US banks underperformed slightly in October 2021 despite their strong absolute performance, the first time of weaker performance vs the broad market over the last three months.
EXECUTIVE SUMMARY
US banks underperformed slightly in October 2021 despite their strong absolute performance, the first time of weaker performance vs the broad market over the last three months.Thus, BKX index increased by 6.3% MoM vs +6.9% MoM of SPX index, the third consecutive month of growth in absolute terms. Absolute October performance was +0.8 std from the mean monthly performance and it is in the top 17% since the index inception. In turn, relative October performance was -0.6% MoM. It is -0.1 std from the mean monthly performance and it is in the bottom 45% of relative performance vs SPX index since the index inception. Despite clearly weak performance in June and July of 2021, banks outperformed SPX in 7 out of 10 months of the current year. So, performance of the first 10 months of the year is the strongest one over last 27 years while relative performance is the strongest one over last 21 years.
US banks dynamics were mixed in October. Thus, the most asset sensitive banks were among outperformers due to the ongoing growth of key rates after the hawkish September FOMC meeting. On the other hand, consumer finance companies were among the key laggards, declining by 5% MoM or more.
US banks reported very strong 3Q21 results again with much better both revenue and EPS figures. It was the 6th quarter in a row when both revenue and EPS figures exceeded consensus estimates considerably after the clearly weak 1Q20 earnings season. The key driver of better NI remains reserve releases, for the fourth quarter in a row, but even NII figures didn’t miss in 3Q21 as it was in the previous quarters. On the other hand, fees were strong again, while underlying trends continued improving with more and more positive signs for future dynamics of loan growth and NIM/NII. From our point of view, the process of releasing the reserves has come to an end but we see a room for further EPS growth given the first signs of the loan growth accelerating and the more hawkish Fed as well as higher buyback volumes. So, even taking into account the significant outperformance of banks in 2021, the rally may well continue in 4Q21 after a short pause in 3Q21. At least, banks are still substantially undervalued vs S&P 500 and they are a good hedge against inflation while the more hawkish Fed increased the probability of a blue sky scenario for US banks.
Banks beat expectations considerably in 3Q21, with better EPS figures for 21 out of 24 banks in our group vs 23 positive surprises in 2Q21 and better results for all 24 banks in 1Q21, compared with a median number of positive quarterly EPS surprises over the last 58 quarters of 18. The median EPS surprise for our group of banks was +13.9% vs a median quarterly figure over the last 14 years of 3.7%, after two quarters in a row of the highest median surprises in the data set, shown in 1Q21 (+41%) and 2Q21 (+35%). The median revenue surprise was positive again, the 23th quarter over the last 24 quarters, +2.3% vs a median quarterly figure over the last 14 years of +0.9%. 19 companies of our group of banks, or 79%, demonstrated positive surprises on revenue, significantly higher than a median quarterly figure since Q1 2007. Notwithstanding, market perception of the results was restrained with slightly weaker growth of banks vs SPX in the first two weeks of the earning season. On the other hand, a median percent change in price around the earnings date of our group of banks was +0.96%, the second consecutive quarter of positive dynamics and the much higher growth than a median figure since 1Q07 of -0.3%. BKX index increased by 3.1% since the start of the earnings season till the end of October 2021, while S&P 500 index added 5.9%. On the other hand, consensus estimates improved significantly during the earnings season. Thus, 4Q21 EPS estimates were revised up by 1.3% since October 12, 2021 (a median of BKX index members) and it is +31.4% ytd, FY21 EPS estimates were +2.4% since the start of the earnings season, or +60.5% ytd, while a median change of FY22 EPS estimates was +0.5% since October 12, 2021, or +12.6% ytd. In turn, median revenue growth was +0.6%, or +5.6% ytd.
Due to reserve releases, ROE/ROA figures increased significantly in recent quarters, remaining at their multi-year highs for the third consecutive quarter. Thus, ROE increased by 221 bps yoy to 12.0% in 3Q21, +105 bps vs 4Q19, but -130 bps qoq. Key credit metrics of US banks still remained pretty resilient due to significant acceleration of the recovery and the ongoing reopening of the economy. We no more expect any deterioration of the credit quality in the near future even after the expiration of various supporting programs. On the other hand, we also don’t see a room for further significant reserve releasing, even despite banks do not exclude that this process may continue. So, it means that ROE/ROA may drop slightly from the current levels in coming quarters but we expect that they will improve in 2H22. So, banks’ profitability will exceed pre-pandemic levels in the nearest 2-3 years as a result of loan growth acceleration and noticeably higher expectations for NII/NIM. Also, banks continue increasing the pace of buybacks after optimistic results of the stress test. So, EPS will continue its fast rebound and it has already exceeded pre-COVID levels noticeably in 2021. Notwithstanding, banks are still trading with a significant discount to S&P 500 but they are no more trading with a substantial discount to their historical averages even after the substantial growth of EPS forecasts in recent months. Thus, banks are trading with -1.0/-0.9 std on P/E CY and +0.9/+1.1 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 29, 2021). As for relative to S&P 500, banks are currently trading at -1.8 std and -1.0 std from the sample mean (2010-current moment) for P/E CY and P/E NY, respectively. On P/B, banks are trading with +1.0 std from the sample mean (2010-current moment) vs SPX with +2.8 std.
EU banks increased markedly on an absolute basis in October 2021 as well, the third month of growth in a row after two consecutive months of negative dynamics. They outperformed the broad market again, the third month in a row of stronger dynamics. Thus, on an absolute basis, SX7P increased by 5.5% MoM in October, or +0.8 std from the mean, and it is in the top 16% of absolute monthly performance of SX7P index. On the other hand, relative monthly performance was +0.9% MoM, or +0.3 std, and it is in the top 35% of relative monthly performance in SX7P index history. So, it was very strong price performance in the first 10 months of the year, +37.2% ytd, after clearly weak dynamics in three previous years. However, SX7P index underperformed in each of the last 3 years and it is still 19.3% lower than it was at the end of 2017, underperforming STOXX 600 index by 21.8% over this period.
The key outperformers among EU banks increased by 10% MoM or more. In turn, the key EU underperformers, which ended October in the red zone, were banks with weaker 3Q21 results.
We anticipate that the growth of EU banks may continue in the near future due to the strong start of the earnings season and better earnings visibility as a result of ongoing vaccination campaigns and GDP growth acceleration. But we no more expect their substantial outperformance vs the broad market given relatively rich valuations and still challenging revenue environment in coming years, as the ECB continues to preserve favourable financing conditions and being as flexible as it can. So, key rates will remain negative in the foreseeable future but rate expectations improved noticeably in recent months. Moreover, EU banks are no longer traded with a deep discount to their historical averages while a discount to US peers is insignificantly wider comparing to historical averages. Thus, the premium to historical averages is already 7% (+0.4 std at the moment from mean P/E NY of SX7P index members, sample from 2010 to the present) but the discount to US peers (on median P/E NY of BKX index vs SX7P index) is 26% as of October 29, 2021 vs an average from 2010 of 21%, -0.6 std. On the other hand, the worst in terms of operational results is in the past but it is a bumpy road ahead with a still challenging revenue environment and relatively low ROE/ROA in the near term.