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Banking Sector Monthly Report - September 2021

EXECUTIVE SUMMARY

US banks outperformed the broad market significantly in September 2021, for the second month in a row. Thus, BKX index increased by 1.6% MoM vs -4.8% MoM of SPX index, the second consecutive month of growth in absolute terms either. Absolute September performance was +0.1 std from the mean monthly performance and it is in the top 49% since the index inception. Relative September performance was +6.7% MoM. It is +1.4 std from the mean monthly performance and it is in the top 6% of relative performance vs SPX index since the index inception. Despite clearly weak performance in June and July of 2021, banks outperformed SPX in all other months of the current year. So, the performance of the first 9 months of the year is the strongest one over last 24 years, while relative performance is the strongest one over last 21 years.

US banks dynamics were mixed in September. Thus, the most asset sensitive banks were among outperformers due to hawkish FOMC meeting. So, SIVB increased by 15.6% MoM. On the other hand, trust banks were laggards in September as well as investment banks with a decline of 6% MoM or more.

The earnings season of US banks will start on October 13, 2021, when 3Q21 results will be provided by JP Morgan. After that date, all members of BKX index will provide their quarterly results within two weeks. US banks reported much better both revenue and EPS figures in recent quarters despite revenue environment remained challenging. But the situation is gradually beginning to change for the better and the revenue outlook has improved significantly in recent months due to acceleration of the economy and more hawkish Fed. We expect that rates will soon become a tailwind instead of being a headwind as it was in two previous years. So, positive EPS momentum which began in 3Q20 remains and the estimates will continue to be revised up. Thus, according to Bloomberg consensus, the median growth of 3Q21 EPS of BKX index members was +35.3% ytd, but still -0.8% vs the end of 2019 (as of the end of September). 3Q21 EPS estimates dynamics was positive on ytd basis for all members of BKX index, except for BK.  Full-year estimates for both current and next year were also revised up meaningfully on both ytd and qtd basis. The median growth of EPS 2021/2022 of BKX index members was +54.7%/+14.2% ytd, respectively, but projections were +10.8%/-5.4% vs their pre-pandemic levels. 3Q21 revenue estimates increased by 3.9% ytd, still remaining markedly below the pre-pandemic levels, -2.9% since then.

After relatively weak dynamics in 2Q21 and the majority of 3Q21, rates resumed their growth after the most recent FOMC meeting, where it was given a clear signal regarding tapering, which is expected to be announced at the November meeting and could be completed around mid-2022. Despite the Fed Chair didn’t give any hints about raising rates during the press conference, the dot plot did it instead. Thus, the dot plot implies that we will see one rate hike till the end of 2022 and three more in both 2023 and 2024. The market is less optimistic on this issue, but we think that rate expectations will be revised up in the nearest future, especially if inflation continues to accelerate. Moreover, NII/NIM estimates have already stopped deteriorating recently. In accordance with the optimistic commentaries of the banks during 2Q21 earnings season, the loan portfolios resumed their growth in 3Q21 after five consecutive quarters of weak dynamics. All major segments, except for C&I, demonstrated a noticeable growth qtd even despite uncertainty related to Delta variant spreading, still elevated liquidity and ongoing restrictions/disruptions related to the pandemic. Notwithstanding, operating leverage is expected to remain negative again in 3Q21, for the 9th consecutive quarter, but the momentum has already begun to improve given better revenue projections and relatively good cost control. So, we expect that it will be positive again in 2022. Capital ratios remain strong, and it seems that capital return estimates will continue to go up. Median dividend yield FY21E of our group of banks is currently 2.5% and dividend yield FY22E is 2.8%. But total returns could reach 8-9% of the market cap for a number of banks in the nearest years.

Operating environment for US banks is still challenging but it continues improving very fast. Moreover, banks are considered as a relatively good hedge against inflation while more hawkish Fed increased the probability of a blue sky scenario for US banks. Vaccination campaign has already shown success in the fight against the pandemic even despite the spread of more contagious strains such as Delta variant. So, relatively fast economic recovery remains intact with an ongoing positive impact on banking fundamentals. Three previous earnings seasons were quite encouraging for banks and we expect that nothing will change in this regard for 3Q21. We think that improved rates and loan growth outlook aren’t in the price yet. So, we expect that estimates will continue to go up, positively impacting banks’ multipliers which were relatively rich vs historical averages in recent months. However, banks are still undervalued significantly vs the broad market. Thus, banks are trading with -0.8/-0.7 std on P/E CY (as of October 1, 2021) but +0.7/+0.9 std on P/E NY (on the basis of samples from 2000 and 2010 years to the current moment) relative to their historical averages. As for relative to S&P 500 performance, US banks are currently trading at -1.6 std and -0.9 std from the sample mean (2010-current moment) for P/E CY and P/E NY, respectively. On P/B, banks are trading with +0.8 std from the sample mean (2010-current moment) vs +2.6 std for SPX index. So, we expect that US banks will outperform vs the broad market in coming months, given banks are still cheap vs the broad market while EPS / revenue outlook has improved significantly.

EU banks increased markedly on an absolute basis in September 2021, the second month of growth in a row after two consecutive months of negative dynamics. It outperformed the broad market significantly and it was the best month on a relative basis over the last seven. Thus, on an absolute basis, SX7P increased by 3.7% MoM in September, or +0.5 std from the mean, and it is in the top 28% of absolute monthly performance of SX7P index. On the other hand, relative monthly performance was impressive +7.4% MoM, or +2.0 std, and it is in the top 3% of relative monthly performance in SX7P index history. So, it was very strong price performance in the first 9 months of the year, +30% ytd, after clearly weak dynamics in three previous years. However, SX7P index underperformed in each of 3 previous years and it is still 23.4% lower than it was at the end of 2017, underperforming STOXX 600 index by 26% over this period.

The key EU outperformers increased by 10% MoM or more. In turn, the key EU underperformers, which ended September in the red zone, were banks with a noticeable Asian exposure because of Evergrande case.

We anticipate that the growth of EU banks could continue in the near future as a result of better earnings season and better earnings visibility due to the ongoing vaccination campaign and GDP growth acceleration. But we no more expect their substantial outperformance vs the broad market given relatively rich valuations and more challenging revenue environment in coming years, especially vs US banks, as the ECB continues to preserve favourable financing conditions and being as flexible as it can. So, key rates will remain negative in the foreseeable future. Moreover, EU banks are no longer traded with a deep discount to their historical averages, while the discount to US peers is insignificantly wider than its historical averages. Thus, the premium to historical averages is 1% (+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 28% as of October 1, 2021 vs the average from 2010 of 21%, -0.8 std. On the other hand, due to meaningful and ongoing EPS upgrades, EU banks still don’t look very expensive either even after their significant quote 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.

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