HomeResearch and NewsBanking Sector Report - May 2017
Mikhail Zavaraev CFA, Senior Analyst
Report

Banking Sector Report - May 2017

EXECUTIVE SUMMARY

In May US Banks decreased by 2.6% MoM vs +1.2% of S&P 500 Index. SPX continues to outperform financial sector YTD: +7.7% vs -3.2% of BKX index. Absolute May performance was -0.5 StD from the mean monthly performance. This result is in the bottom 26% of absolute monthly performance of BKX Index for all available data from Bloomberg. Relative underperformance vs SPX index in May was -3.7% MoM and it is -0.8 StD from the mean. This result is in the bottom 14% of relative performance of BKX index vs SPX.

Dynamics within the sector was relatively uniform. All banks from our sample except for Citigroup and Signature decreased in May. The key driver of banks’ dynamics was de-risking because of lack of progress with Trump’s reforms, no acceleration of loan growth and relatively weak trading revenues in the beginning of 2Q17.  

Macro data continues to demonstrate strong optimism both in corporate sector and in consumer segment. This is especially true for the soft data, majority of which is near the cycle highs. However, not everything is so rosy. At least, loan growth continues to decelerate with no signs of a possible revival of acceleration of growth in 2H17, especially in corporate segment. There are more and more red flags in CRE and auto areas, where current fundamentals are still solid but weakening and banks continue to tighten standards in these segments. Given rising rates and no progress in reforms, the situation doesn’t seem so clear. 

April Senior Loan Officer Survey (SLOOS) indicated that demand on loans was relatively weak across the board except for mortgage loans. The most challenging situation with demand remains in CRE. There were tightening of loan standards in CRE (the 7th consecutive quarter) and auto areas (the 4th consecutive quarter). In turn, it was objected easing standards in mortgage, credit cards and LC & MC C&I loans (the first time in the last 7 quarters). Overall, SLOOS survey confirmed what we observed in the last earnings season: ongoing decelerating of loan growth because of ‘wait and see’ position of both banks and clients until the clarified language on tax reform, deregulation and other initiatives of the President. The riskiest segments remain CRE & Auto loans where there are both weakening fundamentals and tightening standards.

One of the key events of the coming month will be June FOMC meeting where, as expected by the market with the probability of 93%, the key rate will be hiked by 25 bps. On May FOMC meeting, the Fed expressed confidence that the weakness of the economy in the beginning of the year was transitory. The market perceived this information as the sign of continuation of gradual tightening of the monetary policy. However, despite relatively optimistic comments of the Fed, the long end of the curve went down because of political uncertainty. So, the curve becomes flatter and treasury spreads go down. It is not critical for banks’ NIM as it more depends on prime rate, but the steeper curve usually is positive for banks’ NIM as they fund LT assets with ST liabilities. We expect that NIM will continue to grow in the next twelve months with significant positive effect on the bottom line. However, rising rates also imply negative impact on quality of the loan portfolio and capital because of revaluation of securities. Taking into account weak loan growth, progress in Trump’s reforms is becoming increasingly crucial for the further dynamics of banking stocks.

The other important driver for US banks should be a release of CCAR results which is scheduled by the end of June. It is commonly expected by the Street that payout ratios could grow as much as higher than 100% and it will be positive sign for banking stocks. First of all, it will mean that process of deregulation has finally started.  We also expect that banks could markedly increase their payout ratios, especially regional financial institutions, as capital ratios continue to grow and they already remain significantly higher than minimum required levels while CCAR requirements and scenarios was relaxed. However, it is largely expected scenario and, to the greater extent, further stock dynamics will depend on June FOMC meeting comments and progress with the Trump’s reforms. Taking into account recent removal of after the election outperformance of US banks (vs SPX index), chances for growth of banking stocks are becoming higher even in case of no positive surprises from CCAR results. However, if we see negative surprises, we might observe markedly negative price dynamics given recent banks’ comments about relatively weak trading income trends, more cautious outlook on rates and necessity ‘to be patient about regulatory reform’.

In May EU Banks decreased by 1.9% MoM vs +0.7% of STOXX 600 Index. EU banks were trading in a fairly narrow sideways channel for five months but it came up from the channel in May. However, this movement didn’t result in outperformance of EU banks. Absolute May performance of SX7P is -0.3 St. Dev from the mean and this result is in the bottom 30% of absolute monthly performance of SX7P since the index inception. Relative underperformance of SX7P vs STOXX 600 index in May was -2.6% and it is in the top 20% of relative monthly performance vs STOXX 600 (-0.7StD).

The key driver of European banks was the earnings season and dividend payments. Banks with strong quarterly positive surprises outperformed. The best performers among EU banks were Raiffeisen Bank, DNB and HSBC. The weakest performance was demonstrated by Italian UBI Banca and Emilia Romagna because of relatively weak quarterly earnings and speculations about early elections in Italy.

Current macro data indicates that broad-based recovery of EU economy continues. Citi EU economic surprise index remains near the highest level for 4 years. Composite PMI, which is well correlated with GDP growth, stayed at a six-year high in May. It was 56.8 pts as expected by market and unchanged from April. PMI points at strong employment dynamics and business optimism figures. Economic sentiment in EU is at six-year high. Consumer confidence continues to be near the highs for more than 9 years. So, GDP forecasts are revising further up. GDP forecasts for 2017 and 2018 years changed by +7 bps (to 1.7%) and +3 bps (to 1.61%), respectively, during the last month.

The last earnings season of European companies was very strong with just around 20% of negative profit surprises among reported firms. So, we see rising estimates and ongoing earnings momentum of EU banks.

The key June event for EU banks will be ECB monetary meeting, which will be held on 8 June. The market continues to expect some signs of tightening language from June ECB meeting, so yields also continue to go up especially the long end rates. However, there are some doubts about the time and pace of possible tightening of monetary policy of ECB. From the one side, we see a solid recovery of EU economy. From the other side, inflation is still late and it is a problem as ECB attaches great importance to it.

Diminished political uncertainty in Europe gives more arguments to proponents of early tightening of ECB’s monetary policy. However, taking into account usually cautious behavior of ECB, we will not be surprised if it prefers to wait for a while to be assured that both EU economy growth and inflation are sustainable and move in the right direction. At least, we are absolutely convinced that after a long period of very accommodative monetary policy, even small changes in communication with investors will have a strong influence on EU financial markets, so ECB should be as careful as it is possible. At least, higher rates could have a negative effect on the sustainability of debt of peripheral countries. So, the immediate ECB meeting (8 June) is very important for further movement of EU banking prices. If we don’t hear signs of tightening language from ECB, EU banks could fall, as too much optimism about further rates dynamics is already priced in banking quotes.

Download PDF

banks, investment

Read more

Report Oil Market Report - August 2017 Vitaly Gromadin

Crude oil market is trading in very narrow range again in anticipation of stocks rebalancing. Long awaited crude oil storage levels drawdown have been finally happening for several weeks in the USA and it stimulated return of hedge funds long positions to crude oil futures and options market. Additionally U.S. gasoline demand looks much stronger comparing to May and June period of worryingly low numbers in EIA weekly data.

oil, investment, equity

Report Banking Sector Report - August 2017 Mikhail Zavaraev

In August US Banks decreased by 3.1% MoM vs flat dynamics of S&P 500 Index. SPX continues to outperform financial sector YTD: +10.4% vs +1.3% of BKX index and this gap markedly increased in the last month. Absolute August performance was -0.7 std from the mean monthly performance. This result is in the bottom 22% of absolute monthly performance of BKX Index. Relative monthly outperformance vs SPX index in August was -3.2% and it is -0.7 std from the mean monthly performance. This result is in the bottom 17% of relative performance of BKX index vs SPX. 

banks, investment

Report Oil Market Report - April 2017 Vitaly Gromadin

Crude oil market is trading in anticipation of OPEC meeting on May 25. There has been so much talking from OPEC about probable extension of the deal that it is possibly already priced in by the market, at least base-case scenario with higher production ceiling. Evidently, if OPEC does not deliver this, the price will collapse. 

oil, investment, equity