HomeResearch and NewsArbat Capital: Banking Sector Report - April 2020

Arbat Capital: Banking Sector Report - April 2020

EXECUTIVE SUMMARY

US banks increased significantly in April after very weak performance in the first 3 months of 2020. However, the broad market was only slightly outperformed after 3 months in a row of lagging dynamics. Thus, BKX index increased by 13.6% MoM in April vs +12.7% MoM of SPX index. Absolute performance on MoM basis was +1.9 std from the mean and it is in the top 4% of absolute MoM performance of BKX index. Relative April performance was +0.8% MoM, it is +0.2 std from the mean and it is in the top 42% of relative MoM performance vs SPX index since 1992. It was the worst first four months of the year on both absolute and relative basis over more than 28 years with the total absolute performance of -34.4% ytd and relative performance of -27.2% ytd.

Due to relief rally, all banks ended April in the green zone but variance of growth rates was substantial caused by earnings season results. So, banks with better quarterly figures demonstrated markedly better dynamics. However, banks which missed expectations lagged considerably. Thus, Wells Fargo added just +1.2% MoM.

April FOMC meeting brought us little news – forward guidance remained unchanged and there were no more details for QE program. However, Powell noted that corporate credit facilities were near being finalized but the Fed could only make loans to solvent entities. Powell also said that the Fed would be patient and would not hurry to move rates up. Given expectation that the economy will likely drop at an unprecedented rate in 2Q20 and that unemployment could be surged into double-digit, it is obvious for us that there will be no rate hike for a very long time. And it will get worse at first before it gets better as even such massive fiscal and monetary stimuli can’t save US economy from falling into very deep recession.

US banks reported highly mixed figures with the lowest number of positive EPS surprises among our group of banks since 4Q08, the worst quarter during GFC, but relatively solid revenues given current challenging revenue environment. Underlying trends were better than feared while key reason of large number of negative EPS surprises was large loan-loss reserve build which will remain elevated in coming quarters. From the other hand, NIM/NII dynamics were better than expected, capital markets revenues were very strong again and OpEx remained controlled while dividends were affirmed but buybacks were postponed. Thus, just 6 out of 24 of our group of banks demonstrated positive EPS surprises vs median number of positive quarterly EPS surprises of 17 over the last 52 quarters and the lowest figure so far of 5 in 4Q08. Thus, median EPS surprise for our group of banks was -29.6% vs median quarterly figure over the last 13 years of +3.5%. In turn, revenue surprise was positive, the 22nd quarter over the last 23 quarters, +1.7% vs median quarterly figure over the last 13 years of +0.8%. 14 companies of our group of banks or 58% demonstrated positive surprise on revenue, in-line with the median quarterly figure since Q107. Unsurprisingly, market perception of the results was negative for the second quarter in a row with median percent change in price around the earnings date of our group of banks of -0.8%, markedly lower than median figure since Q107 of -0.36% but better than 4Q19 figure of -1.8%. BKX index increased by 2.9% since the start of the earnings season till the end of April while S&P 500 index added 5.5% over the same time as COVID-19 fears eased somewhat recently. Notwithstanding, consensus estimates continued to go down. Thus, 2Q20 EPS estimates were revised down by 56.7% ytd / -28.6% since 13 April (median of BKX index members), FY20 EPS estimates were -49.3% ytd / -23.9% since the start of the earnings season while median change of FY21 EPS estimates was -29.3% ytd / -2.9% since 13 April.

Overall, underlying trends of US banks were strong so far but significant deterioration is inevitable under current conditions. The key uncertainty is related to credit quality which will worsen meaningfully in coming quarters but questions about how much it will deteriorate and how long provisions will remain elevated are open. Relatively strong 1Q20 revenues don’t look sustainable, from our point of view, taking into account significant decline of key benchmark rates ytd and lower consumer spending because of COVID19 impact but median decline of revenue 20E was just 3.8% ytd for BKX index members. So, banks will continue underperform the broad market, from our point of view. Due to meaningful decline of EPS estimates, banks is no more trading with significant discount to historical averages (it isn’t relevant for 21E) but excessive discount to S&P 500 index remains because of significant intensification of credit quality concerns. Thus, banks are trading with +0.5 / +0.5 std on P/E CY and -1.6 / -1.3 on P/E NY (on the basis of samples from 2000 and 2010 yrs to current moment) relative to historical averages (as of May 1st). As for relative to S&P 500, banks are currently trading at -1.4 std and -2.1 std from the sample mean (2010-today) for P/E CY and P/E NY, respectively. On P/B, banks are trading with -2.1 std from the sample mean (2010-today) vs SPX with +0.9 std.

Despite stocks are still trading at significant discount to S&P 500 index, we remain cautious on US banks given severity of upcoming recession and high level of uncertainty about the speed of US economic recovery. Absence of outperformance of US banks vs SPX index during recent rally despite high beta indicates that investors still prefer not to get involved with banks. So, we still remain on the sidelines until we see the first signs of fundamentals improvement.

EU banks finally increased in April after 3 consecutive months of negative absolute performance. However, on relative basis it underperformed the broad market again, the 4th month over the last 6. On absolute basis, SX7P index increased by 2.2% MoM in April or 0.3 std from the mean and this result is in the top 41% of absolute monthly performance of SX7P since index inception. Also, relative monthly performance was -3.8% MoM or -1 std and it is in the bottom 13% of relative monthly performance. Despite weak relative dynamics in two previous years when SX7P index underperformed the broad market by 12.1% and 17.1% in 2019 and 2018, respectively, EU banks continue to lag broad market considerably. On ytd basis, SX7P underperformed by 23% as the end of April.

Despite relief rally, only 2/3 members of SX7P managed to end April in the green zone while key underperformers lost around 20% of market cap. The main driver of significant variance of price performance was the start of earnings season which was less optimistic than US one.

EU economy contracted at a record pace in 1Q20 but the speed of decline will be significantly higher in 2Q20. According to ECB’s introductory statement, “euro area GDP could fall by between 5% and 12% this year, depending crucially on the duration of the containment measures and the success of policies to mitigate the economic consequences for businesses and workers”. Notwithstanding, ECB kept rates unchanged at April meeting as well as terms of asset purchase programs. But Christine Lagarde noted during press conference that PEPP might be extended further than the end of 2020 and its size also could be adjusted if necessary. Anyway, we still expect that fundamentals of EU banks will remain weak in coming years. As the end of April, median decline of FY20 EPS of SX7P index members is 46.6% ytd, FY20 revenue -5.1% ytd, FY20 NII -3.8% ytd, FY20 provision +115% ytd. EU banks continue to trade with noticeable discount to historical averages
(-16% / -0.9 std from mean P/E NY of SX7P index members, sample from 2010 to the present) but discount to US peers (on median P/E NY of BKX index vs SX7P index) is just 20.6% at the moment, in-line with average since 2010, out of synch with reality, from our point of view, given higher risks associated with EU banks which have not fully recovered from the previous crisis yet.

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