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Banking Sector Monthly Report - September 2022

EXECUTIVE SUMMARY

US banks underperformed the broad market slightly in September 2022, for the third time over the last four months. Moreover, BKX index ended September in the red again, for the 6th time out of the first 9 months of 2022. BKX index tumbled by 9.4% MoM in September vs -9.3% MoM of SPX index. Absolute September performance was -1.3 std from the mean monthly performance, and it was in the bottom 7% of absolute monthly performance in the index history. Relative September performance was -0.1% MoM. It is just +0.04 std from the mean monthly performance and it is almost in the middle of relative performance vs SPX index since the index inception. Despite a skyrocketing growth of rates and a still quite fast loan growth, US banks underperformed the broad market slightly since mid-February 2022 as a result of higher uncertainty and growth of the recession risks.

US banks' dynamics were relatively uniform in September 2022 with just two banks out of our group ended the month under review in the green. The best performers were FHN and PBCT, which, however, were almost flat MoM. The worst performer was SIVB, which disappointed market by its updated NII/NIM forecasts.

The earnings season of US banks will start on October 14, 2022, when 3Q22 results will be provided by JP Morgan, Wells Fargo and Citigroup (in fairness, the FRC, which reports on October 13, 2022, starts first). After that, all members of BKX index will provide quarterly results within roughly 2 weeks. Despite growing recession risks, mixed fee income trends and the first signs of credit quality deterioration, we expect that 2H22 operating figures will be quite strong as a result of a substantial growth of NIM/NII due to still solid loan dynamics across all key segments and a skyrocketing growth of rates, both ST and LT. So, we expect that revenue dynamics will remain quite strong in 3Q22 as NII growth will overshadow poor fee income figures. Operating leverage will continue improving in coming quarters despite wage growth risks. It will be positive for the second consecutive quarter after 8 quarters of negative leverage dynamics in a row. Credit quality remains exceptionally strong with still much lower (vs historical averages) delinquencies and charge-offs. Nonetheless, subprime indicators have deteriorated noticeably in recent months. So, positive EPS momentum, which began in 3Q20, remains but fading, and it seems that estimates will start to be revised down in coming months given growth of the recession risks. Currently, the probability of recession in the next 12 months is estimated at 50% vs approximately 30% in June 2022. Nonetheless, although median 3Q22 EPS growth of BKX index members is positive on ytd basis, it is negative on qtd basis and estimates of a number of banks demonstrated negative dynamics even in ytd terms. Thus, according to Bloomberg consensus, a median growth of 3Q22 EPS of our group of banks was 5% ytd, but -1.1% qtd. 3Q22 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 +3.5%/+3.0% ytd, respectively, or +22.9%/+3.9% vs the end of 2020. 3Q22 revenue estimates increased by 5.3% ytd, or +0.5% qtd.

Revenue environment for US banks improved noticeably in 2022 even despite weaker dynamics of some core fee lines. On the other hand, recession risks continue going up and bank quotes cannot but react to this as macro is one of the key drivers for banks. Nonetheless, banking fundamentals still remain quite strong and will continue to be strong in 2H22. But the first signs of deterioration have already been observed. So, EPS estimates have already stopped being revised up despite rates and rate expectations continue going up. FY23 EPS estimates are still higher ytd, but full incorporation of recession impact into estimates will inevitably lead to decline of projections. But quotes traditionally play ahead of the curve, so banks underperformed the broad market ytd. So, banks still look quite cheap both vs historical averages and vs SPX. Thus, banks are trading at -2.5/-2.3 std on P/E CY (as of September 30, 2022) or -2.7/-2.3 std on P/E NY (on the basis of samples from 2000 and 2010 years to the current moment) relative to historical averages. As for relative to S&P 500, banks are currently trading at -1.3 std and -1.6 std from the sample mean (2010-current moment) for P/E CY and P/E NY, respectively. On P/B, banks are trading at +0.2 std from the sample mean (2010-current moment) vs +0.6 std for SPX index. Bank stocks have already partially priced the recession in, but the key unknown variable at the moment is how deep it will be. Even the Fed’s Chair found it difficult to answer this question at the last meeting. So, we also recommend staying on the sidelines from buying bank shares at the moment. Nonetheless, we believe that banking quotes are not very far from the trough of the cycle, and BKX index decline by another 15-20% will be a strong catalyst for us to buy.

EU banks decreased noticeably MoM in nominal terms in September 2022, but outperformed the broad market again, for the second consecutive month. Thus, on an absolute basis, SX7P decreased by 4.7% MoM in September, or -0.7 std from the mean, and it is in the bottom 20% of absolute monthly performance of SX7P index. In turn, relative monthly performance was +2.0% MoM, or +0.6 std, and it was in the top 21% of relative monthly performance in SX7P index history. Nonetheless, EU banks are still performing roughly in-line with the broad market 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. Thus, it is still 35.3% lower than it was at the end of 2017, underperforming STOXX 600 index by 35.1% over this period.

Dynamics of EU banks weren’t uniform in September 2022 again due to much higher rates MoM, accompanied by significant growth of recession risks. In result, the best performers were the most asset sensitive banks. In turn, the worst performer was Credit Suisse, which lost more than 20% MoM on rumors about the need to raise additional capital.

Despite European banks reported markedly better results again in 2Q22 with positive surprises on both revenue and net income, we still remain cautious on EU financial institutions, given the energy crisis, still elevated core inflation and a significant growth of recession risks which are gradually coming to the fore, eclipsing the entire positive from skyrocketing rates growth. So, the key P&L risk at the moment is asset quality dynamics in the nearest quarters, which will eventually result in a noticeable provisions growth and lower profit forecasts. Despite fundamentals are still quite strong and remain solid for some time, earnings momentum will begin to deteriorate in coming months, from our point of view. Thus, a median growth of FY22 NI was +4.4% ytd as the end of September 2022 (+3.1% qoq or +0.4% MoM), implying a growth of just 0.1% yoy. As of FY23 NI estimates, a median growth was +4.2% ytd (+1.8% qoq or +0.5% MoM), implying a growth of +9.4% yoy. Also, revenue estimates added 4.7% ytd for FY22 revenue, or +2.1% qoq. In any case, we don’t expect that that asset quality deterioration will lead to any serious problems with the solvency for the banking industry given quite strong capital position. On the other hand, banks usually underperform substantially immediately before and during a recession that has not been observed yet, as European banks were relatively flat during last 7 months and continue outperforming the broad market ytd. Unsurprisingly, EU banks don’t look exceptionally cheap at the moment, especially taking into account that revenue/EPS projections should start going down in coming quarters. Thus, a discount to historical averages is 29% (-1.6 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 just 19% as of September 30, 2022 vs the average since 2010 of 21%, or +0.2 std. A discount to the broad EU market is more than 38% vs the average of 30%, or -0.9 std. So, we still prefer US banks to EU peers as we expect less deep recession in the US than in the EU.

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