US banks outperformed the broad market slightly in August 2022, for the first time over the last three months.
EXECUTIVE SUMMARY
US banks outperformed the broad market slightly in August 2022, for the first time over the last three months. However, BKX index ended the month in the red, for the 5th time out of the first 8 months of 2022. BKX index decreased by 2.4% MoM in August 2022 vs -4.2% MoM of SPX index. Absolute August performance was -0.5 std from the mean monthly performance, and it was in the bottom 28% of absolute monthly performance in the index history. Relative August performance was +1.9% MoM. It is +0.4 std from the mean monthly performance and it is in the top 30% of relative performance vs SPX index since the index inception. Despite an overwhelming growth of rates and a still quite fast loan growth, US banks underperformed the broad market slightly since mid-February as a result of higher uncertainty and a growth of the recession risks.
US banks' dynamics were multidirectional in August 2022, but more than a half of our group of banks ended the month in the red. The best performers were asset-sensitive banks, thanks to the Fed's hawkish statements and a significant rates growth. In turn, NYCB as one of the most liability-sensitive banks lost more than 7% MoM in August.
Despite the US economy was technically in a recession in 1H22 (two consecutive quarters of GDP contraction), banking fundamentals remain quite strong, even taking into account much higher uncertainty, very fast monetary tightening, ongoing supply-chain bottlenecks and still elevated energy prices. Thus, NII/NIM growth in 2022/2023 will be the strongest one over the years; loan growth continues accelerating across the majority of the key segments; credit quality is exceptionally strong; operating leverage will be positive again after two consecutive years of negative dynamics. Nonetheless, banking quotes continues to be under pressure because of investors’ concern about fully-fledged recession in the coming quarters (not the technical one). However, recent macro data remained quite strong but deteriorating, and GDP growth forecasts for the coming years were still positive in recent months. Unsurprisingly, banks’ EPS estimates still remain strong ytd due to better earnings in 1H22 and the resilience of the US economy. Thus, the median growth of FY22 EPS of our group of banks is 3.9% ytd, but -0.2% qtd, while FY23 EPS increased by 4.7% ytd, but -1.2% qtd. FY21 revenue estimates have already increased by 0.4% qtd, or +3.9% ytd. According to the Fed H.8 survey, total loans of US banks increased by 11.1% yoy (as of August 17, 2022) vs +4.0% yoy at the end of 2021. The loan growth remains broad-based with a growth of each of the key segments by more than 4% ytd, while credit cards skyrocketed by 11.8% ytd. Nonetheless, banks continue underperforming ytd. So, banks are again trading at a substantial discount to their historical averages, while a discount to S&P 500 still remains quite high. Thus, banks are trading at -2.1/-1.9 std on P/E CY and at -2.1/-1.7 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 August 26, 2022). As for relative to S&P 500, banks are currently trading at -1.5 std and -1.6 std from the sample mean (2010-current moment) for P/E CY and P/E NY, respectively. On P/B, banks are trading with +0.7 std from the sample mean (2010-current moment) vs SPX with +1.5 std.
EU banks decreased slightly MoM in nominal terms in August 2022, but outperformed the broad market markedly, just the second month of outperformance over the last seven. Thus, on an absolute basis, SX7P decreased by 1.6% MoM in August, or -0.3 std from the mean, and it is in the bottom 33% of absolute monthly performance of SX7P index. In turn, relative monthly performance was +3.9% MoM, or +1.1 std, and it was in the top 12% of relative monthly performance in SX7P index history. Nonetheless, EU banks are still performing roughly in-line with the broad market in 2022, despite a substantial growth of recession risks, after clearly strong 2021 year when their index added 34% (+9.6% on a relative basis). On the other hand, SX7P index underperformed in each of 2018-2020 years. Thus, it is still 32% lower than it was at the end of 2017, underperforming STOXX 600 index by 36% over this period.
Dynamics of EU banks weren’t uniform in August 2022 either, as it was driven by the end of the earning season as well as a noticeable growth of the rates and rate expectations. Thus, the best performers were BPER and SAB, which increased by more than 10% MoM. In turn, the worst performers (EBS, NWG, and CSGN) lost more than 7% MoM.
European banks reported markedly better results again in 2Q22 with positive surprises on both revenue and net income. Thus, 29 out of 34 banks from our group of banks for which consensus estimates were available reported better revenue figures in 1Q22 vs 31 out of 34 in 1Q22. Net income was higher than expected for 28 out of 34 banks vs 29 out of 34 in 1Q22. EPS exceeded estimates for 27 out of 33 banks with available estimates in 2Q22 vs 27 out of 33 banks in 1Q22. The key drivers of better results were higher NII/NIM due to a skyrocketing growth of the key rates ytd and still lower provisions despite a worse economic outlook and a substantial growth of risks. Unlike to US peers, even fee revenues were solid in 2Q22. So, earnings momentum still remains strong but its future dynamics doesn’t look cloudless even taking into account much better NII/NIM prospects as a result of an ongoing acceleration of inflation and the much more hawkish ECB. The key risk factor at the moment remains asset quality dynamics in the nearest quarters, given a growth of the recession risks. At least, the median growth of operating profit of SX7P index members was just +1% yoy in 2Q22 vs +11% yoy in 1Q22 and +43% yoy in 2Q21. The median growth of revenue was +8.2% yoy in 2Q22 (even +7.0% vs 4Q19), the 6th quarter of positive yoy growth in a row, following negative dynamics over four consecutive quarters. In turn, the median revenue surprise was +4.3%, markedly better than a median quarterly surprise over the last 10 years of +1.2%. The revenue growth was broad-based with the fourth consecutive quarter of positive NII growth on a yoy basis over the last 8 quarters, but just 0.7% yoy growth of non-II, the 6th quarter in a row of positive growth. So, the median growth of FY22 NI was +4.2% ytd (+17.7% vs the end of 2Q21), implying a growth of 0.5% yoy. As of FY23 NI estimates, the median growth was +2.8% ytd (or +10.5% vs the end of 2Q21), implying roughly flat yoy dynamics. On the other hand, revenue estimates added 4.4% ytd for FY22 revenue, or +6.9% since the end of 2Q21. As a result of better earnings season and higher rate expectations, the market perception of the results was positive even despite much higher uncertainty. Thus, the median 1-day performance of SX7P index members around the earnings date was +0.8% vs 10yr average of +0.1% and 1Q22 figure of -0.1%, the highest 1-day growth over the last 9 quarters. Overall performance since the start of the earnings season wasn’t weak either with a growth of SX7P index of 1.3% (from July 11, 2022 till the end of August 2022), while STOXX 600 index was flat during the same period.
Despite better 2Q22 earnings season and much higher rate expectations, European banks were relatively flat in the last 6 months after their substantial decline at the end of February and in early March of 2022, driven by much higher risks for the EU economy because of Russia’s invasion of Ukraine, which would undoubtedly have a material impact on economic activity in the euro area through higher energy and other commodity prices, disruption of international commerce and noticeably higher inflation. So, we still remain cautious about EU banks’ prospects as we can’t answer negatively to the key question about a possible recession in the EU in the near future with certainty. Moreover, EU banks don’t look exceptionally cheap at the moment, especially taking into account that revenue/EPS projections will start going down in the coming quarters given much higher recession risks. Thus, a discount to historical averages is 26%, or -1.5 std, at the moment from mean P/E NY of SX7P index members (sample from 2010 to the present) but a discount to US peers (on median P/E NY of BKX index vs SX7P index) is 25% as of August 26, 2022 vs the average since 2010 of 21%, or -0.4 std. A discount to the broad EU market is more than 43% vs the average of 30%, or -1.4 std. So we still prefer US banks over EU financial institutions.