There’s no better time than now to buy into US banks. Here’s why

The Bank of Singapore (BoS), a subsidiary of Oversea-Chinese Banking Corporation (OCBC), remain "overweight" on the US financial sector due to the potential de-regulation for US banks as well as their prospects for higher-than-expected rates.

In a fully-valued and sideway market, it continues to advocate for investors to employ a rotation strategy - namely rebalancing out of overvalued sectors like technology, and rotating into undervalued sectors such as US financials.

"We think the markets are underpricing inflation and the Fed's hiking cycle. If inflation expectations were to increase and the Fed to raise rates according to its plans, the financial sector could benefit from it," comments BoS investment strategist James Cheo in a Friday report (30 June).

This comes after the US Federal Reserve's release of its Dodd-Frank Act Stress Test 2017 results, which suggest that banks are now have stronger capital positions and better risk management, and therefore more likely to have higher dividend payout and more share repurchases.

For the first time, the Fed has also waved through the capital distribution plans of all the major banks that it has tested, giving the green light to a record level of post-crisis distributions - share buybacks and dividends.

Cheo believes the favourable stress test results reinforces the bank's positive view on the financial sector, and recommends Capital One Financial Corp as well as Wells Fargo & Co as his top "buy" picks among the US banking sector, with fair values of US$102 and US$67, respectively.

"The reasons behind the Fed's sanguine outlook is because US banks have substantially increased their capital since the first stress tests in 2009. The common equity capital ratio - which compares high-quality capital to risk-weighted assets - of the 34 banks has more than doubled from 5.5% in the first quarter of 2009 to 12.5% in the first quarter of 2017," explains the strategist.

"This reflects an increase of more than US$750 billion ($1 trillion) in common equity capital to a total of US$1.25 trillion now."

Further, Cheo believes that the Fed makes its stress test "less onerous", judging from how it dropped its qualitative part of the test in recent years for smaller US lenders and several foreign groups.

"In the past, Fed has urged the banks to build capital and to improve the way banks monitor risks. Even if they passed the test, banks were often issued with long lists of 'matters requiring attention'. Now, it appears that the Fed is becoming more comfortable with the ways banks manage their risk," he observes.

Noting that the 34 US banks tested were, in aggregate, projected to pay out close to 100% of net earnings over the next four quarters compared to 65% last year, Cheo says banks such as JPMorgan will be returning more capital than they are generating, while many of the rest will be radically lifting payouts from previous levels.

Citigroup, for instance, was recently cleared to return US$18.9 billion to shareholders, which represents an 82% increase from the year before.

"Ever since the financial crisis, shareholders of banks had to live with a pare-back payout as the Federal Reserve wanted the banks to rebuild its capital positions. With the improved capital positions and better risk management, US banks are now able to give higher payouts either in dividends or share buy backs," concludes Cheo.


Source :
1) TheEdge Singapore, 3rd July 2017.