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

Banking Sector Report - October 2017

EXECUTIVE SUMMARY

In October US Banks increased by 2.2% MoM, flat dynamics vs S&P 500 Index after the strong outperformance in the previous month due to positive perception of the September FOMC meeting. However, SPX still continues to outperform financial sector YTD: +15.0% vs +10.5% of BKX index. Absolute October performance on MoM basis was just +0.22 StD from the mean monthly performance and this result is in the top 42% absolute monthly performance of BKX Index. Relative October performance vs SPX index was 0% MoM in absolute terms, it is -0.004 StD from the mean, and this result is in the top 49% of relative performance of BKX index vs SPX.

Dynamics within the sector was driven by the quarterly results, so the banks with positive surprise on core EPS showed strong growth (SVB Financial, Capital One Financial and Bank of America), while banks missing consensus estimates decreased (First Republic, State Street and KeyCorp).

Banks demonstrated solid figures during the last earnings season. Despite the lowest median EPS surprise in more than two years, it was a relatively good quarter, from our point of view. The median EPS surprise of our group of banks was +1.34% vs +5.16% in 2Q17 and +3.22% in 1Q17. 16 out of 24 banks demonstrated positive surprises, the lowest share in 1.5 years. In 1Q17 and 2Q17 the share of positive EPS surprises was 79.2% and 91.7%, respectively. Median revenue surprise was +0.61% in 3Q17 vs +1.2% in both 1Q17 and 2Q17. The share of positive revenue surprises was the same as EPS’s one in 3Q17, 67%. The key driver of revenues and EPS remains NIM. Banks also demonstrated good cost control. Reserve building in credit cards shouldn’t be a big problem as it was possibly perceived by the market, quality of card loan portfolio remains resilient. The main disappointment remains loan growth which continues to be weak despite expectations of accelerating in the near future. 

Median growth of NIM of BKX members was +7.5 bps qoq vs 8.5 bps qoq in the previous quarter. 6 out of 24 BKX members demonstrated negative NIM dynamics in 3Q17, the same amount as in 2Q17 vs 4 banks in 1Q17. The key driver of NIM remains loan yield, median one of BKX index members increased by 15 bps qoq to 4.17% in 3Q17 vs growth of 9 bps qoq in 2Q17 and +8.5 bps in 1Q17. The key problem for future NIM dynamics is growth of funding costs. Interest-bearing deposits cost increased by 5 bps qoq to 0.35% vs growth of 4 bps in 2Q17 and +3.5 bps in 1Q17. Cost of interest-bearing liabilities increased by 10.5 qoq in 3Q17 vs growth of 4.5 bps qoq both in 2Q17 and 1Q17. Total net interest income of BKX members increased by 2.9% qoq or +10.8% yoy vs +2.6% qoq or +8.4% yoy in 2Q17. Despite positive median NIM surprise, BKX members showed negative surprise on NII because of weak loan growth. Median growth of average loans of BKX members was just +0.3% qoq and +1.8% yoy vs +0.5% qoq or +2.5% yoy in 2Q17 and flat qoq or +4.2% yoy in 1Q17. We saw decelerating of growth across all major loan segments.

Macro data was strong in October despite negative effect of the recent hurricanes. Citi economic surprise index continued to go up. It increased by 48 pts MoM to +40.2 pts in October, the highest level in 7 months. The index returned on the positive territory in the early October, for the first time since April. 3Q GDP estimate was 3% significantly beating consensus of 2.6%. Treasury yields slightly increased in October after significant growth in September. The implied probability of rate hike till the year end increased from 20% as start of September to more than 85% currently. Overall, recent rate dynamics is positive for US banking quotes but further affirmative effect of rising rates will be depended on deposit beta behavior.

Overall, banks showed relatively good results but these results weren’t as strong as figures of 1H17. Nevertheless, banks continued to go up as the market concentrated on future EPS growth potential on tax reform and deregulation. These possible reforms are a tailwind for operating results but the question is whether current multipliers are justified even in case of successful adoption of these reforms. From one hand, we see weaker operating trends, rich multipliers and decelerating loan growth. From the other hand, the possible reforms will substantially increase future income of banks. From our point of view, multiples are rich now and this fact forces us to follow our cautious short-term view on US banks, but currently we are more constructive as we were at the end of last year, especially regarding Large Caps. We remain Neutral on US banking sector, but if we see a long expected correction in US banking stocks without deterioration in the macro data, we will be buyers because possible deregulation will be good driver for US banking stocks, especially for major banks.

In October EU Banks decreased by 1.6% MoM vs +1.8% of STOXX 600 Index. Banks were flat YTD vs broad based market index to the current time. EU banks continue trading in the narrow sideway channel for more than 6 months (175-191 pts on the SX7P index). Absolute October performance of SX7P was -0.32 std from the mean and this result is in the bottom 32% of absolute monthly performance of SX7P since the index inception. Relative outperformance of SX7P vs STOXX 600 index in October was +1.0% and it is in the top 34% of relative monthly performance vs STOXX 600 (+0.7 std).

Dynamics of European banks wasn’t uniform in October. The key underperformers were Italian banks due to fears of investors about the new ECB proposals for Non Performing Exposure. In result, BPER decreased by 17.3% MoM, UCG went down by 8.3%, UBI declined by 8.1%. RBI continues to be among the best European performers due to solid 2Q17 results and expectations of further strong dynamics of operating results. Despite miss on 3Q17 EPS, RBS added +5.3% MoM thanks to the progress on capital issues.

EU macro data remains strong but composite PMI, which is well correlated with GDP growth, slightly decreased in October after significant growth in September, however it still remained near its six-year high. Preliminary composite index decreased by 0.8 pts from September level of 56.7 pt, well below estimates of 56.5 pts. Manufacturing PMI increased by 0.5 pts to 58.6 pts and it is currently at multi-year high, significantly beating consensus of 57.8 pts. So, we saw weak corporate loan growth in EU while consumer loan growth accelerated in the recent months. EU rates still demonstrate weak dynamics but it has been appearing more and more encouraging signs recently. Front books started to grow in some segments, e.g. mortgage, despite still negative rate environment.

As was widely expected, ECB announced in October that monthly asset purchases will be reduced from current €60 bn to €30 bn as of January 2018. The reduction is slightly exceeded expectations but overall tone was more dovish than expected, from our point of view. There is also a remark that ECB could continue net asset purchases at a monthly pace of €30 bn beyond September 2018 if necessary. So, the long end of the yield curve reacted negatively on ECB announcement. 10yr EU generic yield decreased by 10 bps in October. It still remains markedly below of July’s high, -25 bps, but it is materially higher than it was at the end of 2016, +15 bps YTD.

So, we still think that it is too early to buy banks because of possible rising rates in future taking into account very strong outperformance of European banks in the last year. Of course, fundamentals will continue gradually improve but the short end of the curve will not change significantly until the key policy rates will eventually start to grow; low rate environment will persist for several more years; growth of long end is largely already priced in, from our point of view; valuations don’t look as reasonable as before; loan growth is still sluggish, especially in corporate segment while credit quality issues remains.

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