17-Nov-23 Americas

Unloved U.S. banks

Compared to the overall market, the U.S. bank sector is bobbling around near its record lows. Rightly so, we say, because banks don’t offer much to please shareholders.

When the U.S. inflation figures surprised slightly to the downside on ,November 14th, markets reacted strongly, and banks were among the main beneficiaries. At its peak, the S&P 500 banks index gained almost 5% during the day. Such good days have been rare this year. The big slump came with the regional banking crisis in March, and the index has not been able to recover sustainably since then. It is currently once again trading close to its historic lows compared to the S&P 500.

This Tuesday’s (November 14th) reaction may seem surprising at first glance, as banks are normally beneficiaries of higher interest rates (which higher inflation would oblige). But this year has not been normal. Not only because of the speed of the interest rate hikes, with fast corresponding losses in value for bonds, especially long-dated bonds. But also because U.S. regulators have used the difficulties of the U.S. regional banks as an opportunity to start tightening the rules – from higher capital requirements for the big banks, to stricter accounting requirements and stress tests for the smaller institutions. But the biggest headwind for banks remains higher refinancing costs. 

Share of U.S. banking sector in the market capitalization and net earnings of the S&P 500

*Market Cap share of S&P 500 Banks Index less income share of banking sector of S&P 500

Sources: Bloomberg Finance L.P., DWS Investment GmbH as of 11/14/23

Now that the Fed's cheap money has dried up, banks have had to focus on traditional customer deposits again in order to obtain liquidity. And customers appears to be aware that while government bonds have been yielding up to 5% this year, they are being paid a fraction of this for their bank deposits. This could lead to a corresponding outflow of funds from banks if they do not raise the deposit rates they offer.

Our Chart of the Week does not show the performance of the S&P 500 banks index versus the S&P 500, but rather the share of the sector’s market capitalization in the overall . It shows that we are getting very close to the lows of 2008 again. And the share has more than halved since 2003, to less than 3%. This is not surprising since, as the chart also shows, banks' share of profits in the overall index has also halved – to 8% now. A 3% share of market capitalization versus an 8% share of profits – this shows the valuation discount investors are applying to the banking sector. For good reason, as the sector combines a very cyclical, low-margin business model with high capital intensity and high regulatory pressure.

What is perhaps more surprising, as the chart also shows, is the narrow range in which the valuation discount has moved, especially over the last ten years. For the time being, we see no reason for the U.S. banking sector to break out to the upside. The headwinds are too strong for a narrowing of the valuation discount to occur. These headwinds include the noticeable weakening of the U.S. economy that we now expect and consequent increase in insolvencies. We believe it is too optimistic to expect even a medium-term improvement in margins at the largest banks due to the ongoing consolidation that is taking place [1] Individual banks too regularly surprise us with major operational slippages. In the past twelve months the four largest banks have earned a good profit overall (for a total of around 115 billion dollars between them). However, almost half of this was attributable to just one bank.

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1. Which can only happen organically, as banks with a market share of deposits of more than 10% are generally not allowed to pursue acquisitions.

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