Western Asset Management: Do not give up on US banks

Negative market sentiment should not deter investors in US banks, said Ryan Brist, head of US investment grade credit at Legg Mason subsidiary Western Asset Management.

Although Brist admitted investors have had a "hazardous" experience with US bank equities and fixed income securities recently, he said there are now grounds for optimism and it is not the time to abandon the sector.

"While it appears that no immediate positive catalysts are on the horizon, we believe now is not the time to give up on the US banking sector," said Brist.

"Investors have been focusing on the near-term negative details and have all but disregarded what we believe are the solid, longer-term fundamentals," he added.

Low interest rates, legal and regulatory pressures combined with European contagion fears have dragged down investor confidence in the US banking sector.

US bank shares have lost considerable ground over the past year, with Bank of America and Goldman Sachs seeing the heaviest falls.

Bank of America shares were $12 this time last year but have now more than halved in value to $5.64 today, according to BBC data. Goldman Sachs shares were priced at $170 a year ago but have now fallen back to $97.25.

Meanwhile JP Morgan and Wells Fargo's share price movement has been more steady. JP Morgan shares were priced at $40 in December last year, peaked at $47 in April, but have now dropped to $32.33. Wells Fargo shares were priced at $29  a year ago, rose to $34 in February, but are now valued at $26.

Low valuations now provide an attractive opportunity for investors, said Brist, though it may take time to see upside on investments, he warned.

"A move to overweight US banks may not be rewarded immediately, but we believe that, longer term, balance sheet fundamentals will ultimately be reflected in spreads. Investors are still ignoring the improvements made to bank balance sheets across the globe but they should remember this is about investing for the coupons of the future, not the past."

US banks have doubled the equity on their balance sheets over the last two years and reduced reliance on the commercial paper market as a funding vehicle, boosting Brist's confidence in the sector. He also said banks are seeing a decline in new delinquencies, with loan-loss reserves falling worldwide.

A total of 80% of US bank losses have been written off, with 20% of future losses expected to be absorbed through earnings and revitalised capital bases, according to Western.

"While we are very concerned about near-term volatility and the fact negative sentiment can influence consumer behaviour, we do not believe large-cap US banks represent future defaults for bondholders around the world," he said.

"The next three to six months may continue to be a very bumpy ride, but in the longer term we do not expect loss of principal on fixed income securities of the major financial institutions."

Additionally, investors should not be put off my credit rating agency downgrades of US banks, said Brist.

"We believe balance sheet fundamentals do not correspond to the underlying ratings trajectory. Large-cap US banks have made undeniable progress in funding, capital adequacy and asset quality. Credit worthiness has improved substantially. But we do not expect good news anytime soon on the ratings front. The recent downgrade of Bank of America is just another example of Moody's overcompensating for its mistake of overrating the sector."

He added today's crisis is not the same as the liquidity driven financial crisis of 2008.

"Today, we have the opposite situation - while a lack of confidence still shadows the market, banking deposits have never been higher, and banks are flush with liquidity on their balance sheets. Fundamentally, the so-called ‘wall of worry' is sounding from a very different starting point than it did in 2008," he added.