Banks benefit from earnings tailwind - July Trust Update

Market and Trust review

Equity markets hit all-time highs in July on the back of supportive economic data and earnings with a rally in the US dollar adding to returns for sterling investors. Credit markets were also strong with the Federal Reserve, the Bank of Canada and the European Central Bank all holding interest rates steady but an expectation the easing cycle would continue.

Against that background, the Trust’s net asset value rose 3.4% against the benchmark, the MSCI All Country World Financials Index return of 4.0%. Good performance from holdings in Globe Life, UniCredit and Interactive Brokers Group was more than offset by the insurance subsector with holdings in Axis Capital, Intact Financial and Beazley some of the biggest drags on performance.

US banks

US bank results were better than expected with strong performance in trading and investment banking revenues and guidance raised for earnings. Furthermore, provisioning came in below expectations, reflecting the health of the US economy. In answer to a question on the robustness of the US consumer, JP Morgan CFO Jeremy Barnum said: “It's obviously a very important question. We look at it very closely. It obviously matters a lot for us as a company. But we continue to struggle to see signs of weakness. The consumer basically seems to be fine. Now a few things are true. Like if you look at indicators of stress, not surprisingly, you see a little bit more stress in the lower income bands than you see in the higher income bands. But that's always true. That's pretty much definitionally true. And nothing there is out of line with our expectations.”

European banks

European banks continued to perform strongly over the month, benefiting from the tailwind of better earnings and valuation support. UniCredit, the second largest Italian bank, announced it would withdraw from its bid for Banco BPM, one of its smaller peers, due to steps taken by the Italian government to put onerous restrictions on its approval. While earnings growth has slowed or even gone into reverse for some banks, as lower interest rates in the Eurozone have put pressure on revenues, the sector has managed net interest margins better than expected, supported by a pickup in loan growth, and therefore benefited from stronger net interest income revenues. Profitability is being sustained at a mid-teens return on equity level across the sector which would suggest valuations can rise further. Asset quality trends also continue to remain benign even though there has been some softening in economic data.

Insurance

Insurance stocks were weak in July which has exacerbated their poor relative performance over recent months. A softening in organic growth due to the moderation in US commercial insurance rates has led to a large correction in the share price of insurance brokers in particular. However, a rotation out of the subsector due to its defensive characteristics against the background of an increasing appetite for risk, has also put pressure on share prices across the subsector. Intact Financial, a Canadian insurance company, and Axis Capital, a Bermudan specialty insurer – both holdings in the Trust – reported better than expected earnings but softer guidance from Intact Financial led to its share price underperforming. Even an earnings upgrade for Axis Capital was insufficient to reverse its fall over the month.

Investment activity

While we think equity markets have overreacted to some of the news from the insurance sector it will likely need a couple of quarters before the companies can prove doubters wrong that they can deliver on financial targets even against a less positive operating environment for revenues. Consequently, we took the opportunity to reduce a number of holdings across the sector. Conversely, we bought a new holding in BPER Banca, the sixth largest bank in Italy with €144bn in assets, that has just closed the acquisition of Banca Sondrio with €56bn of assets, a smaller bank also headquartered in the north of Italy where we see the opportunity for greater capital and cost synergies from the combination of the two banks.

BPER Banca just closed the acquisition of Banca Sondrio, where we see the opportunity for greater capital and cost synergies from the combination of the two banks

We also started a new holding in Permanent TSB Group (PTSB), Ireland’s third largest bank which has a >20% share of the mortgage market, following a placing by NatWest Group of its stake in the bank which it inherited when it sold assets and branches of Ulster Bank to it in 2021. The Irish government still owns over 50% of PTSB and is keen to see more competition as its two larger peers dominate the Irish banking market. Its profitability currently falls well short, but it is forecast to close that gap materially over the coming two years. Furthermore, it is handicapped by more onerous capital requirements, making it harder to compete and, assuming as is expected that these are adjusted lower in 2026, it is a catalyst for the bank to grow faster and/or return more capital to shareholders.

Outlook

The sector has given back some of its year-to-date outperformance, in large part due to the strong rally in technology shares but also reflecting its better performance in the April selloff as it was seen as less impacted by trade tariffs. Outside the insurance sector, as highlighted above results have been positive and with commentary around the outlook for capital markets and IPOs suggesting a continued pickup in activity. Financials only recovered their post-global financial crisis share price levels in 2024 showing how long it took for the sector to recover its losses. Conversely, for the UK and Europe, where we have our strongest convictions, share prices are still over 20% below the levels reached in 2007 and valuations do not show any of the exuberance seen in wider equity markets.