US banks outperformed the broad market noticeably in May 2022, for the first time over the last three months. It was just the second month with positive absolute performance in 2022.
EXECUTIVE SUMMARY
US banks outperformed the broad market noticeably in May 2022, for the first time over the last three months. It was just the second month with positive absolute performance in 2022.Thus, BKX index increased by 5.9% MoM vs flat MoM dynamics of SPX index. Absolute May performance was +0.8 std from the mean monthly performance and it is in the top 20% since the index inception. Relative May performance was +5.9% MoM. It is +1.2 std from the mean monthly performance and it is in the top 8% of relative performance vs SPX index since the index inception. Despite an overwhelming growth of rates, US banks underperformed the broad market significantly since mid-February as a result of much higher geopolitical risks and an expected noticeable deceleration of US GDP growth.
US banks' dynamics were relatively uniform in May 2022 with positive dynamics for all our group of banks, except for 2 financial institutions. Among the worst performers were AXP and SBNY. The dynamics of the latter was quite weak due to a significant decline of the crypto-currency market. Among the best performers were liability-sensitive NYCB and money-centers JPM and C.
Despite banking fundamentals remain solid, while economic growth is still resilient given monetary tightening, ongoing supply-chain bottlenecks and quite high inflation and energy prices, banking quotes continues to be under pressure because of investors’ concern about recession in the coming quarters. According to Bloomberg, probability of US recession in the nearest year is estimated at 30% at the moment – up from 15% at the beginning of the year but roughly in-line with the figure at the end of 2019. However, recent macro data were quite strong and better than expected despite quite weak consumer sentiment. Nonetheless, US GDP growth estimates were revised noticeably down ytd, but they do not indicate a recession in the coming years either. According to Bloomberg May survey, US GDP growth is forecasted at +2.7%/+2.1%/+2.0% yoy in 2022/2023/2024 years, respectively, vs +3.7%/+2.5%/+2.1% yoy in Bloomberg January survey. Unsurprisingly, EPS estimates of US banks continue going up due to much higher NII/NIM expectations, still very strong asset quality (although gradually normalizing), an accelerating loan growth and a controlled OpEx growth. Thus, a median growth of FY22 EPS of our group of banks is 2.4% qtd, or +4.8% ytd, while FY23 EPS increased by 1.8% qtd, or +6.6% ytd. FY22 revenue estimates have already increased by 1.2% qtd, or +3.2% ytd. According to the Fed H.8 survey, total loans of US banks increased by 7.7% yoy (as of May 11, 2022) vs +4.0% yoy at the end of 2022. The loan growth remains broad-based with a growth of each of the key segments by more than 3.4% ytd while credit cards skyrocketed by 8.4% 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 -1.7/-1.5 std on P/E CY and at -2.0/-1.7 std on P/E NY (on the basis of samples from 2000 and 2010 years to the current moment) relative to their historical averages (as of May 27, 2022). As for relative to S&P 500, banks are currently trading at -1.3 std and -1.7 std from the sample mean (2010-current moment) for P/E CY and P/E NY, respectively. On P/B, banks are trading with +1.1 std from the sample mean (2010-current moment) vs SPX with +1.6 std.
EU banks increased on both an absolute basis and a relative basis in May 2022, the first month of growth over the last four. Thus, on an absolute basis, SX7P increased by 4.7% MoM in May 2022, or +0.6 std from the mean, and it is in the top 20% of absolute monthly performance of SX7P index. In turn, relative monthly performance was +6.4% MoM, or +1.7 std, and it was in the top 5% of relative monthly performance in SX7P index history. So, EU banks outperformed the broad market slightly in 2022 despite to a growth of recession risk after clearly strong 2021 year when they 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 24.7% lower than it was at the end of 2017, underperforming STOXX 600 index by 33.9% over this period.
Dynamics of EU banks were quite mixed in May 2022 again and it was driven mainly by 1Q22 earnings and rates dynamics. Among the key underperformers were KBC and VMUK, which lost more than 10% MoM. CBK due to better earnings and UCG due to talks to sell Russian business were among the best performers in May, adding more than 20% MoM.
European banks reported markedly better results in 1Q22 with positive surprises on both revenue and net income. Thus, 31 out of 34 banks from our sample of banks for which consensus estimates were available reported better revenue figures in 1Q22 vs 27 out of 33 in 4Q21. A median revenue surprise was +4.3%, markedly better than the median quarterly surprise over the last 10 years of +1.2%. Net income was higher than expected for 29 out of 34 banks vs 26 out of 31 in 4Q21. The key drivers of better results were higher NII due to a skyrocketing growth of the key rates in recent quarters and still lower provisions despite a worse economic outlook and a substantial growth of risks. Thus, a median NII growth of EU banks was +8.3% yoy in 1Q22, the third consecutive quarter of yoy growth after five quarters of negative dynamics in a row. Moreover, it was positive on a qoq basis, adding 3.2%, even despite lower day count. A median decline of provisions was 17% yoy, but +35% qoq, the fifth quarter of yoy decline in a row after 7 consecutive quarters of positive yoy growth. So, the earnings momentum still remains strong but its future dynamics doesn’t look cloudless, even taking into account much better NII/NIM prospects. Thus, a median growth of operating profit of our sample of EU banks was +16% yoy in 1Q22 vs +11% yoy in 4Q21 and +33% yoy in 3Q21. A median growth of revenue was +8% yoy in 1Q22 (even +12% vs 4Q19), the fifth quarter of positive yoy growth in a row, following negative dynamics over four consecutive quarters. The key risk factor at the moment is asset quality dynamics in the nearest quarters given a growth of the recession risk. Nonetheless, a median growth of FY22 NI was +0.9% ytd (+7.2% vs the end of 2Q21), implying a decline of 2.2% yoy. As of FY23 NI estimates, their median growth was +0.7% ytd (or +9.1% vs the end of 2Q21), implying a growth of +8.1% yoy. On the other hand, revenue estimates added 2% ytd for FY22 revenue, or +5.2% since the end of 2Q21.
Despite better earnings season, higher EPS/revenue estimates ytd, and an ongoing growth of rate expectations, the market perception of the results was negative. Thus, median 1-day performance of SX7P index members around the earnings date was -0.5% vs 10yr average of +0.2% and 4Q21 figure of -0.2% (the second decline during the earnings season in a row). On the other hand, the overall performance since the start of the earnings season wasn’t clearly weak with a decline of SX7P index of just 0.2% (from April 19, 2022 till the end of May 2022), while STOXX 600 index decreased by 3.6% over the same period.
In spite of strong and improving fundamentals, at least so far, European banks' dynamics remain relatively flat after a substantial decline at the end of February and in early March, 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 no to the key question about possible recession in EU in the near future with certainty. Moreover, EU banks don’t look very cheap at the moment, even taking into account higher revenue/EPS projections ytd. Thus, a discount to historical averages is 16% (-0.9 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 16% as of May 27, 2022 vs the average since 2010 of 21%, or even +0.7 std. A discount to the broad EU market is more than 38% vs the average of 30%, or -0.9 std. So we still prefer US banks over EU financial institutions.