After a stomach-turning 2020, bank investors have reasons to feel hopeful next year.
The formerly shunned sector has increasingly won Wall Street’s favour as analysts predict funds will flow from highflying tech names into more value-oriented sectors. But banks could prove to be an attractive investment on their own merits, even without the sector rotation.
For one thing, the sector still looks relatively cheap. While fewer banks trade below tangible book value now than they did in the middle of the year, they still trade below their valuations seen at the end of 2019. As Covid-19 vaccines are rolled out, providing more confidence for a full economic recovery, bank stocks are expected to close that gap.
But while the whole sector is poised to do well, analysts at Keefe, Bruyette & Woods still see opportunities for stock pickers based on three themes they identified for 2021.
Credit conditions, though still somewhat uncertain, will be improving. In the first half of 2020, banks added tens of billions of dollars to their reserves in accordance with new accounting standards and the expected onslaught of soured loans due to the pandemic. While those bad loans might materialise next year, KBW analysts expect lower reserve levels in future quarters, providing a boost to earnings. Universal banks — a group that includes Goldman Sachs Group and JPMorgan — are expected to fare slightly better given their larger loan books. This cohort of banks could see earnings increase by 15.4% in 2021 and 4.6% in 2022.
Pretax, preprovision (PTPP) earnings will be in focus in 2021. In a continued low-interest-rate environment in which loan growth may also stay weak, investors will be looking at how banks manage their expenses. Banks that have been quick to adopt digitisation and have seen growth in online engagement will fare better than more branch-dependent banks. The team at KBW likes Goldman Sachs, State Street, First Republic Bank, Fifth Third Bancorp, First Horizon, Signature Bank, Western Alliance Bancorp. Pinnacle Financial Partners, Eastern Bankshares, Independent Bank, and First Merchants.
Capital return will also be in focus. In response to the economic uncertainty spurred by the pandemic, the Federal Reserve restricted banks from buying back their shares and capped dividends based on recent earnings. While the Fed will release the results of its second stress test this week, few expect those restrictions to be dropped. But in the second half of next year, when the economy is presumably on firmer footing, analysts expect buybacks to resume. Citigroup, Wells Fargo, Truist Financial, Fifth Third, and US Bancorp would benefit most from increased buyback activity.
Bank stocks did well in trading on 15 December, gaining 1.8%, while the S&P 500 advanced 1.3%.
Write to Carleton English at email@example.com
This article was published by Barron’s.