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Can We Bank on Banks?

Our latest research looks at how banks might be affected at this point in the economic cycle.

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Eric Compton: The current economic expansion has gone on for more than 10 years, and it seems we are closer to the end of the cycle than the beginning. As such, having a view on future credit costs for the banks is invaluable. We find that bank's credit costs are difficult to analyze for investors, and for good reason. It is quite difficult to gather and make sense of the disparate, diverse, disjointed, and even discordant information available on the subject. To help investors make sense of credit costs for the banks, we recently conducted a deep dive on the subject. We find that predicting the timing of a cycle in inherently difficult, if not impossible, but even if perfect timing isn't a given, there is still room for worthwhile analysis. 

In our deep dive, we analyzed each section of the debt markets, analyzing where we see elevated risks and where we think the risks are manageable. Our big takeaway is that risks currently appear manageable for the banks, with the riskier asset classes generally being concentrated outside of the banking system. As an example, we see some of the most irrational behavior within student lending, but over 90% of this market is controlled and underwritten by the government, not the banks. We also dive into leverage loans and CLOs, two areas which have captured investor and regulatory scrutiny over the last several years. Again, we find that the risks here appear manageable for the banks, and we see nothing like a 2007-type buildup occurring today. As such, our overall thesis is that the next downturn will be mild compared to 2007, and it will not be as concentrated within the large banks.

Eric Compton does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.

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