As we have written in the past, in the Hamilton Capital Global Bank ETF (HBG), we generally prefer mid-cap U.S. banks over their larger peers. With respect to the Hamilton Capital Global Financials Yield ETF (HFY), our U.S. bank allocation is very small (~6%), because yields for the sector are among the lowest in global banking (although we expect them to rise in the next two years).
That stated, we continue to monitor the mega-cap banks for insight into key industry and economic trends. Among the mega-caps, we view JPMorgan (“JPM”) as a bellwether for the banking industry, as the firm is involved in virtually every business line (e.g. trading, mortgage banking, personal and commercial lending, credit cards, etc.). JPM held its annual investor day this week, which provided us with an outlook on how the executives are thinking about the potential changes to the regulatory environment, tax reform, and interest rates in the wake of November’s U.S. elections.
Regulatory Relief Could Lead to Higher Payouts
The bank is clearly expecting regulatory relief under the new administration, as it has now estimated that it will be able to shift to a “net payout ratio” of 80-120% in the medium term – i.e. increasing the aggregate capital returned from dividends and buybacks (reducing its CET1 ratio to closer to 11% from 12% currently). This return of capital to shareholders represents a huge increase over the bank’s 65% net payout ratio from 2016, and was a positive surprise. This bullish forecast came with large caveat: it assumes the bank will not be forced to hold additional capital as a result of further modifications in global capital rules from the Basel Committee. JPM noted this as the most important factor related to potential regulation.
Tax Reform Will Take Time
Unsurprisingly, bank executives stated that they are supportive of corporate tax reform in the U.S. Jamie Dimon, CEO of the bank, did note though that he believes it will take 12 months to pass the legislation (best case scenario), given the preference amongst lawmakers to first address healthcare reform. Importantly, the bank’s guidance for return metrics did not include any benefits associated with changes to the U.S. tax system. In our view, the market is pricing in material declines in corporate tax rates, applied retroactively to the beginning of the year, as it evident from the large expansion in P/E multiples.
Rising Deposit Costs Will Mitigate Benefits From Rates Increases
The bank’s presentation showed that it is experiencing a higher “deposit beta” in this rate cycle (the change in rates paid on deposits divided by the change in market interest rates). Put differently, the bank is paying out higher deposit rates as the Fed Funds rate increases, in order to retain customers (and keep this source of low-cost funding), which is mitigating potential margin growth. This is an extremely important observation, since many investors remain focused on the asset side of the balance sheet (e.g. loans and securities) and the potential for rising loan yields to support higher revenues/earnings. If JPM believes that it will need to pay out higher rates (than estimated by the market) for its deposit relationships, then the bank will benefit less from rising rates than previously expected. That stated, the bank still estimates that rising rates will be beneficial, and could potentially add ~$11bln in net interest income (cumulatively, based on the forward curve) over the next three years (for reference, the bank will likely generate ~US$100 bln of revenues in 2017 alone).
Note: Comments, charts and opinions offered in this commentary are produced by Hamilton Capital and are for information purposes only. They should not be considered as advice to purchase or to sell mentioned securities. Any information offered is believed to be accurate, but is not guaranteed.