US banks outperformed the broad market significantly in October 2024, for the first time over the last 3 months. However, it was only the 10th time of outperformance over the last 24 months. Also, US banks ended October in the green, for the third time over the last 4 months.
EXECUTIVE SUMMARY
US banks outperformed the broad market significantly in October 2024, for the first time over the last 3 months. However, it was only the 10th time of outperformance over the last 24 months. Also, US banks ended October in the green, for the third time over the last 4 months. Moreover, it was the 8th time of growth over the last 12 months. Thus, the BKX index increased by 6.5% MoM in October vs -1.0% MoM of the SPX index. Absolute October 2024 performance was +0.8 std from the mean monthly performance, and it was in the top 17% of absolute monthly performances in the index history. Relative October 2024 performance was +7.5% MoM. It is +1.5 std from the mean monthly performance, and it is in the top 5% of relative performance vs the SPX index since the inception of BKX index. Given quite strong performance in October, BKX index again has been outperforming the broad market ytd, +6.1% or +0.6 std. If the situation doesn’t change in the rest months of 4Q24, this year will be the first time of outperformance over the last three years. Thus, 90% of our sample ended October in the green. EWBC and WFC, the best performers in October, increased by 17.8% MoM and 14.9% MoM, respectively. But regional banks were again among the worst performers in October, driven among other things by volatility of interest rate expectations. The difference of monthly price changes between the best and the worst performers of our sample of banks was 28.7% in October vs 12.3% in September. In turn, 1Q24 was the most volatile start of a year since GFC. Nonetheless, the correlation between price changes yoy and EPS FY24E changes yoy increased slightly MoM in October for the first time over the last three months, still remaining quite high, at 77% as of the end of the month.
US banks continue trading with a significant discount to the broad market but not to their historical averages. The discount to the SPX index was driven by quite weak performance of US banks on absolute and relative bases in two previous years, even despite it was accompanied by a decline of profit and revenue estimates. However, the discount narrowed considerably in recent months after roughly flat but volatile 1H24. Thus, median P/E 24E of our group of banks increased from 11.9x (as of September 27, 2024) to 12.2x (as of October 31, 2024). Also, median P/E 25E went up from 10.7x to 11.3x over the same period of time. Hence, banks are already trading at just -0.2/0.0 std on P/E CY and at -0.1/+0.1 std on P/E NY (on the basis of samples from 2000 and 2010 years to the current moment) relative to historical averages (as of October 31, 2024). As for a valuation relative to the S&P 500 index, banks are currently trading at -1.2 std and -1.0 std from the sample mean (2010-current moment) for P/E CY and P/E NY, respectively. Median P/B of our group of banks was roughly flat in 2Q24, hovering around 1.17x. However, the ratio increased notably during the recent months, rising from 1.17x (as of June 28, 2024) to 1.26x (as of the end of October). So, on P/B, banks are trading already at +0.2 std from the sample mean (2010-current moment) vs the broad market with +2.0 std, despite the current adj. ROE premium to historical averages are roughly the same for both BKX and SPX indexes. As for individual names, multipliers are still quite different. And dispersion across banks increased slightly ytd (even excl. FLG impact). In turn, OZK’s P/E estimates for the nearest years are around 7-8x while CFR’s ratios are 15-16x at the moment.
The US economy remains strong while election uncertainty is coming to an end. Indeed, the US economy continues growing well above expectations, and even after some expected deceleration of growth rate it will remain solid, despite still elevated interest rates. US GDP increased by 2.8% qoq in 3Q24 vs the consensus of 2.9% and the growth of 2.8% in 2Q24. Moreover, the key driver of the GDP growth – consumer spending – was again quite strong, beating consensus notably, but it wasn’t strong across the board, mainly driven by higher-income households. So, despite the most recent data points to growing imbalances in the US economy, it is estimated that growth rates will remain around 2% in the nearest 5 quarters, according to current market expectations. Moreover, the probability of recession in the nearest 12 months is forecasted at just 25% at the moment, the lowest figure over more than 2 years. Evaporation of election uncertainty will eventually stimulate business investment, regardless of who wins. But the further investment dynamics as well as loan growth rates will depend on the speed of the monetary easing, and just the latter already depends on who wins. Hence, volatility of rate expectations increased noticeably in recent months. Thus, it is now expected less than 2 rate cuts till the end of the year (with an overall decline of just 44 bps) and 3 more in the next year with the federal funds (FF) rate around 3.6% at the end of 2025 (although it was expected 4.3% at the end of May). Key macro data revealed in October were mixed again, from our point of view, with stronger retail sales and better employment, roughly in-line inflation but slightly weaker GDP growth, consumer sentiment and industrial production. So, risks are still elevated but gradually moving down, from our point of view.
The 3Q24 earnings season was notably better than expected, confirming that US banking fundamentals have already reached an inflection point. Moreover, the outlooks also were more optimistic than feared, even despite labor market cooling and the jumbo rate cut in September. Thus, 24 out of 30 banks from our sample reported better than expected EPS (vs 25 banks in 2Q24). A median surprise was +8.3% in 3Q24 vs +5.4% in 2Q24. Revenue of 23 out of 30 banks from our sample exceeded estimates in 3Q24 with a median surprise of +1.1% vs 23 banks and +0.9% in 2Q24. A median fee beat was 2.3% while NII exceeded estimates by 1.2% even despite roughly in-line NIM and weaker loan growth. Thus, 15 out of 28 banks from our sample for which estimates were available beat NIM estimates in 3Q24 with a median beat of 1.0 bps (vs just 11 banks and a miss of -1.5 bps in 2Q24). In turn, more than 70% of the sample exceeded NII estimates. Given quite fast decline of rate expectations and still weak loan growth, NII/NIM guidance held the limelight of the investors again. And NII outlooks were improved slightly but the growth would remain weak in the nearest quarters, given faster decline of asset yields relative to funding costs, at least at first. Hence, NIM estimates decreased slightly in recent months. Thus, median FY24E NIM decreased by 0.5 bps MoM, or -5.4 bps ytd, to 2.87% as of the end of October while FY25E NIM decreased by 0.6 bps MoM, or -1.3 bps ytd, to 2.98%. In turn, loan growth still remains relatively weak even despite lower rates, including due to elections uncertainty. According to the Fed H8 data, total loans increased by 2.3% yoy (as of October 16, 2024) vs +3.9% yoy a year ago. And only 12 out of 30 banks from our sample beat total loans estimates in 3Q24 (vs 19 banks in 2Q24). Fees of 22 banks from our sample exceeded estimates in 3Q24 while OpEx were roughly in line with expectations and remained well controlled. So, operating leverage was positive again, for the first time over the last 1.5 years. And we believe that it will remain positive in the nearest years, given gradual acceleration of NII growth. Due to still strong economic recovery, credit quality remained solid and notably better than feared. Thus, just 8/13 banks from our sample missed NCO/NPLs projections.
Revenue environment still remains challenging for US banks in the short-term, but longer-term prospects are less impacted by the rates decline. So, we still expect that FY EPS of US banks will return to growth in 2025 after three consecutive years of negative dynamics. In turn, positive EPS growth implies gradual re-rating of US banks, which continue trading at a notable discount to the SPX index. Given still high but declining interest rates, US banks may remain volatile near term, but we still believe that the banks manage to end the 2024 year in the green on a relative basis. So, we remain bullish on the sector but recognize elevated risks.
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