With the global economy still looking reasonably optimistic with signs of reflation in the US, UBS expects Asian banks to continue to perform well.
“Generally, asset quality is holding together well, while loan growth is steady and margin expansion is starting to emerge in countries leveraged to rising global rates."
However, the regulatory pendulum is still moving against banks, particularly in Hong Kong and Australia where regulators worry about the housing markets. The bank levy is also an issue for the banking team.
“The risk is that you not only get federal taxes and the federal levy moving higher as budgets come under stress, but you also get some of the states trying to weigh into this discussion as well, so it becomes an open-ended argument, very very hard to control as a bank management team, if you're trying to build profitability.”
New banking reforms are also tipped for China. According to China analyst, Jason Bedford, the market has become too complacent in light of the People’s Party Congress at the end of the year.
“The appointment of new heads to the three regulatory bodies for insurance, banking and securities, as well as the recent slew of new regulation, all suggest a very serious commitment to financial reform," he said.
Bedford claims these new credit-tightening measures - which cap interbank borrowing at a third of a bank’s total liabilities - are not broad-based credit tightening but rather very targeted.
"The impacted banks are not the major institutions, not the big five banks, but rather some of the rapidly growing joint stock banks as well as many of the regional banks where annualised balance sheet growth can often be in excess of 60 per cent.”
ROE estimates globally have picked up to 11.1 per cent for 2017 and 11.3 per cent in 2018.