The global economy today is facing a multitude of challenges, from soaring inflation to the Russia-Ukraine war. The possibility of a slower-than-expected economic growth and deteriorating asset quality have led investors to become concerned over the earnings prospects of global bank. In this article, we discuss the recent global events and their impact on the global banks.
Ferlyn Tan | Published on 19 May 2022
• The world is anticipating an aggressive rate hike cycle. It is evident that short-term rates are moving up, and with higher interest rates, comes higher net interest income.
• Several of the major banks’ managements shared that they are still expecting to see loan growth in 2022 as corporations continue to ramp up capital expenditure to meet rising consumer demand.
• Consumer spending is likely to remain resilient, generally supported by the demand for services as international borders reopen again.
• Majority of global banks have been significantly reducing exposure to Russia ever since the invasion of Crimea in 2014, and they continue to maintain strong capital positions despite risk-weighted assets (RWA) inflation due to higher market risk.
• Recession risk remains to be the biggest risk that global banks are facing now. A recession will materially affect the banks’ outlook given the cyclical nature of the banking industry.
• Overall, we believe that the global economic outlook will remain constructive for the global banks, and investors can expect almost 30% upside potential from them by the end-2024.
Compared to the start of 2022, the global economy today is facing a multitude of challenges, largely because of the Russia-Ukraine war that started in late February this year. Inflation was already a concern due to supply-demand imbalances as the world emerged from the pandemic, and the war has exacerbated this issue given that both countries are major suppliers of essential commodities such as food and fuel.
To curb soaring inflation, all eyes are on the Federal Reserve and other key central banks as the market anticipates an aggressive tightening of global monetary policy, with at least seven rate hikes in the US this year. Uncertainty continues to plague the economy, which has led to significant market volatility over the last three months.
In light of the abovementioned issues, investors have become concerned over the asset quality of banks and the possibility of slower-than-expected economic growth, both of which will hurt earnings prospects going forward. In this article, we discuss the recent events and their impact on global banks.
Higher net interest income
During the March Fed fund meeting, the Fed finally approved its first 25bps rate hike, followed by a 50bps rate hike in the May meeting. It signalled for further rate hikes in each of the remaining meetings for the rest of the year, where more 50bps rate hikes could be expected. Meanwhile, central banks around the world have also joined the Fed in a race to raise rates in order to curb sky-high inflation. Both the Bank of England and the Reserve Bank of Australia (RBA) have raised their short-term rates by 25bps during their May meetings.
It is evident that short-term rates are moving up, and with higher interest rates, come higher net interest margins.
However, we acknowledge that the outlook for rising interest rates is not all rosy. What is expected to come next is slower economic growth, given that central banks are likely to raise rates aggressively in the coming months. Considering the cyclical nature of banks, it was not surprising to see a correction in the global financials sector, as measured by the S&P Global 1200 Financials Index (SGFS Index).
Chart 1: SGFS Index price movements
At the current juncture, we expect the global economy to continue its positive growth in 2022, albeit at a slower pace due to the spillover effects of the war. We maintain our stance that a growing economy would be accompanied by healthy loan growth across banks, which should further support net interest income.
Interestingly, several of the major banks’ management have shared that they are still expecting to see loan growth in 2022 as corporations continue to ramp up capital expenditure (CAPEX) to meet rising consumer demand. In fact, Wells Fargo (NYSE:WFC) has upgraded its guidance for loan growth in FY2022 from low to mid-single digits to mid-single digits. US Bancorp (NYSE:BNC) has also pointed out that higher loan demand is attributable to the fact that many businesses are catching up on years of underinvestment with respect to capital expenditure.
Given the expectation for higher interest rates and further loan growth, we can expect significant improvement in the net interest income of the banks in the next several quarters.
Resilient consumer spending despite the sky-high inflation
Over the past year, we have observed accelerating inflation as a result of an imbalance in global supply-demand dynamics. Inflation continued its ugly rise in April, casting doubt over future consumer spending (Chart 2).
Chart 2: Soaring inflation across the globe
However, we believe that consumer spending is likely to remain resilient amidst the global economic recovery. As mentioned in our previous article, we believe consumer spending will generally be supported by demand for services as international borders reopen again (Chart 3).
Chart 3: Spending on services is expected to support consumer spending as international borders reopen again
Moreover, we believe it is imperative to note that household balance sheets remain healthy, and consumers today are still in good shape thanks to the stimulus checks during the pandemic (Chart 4). Not only do they have a stronger ability to repay their debt, but they are also sitting on a lot of extra cash.
Chart 4: Consumers today are in good shape
It is also worth highlighting that consumer spending, especially in the travel, entertainment and restaurant segment, has remained resilient as evident in the banks’ 1Q22 earnings results.
VISA’s (NYSE:V) CEO said that he expects to see continued growth driven by a robust travel recovery despite an uncertain geopolitical environment. Meanwhile, Bank of America (NYSE:BAC) shared that both the dollar volumes and the number of transactions have grown steadily, in line with both the reopening of international borders and the shift towards digital payment methods.
To further discuss the heavily debated topic on purchasing power due to soaring inflation, JPM (NYSE:JPM) has also mentioned that it has yet to see any delinquencies picking up across the consumer segment, even in the Low-to-Moderate Income (LMI) segment. Nonetheless, this will be something that the banks will be monitoring closely in the coming quarters.
Strong capital positions despite higher volatility from the Russian-Ukraine conflict
Finally, wars are unpredictable and the outcome of the Russia-Ukraine war remains unforeseeable. Such uncertainty was reflected in the financial market in the first quarter of 2022, as we observed one of the most volatile periods ever since the depths of the pandemic in 2020.
At this juncture, investors are concerned over the banks’ asset quality, especially the European banks, given their slightly higher exposure to Russia as compared to other international banks. However, it is worth noting that the majority of the global banks have been significantly reducing exposure to Russia ever since the invasion of Crimea in 2014, as many lost confidence in Russia under Putin’s regime (Chart 5).
Chart 5: Exposure to Russia has reduced significantly over the years
Nonetheless, the first round of losses from direct exposure to Russia has already been accrued in 1Q22, during which big European banks such as UBS (NYSE:UBS) and HSBC (HKEX:5) reported higher provisions to reflect their direct and broader economic impact of the Russia-Ukraine war and inflationary pressures.
Societe Generale and UniCredit, the two banks with the highest exposure to Russia, have also provided further clarification regarding their asset quality over the past month, which was largely deemed as reassuring. Societe Generale shared in a press release that it will cease all activities in Russia and sell its stakes in its Russian subsidiaries. Despite that, the impact of disposal on the Group’s CET1 ratio is expected to be only about 20bps. UniCredit also remained very well-capitalised after taking into account the capital impact from Russia, which is still well above its minimum regulatory requirement.
Overall, global banks continue to maintain strong capital positions despite risk-weighted assets (RWA) inflation due to higher market risk. This puts them in a good position to weather heightened volatility ahead, especially if the Fed’s efforts to fight inflation result in a hard landing (Table 1).
Table 1: Strong capital positions to weather uncertainties
| Geography | CET1 Ratio | Minimum CET1 ratio | |
| JPMorgan | US | 11.9% | 11.2% |
| Bank of America | US | 10.4% | 9.5% |
| Wells Fargo | US | 10.5% | 9.6% |
| Citigroup | US | 11.4% | 10.5% |
| HSBC | HK/UK | 14.1% | 9.2% |
| Societe Generale | Europe | 12.9% | 9.2% |
| Deutsche Bank | Europe | 12.8% | 10.4% |
| UniCredit | Europe | 14.0% | 9.0% |
| UBS | Europe | 14.3% | 10.0% |
| Barclays | UK | 13.8% | 11.0% |
| Lloyds Banking Group | UK | 14.2% | 11.0% |
| Source: Respective banks’ 1Q22 reportsData as of April 2022 |
While provisions will not return to COVID levels, investors should still be aware that provisions will be higher in 2022 relative to 2021. This is largely because many banks managed to reverse their provisions set aside thanks to lower COVID-related losses in 2021.
A recession is the key investment risk
With all said and done, recession risk remains the biggest risk that global banks are facing now. A recession will materially affect the banks’ outlook given the cyclical nature of the banking industry.
In the event of a recession, corporations will likely cut back CAPEX plans, affecting the banks’ loan growth, while consumer spending is expected to fall. We reckon that a significant amount of provisions will also have to be set aside, as many businesses or consumers may struggle to stay afloat during a recession. In such a scenario, the banks’ profitability will deteriorate significantly.
The possibility of a suspension in capital return programs may be something to take note of as well, especially if the current geopolitical situation deteriorates. Capital return programs are an important component of bank investors’ total return, therefore, any intervention by regulators to suspend dividends or share buybacks will weigh on investor sentiment.
Global banks remain attractive
Overall, we believe that the global economic outlook remains constructive for global banks, which make up the lion’s share of the global financials index as of April 2022.
Based on our fair PB multiple of 1.3X, investors can expect over 30% upside potential by the end-2024 after the recent pull-back in equity markets (Table 2). As such, we maintain our star ratings for the global financials sector at 3.5 Stars “Attractive”. On top of that, investors can also expect an average dividend yield of 2.7% per annum after taking into account dividend withholding tax.
Table 2: Valuations of the global financials sector
| FY2021 | FY2022 | FY2023 | FY2024 | |
| PE ratio | 9.9 | 10.9 | 9.6 | 8.7 |
| Earnings growth | 74.2% | -9.5% | 13.0% | 10.9% |
| EPS | 150.9 | 136.5 | 154.3 | 171.0 |
| PB ratio | 1.1 | 1.1 | 1.0 | 1.0 |
| Book value per share | 1,362.3 | 1,350.9 | 1,453.0 | 1,556.3 |
| Projected fair price (based on 1.3X fair PB ratio) | 1,956.1 | |||
| Potential upside | 31.5% | |||
| Source: Bloomberg Finance L.P., iFAST estimatesData as of 19 May 2022 |
To take part in the growth of the global financials sector, our preferred approach is through the Blackrock World Financials A2 USD, which gives investors a comprehensive exposure to both traditional financials and FinTech. Nonetheless, if you prefer a passive approach, our recommended ETF for the global financials is the iShares Global Financials ETF (NYSE:IXG).
Table 3: Recommended products for global financials
| Unit Trust | ETF | |
| Global Financials | Blackrock World Financials A2 USD | iShares Global Financials ETF (NYSE:IXG) |