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Banking Sector Report - November 2017


In November, US Banks increased by 3.1% MoM vs +2.8% MoM of S&P 500 Index after the flat performance (vs SPX index) in the previous month. Despite strong performance of banks in the last 3 month, SPX still continues to outperform financial sector YTD: +18.3% vs +13.9% of BKX index. Absolute November performance on MoM basis was just +0.35 StD from the mean monthly performance and this result is in the top 36% of absolute monthly performance of BKX Index. Relative November performance vs SPX index was +0.3% MoM in absolute terms, it is +0.05 StD from the mean, and this result is in the top 46% of relative performance of BKX index vs SPX.

Dynamics of the sector was driven by progress in the tax reform, Powell’s testimony, deregulation optimism and expectations of December hike. The most impressive dynamics was demonstrated by SYF, RF, CFG and ZION. FRC, COF and BBT performed relatively weak during the last month. 

Recently, the odds to complete tax reform in the near future have significantly increased due to approval of the bill in the House and successful talks in the Senate, so banks positively reacted to this news. The tax reform is surely a good driver of EPS growth, even despite the proposed lowering the statutory federal corporate tax from 35% to 20% is markedly below than the initial Trump’s promise of lowering it to 15%. The Powell’s testimony, where he said that the regulation was already tough enough and that banks weren’t still too big to fail, was interpreted as the sign of the further deregulation. It was also positively impacted on banking quotes. The uncertainty around the final version of tax reform is still relatively high (even timing, at least timing of effective date of lowered tax rate) and we don’t exclude temporary correction in US financial sector in case of some problems with the reform enactment and some changes compared to the House version of the bill. But we consider this scenario as a buy opportunity even despite rich valuations, because fundamentals of US banks still remain valid while tax reform and deregulation should be strong positive driver for operating results of US banks.

As was widely expected, the FOMC left the Fed funds rate unchanged at the November meeting, which was held on November 1. Overall, there were almost no changes in the statement. But taking into account recent macro data and the minutes from the November FOMC meeting, there is little doubt that FOMC will not hike rate at the December meeting (December 13). Currently, the market estimates the probability of the event at 98.3% vs around 20% as start of September. Despite the majority of the FOMC members consider current low inflation as temporary event, the minutes contained quite a long discussion about low inflation. In turn, inflation estimates were slightly revised down and it was noted that core inflation remained soft. Also, the wording about growth of the economy was changed to “solid” from “moderate”. Overall, the FOMC meeting announcements are quite positive for operating results of US banks as rates will probably continue to rise but it seems that it has already been largely priced in. Moreover, deposit beta has begun to grow fast enough recently. Currently, it is around 40% at some banks. Of course, average beta is still significantly below levels of the previous cycles, but it has already started negatively impact on NIM growth. The other problem is flattening yield curve that fully complies with the previous Fed tightening cycles when the yield curve flattened during the rate hike cycle. 10yr-2yr spread continues to go down and currently it is near the lowest level since 2007.

Macro data was strong in November. Citi economic surprise index continued to go up. It increased by 19.2 pts MoM to +59.4 pts in November, the highest level in more than 3 years. The index returned on the positive territory in the early October and it continued to grow in early December. But banks go on to tighten credit standards in many segments. The October 2017 Senior Loan Officer Opinion Survey indicated that C&I lending standards were modestly eased to both small firms, large and middle-market firms over the past three months. Technically, banks slightly eased standards in C&I for the third consecutive quarter after tightening standards 6 quarters in a row. More aggressive competition from other banks was by far the most emphasized reason for easing. Notwithstanding, banks continue reporting weaker demand. CRE lending standards were tightened for the ninth consecutive quarter. Banks also reported that demand for CRE loans was weaker during the last quarter. All surveyed categories of mortgage lending either eased or remained basically unchanged over the past three months. Lending standards for consumer loans were tightened in the last three months. Specifically, standards were tightened in Credit Cards and Auto loans while standards for other consumer loans were basically unchanged. “Major shares of banks reported that a less favorable or more uncertain economic outlook, a deterioration or expected deterioration in the quality of their existing loan portfolio, and a reduced tolerance for risk were important reasons for tightening their standards or terms on credit card and auto loans to prime and subprime borrowers”.

In November EU Banks decreased by 2.1% MoM vs -2.2% MoM of STOXX 600 Index. It is the third month in the last four ones of the negative dynamics for European banks. However, 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 7 months (175-191 pts on the SX7P index). Absolute November performance of SX7P was -0.39 std from the mean and this result is in the bottom 29% of absolute monthly performance of SX7P since the index inception. Relative performance of SX7P in November was around 0%.

Dynamics of European banks wasn’t uniform in November. The key underperformers were French banks because of relatively weak 3Q17 earnings in the early November. BPE added around 10% in November after the weak performance in October. Among banks with the best performance are also DBK and CS, which are the biggest European beneficiaries of possible deregulation and the tax reform in US.

Steady economic expansion in the euro area continues with GDP YoY growth higher than 2% and recent macro data indicates that it will remain solid in 2H2017. The second estimate of 3Q17 EU aggregate GDP growth was +0.6% QoQ and +2.5% YoY. We don’t exclude some deceleration of growth of EU economy because of euro strengthening, but it should still remain supportive for quotes of European banks in near years given the broad-based and self-sustained character of the current stage of recovery of the European economy. Eurozone GDP growth consensus was revised up by 10 bps for 2017 (to 2.2% yoy from 2.1% yoy 1 month ago), estimates of GDP 2018 was also revised up by 10 bps to 1.9% in the Bloomberg’s November survey while consensus estimate of 2019 GDP growth was unchanged at 1.6%.

EU rates were relatively flat in November because of dovish results of the October ECB meeting. The yield curve continues to become steeper, but given the market expectations, the first rate hike will not happen earlier than in 1H2019, from our point of view,  and negative deposit facility rate environment will persist at least until the middle of 2020. Growth of the long yield hasn’t transformed into growth of back book yields yet. So, we still think that it is too early to buy EU banks because of possible rising rates in future given 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 remain.

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