Banking Forecast: Holding, with a Chance of Headwinds


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Will Nasgovitz

Nasgovitz is CEO and Portfolio Manager of the Select Value and Mid Cap Value Funds and their corresponding separately managed account strategies. He also is CEO of Heartland Funds. He has 18 years of industry experience, 15 at Heartland.


Performance of banks in 2018 has been pretty good. They’ve held up well in a very volatile market.   

When we think about bank performance and what drives it, three things really come out.  

Loan Growth

One is their top line growth, or their sales growth, which is driven by their loan growth—whether or not they are I taking in new loans greater than their peers, or great than the broader industry.  

I’d say loan demand overall has been okay. Surprisingly, it hasn't been as strong as we would have anticipated, given the uplift in both consumer and business confidence. Perhaps we’ll see that flow through here in the second half of 2018.   

Loan Demand Yet to Heat Up

Heartland Advisors Value Investing Loan Demand Chart Source: FactSet Research Systems Inc. and the Conference Board, 1/30/1998 to 3/30/2018
Commercial and Industrial Loans Outstanding (in 1996 $): is one of the seven components in the Conference Board Composite Index of Lagging Indicators.This series measures the volume of business loans held by banks and commercial paper issued by nonfinancial companies. The underlying data is compiled by the Board of Governors of the Federal Reserve System. The Conference Board makes price level adjustments using the same deflator (based on personal consumption expenditures data) used to deflate the money supply series in the leading index. The series tends to peak after an expansion peaks because declining profits ususally increase the demand for loans. Troughs are typically seen more than a year after the recession ends.
Past performance does not guarantee future results.

Net Interest Margin

Other variables that we would look at would be their net interest margin. What are they earning on the loans that they’re selling out to consumers or businesses relative to what they’re paying on deposits? So, a wider net interest margin leads to greater profitability.  

And, interest rates—shorter-term interest rates—have moved up higher. Credit, which should probably deteriorate because of this. Loans, which should probably get repriced, and that will weigh into the overall fundamentals of some businesses.

3-Month LIBOR (USD)

Heartland Advisors Value Investing LIBOR Chart

Source: FactSet Research Systems Inc., 5/29/1998 to 4/30/2018
Past performance does not guarantee future results.

Credit Quality

And the third component in terms of driving performance would be credit quality. Generally speaking, banks that have a better history of less nonperforming loans or charge offs get a premium relative to the broader banking industry.

Without a doubt, the quality of credits—whether it’s on the consumer side or the business side—has been phenomenal throughout this long economic expansion. I think it’s a function that we’ve had this slow grind higher in GDP over the last several years. The economy has never gotten too hot.

But in our opinion, the reality is that credit is probably as good as it can get. We’ve thought that for some time. But when you think about the levels of corporate debt to GDP, for instance, approaching the levels that we saw in 2007—the spread on credit relative to risk-free interest rate is extremely low.

Implications for the Multi-Cap Value Portfolio

As we think about where we are in the cycle, perhaps being later innings, the reality is credit is going to eventually rear its ugly head. And we want to be in those banks that have the history of being able to withstand any hiccups in bad credits etc. 

We think right now it’s probably better to be in larger banks versus smaller banks.

It’s not us making a call on large outperforming small. It’s a function of us sticking to our process and the valuation in particular, where initially we were finding better bargains in the small-cap space. There’s been a fair amount of appreciation there, multiple expansion in those smaller-cap banks, so we’ve reduced our exposure.

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Past performance does not guarantee future results.

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