Now is not the time to give up on the US banking sector

While investors’ recent experience with bank equities and fixed income securities has proven “hazardous” and led to some investors, based on a collapse in confidence, declaring the sector “un-investable”, Brist says there are significant grounds for optimism.

“While it appears that no immediate positive catalysts are on the horizon, we believe now is not the time to give up on the US banking sector,” he says. “Investors have been focusing on the near-term negative details and have all but disregarded what we believe are the solid, longer-term fundamentals.”

The abnormally low interest rate environment, legal and regulatory pressures, and European contagion fears are all contributing to the overwhelmingly negative sentiment and associated “buyers’ strike” in the US financial sector, says Brist. But he believes the resulting low valuations provide an attractive opportunity for investors to boost their weightings to US bank stocks, although he cautions it may take time for the position to bear fruit.

“A move to overweight US banks may not be rewarded immediately but we believe that longer-term balance-sheet fundamentals will ultimately be reflected in spreads,” he says. “Investors are still ignoring the improvements made to bank balance sheets across the globe but they should remember this is about investing for the coupons of the future, not the past.”

Brist points out that US banks have almost doubled the amount of tangible equity on their balance sheets over the last two years and have reduced their reliance on the commercial paper market as a funding vehicle. Moreover, he highlights the fact that banks are experiencing a decline a new delinquencies, with loan-loss reserves falling across the globe. Indeed, recent analysis shows that 80% of US bank losses have already been written off, with 20% of future losses expected to be absorbed through earnings and revitalised capital bases.

“While we are very concerned about near-term volatility and the fact that negative sentiment can influence consumer behaviour, we do not believe that large-cap US banks represent future defaults for bondholders around the world,” he says. “The next three to six months may continue to be a very bumpy ride, but in the longer term we do not expect loss of principal on fixed-income securities of the major financial institutions.”

Nor does he believe that the recent rating agency downgrades of a number of US banks should have any bearing on investors’ perception of the sector. “We believe that balance sheet fundamentals do not correspond to the underlying ratings trajectory,” he says. “Large-cap US banks have made undeniable progress in funding, capital adequacy and asset quality. Credit worthiness has improved substantially. But we don’t expect good news anytime soon on the ratings front. The recent downgrade of Bank of America is just another example of Moody’s overcompensating for its mistake of overrating the sector.”

Additionally, Brist says there is little to be gained from comparing the current market environment with the liquidity-driven financial crisis of three years ago. “Today, we have the opposite situation; while a lack of confidence still shadows the market, banking deposits have never been higher, and banks are flush with liquidity on their balance sheets. Fundamentally, the so-called ‘wall of worry’ is sounding from a very different starting point than it did in 2008.”