HomeResearch and NewsArbat Capital: Banking Sector Report - June 2021

Arbat Capital: Banking Sector Report - June 2021

EXECUTIVE SUMMARY

US banks underperformed the broad market significantly in June 2021, after it demonstrated better dynamics for 8 months in a row. BKX index decreased by 6.3% MoM vs +2.2% MoM of SPX index, the first decline in absolute terms after five consecutive months of positive performance. Absolute June performance was -1.0 std from the mean monthly performance and it is in the bottom 13% since the index inception. Relative June performance was -8.3% MoM. It is -1.7 std from the mean monthly performance and it is in the bottom 5% of relative performance vs SPX index since the index inception. Despite the significant underperformance in June, it remained the strongest first half of the year on an absolute basis in the index history and the strongest year on a relative basis in the last decade.

US banks dynamics was relatively uniform in June with negative MoM dynamics for the majority of banks in our sample. The key outperformers were consumer finance companies as well as GS and MS due to the positive outcome of the stress test. In turn, the majority of smaller banks with a high share of corporate lending were among underperformers.

The earnings season of US banks will start on July 13, 2021 when 2Q21 results will be provided by JP Morgan. After that, all members of BKX index will provide their quarterly results within two weeks. US banks reported much better both revenue and EPS figures in two recent quarters though revenue environment was quite challenging. Operating environment got slightly better since then while the long-term outlook improved significantly. Unsurprisingly, the positive EPS momentum, which began in 3Q20, remains, and estimates were revised significantly up ytd as a result of ongoing vaccination campaigns, an acceleration of the economic recovery and sooner than expected rate hikes. Thus, according to Bloomberg consensus, a median growth of 2Q21 EPS of BKX index members was 35.5% ytd, but still -3.7% vs the end of 2019 (as of the end of June 2021). 2Q21 EPS estimates dynamics was positive for all members of BKX index. Full-year estimates for both current and next year were also revised up meaningfully on ytd basis. A median growth of EPS 21/22 of BKX index members was +44.8%/+12.8% ytd, respectively, but projections were still +0.2%/-5.3% vs the pre-pandemic levels. 2Q21 revenue estimates increased by 2.6% ytd, still remaining markedly below pre-pandemic levels, -2.5% since then.

As a result of optimism about the faster economic recovery and an acceleration of the vaccination campaign, key benchmark rates increased significantly ytd but the long end decreased on qoq basis in 2Q21 even despite to more hawkish Fed. Moreover, a growth of the loan yields remained restrained so far, for all segments except for consumer loans. Notwithstanding, rate expectations moved also meaningfully up recently. Thus, according to FF futures, the first rate hike is expected as early as in 1-1.5 years while the Fed’s dot plot pointed to two rate hikes till the end of 2023 given the recent FOMC meeting. It seems that the market is too optimistic about the dynamics of the short end in coming years but the fact is that the rate environment is no more a headwind for future NIM dynamics. Unsurprisingly, NII/NIM estimates stopped deteriorating recently. Notwithstanding, according to Bloomberg consensus estimates, a median decline of NIM of BKX index members in 2Q21 will be -0.7 bps qoq, or -19 bps yoy, a significant deceleration of pace of decline vs NIM decline in two previous quarters. Median 2Q21 NIM estimate of BKX index members decreased by 4.2 bps ytd, or -1.6 bps qoq, to 2.5% as of the end of June. In turn, median NIM 2021/2022 decreased by 4.5, but +3.9 bps ytd, to 2.51%/2.6%, respectively. On the other hand, a median growth of 2Q21 NII (BKX index members) was +2.6% ytd as of the end of June. But it is expected that it would increase by 2.0% qoq (primarily because of lower day count in 1Q), but still -1.7% yoy. However, the deposits growth still remains very strong and it will support NII in the near future as a result of investing very high levels of liquidity in securities which yields have increased markedly in recent months.

Operating environment for US banks is still challenging but it continues improving very fast. Moreover, the visibility of future earnings is currently much better than it was a couple of quarters ago due to an acceleration of the economic recovery, new fiscal stimulus and a gradual reopening of the economy. Even the Fed has already admitted that risks declined meaningfully in recent months and it was sent clear signal that the rate will be hiked sooner than expected at the June FOMC meeting. A number of recent earning seasons were quite encouraging (e.g. all banks from BKX index beat EPS estimates in 1Q21) and estimates continued to go up. However, much of the expectations are already in the price, from our point of view, especially taking into account the significant outperformance of banks in recent two quarters and relatively rich valuations. Thus, US banks aren’t clearly cheap vs their historical averages. But they are still undervalued vs the broad market. Thus, banks are trading with -0.9/-0.8 std on P/E CY (as of June 25, 2021) and +0.3/+0.5 std on P/E NY (on the basis of samples from 2000 and 2010 years to current moment) relative to their historical averages. As for relative to S&P 500, banks are currently trading at -1.9 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 +0.7 std from the sample mean (2010-current moment) vs +2.9 std for SPX index. So, if the upcoming earnings season won’t meet the expectations, especially in terms of further loans growth, expected NIM dynamics and future capital returns, we will see a correction in US banking stocks given the rally in 1H21 and not clearly cheap valuations. We remain neutral on US banking sector until we see a noticeable acceleration of the loan growth.

EU banks decreased noticeably on an absolute basis in June 2021, after four months of positive absolute return in a row. It underperformed the broad market again after two consecutive months of outperformance. Thus, on an absolute basis, SX7P decreased by 4.1% MoM in June, or -0.6 std from the mean, and it is the bottom 21% of absolute monthly performance of SX7P index. On the other hand, relative monthly performance was -5.4% MoM, or -1.3 std, and it is in the bottom 8% of relative monthly performance in SX7P index history. Notwithstanding, it was very strong price performance in the first half of the year after clearly weak dynamics within three previous years. Thus, SX7P index underperformed in each of last 3 years and it is still 27.2% lower than it was at the end of 2017, underperforming STOXX 600 index by 37.4% over this period.

The key outperformers were Sweden banks which were among key underperformers in May because of rumors of possible extra tax. In turn, key underperformers were banks which demonstrated much better dynamics in the previous months due to relatively strong 1Q21 results.

As a result of stronger 1Q21 earnings season and better earnings visibility due to the ongoing vaccination campaign and an expected GDP growth acceleration, we anticipate that growth of EU banks could continue in the near future but we no more expect substantial outperformance vs the broad market given relatively rich valuations. EU banks are no longer traded with a discount to their historical averages while a discount to US peers is just slightly wider than it was historically. Thus, premium to historical averages is 5% (+0.3 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 23% as of June 25, 2021 vs an average since 2010 of 23%, or -0.2 std. On the other hand, due to meaningful and ongoing EPS upgrades, they still don’t look very expensive either even after the significant price 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. Although 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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