HomeResearch and NewsArbat Capital: Banking Sector Report - December 2019

Arbat Capital: Banking Sector Report - December 2019

EXECUTIVE SUMMARY

US banks outperformed the broad market in December (as of December 24), the fourth consecutive month of outperformance after very weak dynamics in August. Thus, BKX index increased by 3.2% MoM vs +2.6% of SPX index. Absolute December performance on MoM basis was +0.4 std from the mean and it is in the top 36% of the absolute MoM performance of BKX index. Relative December performance was +0.6% MoM, it is +0.1 std from the mean and it is in the top 46% of relative MoM performance vs SPX index since 1992. BKX index is currently +32% ytd, and it is the second strongest yearly growth in absolute terms since 1997. On relative basis, it is +2.6% ytd after two years in a row of underperformance.

Dynamics within the sector wasn’t uniform in December after positive absolute performance of all BKX index members in November. But the key drivers of the sector still remained rebound of interest rates and stabilization of macro data. Also, growth of some regional banks (e.g. SBNY, SIVB and FRC) quotes was driven by positive perception of their outlook on 2020 at Goldman Sachs US Financial Services Conference.

The earnings season of US banks will start on January 14th, when 4Q19 results will be provided by JP Morgan, Citigroup and Wells Fargo. After that, within two weeks, all members of BKX index will provide quarterly results. So far, US banks have reported reasonable headline numbers but estimates continue to decline. Thus, 19 out of 24 of our group of banks demonstrated positive EPS surprises in 3Q19 despite challenging revenue environment, slightly higher than median number of positive quarterly EPS surprises over the last 51 quarters. Median EPS surprise for our group of banks was +3.2% vs median quarterly figure over the last 12.5 years of 4.1%. According to Bloomberg consensus, median decline of 4Q19 EPS of BKX index members is equal to -0.8% qtd (as of December 23) or -7.1% ytd. Full-year estimates for the current and next years were also revised down ytd by -3.7% and -7.6%, respectively. Given recent stabilization of macro environment, better than feared rates dynamics, and still strong credit, we don’t expect that FY2020/21 EPS estimates will continue to go down significantly further but the key EPS driver remains high buybacks which is not a strong catalyst for growth of banking quotes taking into account that valuations moved back to historical averages. We expect that 4Q19 numbers will be relatively weak with median EPS growth of BKX index members of just 0.3% yoy but -0.8% qoq, the weakest growth on yoy basis over the last 3.5 years.

Overall, operating trends of US banks were strong so far but gradually deteriorating because of challenging revenue environment while still high credit quality, good cost control and small but positive operating leverage. We see almost no EPS drivers in the near future with rising political uncertainty given election year and ongoing trade tensions while valuations have become less attractive in recent months. Thus, banks continue to trade with significant discount to S&P 500 index, reflecting late cycle concerns but it hasn’t already been cheap vs historical averages. Thus, banks are trading with -0.8/-0.8 std on P/E CY and -0.2/+0.1 std on P/E NY (on the basis of samples from 2000 and 2010 yrs to current moment) relative to historical averages (as of December 20). As for relative to S&P 500, banks are currently trading at -2.0 and -1.5 std from the sample mean (2010-current moment) for P/E CY and P/E NY, respectively.

Despite stocks are still trading at a significant discount to S&P 500 index but in-line with historical averages, we maintain our cautious view on US banks given higher risks and marked outperformance of US banks in 2019. NIM prospects are not as weak as it was feared 1 quarter ago but it will not resume its growth in current rate environment. In turn, there is no more room for credit costs and opex reduction, so positive operating leverage in uture is under question. Capital return will remain high near term but it is too little to change the mood of investors given late cycle concerns.

EU banks markedly outperformed the broad market in December after slight underperformance in November. On absolute basis, SX7P index increased by 4.9% MoM (as of December 24) or +0.7 std from the mean and this result is in the top 21% of absolute monthly performance of SX7P since the index inception. Relative monthly performance was +2% MoM or +0.6 std and it is in the bottom 20% of relative monthly performance of SX7P index. Notwithstanding, despite significant growth in recent months, SX7P index is still just +8.9% ytd even on absolute basis while on relative basis it is -12.2% ytd with negative MoM relative performance in 6 out of 12 months of this year.

Contrary to US banks, dynamics of EU peers was relatively uniform in December with positive performance of all SX7P index members except for MB IM and CSGN SW. The key outperformers were Scandinavian banks due to rate hike in Sweden, more optimistic next year outlook and less fears on possible size AML fines.

ECB’s December policy meeting brought us no surprises even despite it was the first one for the new president Christine Lagarde. The policy statement was unchanged as well as the rates guidance. The meeting confirmed that new president will not make any drastic steps regarding the current accommodative monetary policy stance and that the comprehensive package of policy measures in September was a right thing given some stabilization of macro environment since then. Notwithstanding, the risks are still tilted to the downside but “have become somewhat less pronounced”. So, the challenging rate environment will remain a drag (but less than feared few months ago) for European banks for longer. European macro data published in December were slightly positive after better figures in November and October. However, composite PMI missed expectations again, 50.6 pts vs expectations of 50.7 pts in December, still pointing to positive but weak GDP growth of Euro Area in coming quarters. According to new staff projections, GDP growth is expected at 1.2%/1.1%/1.4% yoy in 2019/2020/2021, respectively. Despite slowdown of economy and high political uncertainty in 2019, loan growth remained solid. Thus, total corporate loans increased by +2.2% yoy, +0.4% MoM. EU loans to households increased by 3.1% yoy or +0.3% MoM in October (slight acceleration from 2.6% yoy as the end of 2018). So, operating figures of European banks remains relatively resilient. Thus, 15 out of 31 banks from SX7P index for which estimates were available reported positive surprises on EPS in 3Q19 but after significant decline of estimates ytd while management outlook was more cautious during the last earnings season. However, earnings momentum also improved in 3Q19 after two consecutive quarters of negative yoy dynamics of operating profit.

Despite significant growth in recent months, European banks continue to trade at marked discount on both historical averages and vs US peers. Thus, EU banks trading at 9.6x P/E CY vs median for the sample from 2010 to the present of 10.9x, -0.7 std. For P/E NY it is -0.2 std for the same sample. Current discount to US peers (on median P/E CY of BKX index vs SX7P index) is 18% vs average of 15% since 2010, just -0.4 std. But operating environment of EU banks remains very challenging so far with still high but decreased risks while upside, implied by Bloomberg consensus price targets, is around 6% at the moment vs the mean of 14% of the sample since 2010 or -0.7 std. In spite of significant underperformance in two previous years and decline of political uncertainty we still see few catalysts for European banks in the near future while valuations don’t look extremely cheap anymore.

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