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Banking Sector Monthly Report - February 2022

EXECUTIVE SUMMARY

US banks outperformed the broad market again in February 2022 despite to their negative absolute performance, after three consecutive months of positive dynamics. Thus, BKX index decreased by 0.6% MoM vs -3.1% MoM of SPX index. Absolute February performance was -0.2 std from the mean monthly performance and it is in the bottom 37% since the index inception. In turn, relative February performance was +2.6% MoM. It is +0.6 std from the mean monthly performance and it is in the top 24% of relative performance vs SPX index since the index inception. Despite to a significant growth of the geopolitical risks and lower rate expectations, US banks outperformed the broad market by more than 10% in the first two months of the year.

US banks' dynamics were quite mixed in February. Thus, the best performer, First Horizon National, skyrocketed by 37.2% MoM due to the news that came out on the last day of the month that it will be bought by TD. On the other hand, large banks with a relatively high share of international revenues and Trust banks were among the underperformers.

Overall, fundamentals of US banks remain quite strong and will continue improving in the coming years, even despite growing risks of a lower GDP growth, sanctions-related spillover effects, and higher inflation. Rate expectations went down after Russia’s invasion to Ukraine, but it is still expected 5 rate hikes till the end of 2022. We don’t exclude that rate expectations may go down further in the near term but we believe that the impact of the conflict between Russia and Ukraine will have a limited impact on US banks. At least now, we don’t expect significant revenue/EPS downgrades. On the other hand, banks don’t look quite cheap at the moment. US banks are still trading with a noticeable discount to S&P 500 but roughly in line with historical averages. Thus, banks are trading at +0.1/+0.1 std on P/E CY and at -0.5/-0.2 std on P/E NY (on the basis of samples from 2000 and 2010 years to current moment) relative to their historical averages (as of February 25, 2022). As for relative to S&P 500, banks are currently trading at -0.7 std and
-1.1 std from the sample mean (2010-current moment) for P/E CY and P/E NY, respectively. Nonetheless, we still remain positive on US banks' prospects and recommend buying the dips.

EU banks decreased substantially both on an absolute basis and on a relative basis in February 2022, after two consecutive months of their significant growth on both bases. Thus, on an absolute basis, SX7P tumbled by 9.3% MoM in February, or -1.4 std from the mean, and it is in the bottom 8% of absolute monthly performance of SX7P index. On the other hand, relative monthly performance was -6.1% MoM, or -1.5 std, and it was in the bottom 7% of relative monthly performance in SX7P index history. Nonetheless, EU banks continue outperforming the broad market in 2022 after clearly strong 2021 year when they added 34% (+9.6% on relative basis). On the other hand, SX7P index underperformed in each of 2018-2020 years. So, it is still 23.2% lower than it was at the end of 2017, underperforming STOXX 600 index by 34.1% over this period.

All European banks from our group, except for Banco Sabadell and CaixaBank, ended the month under review in the red. The key underperformers were Erste Group and Raiffeisen Bank because of their high exposure on CEE. RBI has also business in Russia and Ukraine, so it lost more than 40% in February.

European banks reported markedly better results in 4Q21 as they did in five previous quarters after clearly weak figures in 1Q20. Both revenue and net income demonstrated positive surprises. Thus, 27 out of 33 banks from our group of banks for which consensus estimates were available reported better revenue figures in 4Q21 vs 32 out of 33 in 3Q21. Net income was also better than expected for 26 out of 31 banks vs 31 out of 33 in 3Q21. EPS was higher for 24 out of 31 with available estimates in 4Q21 vs 29 out of 33 banks in 3Q21. The key driver of better results was lower provisions due to better economic outlook and ongoing revenue momentum. Even NII/NIM figures weren’t weak for the third consecutive quarter despite rates environment remained challenging, but gradually improving. So, NII prospects for coming years improved meaningfully in recent months due to accelerated inflation and more hawkish ECB. Hence, earnings momentum continues getting better after significant worsening in 1H20. Thus, a median operating profit growth of SX7P index members was +14% yoy in 4Q21 vs +31% yoy in 3Q21 or +45% yoy in 2Q21. A median growth of revenue was +7.7% yoy in 4Q21 (even +1% vs 4Q19), the fourth quarter of positive yoy growth in a row, following negative dynamics over four consecutive quarters. In turn, a median revenue surprise was +2.3%, markedly better than a median quarterly surprise over the last 10 years of +1.2% (but slightly lower than the figure of 3Q21). A revenue growth was broad-based with the second consecutive quarter of yoy NII growth over the last 7 quarters and 8%+ yoy growth of non-II for the fourth quarter in a row. Despite better earnings season, acceleration of the recovery and higher rate expectations, the market perception of the results was restrained (primarily because of Russia’s invasion to Ukraine). Thus, median 1-day performance of SX7P index members around the earnings date was -0.2% vs 10yr average of +0.2% and 3Q21 figure of +0.5%. On the other hand, overall performance since the start of the earnings season was clearly weak with a decline of SX7P index by 10.2% (from January 19, 2022 till the end of February 2022), while STOXX 600 index decreased by 5.8% over the same period.

A median growth of EU banks’ net income (our group of 36 banks) was 62% yoy in 4Q21 after a growth of 50% yoy in 3Q21, the fourth consecutive quarter of yoy growth after 4 quarters in a row of decline. Moreover, 4Q21 net income was even 6% higher than 4Q19 one due to significant reserve releases and better revenue dynamics. Thus, provisions decreased by 61% yoy and provisions were negative for 9 members of our group of banks out of 36 (vs 11 banks in 3Q21). Moreover, consensus forecasts already imply that FY22 NI will be higher by 4% vs FY19 NI. Also, median ROE of EU banks markedly increased on qoq basis in 4Q21 and it is already higher than it was in 2019. Thus, median ROE increased by 110 bps qoq, or +481 bps yoy, to 8.7% in 4Q21, while it was around 8% in 2H19. Due to a positive EPS surprise and improved economic expectations as well as a substantial growth of rates and expectations, estimates have increased meaningfully in recent months. Thus, the median growth of FY22 NI was +0.8% ytd (+10.4% vs the end of 2Q21), implying a decline of 3% yoy. As of FY23 NI estimates, the median growth was +1.2% ytd (or +8.3% vs the end of 2Q21), implying a growth of +7.8% yoy. On the other hand, revenue estimates added just 0.4% ytd for FY22 revenue, or +2.5% since the end of 2Q21.

Due to improving earnings momentum as a result of faster economic recovery, higher rate expectations and stronger earnings seasons, the dynamics of the banking stocks was quite strong starting from the third decade of December 2021 and ending with the first decade of February 2022. As a result of profit-taking and escalation between Russia and Ukraine, the SX7P index almost returned back to where the rally started. So, EU financial institutions don’t look expensive again, especially taking into account ongoing growth of revenue/EPS estimates for 2022/23 years and still higher rate expectations. Thus, a 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), but a discount to US peers (on median P/E NY of BKX index vs SX7P index) is 30% as of February 25, 2022 vs the average since 2010 of 21%, or -1.0 std. So, we could assume that the growth of EU banks could resume in the near future if Russia’s invasion's impact on the EU economy isn’t very devastating. But unfortunately, these risks are only increasing every day. Under such conditions, we recommend waiting on the sidelines until the bullets stop flying.

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