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September 2018 | Corporate Credit Views

Sector Spotlight: US Banks


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Within our investment grade corporate strategy we are overweight European and US Bank issuers¹. We expect the banking sector to benefit from improved capital positions and a rising rate environment. Below we outline dynamics in the US Banking sector, some of which are more constructive outlook for larger banks with national presence relative to smaller regional banks. Overall, we prefer larger banks that are able to attract deposits and keep costs low due to technology capabilities. Similarly, we seek to limit exposure to smaller banks with undifferentiated deposit offerings.

1. Divergent deposit and loan trends. Larger banks have increased their retail deposit base by 40% over the last five years; four times more than smaller regional banks that account for 18% of the bank branch count. At the same time, smaller banks have embarked upon greater loan issuance. This has led to a rise and decline in loan-to-deposit ratios for smaller and larger banks, respectively (Fig.1). A higher ratio for smaller banks means a higher reliance on deposits to fund loan growth, and therefore a higher or more competitive rate of interest to maintain deposits (i.e. higher costs).

2. A smartphone is closer than a branch. Smaller banks have had their key competitive advantage–the convenience of a local branch–upstaged by the advent of online banking. Second quarter earnings calls revealed large national banks are increasing investment expenditure on technology to develop tailored services for specific customer groups; we do not think smaller regional banks have will keep pace with the scale or scope of these technology investments.

3. Deposit incentives. Growth in both retail and commercial deposits is moderating; the former faces competition from a large number of online deposit products and the ease of switching to the highest deposit rate provider, while the latter is being pressured by money market flows and high net worth clients moving into equity market. These shifting market dynamics are compelling banks to adapt and offer incentives to both attract and retain deposits. Larger banks are able to take advantage of their scale and branding power, offering higher rates of interest, cash rewards on debit card transactions, and services that allow users to better manage their finances.

4. Value of a bank is determined by its deposit franchise. Loan growth can be deployed by both smaller and larger banks but bank profitability lies in the ability to finance these loans at a low cost. Larger banks are able to secure funding at a relatively lower cost, and as outlined above, are able to attract and retain deposits through investment in smart phone banking and by offering incentives. Furthermore, with the US Federal Reserve’s (Fed) balance sheet unwind underway, the overall deposit base in the system is set to decline; we think larger banks will fare better with respect to both retaining deposits but potentially also gaining deposits from smaller banks.

5. Demographics – baby boomers outweigh millennials. While the preferences of the millennial generation are upending sectors from retail to autos, finance is one sector where we think the ‘baby boomer’ generation still claims greater weight – largely due to their heavier wallets (Fig. 2). We believe that these deposits are likely to be directed to larger banks with strong industry positions.

Exhibit 1: Divergent deposit-to-loan trends


Exhibit 2: Demographics – older savers matter



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