Why investors shouldn't desert quality banks

Pendal

April 2023

Here, Pendal's head of global equities ASHLEY PITTARD makes the case for quality banks ahead of a likely US recession

• UBS, JP Morgan, Wells Fargo top picks

• US recession likely; should trigger a steepening of the yield curve

THE turmoil among global banks over the past six weeks has created opportunities for investors, with Swiss based UBS and Wall Street giants JP Morgan and Wells Fargo the top picks, says Ashley Pittard, our head of global equities.

"I think UBS is a standout for the next ten years as an investment," he says.

"You want to invest in a bank that's one or two in its market, and has high quality management.

"Bank stocks can go down in a crisis environment, but the quality banks don't go broke and that's a key point."

Banks should do well in coming quarters as they reprice credit and achieve higher margins.

"Near term, interest rates have stopped rising and the yield curve is flattish or even inverted.

"But if we fast-forward through the year, we believe there's going to be a recession in the US. That would likely mean the Federal Reserve will have to cut rates into next year.

"The yield curve will steepen and that's good for banks because they borrow short and lend long and they are going to get a wider spread. That will feed back in a couple of years' time into higher earnings."

The current turmoil could push out weaker lenders who aren't pricing loans rationally - which would help the top banks.

Short-term risks

Pittard warns there are risks in the short term.

"What are the write-downs going to be, particularly if the recession is hard? That's the big near-term risk.

"That's why you want to be with the highest quality banks - number one or two in their market."

On UBS, Pittard says its metrics are strong. It has just absorbed its second largest competitor, has a 30 per cent plus share in retail banking in Switzerland, and is the number one global bank for ultra-high net worth individuals.

Importantly, UBS has strong management, he says.

"The new CEO, Sergio Ermotti, is the Tom Brady of European banking," Pittard says, referring to most successful quarterback in US football.

Ermotti left the bank in 2020 after a successful stint, and then took the top job again on April 5.

"He first came to UBS after the global financial crisis and got them out of high-risk investment banking, increased market share in their ultra net worth business, and boosted dividends and the stock price. 

"He just grinds away. He gets costs out of the business, right sizes the riskier parts and gives money back to shareholders."

Pittard says two US bank stocks worth looking at are JP Morgan, run by the very experienced Jamie Dimon, and Wells Fargo, run by Charles Scharf.

"Dimon is the last remaining US bank CEO who actually went through the GFC," Pittard says. "Scharf got the CEO job at Wells Fargo in late 2019 and has cleaned it up and ticked all the boxes."

In terms of why the global banking sector found itself in its current situation, there are several factors, Pittard says.

"There were poor management practices. There's also been mishandling of the repricing of the rapid interest rate changes over the last year. You've also had volatility around what the US Federal Reserve is going to do."

Pittard says there's also a regulatory overlay.

"When Donald Trump was in power, he rolled back some of the banking regulations that were put in place directly after the global financial crisis which meant the regulation of smaller banks, like Silicon Valley Bank, was lighter than regulation of the big banks," Pittard says.

"Also stress testing of the bank last year didn't consider large jumps in interest rates, which is what actually happened."

Author: Ashley Pittard, Pendal's Global Equities

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