We believe four key themes will likely affect global banks in 2015, in terms of the industry’s underlying fundamentals as well as sector performance:
-Interest rates: In light of the diverging outlook for interest rates, we believe the prospects for net interest margins (NIM) are likely to be contrasting. On the one hand, we are moving closer to an inflection in banks’ margins in the US and the UK, but foresee potential downside risk to sector NIM in Japan and the eurozone especially if we have quantitative easing (QE). In emerging markets, the outlook is more mixed, with upside risk to NIMs in Brazil, South Africa and Mexico, but likely downside risk for those in China (following the recent cut in policy rates).
-Capital deployment: Given the low growth outlook for global banks, we believe capital deployment will become a more important theme for banks next year. Banks that are well positioned to increase capital deployment via dividend payments or share buybacks should be in a better position to outperform their peers and vice versa. We also think this theme will gain greater recognition in emerging markets as the cyclical slowdown in the sector’s balance sheet growth enters its third consecutive year.
– Rising cost of cross-border banking: Increased regulatory requirements are raising the cost of doing cross-border banking. The cost of compliance has weighed on returns, raising the question if this model adds value to shareholders. With the prospect of higher regulatory capital requirements especially for the largest global banks, and as shareholders put greater pressure on management to improve profits and returns, we expect to see more banks with cross-border exposure dispose of non-core and underperforming assets in order to unlock value.
– Renewed regulatory headwinds: We expect regulatory uncertainty to persist in two areas: (1) additional capital buffers for the largest global banks in the form of total loss-absorbing capital (TLAC) – while this is currently only a proposal, exact requirements are expected to be finalised in 2015, potentially pushing up the possible maximum theoretical TLAC capital to 26%; and (2) the introduction of risk weight floors by national regulators that are concerned with the low risk weightings generated from IRB (internal rating-based) models as used by the larger banks.
What are the risks?
Potential risks could arise from a hard landing in China, deflation in Europe, an unexpected shock to US inflation or more onerous bank regulation. A delay to the normalisation of Fed fund rates would postpone margin recovery in the US, but could also ease FX/liquidity concerns for emerging markets. There are upside risks, too: stronger-than-expected global growth would support business confidence, credit demand and risk appetite, and underpin the sector’s operating outlook.
Regional strategy: Upgrading US banks to overweight (from neutral)
Our upgrade of US banks reflects our positive macro growth outlook that should broaden the recovery in credit demand while the start of a new tightening cycle from mid-2015 bodes well for sector margins. We are neutral on banks in both Europe (remaining unconvinced that the latest ECB measures will stimulate loan growth although sector valuations appear to already price this in) and emerging markets (the recent China rate cuts have eased NPL fears) while maintaining our underweight stance in Australia (heightened regulatory risk and poor valuations).