Dividends to rise as US Banks rebound

By Harvest Portfolios Group 

The U.S. banking sector has rebounded strongly with the reopening of the American economy.

Consumer loans for homes and cars are rising, the banks are reducing loan loss provisions and as longer-term interest rates rise, margins should also improve.

These trends are improving balance sheets and that means U.S. banks will likely start increasing their dividends soon, says James Learmonth, senior portfolio manager at Harvest Portfolios Group.

Mr. Learmonth says U.S. banking regulators showed confidence in an improving economy at Christmas, when the Federal Reserve allowed banks to resume share buybacks. With loan losses provisions continuing to fall in the first quarter, dividend increases will likely resume as soon as the end of June, 2021 once annual stress tests are completed.

“It’s widely expected that the Fed will allow dividend increases, but I don’t know if people appreciate the magnitude, “ Mr. Learmonth says. “Once the caps are removed we don’t think any of the major banks will have issues,” Mr. Learmonth says.

Mr. Learmonth said the U.S. banking sector has gathered strength since the fall. Year-to-date, the S&P 500 Banks index (SBIDX) is up 36.3% and is up 50% in the past 12 months.[i] That compares with the S&P 500 index which is up 12.6% year-to-date and 32.4% in the past year.

“Banks tend to lead from the bottom of the cycle,” Mr. Learmonth says. “We’re still very early on in the recovery, so they will continue to benefit with loan growth and interest margins improving as we move through the balance in the year.”

A second positive theme is the uptick in long term interest rates. A steepening yield curve leads to better profit margins, so while the increases have been modest, margins will respond. Mr. Learmonth expects them to work slowly through the system.

“It’s going to take some time,” he says.

Most banks have steadily reduced their loan loss provisions which adds cash directly to their bottom line. He noted that in the final quarter of 2020 and first quarter of 2021 the banks aggressively started to reduce them.

For example, JP Morgan Chase & Co., a top Harvest ETF holding, reported first quarter profit and revenue that exceeded expectations on strong trading results and a US $5.2 billion gain from reducing loan loss provisions. It contrasts with a year ago, when the firm raised its loss reserves by setting aside US $6.8 billion in the quarter.

Mr. Learmonth says JP Morgan’s provision for bad loans has fallen $9.1 billion since its peak in the second quarter of 2020.

Another round of stimulus has put money into the pockets of American consumers and many are responding by taking out car loans and jumping into the housing market.

“These low rates are encouraging people to get off the sidelines.”

A few challenges remain. Commercial real estate lending is weak. Credit card revenue is also down as consumers use stimulus payments and accumulated savings to reduce credit card debt.

Harvest captures the US banking industry through its Harvest US Bank Leaders Income ETF (TSX:HUBL). The ETF is passively managed and holds 15 large cap banks and bank-like businesses, plus one insurance company. (A bank-like business is an investment bank like a Goldman Sachs.) The ETF is equally weighted which diversifies the holdings A covered call strategy enhances income which makes the fund yield attractive. The current yield is  5.58%[ii] The ETF has a 0.75% management fee.

Mr. Learmonth says banks will continue to benefit from loan growth and interest margins improvements.

“The capital positions of the banks are fantastic and continue to improve. So, I think there’s lots of room for shareholder return.”

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[i] To June 5, 2021

[ii] To May 31, 2021