HomeResearch and NewsArbat Capital: Banking Sector Report - March 2021

Arbat Capital: Banking Sector Report - March 2021

EXECUTIVE SUMMARY

US banks outperformed the broad market in March, the sixth month in a row of outperformance after five consecutive months of weaker dynamics. BKX index increased by 5.9% MoM vs +4.2% MoM of SPX index. Absolute March performance was +0.8 std from the mean monthly performance and it is in the top 19% since index inception. In February, it was shown the 9th-best monthly performance in history. Relative March performance was +1.6% MoM. It is +0.4 std from the mean monthly performance and it is in the top 33% of relative performance vs SPX index since index inception. Despite to significant outperformance in recent months, when BKX index outperformed SPX by 39.1% over the last 6 months, it still underperformed the broad market by 13.8% since the end of 2019.

All members of BKX index except for PBCT, KEY and SIVB ended the month in the green. Thus, the key outperformers were trust banks which were the key laggards in February. The key March laggard was SIVB which was one of the best performers during the last 12 months, almost tripling over the period.

The earnings season of US banks will start on the 14th of April, when 1Q21 results are provided by JP Morgan and Wells Fargo. After that, all members of BKX index will provide 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, positive EPS momentum, which began in 3Q20, remains, and estimates were revised significantly up ytd as a result of new fiscal stimulus, an ongoing vaccination campaign and an acceleration of the economic recovery. Thus, according to Bloomberg consensus, a median growth of 1Q21 EPS of BKX index members was 19.1% ytd but still -6.3% vs the end of 2019 (as of the end of March). 1Q21 EPS estimates dynamics was negative ytd only for BK and STT while COF’s consensus increased by more than 45% ytd. Full-year estimates for both current and next year were also revised up meaningfully on ytd basis. A median growth of EPS 2021/2022 of BKX index members was +17.2%/+6.7% ytd, respectively, but projections were still -10.3%/-10.5% vs pre-pandemic levels. 1Q21 revenue estimates increased by 1.8% ytd, still remaining markedly below pre-pandemic levels, -3.9% since then.

From our point of view, the drivers of mid-term EPS growth which could move banking quotes higher include a faster loan growth, higher short-term rates and a growth of capital returns. We believe that EPS growth on reserve releases as a result of strong credit quality of US banks loan portfolios and a much better economic outlook is already fully priced. So, as a result of optimism about a faster economic recovery and ongoing vaccination campaign, key benchmark rates increased significantly ytd. On the other hand, a growth of the loan yields remained restrained so far, especially for C&I loans which yields are linked to the short end of the curve. Notwithstanding, rate expectations moved also meaningfully up recently. Thus, according to FF futures, the first rate hike is expected till the end of 2022 while the Fed’s dot plot pointed to the first rate hike only in 2024. It seems that the market is too optimistic about dynamics of the short end in coming years but the fact is that the rate environment is no more a headwind for NIM. A loan growth remains relatively weak, but it should accelerate markedly in 2H21. Thus, a solid growth of other consumer loans in 1Q21 was leveled by a decline of mortgage loans. Due to lifting temporary restrictions on dividends and buybacks after June 30, 2021 we expect a significant growth of capital returns in 2H21 which among other things will lead to the noticeable growth of EPS.

As a result of a number of positive news in recent months, banking quotes increased meaningfully in last six months, even despite operating environment still remains challenging. Notwithstanding, the situation is beginning to change for the better. On the other hand, much of the expectations are already in the price, from our point of view. So, if the upcoming earnings season doesn’t meet the expectations, especially in terms of a further loans growth, expected NIM dynamics and future capital returns, we will see a correction in US banking stocks given the recent rally and the fact that US banks aren’t already cheap vs historical averages. But they are still undervalued vs the broad market. Thus, banks are trading with 0.0/0.0 std on P/E CY (as of March 26, 2021) and +0.4/+0.6 std on P/E NY (on the basis of samples from 2000 and 2010 years to current moment) relative to historical averages (as of the end of February). As for relative to S&P 500, banks are currently trading at -1.6 std and -1.2 std from the sample mean (2010-current moment) for P/E CY and P/E NY, respectively. On P/B, banks are trading with +0.6 std from the sample mean (2010-current moment) vs +2.8 std for SPX index. Notwithstanding, we still see ongoing momentum in US banks and recommend buying on dips but being selective as valuations of a number of banks look rich, from our point of view.

EU banks increased significantly on an absolute basis in March 2021 after it was shown the third-best monthly performance in the index history both on an absolute and relative basis in February. Notwithstanding, it underperformed the broad market again, the third month of weaker dynamics over the last 4. Thus, on an absolute basis, SX7P increased by 6% MoM in March or +0.8 std from the mean and it is in the top 14% of absolute monthly performance of SX7P index. On the other hand, relative monthly performance was -0.1% MoM, but +0.1 std, and it was the median relative monthly performance for SX7P index since inception. It was the very strong first quarter of the year after 3 clearly weak previous years. Thus, SX7P index underperformed in each of three last years and it is still 30% lower than it was at the end of 2017, underperforming STOXX 600 index by 32% over this period.

The key outperformer in March was Sydbank due to much better 4Q20 results. It increased by more than 20% MoM. The key underperformer in March was Credit Suisse which was at the center of the scandal with Archegos. CS’s losses could be up to $4 Bn. Also, regulator’s sanctions are quite possible. Unsurprisingly, CS lost almost 25% MoM.

Despite to a better economic outlook, a markedly higher long end of the curve and stronger 4Q20 earnings season, NI projections of EU banks were almost unchanged in March with a median growth of just +0.3% MoM for both 2021E and 2022E. As a result of a slower than expected EU’s vaccine rollout campaign, risks are still tilted to downside but risks became more balanced, according to the ECB. The ECB acknowledged at March meeting that incoming economic data, surveys and high-frequency indicators pointed to continued economic weakness in 1Q21 and it is quite possible that 1Q21 GDP growth would be negative on qoq basis again, implying the second technical recession over the last 5 quarters. Notwithstanding, the ECB remains optimistic, but GDP growth projections for three nearest years were almost unchanged in March 2021 vs December 2020. Moreover, despite to markedly higher inflation forecast for 2021, it was announced that purchases under PEPP over 2Q21 to be conducted at a significantly higher pace than it was in 1Q21 to improve financial conditions in the EU given a recent growth of the long end. In any case, the key near-term profit driver for EU banks will remain reserve releases while revenue environment will remain challenging. So, we don’t expect that EPS estimates will return to 2019 levels not earlier than in 2H22, but it seems that the market is currently looking much further in time. On the other hand, EU banks don’t already look clearly cheap. Thus, premium to historical averages is just 2% (+0.1 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 25% as of March 26, 2021 vs an average since 2010 of 20%, or -0.5 std. Notwithstanding, we remain tactically bullish on EU banks and we recommend buying on dips, but we continue to prefer US banks to EU ones in the longer run.

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