Banking Sector Under the Microscope

The US financial sector faced heavy scrutiny in the wake of the global financial crisis of 2008-2009, but the end result was that banks emerged in better shape overall, according to Shawn Lyons, vice president and portfolio manager, Franklin Templeton Fixed Income Group. He says the combination of a healthy US economy and tax reform should bode well for bank fundamentals.

Outlook for US Banks

The US financial sector has been under a microscope since the global financial crisis (GFC) of 2008–2009, and I think that scrutiny has actually left US banks in a very enviable position.

When analyzing the health of banks from a fixed income perspective, we use the CELS rating system also known as “CAMELS,” which incorporates six factors: capital adequacy, asset quality, management, earnings, liquidity and sensitivity to risk. Considering these factors, we think industry fundamentals are sound.

Capital levels are well in excess of where they were a decade ago. Asset quality remains very strong among most sectors. Liquidity is good, with bank deposits generally growing across the industry. Loan-to-deposit ratios have generally been declining since 2010, although there has been a recent uptick.

As with any industry, a few management teams have had challenges, but in general, we think the banking system has solid quality and experienced management teams.

Banking on Tax Reform

US banks have traditionally faced heavy tax burdens, which weigh on their bottom line. As such, I think recent US tax reform looks to be positive for banks. Corporate tax rates moved from 35% to 21% across the board.

One of the consequences of the GFC was a tightening of lending standards—making it more difficult for riskier applicants to obtain credit. About four or five years post-crisis, commercial and industrial lending (C&I) was one of the first segments to see lending standards ease, and we saw pretty good growth in that segment. Subsequently, we started to see some easing in other areas, for example, auto lending and credit cards.