Stephen Biggar, Director of Financial Services Research, Argus Research Group
Stephen Biggar is Director of Financial Services Research at Argus Research Group specializing in banks and asset managers. Mr. Biggar is responsible for coverage of large global banks, regional banks and domestic credit card companies.
“We can look at pre- and post-pandemic, or at least the start of it, clearly all the groups like everything else had a pretty difficult time in early 2020 and most were growing fairly well before that. And the pandemic had a way of checking some winners and losers along the way.
Banks had a difficult time as the Federal Reserve moved rates down to zero.
So that had a pretty poor impact on net interest margins.
But that was kind of quickly superseded by — about a quarter or two later as we started to emerge, it became clear that particularly for the large banks and multinationals that trading was doing extremely well. Companies were very active in investment banking, debt and equity underwriting.
Of course, when rates go to zero, that helps debt underwriting.
People were scrambling to refinance at much lower rates. There’s growth in a lot of technology areas. So the investment banking side for the banks did very well.
And then once the economy got going again and the stimulus impact began to wear off, then you had a resumption of loan growth that started in mid to late 2021. And then you had the prospect of higher interest rates from the Federal Reserve to tame inflation.
So you had a resumption of widening of net interest margin. That lasted until earlier this year.
And now we have again a return to the negative cycle where investors are concerned that there’s going to be a very aggressive Fed rate hike cycle here and that’s going to result in a much slower economy and that is not good for loan growth and that may not be good for credit costs, which had up till now been at historically low levels.
So that’s largely the picture.”
Banks and asset managers benefit in rising interest rate environment from being “asset sensitive”.
“Banks are almost universally what analysts would call asset sensitive, which means their assets reprice faster than their liabilities and that is therefore helpful in a rising interest rate environment.
When the Fed raises the Fed funds rate, they immediately raise the prime rate and that’s beneficial. And then they’re slower to reprice liabilities like deposits.
That’s an enormous tailwind.
Banks can make money a few ways. The short end, which largely controls the prime rate and there’s a lot of lending based off that. And then the long end, residential mortgages are based off the 10-year yield generally.
And so when the long end of the curve moves up — so banks will talk about a parallel shift upward or downward in the yield curve, meaning that for every 25, 50 or 100 basis points increase across the yield curve, that will be beneficial by so many — 100 million or 1 billion — to net interest income.
And that’s basically when you’re not doing anything, right? It’s just an automatic tailwind as rates move up. But to a point.
Obviously, if rates move up too quickly and it slows the economy too quickly as well, then you have an impact on lending growth and if banks aren’t making new loans, then they’re not going to benefit as much from that higher interest margin.
And if it slows the economy to the point that there are layoffs that means that credit costs are probably no longer going to be at historical lows.
There is a very high correlation between unemployment levels and credit costs for banks.
If you have a job or if you lose a job and find it easy to replace one, you tend to stay current on your bills.
But if you lose a job and can’t find another job to replace it then you might go delinquent on your bills and that’s where higher credit costs come in for banks.
Banks are starting to put more money aside in expectation of higher loan losses and starting to guide a bit lower for less loan growth as the Fed is aggressive on rate hikes and cools the economy.”
The current legislative and regulatory environment for banks and asset managers is positive in the United States.
“…Regulation, which is always, I think, on the minds of bank investors, and maybe increasingly asset managers — I’ll get to that in a second — but the regulations for banks in particular. Now, we’ve got a CCAR — Comprehensive Capital Analysis and Review — cycle coming up, with an announcement from the Fed later in June where they once a year green light or red light the capital return plans of banks on buybacks and dividends.
Banks up until now, throughout the cycle, had been pretty flush with capital.
So we expected a pretty good improvement on returns based on that.
Now they submit these plans much earlier in the year and then the Fed takes a few months to take a look at all the ratios and see if it’s proper for banks to have the kind of returns that they’re asking for. So it’s going to be a tricky cycle, given what’s transpired since earlier in the year.
Still we expect decent returns, elevated buybacks. I think banks are particularly interested in buying shares back at these reduced levels and would like to return more in terms of dividends as well.
Of course, two years ago there was a moratorium on dividends for the 2020 cycle because of the pandemic.
So, banks — the CCAR banks anyway, the systemically important ones — didn’t have any increases. And then came the improvement a year later in the 2021 cycle. So not completely made up perhaps from the year of no increases.
Banks do have some flexibility there to improve returns across the board.
And there was an interesting proposal yesterday for the asset managers.
Senator Sullivan, out of Alaska, introduced legislation that would return the voting of shares from the large asset managers, which have up till now had the power over how they vote shares that are in ETFs and mutual funds and so forth.
The three largest companies here, BlackRock (NYSE:BLK), Vanguard and State Street (NYSE:STT) have about $20 trillion in combined assets, and they vote something like 25% of all votes at annual meetings.
If that bill passes, it removes a lot of political power from these large firms and others in the asset management space embracing ESG standards for business and so forth.
And shares aren’t always voted, I guess, in the way that an individual shareholder that owns these funds would want them voted. And so it’ll be an interesting power dynamic change, if that goes through as well.
A lot of firms, companies — and politicians for that matter — will want to put pressure on some of these asset management firms to vote a certain way. And so that’ll be an interesting, again, power dynamic change.”
This leads Stephan Biggar to several specific stock picks from his banks and asset managers sector:
“I think Invesco and BlackRock is the way to go. We didn’t touch on a few others, like, maybe Charles Schwab (NYSE:SCHW), who would normally be a natural benefiter from the higher interest rates, also just had a difficult time with the asset levels, so they’ve pulled back. But nothing too surprising there.
Schwab is another company we like because of the product creation, the efficiencies. They rolled out their own ETFs which got a lot of traction and are much more profitable for them.
They have a strong adviser base that attracts assets over time. So that’s another long-term, I think, strong growth story.”
Get the entire list of current banks and money manager company stock picks from Stephen Biggar, Director of Financial Services Research, only in the Wall Street Transcript.
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