Banking on Better Loan Margins From Interest Rate Hikes
US interest rates were reduced to near zero during the onset of the pandemic in March 2020 to fend off a sharp recession. With the economic recovery currently well on track towards normalisation, the US Federal Reserve (Fed) has signalled that it will continue to hike rates to keep inflation within its healthy target of 2%.
For US banks operating from positions of strength, higher rates will boost their income from both consumer and corporate lending as the American economy gets a lift from a post-pandemic resurgence in economic activities. This is already evident in higher levels of employment rates, job vacancies and strong corporate earnings.
The ongoing economic recovery will support banks’ income from higher levels of consumer loans and credit spending, while also lowering risks from non-performing business loans. Many banks have indicated strong loan demand and a healthy influx of enquiries from potential corporate borrowers. The conditions will improve with further expansion of the post-pandemic economy and a gradual easing of supply chain bottlenecks.
Overall, these will lead to improved net interest margins (NIMs) for US banks, despite the flattening or narrowing spreads between the 2-year and 10-year US Treasury yields (typically a past indicator of slower growth) (Figure C6).
Figure C6. The flattening US Treasury yield curve is unlikely to affect banks’ net interest margins and will be driven by loan growth in the months ahead.
Source: MRB Partners, March 2022.
Near-term challenges from Western sanctions against Russia will be limited due to minimal direct exposure to the Russian economy1 (which was already cut back drastically following Russia’s previous annexation of Crimea in 2014).
Valuations of bank stocks generally trade at large discounts to the overall market. Current price-earnings (PE) ratios of US Financials stocks are at an attractive 12.8x, lagging the broader market’s 15.7x and representing a 20% discount which is in line with the average discount over the past decade.1
We remain upbeat on US bank stocks over the next 6 to 12 months, with the view that US economic growth, while moderating, will stay at a strong expansionary level for the year ahead. These salient factors point to opportunities for investors looking to ride on rising interest rates.
- 1MRB Partners 29 March 2022.
