Ferlyn Tan | Published on 24 May 2021


• The banking industry has been one of the most favoured industries this year, with the KBW Nasdaq Bank Index more than doubling from its March low.

• Most banks are now flushed with liquidity due to the massive fiscal stimulus. As the banks redeploy their excess capital into higher-yielding assets, such as loans, it will provide support to the banks’ net interest margins (NIM) and profitability.
• Revenue diversity is one of the US banks’ biggest strengths. Even in a low-interest-rate environment, banks are still able to generate revenue from intermediation activities that produce fee income, instead of depending solely on deposit-taking and lending.
• While we do not expect any rate hikes this year, an earlier-than-expected rate hike will be a major catalyst for the industry as banks tend to benefit in a rising interest rate environment.
• To gain exposure to US banks, investors can consider the Invesco KBW Bank ETF (NASDAQ:KBWB), which has an upside potential of about 11% by the end-2023 and an average dividend yield of about 2.0% (after dividend withholding tax).  
The banking industry has been one of the most favoured industries this year, with stronger earnings prospects propelling the share prices of banks globally, especially US banks. Not only have US banks reversed a portion of their credit reserves in 1Q21 given the brighter economic outlook, they are also expected to face significantly lower loan loss provisions in 2021.
As a result, the KBW Nasdaq Bank Index, which measures the performance of leading US banks, has more than doubled from its March low (Chart 1), and unsurprisingly so. Despite the strong performance, we continue to see several catalysts that will support the share prices of US banks as we move further into 2021. 

Chart 1: Strong rebound since March low

Improving credit environment to drive loan growth and net interest income 

Thanks to the massive fiscal stimulus in the past year, there has been a surge in deposits across US banks. Commercial bank deposits recorded a growth of more than 20% on average, a figure that is way above the five-year historical average of approximately 5%. However, loan growth lagged behind drastically, with total bank lending falling by -0.2% over the same period (Table 1), providing a drag on net interest income across US banks.

Table 1: Growth in bank loans and deposits across top US banks in 2020
Company NameTicker CodeDeposits growthLoan growth
Bank of America CorpBAC25.1%-5.6%
Wells Fargo & CoWFC6.2%-6.3%
Citigroup IncC19.6%-2.5%
JPMorgan Chase & CoJPM37.2%5.5%
Truist Financial CorpTFC13.8%-0.8%
State Street CorpSTT31.8%6.1%
Bank of New York Mellon Corp/TheBK31.6%2.8%
US BancorpUSB18.7%1.6%
Capital One Financial CorpCOF16.3%-4.5%
Fifth Third BancorpFITB25.2%2.3%
PNC Financial Services Group Inc/ThePNC26.6%1.1%
First Republic Bank/CAFRC27.5%24.0%
Average of large US banks23.7%-0.2%
Source: Bloomberg Finance L.P., iFAST compilationsData as of 31 December 2020

However, on a brighter note, most US banks are now flushed with liquidity, and this means that they could start redeploying their excess capital into higher-yielding assets, such as loans, as the credit environment improves. In JPMorgan’s 4Q20 earnings call, its management guided that they are expecting loan growth to normalise in 1H21, before picking up in the second half of this year. Bank of America has also expressed optimism that it will return back to positive loan growth this year. 
While we expect the Fed to hold off on interest rate hikes until at least next year, a further expansion in the loan books of US banks is able to minimise the impact of a still-low interest rate environment, providing support to the banks’ net interest margins (NIM) and profitability.  

Revenue diversity is one of the US banks’ biggest strengths

In our previous article, we shared that the revenue streams of the large US banks are generally more diversified than their international peers. They derive about 40-50% of their total net revenue from non-interest income, while its international peers, like Singapore and Chinese banks, derive approximately 15-30% from non-interest income.

Chart 2: Most US banks derive a large part of their revenue from non-interest income 

In a low-interest-rate environment, having a more diversified business model is an advantage for banks as they are still able to generate revenue from intermediation activities that produce fee income, instead of depending solely on deposit-taking and lending, which are interest-generating, helping to support bank profitability. Moreover, as economic activity picks up, this bodes well for the several segments that help to drive the banks’ non-interest income.
Card fees: Consumer spending has normalised over the past few quarters, thanks to the reopening of the US economy and the generous stimulus package announced by the government. Besides, we see further upside in consumer spending, a development that could drive an increase in card fees, especially if consumer sentiment continues to improve on stronger economic fundamentals, and as a recovery in US domestic travel gets underway. 
Investment banking fees: Investment banking fees are also expected to improve, largely supported by equity underwriting fees given the still-buoyant IPO market, even as fixed income underwriting fees are expected to moderate after an exceptional year in 2020. 
Wealth management fees: Finally, the wealth management arm of the banks will continue to do well in the next few years. PwC has forecasted that assets under management (AUM) in North America will grow at a CAGR of 4.0% from now till 2025 and this should translate to higher wealth management fees in the years to come. 


Earlier-than-expected rate hike a major catalyst for US banks 

We maintain our stance that there will not be any rate hikes for this year, but with inflation risks lurking against the backdrop of a rosy economic outlook, there is the possibility that rate hikes may be brought forward, with the Fed unwinding its easy policies earlier-than-expected.
This will be a major catalyst for the industry as banks tend to benefit in a rising interest rate environment. An earlier-than-expected rate hike will lead to an expansion in NIMs. Combine this with a rapid increase in bank lending, and it will certainly help to drive a sharp increase in net interest income, which represents the other 50% of the revenue generated by US banks. 
That said, even in the absence of an interest rate hike this year, we believe US banks will continue to see strong earnings growth.

One ETF to gain exposure to the top banks in US

As the world continues to recover from the COVID-19 shock, we believe that the US banking industry remains an attractive space for investors to be in.
To gain exposure to US banks, investors can consider the Invesco KBW Bank ETF (NASDAQ:KBWB), which tracks the performance of 24 leading banks that are publicly traded in the US. Based on our valuation methodology for the sector, built on a fair PB ratio of 1.35X, we arrived at our end-2023 target price of USD 76. This translates to an upside potential of about 11% (Table 2).

Table 2: Earnings projection of the KBW Nasdaq Bank Index
FY2020FY2021FY2022FY2023
PE ratio21.314.313.211.8
Earnings growth-33.4%49.0%8.3%11.8%
EPS (USD)6.29.310.011.2
PB ratio1.411.331.251.17
Book value per share (USD)93.699.6105.4112.8
Projected fair price (based on 1.35X fair PB ratio)147.3
Potential upside11.4%
Source: Bloomberg Finance L.P., iFAST estimatesData as of 24 May 2021
Chart 3: KBW Nasdaq Bank Index vs. EPS 

 Besides, investors can also expect an average dividend yield of about 2.0% (after dividend withholding tax) in the next few years. The Fed has recently announced that the US banks may resume dividend growth and share buybacks after the upcoming stress test in June 2021, which means that investors could potentially receive a higher dividend yield.

As a bonus, investors will be pleased to know that the Invesco KBW Bank ETF (NASDAQ:KBWB) has recently been added to our ETF RSP list.
Declaration:
For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) and the analyst who produced this report hold a NIL position in the abovementioned securities.