Growth Drivers for Banks and the Opportunity in Diversified Financials

Financial Funds Portfolio Managers David Ellison and Ryan Kelley discuss the current strength and historically low valuations of the banking sector. They discuss growth drivers for banks and highlight the opportunity among diversified financial and fintech firms. 

September 2019

  • David Ellison
    David Ellison
    Portfolio Manager
  • Ryan C. Kelley
    Ryan C. Kelley, CFA
    Portfolio Manager
 

David Ellison:
The state of the banking industry is the strongest it's been. When you look at capital levels and liquidity levels and credit conditions, the regulatory environment, and sort of the thought process of the managers, they're thinking low risks, they're thinking profitability, they're not thinking overleveraging and taking a lot of credit risk. From that perspective, the industry is very healthy, and that is reflected in the high ROAs and the high ROEs, which are traditional profit measures of the industry.

Growth Drivers for Banks

Dave Ellison:
When you look at traditional banks, the growth drivers are today and I have historically been, loans, and the economy is good now. It has been good for a number of years. Loan growth has been, from a historical perspective, okay, and part of that I think is the lack of sort of a lot of risk-taking at the bank level.

Primarily, I think the risk aversion of the banks is higher than I've seen it in my career. What we see going forward, it's going to be much of the same. It's going to be loan growth, and it's going to be attention to credit detail and attention to expense detail, and that's going to drive returns. The question now is can they use that excess capital to pay dividends, have share buybacks, and continue this level of profitability so that we leverage the profitability over a long period of time.

Bank Valuations

Ryan Kelley:
We think that the valuations for banks right now are attractive. They're attractive if you look at them versus historical terms, as well as where the market is right now. Banks are trading at about 10 or 11 times earnings. The overall market, the S&P, is trading at about 17 times earnings and over the long term, banks tend to trade around 12 to 13 times earnings*. We need a better interest rate environment. You need a potentially steeper yield curve, and both of these will help the earnings of the companies and potentially bring back investor interest into the space.

Diversified Financials

David Ellison:
When it comes to the diversified financials that that sector is really growing primarily because of adoption. It's the adoption of the websites. It's the adoptions of the mobile platforms. The larger traditional banks are investing a lot of money to develop these platforms, and then you have the traditional Visa, MasterCards. I think people trust the platforms like they didn't 10 years ago.

Growth Opportunites

David Ellison:
What we're doing in the portfolio is having buckets of financial technology companies that are clearly not levered that can grow for a long period of time as their products are adopted into the system. We're looking at not only the small companies that are doing that, but the very, very large companies, and then, of course, the traditional banks that are adopting these financial technologies to create these long-term, in a sense, stable streams of income.
 

* As reflected by the KBW Bank Index for returns 2011 - 2018. The KBW Bank Index is an index consisting of the stocks of banking companies and serves as a benchmark of the banking sector.