Global banks: As good as it gets

Banks stocks are losing their shine as investors see a slowdown in earnings momentum even though economic growth expectations are high.

According to UBS's fourth quarter in-house banking survey, the percentage of respondents with a positive view on the sector outlook was down at 45 per cent (versus 56 per cent a quarter earlier).

But, it still exceeds the percentage of respondents with a cautious view at 19 per cent.

Sentiment has weakened both for developed market banks (50 per cent, down from 67 per cent) and emerging market banks (42 per cent, from 50 per cent).

“Despite the improving global growth outlook, the overall bank fundamentals outlook appears to be mixed: while loan growth expectations have improved further, the outlook for margins has started to weaken, given more dovish comments by central banks,” said UBS strategist, Philip Finch.

“The outlook for non-performing loans remains benign overall, although still improving in emerging markets, where asset quality is turning around after more than four years of deterioration.

“Banks are also paying increasing attention to cost control, with technological advancement raising further potential for the optimisation of branch networks,” he said.

Another positive theme that is gaining more traction is higher capital deployment, the survey found.

Capital return

Over the past decade, Finch concluded, banks have rebuilt their core capital positions in preparation for the new Basel III capital rules.

But weaker-than-expected risk weighted asset growth and/or management focus on return-on-equity/leverage has seen more banks returning more capital to shareholders, both in developed markets as well as increasingly in emerging markets.

Earnings momentum, while still positive, has started to moderate.

“Although our earnings-per-share estimates have risen by 3.4 per cent for 2017 and 2.7 per cent for 2018, in recent months, margin expectations have receded, resulting in 2018 return-on equity expectations easing to 11.2 per cent from 11.4 per cent in the past two months."

Despite a benign outlook for asset quality, ROE expectations have lost a little momentum with 2018 estimates easing to 11.2 per cent from 11.4 per cent in recent months.

All up, UBS is Neutral on US banks: weak loan growth prospects, especially in the commercial and industrial segment, have weighed on expectations for better margins from a rising interest rate environment.

“Comments by President Trump recently promoting tax reform have pushed up bank share prices, given bank tax rates are generally high compared with other sectors, so any cuts will likely flow to the bottom line, although, at current valuations, becoming fully priced in,' Finch noted.

Earnings momentum has been modest, remaining below global trends.

Not crazy about Europe or Australia

The banking specialists are also Neutral on European banks.

“Confirmation of the terms of the European Central Banks QE taper and potential clarity on what Basel IV means for the sector as a whole should support the sector rating into the year-end unless third quarter earnings revisions are unexpectedly weak.

“Volatility in geopolitics and the real-world impact of increasing the cost of money appear to have had little-to-no impact on investor enthusiasm for financials – we have no basis for forecasting that this will change.”

UBS is Underweight the sector in Australia because of what it perceives as a subdued outlook and a very challenging 2018.

“We expect the housing market to continue to slow, and, if this does not occur, further macro prudential moves are likely.

Mortgage mis-selling and responsible lending risks are a growing concern, margin pressure is will likely continue given interest-only switching, while bad and doubtful debt can no longer be a tailwind.

“The Australian banks do not afford as much leverage to rising interest rates as their global peers. With a Fed election likely during 2018, we believe it will be difficult for the banks to outperform."

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