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These three US bank stocks are my top sector picks: Analyst
U.S. financials should benefit from lower regulatory costs as well as a healthier economic backdrop over the next two years, RBC Capital Markets' equity research chief said on Wednesday.
"I think what we're going to see is lower expenses for the regulatory costs for these banks…it's going to free up more capital," Gerard Cassidy, managing director of equity research at RBC Capital Markets, told CNBC's Squawk Box.
Additionally, idiosyncratic drivers for some of the universal banks – the largest financial services institutions with global operations – will see certain names primed to outperform peers, according to the senior analyst.
For starters, Bank of America should benefit from rising rates and increasing revenues as well as the broader follow through effects from strength of the U.S. economy. Another name to watch is Citigroup, according to Cassidy, which is overcapitalized and therefore a capital return story.
"Investors should expect higher dividends, more buybacks and a very strong credit card business," advised Cassidy.
For investors seeking out a lower risk name, Cassidy suggests JPMorgan as an attractive candidate given that it is the global leader in many business areas and led by Chief Executive Jamie Dimon who "has done a very good job there".
Looking at the sector more broadly, RBC's managing director says that even without changes being made to financial regulations, a raft of upcoming senior appointments has the potential to reduce the burden on banks. For example, the resignation of the Federal Reserve's top bank regulator Daniel Tarullo in February could lead to his being replaced by a regulator who takes a more lax attitude towards overseeing banks.
Such a stance could be reflected in how Tarullo's successor selects to implement rules which allow for a certain degree of latitude, such as the annual stress tests which could be changed to occur on only a two or three yearly basis without any laws needing to be altered.
For Cassidy the big question remains the level of capital that banks need to hold and he is a clear believer that current capital reserves are excessive.
"We're not saying we're doing away with Dodd-Frank but there will be some reform and do we really need the levels of capital that some of these banks are being required to hold?" he asked.
Explaining that while the law requires 7 percent of core equity capital plus around a 1.5 percent buffer for regional banks, he notes that some banks are currently holding around 12.5 percent of equity capital.
"There's no need for that. Because of the toughness of the Federal Reserve they haven't been able to give it [capital] back more aggressively. We need to have an ample amount of capital, they need to be regulated, but the pendulum swung too much and now it needs to come back and it will come back," Cassidy opined.
The managing director sees a period of increased capital returns to shareholders over the next couple of years, both in the form of buybacks and dividends.
"The industry slashed their dividends during the crisis…now the banks are rebuilding them… we expect dividend payout ratios to rise to 40 percent of earnings," he said, noting that current levels are around 20 to 30 percent.
"Investors should expect over the next two years that dividends should rise not only in dollar terms but also as a percentage of earnings."
Disclaimer: Gerard Cassidy does not personally own the shares of Bank of America, JPMorgan or Citigroup but RBC Capital owns and has relationships with a host of US banks including these three banks.
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