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Banking Sector Monthly Report - June 2022

EXECUTIVE SUMMARY

US banks underperformed the broad market significantly in June 2022, for the third time over the last four months. BKX index ended just two months in the green in the first half of 2022. Thus, BKX index tumbled by 13.3% MoM vs -8.4% MoM of SPX index. Absolute June 2022 performance was -2.0 std from the mean monthly performance, and it was the 9th worst absolute monthly performance in the index history. Relative June 2022 performance was -5.4% MoM. It is -1.1 std from the mean monthly performance, and it is in the bottom 9% of relative performance vs SPX index since its inception. Despite a skyrocketing growth of rates, US banks underperformed the broad market significantly since mid-February 2022 as a result of much higher uncertainty and a growth of the recession risks.

US banks' dynamics were roughly uniform with negative dynamics for all our group of banks in June 2022. The worst performers were consumer finance companies, the operating results of which the recession will have the most negative impact. Thus, SYF lost more than 25% MoM in June. In turn, the best performer of the month, FHN, lost “just” 4.2% MoM.

The earnings season of US banks will start on July 14th, 2022, when 2Q22 results will be provided by JP Morgan (in fairness, the FRC, which reports on July 13th, starts the first). After that, all members of BKX index will provide quarterly results within roughly 2 weeks. Despite mixed 1Q22 results, growing recession risks and very fast monetary tightening, we expect that 2Q22 and 2H22 operating figures will be quite strong as a result of a substantial growth of NIM/NII due to solid loan dynamics across all key segments and a skyrocketing growth of the rates, both ST and LT. On the other hand, fee income is expected to be relatively weak across the majority of key lines. Nonetheless, revenue dynamics will remain quite strong as NII growth will overshadow poor dynamics of fee income. So, operating leverage will continue improving in the coming quarters due to roughly flat OpEx dynamics, and it will be positive again in 2Q22 for the first time over the last 8 quarters. Despite the process of releasing reserves has already ended, asset quality will remain quite strong (NCO ratios are still much lower vs historical averages) in the nearest quarters, without having any significant negative impact on the bottom line. In other words, the positive EPS momentum, which began in 3Q20, remains, and estimates could continue to be revised up in the near future even taking into account an almost inevitable recession in the next 1.5 years. Nonetheless, despite median 2Q22 EPS growth of BKX index members is positive both ytd and qtd, estimates of a number of banks still demonstrated negative dynamics. Thus, according to Bloomberg consensus, a median growth of 2Q22 EPS of our group of banks was +2.4% ytd, or +1.9% qtd. 2Q22 EPS estimates dynamics were negative on ytd basis for 8 out of 24 banks from our group of banks. In turn, full-year estimates for both current and next year were revised up on ytd, and they were much higher vs the end of 2020. A median growth of EPS 2022/2023 of US banks was +4.5%/+5.8% ytd, respectively, or +24.3%/+6.1% vs the end of 2020. 2Q22 revenue estimates increased by 3.1% ytd or +1.3% qtd.

Rate expectations continue going up but the growth slowed down in 2Q22, even despite the much more hawkish Fed and the first 75 bps hike since 1994, which occurred in June 2022. Moreover, current dot plot implies that the fed funds rate will be 3.4% at the end of 2022 (vs just 1.9% implied in March 2022), much higher than a longer run rate. Unsurprisingly, NIM/NII estimates continue going up. According to Bloomberg, median NIM of our group of banks in 2Q22 is expected to be +11 bps qoq and even +3.5 bps yoy at 2.51% in 2Q22, the first yoy growth over the last 14 quarters. Also, it is expected that NIM 2022E will increase by 16 bps yoy. Median NIM growth was +16.7 bps, or +25.7 bps ytd, for 2022 and 2023 years, respectively. A median growth of 2Q22 NII was +8.4% ytd, or +4.3% qtd, as of the end of June 2022. The loans growth remains a tailwind. According to the Fed data, total loans portfolio increased by 3.1% qtd, or +9.7% yoy, (as of June 15, 2022). Assets quality is still quite strong. According to the forecasts compiled by Bloomberg, total provisions of our group of banks will be just $5.4 Bn in 2Q22 or approximately ¾ of total reserves in pre-pandemic quarters. According to 2022 DFAST stress test results, all banks (34 of the largest US banks) passed the exam, which suggests that the banks have sufficient capital to absorb losses even under the severely adverse scenario.

Revenue environment for US banks improved meaningfully in 2022. Nonetheless, banks won’t manage to avoid a decline of EPS on a yoy basis in 2022 driven by normalization of the credit costs and necessity of tech investments as well as relatively weak dynamics of some fee categories such as mortgage and trading. Risks of recession have increased substantially in recent months, which inevitably affected the dynamics of bank quotes. So, banks look quite cheap again both vs historical averages and vs SPX. Thus, banks are trading at -2.4/-2.2 std on P/E CY (as of June 30, 2022), or at -2.7/-2.4 std on P/E NY (on the basis of samples from 2000 and 2010 years to current moment) relative to historical averages. As for relative to S&P 500, banks are currently trading at -1.4 std and -1.7 std from the sample mean (2010-current moment) for P/E CY and P/E NY, respectively. On P/B, banks are trading at +0.1 std from the sample mean (2010-current moment) vs +1.1 std for SPX index.

EU banks decreased on both an absolute basis and a relative basis in June 2022, the fourth month of underperformance over the last five. Thus, on an absolute basis, SX7P decreased by 9.8% MoM in June, or -1.2 std from the mean, and it is in the bottom 7% of absolute monthly performance of SX7P index. In turn, relative monthly performance was -1.8% MoM, or -0.4 std, and it was in the bottom 29% of relative monthly performance in SX7P index history. Nonetheless, EU banks continue outperforming the broad market slightly in 2022, despite a substantial growth of recession risks, after clearly strong 2021 year, when they added 34% (+9.6% on a relative basis). On the other hand, SX7P index underperformed in each of 2018-2020 years. So, the index is still 32.1% lower than it was at the end of 2017, underperforming STOXX 600 index by 35.1% over this period.

Dynamics of EU banks were relatively uniform with a substantial decline of the majority of EU banks in June 2022 as it was driven by market sell-off. Among the key underperformers were CS and DBK, which lost around 20% MoM. BKT and HSBC were the best performers in June, but they also added only 0.6% MoM and 0.5% MoM, respectively.

In spite of strong and improving fundamentals, at least so far, European banks' dynamics remain roughly flat after their substantial decline at the end of February and in early March. The drop was driven by much higher risks for the EU economy, because of the Russia’s invasion of Ukraine, which would undoubtedly have a material impact on economic activity in the euro area through higher energy and other commodity prices, disruption of international commerce and noticeably higher inflation. Nonetheless, a median growth of FY22 NI of EU banks was +1.8% ytd (+10.8% vs the end of 2Q21), implying a median decline of 5.1% yoy. As of FY23 NI estimates, a median growth was +2.2% ytd (or +7.2% vs the end of 2Q21), implying a growth of +8.2% yoy. On the other hand, revenue estimates added 2.4% ytd for FY22 revenue, or +5.2% since the end of 2Q21. However, we still remain cautious about EU banks’ prospects as we can’t answer no to the key question about a possible recession in the EU in the near future with certainty. Moreover, EU banks don’t look obviously cheap at the moment, even taking into account higher revenue/EPS projections ytd. Thus, a discount to historical averages is 28%, or -1.6 std, at the moment from mean P/E NY of SX7P index members (a sample from 2010 to the present), but a discount to US peers (on median P/E NY of BKX index vs SX7P index) is 18% as of June 30, 2022 vs an average since 2010 of 21%, or even +0.4 std. A discount to the broad EU market is more than 42% vs an average of 30%, or -1.4 std. So we still prefer US banks over EU financial institutions, but even with regard to US banks, we remain only cautiously optimistic because of recession risks growth.

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