The Strategist

Is it worth investing in US banks now?

08/03/2018 - 11:46

American banks are boosting profits due to stable economic growth in the US and an increase in interest rates by the Fed. For an investor, this means a good opportunity to earn on shares of companies from the financial sector. It is important to remember the main risk of 2018 is a large-scale trade war that can bring down the quotes of the largest US banks.

longislandwins via flickr
longislandwins via flickr
The season of corporate reporting in the US has just started, but already now we can sum up results of one of the industries. Currently, 15 of the 18 traditional US banks, as well as the largest investment banks such as Goldman Sachs and Morgan Stanley, have disclosed their financial results. Judging by dynamics of their indicators in the second quarter, an investor can determine the favorites in the financial sector, as well as those who maintain the growth potential, despite the growing risks of trade wars.

There is no clear leader in the next round of confrontation between Morgan Stanley and Goldman Sachs, the two major US investment banks. Revenues of Goldman Sachs grew by 19% in the second quarter, while figures of Morgan Stanley rose by 12%.

At the same time, the banks have shown good results in the securities market. Goldman Sachs reported a noticeable increase in revenues in the debt securities segment, and Morgan Stanley - in the segment of shares. In the future, the direction of work with shares in Morgan Stanley can only grow, as the trading desk in the bank was headed by a portfolio manager responsible for the shares. So if a nine-year bullish trend on the US stock market continues, then Morgan Stanley can get extra profit.

Goldman Sachs has retained the title of the largest US investment bank, as its revenues in this segment of services increased by 18% to $ 2.05 billion in the second quarter, which is higher than any of the financial institutions. However, the corresponding business of Morgan Stanley showed more confident revenue growth - by 20%, to $ 2.01 billion.

Goldman Sachs’s managers team can only strengthen with the arrival of new CEO David Solomon since October 1. Goldman Sachs’s intention to develop the retail business segment with the product Marcus is much more interesting. The number of retail customers of the bank has already reached more than 1.5 million at the end of the first half of the year. The company is developing cooperation with Apple, issuing consumer loans, and the DJ's experience of the new leader can help Goldman Sachs become closer to the people.

Goldman Sachs' interest in retail business is not accidental. The US economy is growing at a good pace and is supported by the consumer activity of Americans. Number of payments and retail loans is increasing the, and this is where the bankers earn. The main major banks - beneficiaries of this situation – are JPMorgan Chase and Bank of America. The quarterly report of Bank of America was one of the most pleasant for investors - profit was 12% higher than analysts expected, which caused the stocks to grow by 4.3% on the day of publication of financial results.

Bank of America shares retain their growth potential due to increased demand for loans from businesses. The policy of the Federal Reserve on raising interest rates also has a positive effect on the yield of loans. In addition, the margin is growing thanks to an effective program to reduce costs in the bank.

Once again, JPM was able to boast the best indicator of profitability with ROE of 11.3%. The bank is good not only in retail; it also showed better dynamics of proceeds from stock trading in the second quarter, increasing it by 24%. The diversified business model of JPM allows investors to count on a balanced growth. JPM shares retain a growth potential of 8% by the end of the year.

Reports from other major banks, Wells Fargo and Citigroup, were less than welcome. Wells Fargo, the only major bank, showed a decline in revenues due to restrictions imposed by watchdogs. Citigroup cannot succeed in retail and is more exposed to the risks of deteriorating international relations due to its business model.

Investing in US banks

The risks of the trade war continue to put pressure on many companies, including the financial sector, but some banks are much less influenced by the main "black swan" of 2018. First of all, we are talking about small and medium-sized players.

While the exchange traded fund (ETF) of the financial sector XLF, which include shares of all industry companies from the S&P 500 index, is barely being selected as a plus this year, the ETF of regional banks KRE is steadily growing in price. Since the beginning of the year, it has risen in price by more than 6%. The results of the second quarter serve only as a confirmation of this dynamics.

For comparison, the average profit growth of the five smallest banks among the 15 reported was 42%, while profits of the five largest banks grew by 22%. The two-fold difference is due to the greater share of American customers of small banks. American business received a good impetus due to tax reform, which contributed to the growth of investment and demand for loans. In addition, liberalization of financial regulation has affected small banks to a greater extent, which will continue to contribute to their growth. So ETF KRE becomes an attractive investment idea in the era of trade disputes.

In general, reports of financial companies exceeded investors’ expectations by 5%, so that the second quarter can be called successful for bankers. The effects of tariff increases have not yet affected international business contacts, but remain a significant risk. The main driver for development of the banking business will be stable economic growth, since the financial sector is the "circulatory system" of the economy.