As we come to the end of the second week of bank earnings season, reported results are generally positive for credit investors. While results reflected the headwind of lower rates, banks generally expect stabilization of net interest margins in 2020, as continued modest loan growth and gradual deposit repricing offset the rate pressure. Importantly, while commercial borrowers exhibited caution in 2019 reflecting the uncertainty of the ongoing trade conflict between the US and China, bank CEOs have expressed guarded optimism about commercial borrower activity in 2020 following the signing of the Phase 1 trade deal earlier this month. Conversely, banks have continued to experience good consumer loan growth (mortgages, credit cards, auto loans) with strong consumer sentiment boosted by low unemployment, modest wage growth and generally positive economic and market news. Absent event risk which impacts consumer sentiment, or an outright reversal in employment numbers, we expect the consumer lending business to continue to be a steady contributor to bank results.
Fee income is also expected to boost operating results with mortgage origination and capital markets expected to continue outsized contributions reflecting the strong consumer and stable economic environment. Importantly, asset quality remains very strong, and banks are not reporting any signs of a turn in the credit cycle. To whit, non-performing assets and net charge-offs remain at historic lows and early stage delinquencies are not displaying an upward trend that would presage an increase in credit costs.
From a technical perspective, banks’ strong loan-to-deposit ratios and fully funded regulatory requirements have lowered net issuance expectations for the banking sector, which should provide continued support for spreads. From a relative value perspective, we view bank senior and subordinated bonds as being at the very tight end of fair value. Increased volatility (e.g., trade/Middle East/US elections) is expected to drive a widening in the corporate basis and we continue to view the bank sector as fundamentally strong, but higher beta relative to corporates as a whole, leading us to be selective with new investments.