HomeResearch and NewsArbat Capital: Banking Sector Report - February 2021

Arbat Capital: Banking Sector Report - February 2021

EXECUTIVE SUMMARY

US banks skyrocketed in February 2021 after relatively flat dynamics in January. BKX index increased by 16% MoM vs just +2.6% MoM of SPX index. February was the 5th consecutive month of outperformance after five months in a row of underperformance. Absolute February performance was the ninth-best monthly performance since index inception and it was +2.2 std from the mean. Relative February performance was +13% MoM. It is +2.7 std from the mean monthly performance and it is the sixth-best monthly relative performance vs SPX index since index inception. Despite to significant outperformance in recent months, when BKX index outperformed SPX by 36.9% over the last 5 months, it still underperformed the broad market by 18% since the end of 2019.

All members of BKX index ended the month in the green but dynamics wasn’t uniform. Thus, key outperformers, such as SBNY and PBCT, increased by more than 30% MoM while trust banks, which were the main laggards, went up just by 4-7% MoM. 

Despite to strong 4Q20 results, there was a technical correction in US banks in January 2021, but rapid growth resumed in February as a result of optimism about better fee income in 1Q21 and a rapid growth of key benchmark rates. Thus, the average monthly 10yr treasury yield increased by 18.6 bps MoM to 1.24% in February while 30yr mortgage rate increased by 11 bps to 2.95% after it declined MoM for 10 consecutive months. On the other hand, LIBOR rates and the short end are still very far from pre-pandemic levels. Mortgage volumes remain elevated as well as capital markets/IB volumes but loan growth is still muted. Given current macro forecasts, we expect that credit quality will remain strong and banks will continue to release reserves in coming quarters. In other words, fundamentals are much better than it was feared a half-year ago but it is a relatively long road ahead to fully return to business as it was before the pandemic. 

Despite to significant outperformance in recent months, banks are still trading with a meaningful discount to S&P 500 and with a small one to historical averages. Thus, banks are trading with -0.4/-0.3 std on P/E CY and +0.1/+0.3 std on P/E NY (on the basis of samples from 2000 and 2010 years to the current moment) relative to historical averages (as of the end of February). As for relative to S&P 500, banks are currently trading at -1.7 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 +0.3 std from the sample mean (2010-current moment) vs +2.5 std for SPX index. Given the ongoing momentum in US Financials, we continue to recommend buying US banks as risks/reward is still attractive.

EU banks also skyrocketed in February 2021 after two consecutive months of negative dynamics, following an overwhelming performance in November. Thus, on an absolute basis, SX7P increased by 15.5% MoM in February. It was the third-best absolute monthly performance in the index history and it was +2.2 std from the mean monthly performance. On a relative basis, SX7P increased by 12.2% MoM and it was +3.3 std from the mean. It was also the third-best month of relative performance in index history. Thus, SX7P showed the best second and the best third months in its history during the last 4 months when SX7P added 46.1% and it outperformed the broad market by 22.8%. Notwithstanding, SX7P index underperformed in each of the 3 last years and it is still 34% lower than it was at the end of 2017, underperforming STOXX 600 index by 37% over this period.

Key outperformers in February were French banks and VMUK which were laggards during the previous months. Just two members of SX7P index ended the month in the red zone. Thus, Swedbank decreased by 6.2% MoM as a result of weaker 4Q20 results while CBK went down by 0.9% MoM because of disappointing strategy.

European banks reported markedly better results in 4Q20 as they did in 2Q20 and 3Q20 after clearly weak figures in 1Q20. Both revenue and net income figures demonstrated positive surprises. Thus, 22 out of 33 banks from SX7P index for which estimates were available reported better revenue figures vs 30 out of 40 in 3Q20. Net income was also better than expected with 24 out 29 banks with positive surprises. EPS was higher for 20 out of 25 banks in 4Q20 vs 25 out of 35 banks in 3Q20. The key driver of better results was lower provisions due to a better economic outlook. In turn, NII/NIM figures were weak again and it will remain a headwind in the coming quarters even despite a substantial growth of the long end in recent months. Notwithstanding, earnings momentum began to improve after significant worsening in 1H20. Thus, a median decline of operating profit of SX7P index members improved from -44% yoy in 2Q20 to -23% yoy in 4Q20. A median decline of revenue was -6.1% yoy in 4Q20 after it decreased by 1.4% yoy in 3Q20 and felt by 4.3% in 2Q20. In turn, a median revenue surprise was +2.2% better than a median quarterly surprise over the last 10 years but lower than +3.1% in 3Q20. Revenue decline was driven by NII which decreased by 6.3% in 4Q20 vs -4.8% yoy in 3Q20 and -2.8% yoy in 2Q20. Due to better earnings season and overall optimism as a result of the vaccination campaign and better macro data, market perception of the results was positive. Thus, median 1-day performance of SX7P index members around the earnings date was +0.6% vs 10yr average of +0.2% and 3Q20 figure of -0.9%. So, overall performance since the start of the earnings season was overwhelming with growth of SX7P index by 8.1% (from January 20, 2021 till the end of February 2021), while STOXX 600 index decreased by 1.4% over the same period.

A median decline of EU banks’ net income (SX7P index members) was 29.5% yoy in 4Q20 after dropping by 20.7% yoy in 3Q20 and by 43.3% yoy in 2Q20. And it seems that banks will manage to reach a pre-pandemic level not earlier than in 2H22 given the negative rate environment in the foreseeable future. At least, current estimates imply that FY22 net income estimates are 16% lower than FY19 net income actuals (a median decline of SX7P index). As a result of higher provisions on qoq basis, net income declined again sequentially after positive dynamics in 3Q20. So, median ROE of EU banks continues declining, -72 bps qoq or -374 bps yoy to just 4.2%, the lowest figure over the last 30 quarters. Due to positive EPS surprise and improved economic expectations, estimates have increased meaningfully in recent weeks. Thus, a median growth of FY21 NI was +3.9% ytd (but -37.6% since the beginning of 2020), implying a growth of 26% yoy. As of FY22 NI estimates, a median growth was +2.0% ytd (but -22.6% since the beginning of 2020), implying a growth of 25% yoy. On the other hand, revenue estimates were relatively flat with a growth of just +0.2% ytd for FY21 revenue but a decline of -7.2% since the beginning of 2020.

Revenue environment remains very challenging for European banks even despite markedly better momentum due to the ongoing vaccination campaign. And we don’t expect that revenue environment will be much better in the coming quarters. As a result of better earnings season and better earnings visibility due to the ongoing vaccination campaign and expected GDP growth acceleration, we anticipate that outperformance of EU banks will continue in the near future. Moreover, due to meaningful EPS upgrades, the sector still remains relatively cheap even taking into account a significant price growth in recent months. From our point of view, the worst is behind us but it is a bumpy road ahead with risks still tilted to the downside. Despite we expect that EPS estimates will return to 2019 levels not earlier than in 2H22, it seems that the market is currently looking much further in time. EU banks are still trading with a small discount to historical averages while discount to US peers is markedly wider than it was historically. Thus, discount to historical averages is 5.0% (-0.3 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 27% as of February 26 vs an average level since 2010 of 20%, or -0.8 std. So, we are tactically bullish on EU banks at the moment but we continue to prefer US banks to EU ones in the longer run.

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