HomeResearch and NewsArbat Capital: Banking Sector Report - January 2020

Arbat Capital: Banking Sector Report - January 2020


US banks declined significantly in January after very strong performance in 2019. Thus, the broad market was underperformed substantially after 4 months in a row of leading dynamics. Thus, BKX index decreased by 7.6% MoM in January vs -0.2% MoM of SPX index. Absolute January performance on MoM basis was -1.2 std from the mean and it is in the bottom 1% of absolute MoM performance of BKX index. Relative January performance was -7.4% MoM, it is -1.6 std from the mean and it is in the bottom 6% of relative MoM performance vs SPX index since 1992. It was the worst start of the year on absolute basis over the last 4 years and the third worst January on relative basis over more than 28 years.

Banking quotes were driven by quarterly results and coronavirus threat. So, banks with better quarterly figures demonstrated positive dynamics. However, banks which missed estimates fell significantly more in absolute terms than banks which beat estimates rose. Thus, all 5 worst performers lost more than 10% MoM in January.

US banks reported better than feared headline numbers due to strong capital markets revenues but net income was negative on yoy basis for the second quarter in a row. NII and NIM remains a drag for US banks as well as loan growth is still relatively weak but we see some stabilization of NIM, still strong credit quality and managed CECL impact while opportunities for expense control and positive operating leverage have reduced. Thus, 17 out of 24 of our group of banks demonstrated positive EPS surprises, in line with median number of positive quarterly EPS surprises over the last 51 quarters but slightly lower than a number of positive EPS surprises in the first 3 quarters of 2019. Thus, median EPS surprise for our group of banks was +3.6% vs median quarterly figure over the last 12.5 years of 3.5%. Moreover, revenue surprise was also positive, the 21th quarter over the last 23 quarters, +0.6% vs median quarterly figure over the last 12.5 years of 0.8%. 17 companies of our group of banks, or 71%, demonstrated positive surprise on revenue, markedly higher the median quarterly figure since Q1 2007 of 62%. Surprisingly, market perception of the results was negative for the first time over the last 6 quarters – median percent change in price around the earnings date of our group of banks was -1.7%, markedly lower than median figure since Q1 2007 of -0.25%. BKX index decreased by 6.3% since the start of the earnings season till the end of January while S&P 500 index lost only 1.9% over the same time, but the key reason of significant decline was coronavirus fears rather than quarterly results, from our point of view. Notwithstanding, consensus estimates were almost unchanged qtd. Thus, 1Q20 EPS estimate was revised down by 0.4% qtd / -0.3% since 13 January (median of BKX index members), FY20 EPS estimate was +0.1% / -0.1% since the start of the earnings season while median change of FY21 EPS estimates was +0.3% qtd / +0.2% since 13 January.

Median growth of non-interest revenue of BKX index members was +0.4% qoq or +11.4% yoy, the strongest yoy growth since 4Q12. It was mainly driven by capital markets but we don’t expect that the growth is sustainable given its volatility, high valuations of US markets and inevitable growth of risks in the middle of the year because of elections. In turn, median decline of NII of BKX index members was 0.4% qoq or -2.0% yoy vs -0.7% qoq or flat yoy dynamics in 3Q19. On qoq basis, it was the fourth quarter of decline in a row. The key driver of negative NII dynamics remains ongoing NIM decline after three rate cuts in 2019 but it was slightly better than consensus estimates in 4Q19. From the other hand, median NII surprise of BKX index members was -0.1% (vs estimates as of January 13), negative for the second quarter in a row. Given current rate estimates, we expect that NIM will continue to decline in 1H20 but it will stabilize in 2H20. However, it all depends on the future fed’s policy. For example, a number of banks expect that the rate will be lowered at least once in 2020. Also, opex was again higher than expected. In result, operating leverage of BKX index members was negative in 4Q19 for the second quarter in a row after 9 consecutive quarters being positive. And we don’t expect that banks will be able to demonstrate significant positive operating leverage in 2020 even despite still good expense control given challenging revenue environment and necessity to invest in technology.

Overall, operating trends of US banks were solid so far but gradually deteriorating. So, we still see almost no EPS drivers in the near future except for high buybacks with rising political uncertainty given election year even despite diminished risks of trade war and Brexit recently. At the same time, banks continue to trade with significant discount to historical averages while discount to S&P 500 index has decreased significantly even despite late cycle concerns. Thus, banks are trading with -1.3 / -1.9 std on P/E CY and -1.3 / -1.9 on P/E NY (on the basis of samples from 2000 and 2010 years to current moment) relative to historical averages (as of January 31). As for relative to S&P 500, banks are currently trading at -1.3 and -1.4 std from the sample mean (2010-current moment) for P/E CY and P/E NY, respectively. So, we are neutral on US banks until we see macro and rate environment improvements.

EU banks decreased in January after 4 consecutive months of positive absolute performance. On relative basis, it underperformed the broad market again, after two years in a row of significant underperformance. On absolute basis, SX7P index decreased by 5.1% MoM in January or -0.8 std from the mean and this result is in the bottom 19% of absolute monthly performance of SX7P since the index inception. Also, relative monthly performance was -3.9% MoM or -1.0 std and it is in the bottom 12% 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 2018 and 2017, respectively, EU banks showed the worst January relative performance over the last 4 years.

The key drivers of EU banks in January were also the start of the earnings season and risks associated with coronavirus. So, the worst performers were Spanish banks which significantly missed expectations. Thus, Banco Sabadell lost more than 20% of its market cap in January. In turn, banks with better results increased significantly but the best January performance was demonstrated by DBK which quarterly figures were in-line but progress in restructuring was the reason for relief rally in the last days of the month.

EU macro data published in recent months were slightly better than expected pointing to possible stabilization in EU economy in the near future, especially if coronavirus risk is resolved quickly. But EU GDP added just 0.1% qoq in 4Q19, missing consensus of +0.2%, because of unexpected decline of both French and Italian GDP on qoq basis. Composite PMI also missed estimates in January but it remains above 50 pts. Despite January ECB meeting was uneventful, it was noted again that ECB’s baseline scenario of ongoing but moderate growth of economy of euro area is intact. Start of the earning season was relatively neutral as better/worse results were shared equally, thanks to strong capital markets revenues, which is not bad, given clearly weak results in previous quarters. Despite all above,

EU banks EPS estimates continue to go down because of negative rate environment and still relatively weak macro, but the rate of estimates decline has decreased. So, EU banks continue to trade with significant discount to historical averages (-18% / -1.1 std from mean P/E CY of SX7P index members, sample from 2010 to the present) but discount to US peers (on median P/E CY of BKX index vs SX7P index) is 17.7% at the moment vs average of 15.7% since 2010 or -0.4 std, still minor, given higher risks associated with EU banks. However, if macro and earnings stabilization continues, we could see short-term rally in EU banks in the near future, given underperformance in 2 previous years.

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Arbat Capital: Banking Sector Report - February 2020

US banks tumbled again in February after very weak performance in January amid spreading COVID-19 around the world. The broad market was underperformed substantially for the second consecutive month after 4 months in a row of leading dynamics. Thus, BKX index decreased by 12.5% MoM in February vs -8.4% MoM of SPX index. Absolute performance on MoM basis was -2 std from the mean and it is in the bottom 4% of absolute MoM performance of BKX index.

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Commodity market Report - February 2020

Trade war is officially over but Chinese risks resurfaced from the other side - extreme quarantine measures after coronavirus outbreak in Jan-Feb resulted in significant breakdown in the industrial production chains and construction activity. However monetary and fiscal stimuli quickly reversed negative sentiment and overall risk conditions returned to the high Greed mode with only commodities market kept in risk-off mode. Energy complex was very volatile as its initial sharp drop was lately compensated by OPEC verbal interventions and renewed risk in Libya and Venezuela. Industrial metals fell sharply, but Precious shined brightly with unbelievable bubble in Palladium. Agri commodities were mostly range bound with Cocoa being top performer

Macroeconomic drivers turn to negative as positive developments after the Trade Deal signature and record financial markets levels gave the way to fears of world economic slowdown after the virus outbreak. On the other hand there were not many voices for recession as stimulative monetary policy should provide the cushion. However we think that markets overstated willingness of the Fed to keep on printing and the main risk once again turned to the hawkish surprise when it exits REPO stimulus gambit and the ECB to end QE.