HomeResearch and NewsArbat Capital: Banking Sector Report - January 2021

Arbat Capital: Banking Sector Report - January 2021

EXECUTIVE SUMMARY

US banks decreased slightly in January 2021, after three consecutive months of a significant growth. Notwithstanding, the first half of the month remained strong and BKX index outperformed the broad market again, for the fourth month in a row after five consecutive months of underperformance. Thus, BKX index declined by 0.1% MoM vs -1.1% MoM of SPX index. Absolute performance was -0.1 std from the mean monthly performance and it is in the bottom 41% since index inception. Relative January performance was +1.0% MoM. It is +0.2 std from the mean monthly performance and it is in the top 41% of relative monthly performance vs SPX index since 1992. Despite significant outperformance in three recent months, during which BKX index outperformed the broad market by more than 20%, it still underperformed SPX index by 25% since the end of 2019. 2020 was the second worst year of relative performance in BKX index history.

The majority of US banks increased in January but the dynamics of BKX index members weren’t uniform as a result of the earnings season. So, banks with weaker than expected quarterly reports decreased by 6-8% MoM while key outperformers increased by more than 10% MoM.

US banks reported strong 4Q20 results with much better both revenue and EPS figures. It was the strongest quarter from EPS surprises point of view since at least 2007 year with better figures for all banks in our group except for HBAN (23 out of 24) vs median number of positive quarterly EPS surprises over the last 56 quarters of 17. Median EPS surprise for our group of banks was +24.6% (also the highest one in our dataset from 2007 year) vs median quarterly figure over the last 14 years of +3.6%. Revenue surprise was positive again, the 21th quarter over the last 24 quarters, +3.2% (the second highest figure in our dataset) vs median quarterly figure over the last 14 years of +0.8%. 18 companies of our group of banks, or 75%, demonstrated positive revenue surprises, significantly higher than median quarterly figure since Q1 2007. Notwithstanding, market perception of the results was clearly negative with a significant decline in the first two weeks of the earning season. Thus, median percent change of the price around the earnings date of our group of banks was -2.03% vs -0.14% in 3Q20 and +1.1% in 2Q20 and median figure since 1Q07 of -0.3%. BKX index decreased by 11.5% since the start of the earnings season till the end of January while S&P 500 index lost just 2.1%. In turn, consensus estimates improved significantly during the earnings season. Thus, 1Q21 EPS estimates were revised up by 10.4% since January 14, 2021 (median of BKX index members), but still -8.4% since the end of 2019, FY21 EPS estimates were +7.4% since the start of the earnings season, but -13.8% since the end of 2019 while median change of FY22 EPS estimates was +2.7% ytd.

Overall, underlying trends of US banks were relatively strong even despite NIM was weaker than expected. Due to reserve releases, ROE/ROA figures increased significantly in 4Q20, being even higher than it was in 4Q19, the second consecutive quarter of growth from the decade low, shown in 2Q20. Thus, ROE increased by 113 bps qoq to 11.3% in 4Q20, +20 bps yoy. 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. But asset quality will inevitably deteriorate in 2021 year. Notwithstanding, banks have already begun reserve releases. Despite NIM was weaker than expected in 4Q20, it seems that NIM has already reached the trough of the cycle but it will be relatively flat in 2021. NII prospects look a little brighter due to investing of excess liquidity in higher yield assets and accelerating loan growth, which, however, is still bleak. One of the key drivers of EPS growth in pre-COVID years – buybacks – is also back. So, EPS will continue its rebound but it will not reach pre-COVID levels in 2021.

Notwithstanding, banks are still trading with a significant discount to S&P 500 and it is again trading with a discount to their historical averages after a substantial growth of EPS forecasts in recent months. Thus, banks are trading with -1.5/-1.3 std on P/E CY and -1.1/-0.8 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 January 29, 2020). As for relative to S&P 500, banks are currently trading at -2.3 std and -1.8 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 +2.5 std for SPX index.

Despite a key driver of positive surprises on net income was reserve releases while NIM was weaker than expected, 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 the start of vaccination campaign. Uncertainty still remains high but it is gradually decreasing. Recent earnings season was quite encouraging, especially taking into account NIM headwinds in 2020 and the depth of the recession in 1H20. Banks outperformed significantly in 4Q20 but it underperformed substantially in FY20 and it still remained a meaningful discount both to historical averages and relative to S&P 500. After a correction in January 2021 and a substantial growth of EPS estimates, we recommend buying US banks as risks/reward is again attractive, from our point of view.

EU banks slightly decreased in January 2021, the second consecutive month of a decline after a skyrocketing growth in November, when SX7P index showed the second best absolute monthly performance in the index history. Moreover, it underperformed the broad market again after two consecutive months of outperformance. So, both relative and absolute dynamics of EU banks remain weak. On an absolute basis, SX7P index decreased by 2.7% MoM in January, or -0.4 std from the mean, and it is the bottom 27% of absolute monthly performance of SX7P index. Relative monthly performance was -1.9% MoM, or -0.4 std, and it is in the bottom 27% of relative monthly performance for SX7P index since inception. Despite an overwhelming growth in October and November, SX7P index ended 2020 year in the red zone. It was the third consecutive year of underperformance. During last three years, SX7P index decreased by 41% while STOXX 600 added 2.5%.

Key outperformers in January were SWEDA and SEB which were driven by news about formalizing AML-cooperation program. From the other hand, UK banks were among key underperformers as a result of higher near term uncertainty because of new restrictions.

Current macro environment remains challenging for EU banks as a result of the second wave of the pandemic and slower than expected vaccination process. Despite GDP will decline substantially again in 4Q20 and remaining downside risks to short-term economic outlook, the ECB noted at its January meeting that baseline scenario was still intact. Contrary to US banks, the start of 4Q20 reporting season for EU banks was ambiguous so far. Despite better LT earnings visibility and more optimistic GDP growth forecasts, revenue environment is still challenging. So, EPS estimates of 2021/2022 years increased just by 1% ytd. Moreover, the ECB lifted dividend ban only partially in December and it was also a clear message that EU banking sector hasn’t been completely out of the woods yet. It was allowed to pay in dividends or buybacks no more than 15% of total profit for 2019-2020 and/or no more than 20 bps of CET1 ratio, whichever is lower. Despite a recent rally, EU banks are trading with a discount to their historical averages again while a discount to US peers is slightly higher than it was in the past. Thus, the discount to historical averages is -14% (-0.8 std at the moment from mean P/E NY of SX7P index members, sample from 2010 to the present) and the discount to US peers (on median P/E NY of BKX index vs SX7P index) is 24.4% at the moment vs average since 2010 of 20.3% or -0.5 std, still unreasonable, from our point of view. So, we continue to prefer US banks to EU ones at the moment.

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