HomeResearch and NewsArbat Capital: Banking Sector Report - Jule 2021

Arbat Capital: Banking Sector Report - Jule 2021

EXECUTIVE SUMMARY

US banks underperformed the broad market significantly in July 2021 again, the second consecutive month of weaker performance after the sector demonstrated better dynamics for 8 months in a row. BKX index decreased by 2.5% MoM vs +2.3% MoM of SPX index, the second consecutive decline in absolute terms after five months in a row of positive performance. Absolute July performance was -0.5 std from the mean monthly performance and it is in the bottom 27% since the index inception. Relative July performance was -4.7% MoM. It is -1.0 std from the mean monthly performance and it is in the bottom 11% of relative performance vs SPX index since the index inception. Despite significant underperformance in two recent months, it remained the strongest first 7 months of the year on an absolute basis over last 24 years and the strongest year on a relative basis over last 8 years.

US banks dynamics was mixed in July, driven by the earnings season. Thus, banks with better quarterly figures ended the month in the green zone. In turn, banks with weaker figures decreased by 7% or more. Thus, FHN lost more than 10% MoM.

US banks reported very strong 2Q21 results with much better both revenue and EPS figures. It was the 5th quarter in a row when both revenue and EPS figures exceeded consensus estimates considerably after clearly weak 1Q20 earnings season. The key driver of better NI remains reserve releases, for the third quarter in a row, while NII/NIM figures were below forecasts again. On the other hand, fees were strong (except for mixed trading figures) due to better consumer spending and an accelerating of the recovery, while underlying trends continue improving even for NII/loan growth. From our point of view, the process of reserves releasing has come to an end but we see a room for further EPS growth given the first signs of the loan growth accelerating and more hawkish Fed as well as higher buyback volumes. So, we still see the ongoing momentum in US banks, even taking into account their significant outperformance in 2021. Given correction in banking quotes in two recent months and the fact that banks are still substantially undervalued vs S&P 500, we believe that the rally may well continue in 2H21 due to markedly better both loan and rates outlook. So, we are again bullish on banks and recommend buying US banks on dips but to be selective.

It was very strong quarter again, with better EPS figure for 23 out of 24 banks in our group in 2Q21 after all banks from the group beat consensus in 1Q21 (vs a median number of positive quarterly EPS surprises over the last 57 quarters of 17). Median EPS surprise for our group of banks was +34.7% (the second highest one in our dataset from 2007 year) vs a median quarterly figure over the last 14 years of 3.7%. The previous high of 41% was demonstrated in 1Q21. Revenue surprise was positive again, the 22th quarter over the last 23 quarters, +3.3% vs a median quarterly figure over the last 14 years of 0.9%. 21 companies of our group of banks, or 88%, demonstrated positive surprises on revenue, significantly higher than a median quarterly figure since Q1 2007. Notwithstanding, the market perception of the results wasn’t positive with a noticeable decline in the first two weeks of the earning season. On the other hand, a median percent change in price around the earnings date of our group of banks was +0.5%, the first quarter of positive growth over last year and a median figure since 1Q07 of -0.3%. BKX index decreased by 3% since the start of the earnings season till the end of July 2021, while S&P 500 index added just 0.2%. In turn, consensus estimates improved significantly during the earnings season. Thus, 3Q21 EPS estimates were revised up by 2.8% since July 12, 2021 (a median of BKX index members) and it is +35.5% ytd, FY21 EPS estimates were +5.7% since the start of the earnings season, or +53.3% ytd, while a median change of FY22 EPS estimates was +1.1% since July 12, 2021, or +12.8% ytd. In turn, a median revenue growth was 1.0% and 4.8% ytd, respectively.

Overall, underlying trends of US banks were quite strong even despite NIM and loan growth missed expectations. Due to reserve releases, ROE/ROA figures increased significantly in four recent quarters, remaining at their multi-year highs for the second consecutive quarter. Thus, ROE increased by 25 bps qoq to 13.65% in 2Q21, +798 bps yoy or +272 bps vs 4Q19. Key credit metrics of US banks still remained pretty resilient due to a significant acceleration of the economy and the continued positive effect of previously adopted unprecedented fiscal stimuli. We no more expect any deterioration of the credit quality in the near future even after the expiration of various supporting programs. On the other hand, the current level of profitability is unsustainable, from our point of view, and we expect that ROE/ROA will inevitably decline in coming quarters as there is no room for further significant reserve releases. However, NII prospects improved significantly in the last quarter due to more hawkish Fed and an acceleration of the loan growth, even taking into account that the long end decreased noticeably in 2Q21. Also, banks continue to increase the pace of buybacks after optimistic results of the stress test. 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 no more trading with a substantial discount to historical averages after a significant growth of EPS forecasts in recent months. Thus, banks are trading with -1.5/-1.3 std on P/E CY and -0.3/0.0 std on P/E NY (on the basis of samples from 2000 and 2010 years to current moment) relative to historical averages (as of July 30, 2021). As for relative to S&P 500, banks are currently trading at -2.1 std and -1.6 std from the sample mean (2010-current moment) for P/E CY and P/E NY, respectively. On P/B, banks are trading with +0.2 std from the sample mean (2010-current moment) vs SPX with +3.0 std.

EU banks decreased slightly on an absolute basis in July 2021, after a significant decline in the month prior following 4 months of positive absolute return in a row. It underperformed the broad market again, the second consecutive month of underperformance. Thus, on an absolute basis, SX7P decreased by 0.8% MoM in July, or
-0.2 std from the mean, and it is in the bottom 37% of absolute monthly performance of SX7P index. On the other hand, relative monthly performance was -2.7% MoM, or -0.6 std, and it is in the bottom 20% of relative monthly performance in SX7P index history. Notwithstanding, it was very strong price performance in the first 7 months of the year after clearly weak dynamics in previous three years. Thus, SX7P index underperformed in each of last 3 years and it is still 27.8% lower than it was at the end of 2017, underperforming STOXX 600 index by 39.1% over this period.

The key outperformers were EU banks which released relatively good quarterly results. In turn, key underperformers were banks which were the most asset sensitive financial institutions given more dovish ECB’s meeting as well as banks with weaker quarterly results.

Due to a stronger start of 2Q21 earnings season and better earnings visibility as a result of ongoing vaccination campaigns and an expected GDP growth acceleration, we anticipate that the growth of EU banks could continue in the near future but we no more expect their substantial outperformance vs the broad market given relatively rich valuations. EU banks are no longer traded with a deep discount to their historical averages, while a discount to US peers is just slightly wider than it was historically. Thus, the discount to historical averages is 2.0% (-0.1 std at the moment from mean P/E NY of SX7P index members, sample from 2010 to the present), but a discount to US peers (on median P/E NY of BKX index vs SX7P index) is 21% as of July 30, 2021, in line with an average from 2010. On the other hand, due to meaningful and ongoing EPS upgrades, EU banks still don’t look very expensive either even after a significant quotes growth ytd. We believe that the worst in terms of operational results is behind us but it is a bumpy road ahead with a still challenging revenue environment and relatively low ROE/ROA in the near term. 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.

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