HomeResearch and NewsBanking Sector Report - June 2018
Mikhail Zavaraev CFA, Senior Analyst
Report

Banking Sector Report - June 2018

EXECUTIVE SUMMARY

US banks underperformed the broad market again, the second month in a row and the third month out of six this year. In June banks lost 1.9% MoM vs +0.5% MoM of SPX index, after -1.0% MoM decline in May. Absolute June performance on MoM basis was -0.4 StD from the mean and it is in the bottom 30% absolute monthly performance of BKX Index. Relative June performance is -0.5 StD from the mean, and this result is in the bottom 25% of relative monthly performance vs SPX. But it should be noted that June is a weak month for banks, from a historical performance point of view. Over the past 27 years, in June banks have demonstrated negative dynamics in 15 cases both in absolute and relative terms. 

In June, the key drivers of negative performance were risks of escalating trade wars and flattening of the yield curve (spread between 10yr and 2 yr treasuries decreased to multi-years low). So, key laggards were banks with the most asset sensitive balances. The best performance was demonstrated by WFC which was the main winner of CCAR.

The Federal Reserve released CCAR results on June 28, after the markets were closed. Overall, results were better than expected with significant growth of both dividend payouts and buybacks. All banks passed except for Deutsche Bank (US division – DB USA) that, in fact, wasn’t a big surprise given the news flow around the financial institution in 1H18. But it should also be noted that three banks passed only on a conditional basis – GS, MS and STT. Under severely adverse scenario, median CET1 ratio of stressed banks declined from 11.9% as of 4Q17 to projected minimum of 5.8% given the required minimum of 4.5%. In the same time, tier 1 leverage ratio declined from initial figure of 9.1% to projected minimum of 5.7% given required minimum of 4%. Median growth of dividends of BKX index members is 29% vs the last year stress test figures (the highest growth – RF, JPM, C) while median growth of buybacks is 12% (the highest growth HBAN, WFC, COF). Median total payouts increased by 16% (the highest growth WFC, HBAN, COF, STI). Median payout ratio slightly decreased from 106% last year to 104% currently (on Bloomberg consensus of Net Income CY basis). Median total yield of BKX index members increased from 7.4% last year to 9.0% currently.

US banks earnings season will start on July 13th, when 2Q18 quarterly reports will be provided by JP Morgan Chase, Citigroup and Wells Fargo. After that, within two weeks, all members of BKX index will provide the quarterly results. Despite the fact that US banks declined markedly after very strong start of the year, the street continues to revise up EPS estimates of the financial institutions. Median growth of 2Q18 EPS of BKX index members was +10.9% ytd or flat qoq, just the fifth non-negative qoq revision for 2Q EPS estimates in the last 12 years (median revision for this period is -0.9% qtd / average is -1.4% qtd). Full-year estimates for the current and next years were also revised up significantly. Median growth of CY EPS estimates of BKX index members is +12.8% ytd. The key drivers of revisions remain the same – more hawkish rate outlook, acceleration of loan growth, stronger growth of the economy and the positive effect of expected deregulation. But it also should be noted that risks have also increased recently because of flatter yield curve, rising deposit beta, more political uncertainty in Europe and threats of escalating trade wars.

NIM remains the key driver of both EPS and net income growth as deposit beta is still significantly lower than it was in the previous cycles and the Fed is remaining more hawkish and predictable. But it should be noted that pressure on NIM from deposit costs will intensify further, especially for banks with relatively weak deposit franchise. According to Bloomberg consensus, median NIM of BKX index members will increase by 3 bps qoq or 17 bps yoy to 3.17% in 2Q18 following a growth of 6.5 bps qoq or 22 bps yoy in 1Q18. In 2Q18, FY NIM expectations (median, BKX members, Bloomberg consensus) increased by 5.3 bps and 6.2 bps for 2018 and 2019 years, respectively, due to positive surprises on NIM during the earnings season of 1Q18.

Loan growth still demonstrates relatively weak dynamics but it slightly accelerated in 2Q18, especially in C&I segment. According to the Fed H8 data, total loans increased by 5.1% yoy (as of June 20). Acceleration of loan growth should largely neutralize a negative impact of rising deposit beta on NII growth but it is too early to say that loan growth will be again a key driver for banks’ EPS in the near future.

Overall, dynamics of operating results of US banks remains strong with high growth of revenues and profits, good cost control, high quality of loan portfolio and ample capital levels. Decelerating loan growth is no more a headwind for the industry, while tax reform will still have a significant positive impact on the industry. The direct impact of the reform is in price, from our point of view, while the second-order effects and more hawkish pace of rates dynamics aren’t. We expect that banks will continue to show more positive surprises than negative ones during the upcoming earnings season, as they did in 37 consecutive quarters before, even despite the very strong growth of yearly EPS estimates ytd.

Despite relatively weak dynamics of banks in recent months, we continue to hold the view that US banks will outperform broad market this year and recommend buying on dips as positive effect of tax reform, rising rates, strong economic momentum, and possible deregulation will continue to positively impact both on banking operating results and quotes dynamics. Moreover, banks are no more expensive, from historic point of view, trading with -0.6-0.7 std on P/E CY and -0.1-0.3 std on P/E NY (on the basis of samples from 2000 and 2010 yrs to current year). As for relative to S&P 500, banks are currently trading at -0.8 and -0.9 std from the sample mean (2000-current moment) for P/E CY and NY, respectively.

In June, EU banks finally outperformed the broad market index after three consecutive months of underperformance but absolute dynamics was negative, the second month in a row. SX7P index decreased by 0.6% MoM vs -0.8% MoM of STOXX 600 index. Absolute June performance of SX7P was -0.1 std from the mean and this result is in the bottom 37% of absolute monthly performance of SX7P since the index inception. In turn, relative monthly performance was +0.1 std and this result is in the top 44% of relative monthly performance. In any case, SX7P significantly underperformed STOXX 600 so far, -10.3% ytd. Currently, EU banks are trading at levels of November-December 2016. Dynamics within the sector wasn’t uniform and remained too volatile. The last month underperformer, BPE IM, became the best performer in June due to Unipol raised stake in BPE to 15% and reducing of Italian political uncertainty. The key laggards were Standard Chartered and Royal Bank of Scotland. 

Weak macro figures in 1H18, trade war threats, political uncertainty and, as a result, a significant drop in European yields along the curve, all this continues to have a negative impact on the dynamics of European banks. But ECB continues to exude optimism and believe that solid and broad-based economic growth is intact. Nevertheless, 2018 GDP forecast was revised down from 2.4% yoy to 2.1% yoy at the last meeting. Economic data published in June remains soft with misses on retail sales, industrial production, and consumer confidence. However, composite PMI figures beat expectations in June due to strong figures of services PMI, implying that we can count on the acceleration of the economy in 2H2018 after the relatively weak start of the year. Economic surprise indices bounced off the bottom but they remained not far from multi-years lows. However, loan growth in EU remains solid despite the recent softness of macro data. The latest Italian NPL deals are encouraging but they will not be a game changer for European banks without more hawkish ECB’s monetary policy. While the last meeting was quite dovish, from our point of view. The sell-off of recent months created a good buying opportunity for some banks in Europe but we still prefer US banks to EU financial institutions.

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