HomeResearch and NewsArbat Capital: Banking Sector Report - April 2021

Arbat Capital: Banking Sector Report - April 2021

EXECUTIVE SUMMARY

US banks outperformed the broad market again in April 2021, the 7th month in a row of outperformance after five consecutive months of weaker dynamics. BKX index increased by 5.9% MoM vs +5.2% MoM of SPX index. Absolute April performance was +0.7 std from the mean monthly performance and it is in the top 19% since index inception. Relative April performance was +0.6% MoM. It is +0.14 std from the mean monthly performance and it is in the top 45% of relative performance vs SPX index since index inception. Despite significant outperformance in recent months, when BKX index outperformed SPX by 40% over the last 7 months, it still underperformed the broad market by 13.3% since the end of 2019. Notwithstanding, the first 4 months of 2021 were the best start of the year over the last 11 years.

US banks dynamics wasn’t uniform and it was driven by the earnings season. So, financial companies with much better quarterly results such as consumer finance companies were among the best April performers. On the contrary, HBAN and NYCB decreased by 2.5% MoM and 5.2% MoM, respectively.

US banks reported very strong 1Q21 results with much better both revenue and EPS figures. Despite key driver of positive surprises on net income was reserve release while NIM and loan growth missed expectations, the street estimates have already begun to go up due to a more optimistic view on rates and expectations of faster economic recovery as a result of more fiscal stimulus and ongoing vaccination campaign. So, despite significant outperformance in 4Q20 and 1Q21, the rally in banks may well continue in 2021 as a result of significant EPS growth and multiples expansion. At least, banks are still substantially undervalued vs S&P 500 but not in comparison with historical averages. Notwithstanding, we still see ongoing momentum in US banks and believe that banks are still attractive vs SPX index. So, we recommend buying US banks on dips but being selective.

It was the strongest quarter from EPS surprises point of view since at least 2007 year with better figures for all 24 banks in our group vs median number of positive quarterly EPS surprises over the last 57 quarters of 17. Median EPS surprise for our group of banks was +41% (the highest one in our dataset from 2007 year) vs a median quarterly figure over the last 14 years of +3.6%. The previous high of 24.6% was demonstrated in 4Q20. Revenue surprise was positive again, the 22th quarter over the last 24 quarters, +2.8% vs a median quarterly figure over the last 14 years of +0.9%. 20 companies of our group of banks, or 83%, demonstrated positive surprise on revenue, significantly higher than a median quarterly figure since Q1 2007. Unsurprisingly, market perception of the results was clearly positive with a significant growth in the first two weeks of the earning season. On the other hand, median percent change in price around the earnings date of our group of banks was -1.9%, the third consecutive quarter of negative dynamics even despite to better reported results vs a median figure since 1Q07 of -0.4%. BKX index increased by 4.3% since the start of the earnings season till the end of April 2021 while S&P 500 index added just 1.0%. Also, consensus estimates improved significantly during the earnings season. Thus, 2Q21 EPS estimates were revised up by 5.5% since April 13, 2021 (median of BKX index members) and it is +32% ytd, FY21 EPS estimates were +12.7% since the start of the earnings season, or +37.5% ytd, while a median change of FY22 EPS estimates was +1.9% since April 13, 2021, or +11.8% ytd. In turn, a median revenue growth was +0.9% and +3.1% ytd, respectively.

Overall, underlying results of US banks were relatively strong even despite both NIM and loan growth were weaker than expected. Due to reserve releases, ROE/ROA figures increased significantly in three recent quarters to the multi-year highs. Thus, ROE increased by 230 bps qoq to 13.4% in 1Q21, +710 bps yoy, or +250 bps vs 4Q19. Key credit metrics of US banks still remained pretty resilient due to forbearance actions of banks and unprecedented fiscal and monetary stimuli despite a significant decline of GDP and an explosive growth of unemployment in 1H20, and reserve releases were one of the key drivers of significant profit growth in three recent quarters. Notwithstanding, it also means for us that current levels of profitability are unsustainable and we expect that ROE/ROA will inevitably decline in coming quarters even taking into account better revenue environment. Indeed, NII prospects look brighter and brighter due to investing of excess liquidity in higher-yield assets, much higher long end, sooner growth of the short end, and an acceleration of the loan growth in the foreseeable future. One of the key drivers of EPS growth in pre-COVID years, namely buybacks, is also almost back. Banks are still trading with a significant discount to S&P 500, but the sector is no more trading with a substantial discount to historical averages after substantial growth of EPS forecasts in recent months. Thus, banks are trading with -0.6/-0.6 std on P/E CY and +0.4/+0.7 std on P/E NY (on the basis of samples from 2000 and 2010 years to current moment) relative to historical averages (as of April 30, 2021). As for relative to S&P 500, banks are currently trading at -1.9 std and -1.3 std from the sample mean (2010-current moment) for P/E CY and P/E NY, respectively. On P/B, banks are trading with +0.7 std from the sample mean (2010-current moment) vs SPX with +3.0 std.

EU banks increased noticeably on an absolute basis again in April 2021 after their very strong performance in March and February. It even outperformed the broad market on relative basis but it was just the second month of better dynamics over the last 5. Thus, on an absolute basis, SX7P increased by 3.3% MoM in April, or +0.4 std from the mean, and it is the top 32% of absolute monthly performance of SX7P index. On the other hand, relative monthly performance was +1.5% MoM, or +0.5 std, and it is in the top 27% of relative monthly performance in SX7P index history. Notwithstanding, it was the very strong first four months of a year after 3 clearly weak previous years. Thus, SX7P index underperformed in each of the 3 last years and it is still 27.6% lower than it was at the end of 2017, underperforming STOXX 600 index by 35.6% over this period.

As for US peers, the key driver of EU banking stocks was the earnings season. Thus, banks which demonstrated much better than expected 1Q21 figures increased by more than 10% MoM in April (Sabadell, Deutsche Bank and Santander). In turn, UBS, UniCredit and Barclays lost 5% MoM and more as a result of weaker than expected 1Q21 figures.

Despite to a better economic outlook, markedly higher long end of the curve and a relatively strong start of 1Q21 earnings season, NI projections of EU banks weren’t improved significantly so far with a median growth of 11.2% ytd for 2021E and +4.2% ytd for 2022E. As a result of a slower than expected EU’s vaccine rollout campaign, risks are still tilted to downside but risks became more balanced, according to the ECB. The ECB noted again at the April meeting that services sector is still weak and there is a need for accommodative monetary policy. Notwithstanding, the ECB remains optimistic but GDP growth projections for three nearest years were almost unchanged in March projections vs December 2020. Moreover, despite markedly higher inflation forecast for 2021, it was announced that purchases under the PEPP over 2Q21 to be conducted at a significantly higher pace than it was in 1Q21 to improve financial conditions in EU given a recent growth of the long end. In any case, the key near-term profit driver for EU banks will remain reserve releases while revenue environment will be still challenging. So, we don’t expect that EPS estimates will return to 2019 levels not earlier than in 2H22, but it seems that the market is currently looking much further in time. On the other hand, EU banks don’t already look clearly cheap. Thus, premium to historical averages is 6% (+0.4 std at the moment 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 23% as of April 30, 2021 vs average since 2010 of 21% or -0.2 std. Notwithstanding, we remain tactically bullish on EU banks and we recommend buying on dips.

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