“Sunday Start”, authored by Betsy Grasek, Global Head of Banks and Diversified Finance Research at Morgan Stanley
How can wholesale bank management teams win? US large cap bank stocks are up 22% year to date, but we believe that the long-term growth outlook is challenged. C-Suites will need to deliver on three priorities in the capital markets and consumer businesses to generate above-average growth:
- shift resources to follow the institutional money (in particular China and Alternatives),
- aggressively target legacy to lower costs and raise efficiency, and
- finally leverage tech and data to defend profitable businesses that are at risk of disruption from new entrants.
Easier said than done, but the combination is critical to generate above-average growth.
Year-to-date performance has been driven by valuation and outlook. On valuation, the US major bank P/Es traded at close to cycle lows at 50% relative to the S&P 500 P/E in February. Investors noticed, and helped by strong US loan growth, tightening credit spreads, reopened capital markets and a stabilizing if not improving China, relative valuations have improved modestly to a 54% discount to the S&P 500. We think they can tighten further as revenue growth improves year on year throughout 2019. Why? We expect capital markets revenue growth to improve and peak in 4Q19 at a median 11%Y. More is riding on the capital markets outlook than in recent years, given the flatter curve, which is expected to slow net interest income revenue growth from 6%Y in 2018 for the major US banks to 4%Y in 2019.
But if we extend out our lens to 2020 and beyond, we see stark differences in capital markets revenues growth based on geography and client type. As highlighted in our recent Blue Paper, Searching for Growth in an Age of Disruption, we see global investment banking revenues coming in at a modest 1% over the next three years, with a bull/bear outlook for +/-3%. To generate above-mean growth, investment banks will need to drive the majority of their revenues from the Americas or Emerging Asia, where interest rates are positive and are compounding revenue growth faster than other developed markets.
An increasing business skew to corporate clients is also critical for generating faster revenue growth. We estimate that corporate revenue growth will come through at a 2% CAGR over the next three years, above the 0.5% CAGR of institutional clients. This is due in part to the types of products that corporates consume, as loans and cash management benefit from a 2.4% fed funds rate. In addition, institutional client revenues are under pressure as asset manager fee rates peel back and FinTech solutions offer execution facilities that narrow spreads. Pulling these all together, we expect a three-year capital markets revenue growth CAGR of 4% at our US-covered investment banks and a much lower <1% at our European-covered investment banks.
Looking beyond capital markets to the consumer parts of these banks, a strong Gen Y and Gen Z strategy is vital. In our recent North American Insight, In the Coming Youth Boom, Millennials Fuel Loan Growth, Gen Z Up for Grabs?, we highlight that 70% of consumer loan growth will come from Millennials over the next 10+ years, especially as Baby Boomers are already beginning to shed leverage. Equally important, it is critical to start building mindshare with Gen Z today. With phones from age 12 and apps from age 13, these consumers are mobile natives. Banks need to engage them now, not at 18 after they have already spent five formative years on Venmo, PayPal and ApplePay.
Bottom line: With growth mid-single-digits at best, bank C-Suites need to deliver on these priorities in the capital markets and consumer businesses in order to deliver top-line growth and improving ROEs in the near, medium and long term. For bank investors, expect geographic, client and structural trends to increasingly differentiate the winners.