HomeResearch and NewsArbat Capital: Banking Sector Report - May 2021

Arbat Capital: Banking Sector Report - May 2021

EXECUTIVE SUMMARY

US banks outperformed the broad market again in May 2021, the 8th month in a row of outperformance after five consecutive months of weaker dynamics. BKX index increased by 5.0% MoM vs +0.5% MoM of SPX index, the 4th month in a row of positive absolute performance. Absolute May performance was +0.6 std from the mean monthly performance and it is in the top 24% since index inception. Relative May performance was +4.4% MoM. It is +0.9 std from the mean monthly performance and it is in the top 14% of relative performance vs SPX index since index inception. Despite to significant outperformance in recent months, when BKX index outperformed SPX by 46.2% over the last 8 months, it still underperformed the broad market by 9.4% since the end of 2019. However, the first 5 months of 2021 were the best start of the year at least for the last 30 years.

US banks dynamics was relatively uniform in May with positive MoM dynamics for all banks in our sample except for SBNY and EWBC. The key outperformers were banks that were laggards in April as a result of not as strong as it had been expected results. In turn, the majority of May underperformers demonstrated better dynamics in April.

Loan growth of US banks remained weak in the first two months of 2Q21 even despite significant acceleration of the economic recovery as well as rates dynamics after the strong growth of the long end in 1Q21. Notwithstanding, estimates continue going up driven by clearly strong 1Q21 results, ongoing improvement of the economic outlook and rising inflation. Thus, 2Q21 EPS estimates were revised up by 0.5% MoM in May, +10.5% qtd or +28.2% ytd. FY21 EPS increased by 0.5% MoM, +18% qtd or +43.6% ytd. In turn, FY22 EPS estimates was revised up just 0.1% MoM, +4.5% qtd or +12.7% ytd, being markedly below compared to quotes growth of US banks in 2021. Despite the April Fed minutes contained a very clear hint of a possible near term announcement of future tapering, the long end even decreased on MoM basis, implying that this news is already in the price. So, despite rates outlook is markedly better than it was few quarters ago, it means that bank will operate in challenging rate environment still long enough. Unsurprisingly, revenue estimates were almost unchanged in May. On the other hand, banks are still trading with a significant discount to S&P 500 but it is no more trading with a substantial discount to historical averages. Thus, banks are trading with -0.4/-0.4 std on P/E CY and +0.8/+1.0 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 May 28, 2021). As for relative to S&P 500, banks are currently trading at -1.7 std and -1.0 std from the sample mean (2010-current moment) for P/E CY and P/E NY, respectively. On P/B, banks are trading with +1.1 std from the sample mean (2010-current moment) vs SPX with +2.9 std. So, we no more expect an outperformance of US banks vs the broad market given rich valuations and a lack of catalysts for an acceleration of the profit growth, at least near term.

EU banks increased noticeably on an absolute basis again in May, the 4th consecutive month of a positive absolute return. It even outperformed the broad market on relative basis, the second month in a row. Thus, on an absolute basis, SX7P increased by 4.9% MoM in May, or +0.7 std from the mean, and it is the top 21% of absolute monthly performance of SX7P index. On the other hand, relative monthly performance was +2.7% MoM, or +0.8 std, and it is in the top 16% of relative monthly performance in SX7P index history. So, it was the very strong first five months of the year after clearly weak dynamics during three previous years. Thus, SX7P index underperformed in each of last three years and it is still 24.1% lower than it was at the end of 2017, underperforming STOXX 600 index by 33.9% over this period.

The key driver of EU banking stocks was the earnings season. Thus, banks which demonstrated much better than expected 1Q21 figures increased by more than 15% MoM in May (UniCredit, Commerzbank and Sabadell). In turn, Sweden banks were among the underperformers because of rumors of possible extra tax.

European banks reported markedly better results in 1Q21 as they did in three previous quarters after clearly weak figures in 1Q20. Both revenue and net income demonstrated positive surprises. Thus, 30 out of 35 banks from SX7P index for which estimates were available reported better revenue figures vs 22 out of 33 in 4Q20. Net income was also better than expected with 25 out of 27 banks with positive surprises vs 24 out of 29 in 4Q20. EPS was higher for all 30 banks with available estimates in 1Q21 vs 20 out of 25 banks in 4Q20. The key driver of better results was lower provisions due to the improved economic outlook. In turn, NII/NIM figures were weak again and it will remain a headwind in coming quarters even despite to a substantial growth of the long end in recent months. Notwithstanding, earnings momentum continues improving after significant worsening in 1H20. Thus, a median growth of operating profit of SX7P index members was +20% in 1Q21 (flat vs 4Q19) vs -37% yoy in 4Q20. A median growth of revenue was 5.6% yoy in 1Q21 (even +1.0% vs 4Q19) after it decreased by 4.4% yoy in 4Q20 and by 1.4% in 3Q20. In turn, a median revenue surprise was +3.8% better than a median quarterly surprise over the last 10 years and higher than +2.2% in 4Q20. Revenue growth was driven by non-II which skyrocketed by 13.1% in 1Q21 vs -2.6% yoy in 4Q20 and +1.4% yoy in 3Q20. Due to better earnings season and overall optimism as a result of the vaccination campaign and better macro data, market perception of the results was positive. Thus, median 1-day performance of SX7P index members around the earnings date was +0.3% vs 10yr average of +0.2% and 4Q20 figure of +0.6%. So, overall performance since the start of the earnings season was overwhelming with the growth of SX7P index by 11% (from April 20, 2021 till the end of May 2021), while STOXX 600 index increased only by 3% over the same period.

Median growth of EU banks’ net income (SX7P index members) was 74% yoy in 1Q21 after dropping by 26% yoy in 4Q20 and by 13% yoy in 3Q20. Of course, such an impressive growth on yoy basis is primarily due to the effect of a low base. For example, 1Q21 net income was 22% lower than 4Q19 one. And it seems that banks will manage to reach pre-pandemic levels not earlier than in 2H22 given the negative rate environment in the foreseeable future. At least, current estimates imply that FY22 net income estimates are 7% lower than FY19 net income actuals (a median decline of SX7P index) but +49% vs FY20 NI. The key driver of NI growth was provisions which decreased by 52% qoq. So, median ROE of EU banks slightly increased on qoq basis, and it still remained weak, +56 bps qoq, but -198 bps yoy, just 4.7%, not far from the lowest figure over the last 30 quarters. Due to a positive EPS surprise and improved economic expectations, estimates have increased meaningfully in recent weeks. Thus, a median growth of FY21 NI was +10.7% ytd (but -21.4% since the beginning of 2020), implying a growth of 42% yoy. As of FY22 NI estimates, a median growth was +3.7% ytd (but -11% since the beginning of 2020), implying a growth of 15% yoy. On the other hand, revenue estimates added 1.8% ytd for FY21 revenue, but still -5.3% since the beginning of 2020.

As a result of a better 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 more rich valuations. EU banks no longer are traded with a discount to historical averages while the discount to US peers is just slightly wider than it was historically. Thus, a premium to historical averages is 10% (+0.6 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 May 28, 2021 vs an average since 2010 of 20%, or -0.2 std. On the other hand, due to meaningful 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. 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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