US banks underperformed the broad market again in April 2023, for the 5th time over the last 6 months. Moreover, BKX index ended the month in the red for the third consecutive month. BKX index decreased by 0.9% MoM in April vs +1.5% MoM of SPX index.
EXECUTIVE SUMMARY
US banks underperformed the broad market again in April 2023, for the 5th time over the last 6 months. Moreover, BKX index ended the month in the red for the third consecutive month. BKX index decreased by 0.9% MoM in April vs +1.5% MoM of SPX index. Absolute April performance was -0.2 std from the mean monthly performance, and it was in the bottom 37% of absolute monthly performance in the index history. Relative April performance was -2.4% MoM. It is -0.4 std from the mean monthly performance, and it is the bottom 28% of relative performance vs SPX index since BKX index inception. The second worst monthly relative performance in the banking index history, shown in March 2023, and beliefs that regulators managed to fix the problem gave us hope for relief rally recently, but the reality turned out to be much more complicated.
US banks' dynamics were quite volatile in April 2023 as a result of the earnings season and consequences of the regional banking crisis that started in early March. Thus, the worst performer by a large margin was again FRC, which couldn’t convince investors during 1Q23 earning season that it could cope with the deposit outflows, as a result of which it lost 75% MoM.
US banks reported quite mixed 1Q23 results with slightly better NII but weaker NIM, still quite strong asset quality and solid capital ratios even despite the recent banking turmoil, higher risks of recession and consequences of skyrocketing rates growth in 2022. On the other hand, fees dynamics still remained relatively weak, OpEx was higher than expected again, while deposits/loans dynamics missed expectations noticeably, implying a hazier outlook for future dynamics of fundamentals, at least in the nearest quarters. Moreover, EPS surprises were only slightly higher than expected, mainly due to strong surprises of money centers, while revenues were roughly in line. It was the weakest quarter from median EPS/revenue surprise point of view in years. Despite loan growth miss, it still remains solid but decelerating. The same is true for the credit quality – both NCOs and LLPs were noticeably better than expected again, remaining quite low vs historical averages. Nonetheless, LLPs were slightly higher than expected, and we anticipate that provisions will continue going up and even accelerating as a result of higher uncertainty and possible recession. On the other hand, we don’t expect it will become a significant headwind for US banks, unlike NIM, which has already peaked, and will continue to decline in the near future due to faster reprising of the funding base, especially deposits, because of further outflows due to ongoing yield seeking behavior. So, fundamentals will continue gradually deteriorating from the current quite strong level in the coming quarters. Nonetheless, we believe that weaker than it was expected a few quarters ago future profits dynamics have already been largely priced in. The key question now is how much the reality can be worse relative to the current expectations. At least, market reaction on 1Q23 results, especially on earnings of the most vulnerable banks during the March banking turmoil, points that the market still remains quite nervous even despite to the fact that trust in the system has already largely recovered thanks to the rather prompt intervention of regulators. So, we remain neutral on US banks given still relatively high uncertainty about fundamentals dynamics in the near future, but we are gradually becoming more optimistic (cautiously optimistic), taking into account current low valuations and US banks performance ytd.
Banks beat expectations slightly in 1Q23 with better EPS figures for 12 out of 22 BKX index members vs around 2/3 of positive surprises for BKX index members in 2022. The median EPS surprise of BKX index members was just +0.9% vs the median quarterly figure over the last 10 years of 3.7%. Revenue surprise was positive again, but just +0.1% in 1Q23 vs the median quarterly figure over the last 10 years of 1.1%. Just half of current BKX member beat consensus in 1Q23 vs the mean quarterly beat of 15 members in 2022 year out of 24 banks. Unsurprisingly, market perception of the results was negative, for the first quarter over the last year. The median percentage price change around the earnings date of BKX index members was -0.1%, in line with the median figure over the last 10 years. However, volatility of 1-day performance around the earnings date of BKX index members was the highest one since the GFC. Also, BKX index dynamics in the first two weeks after the earnings season started was negative, and it underperformed S&P 500 index by 1.5% during this period. Unsurprisingly, consensus estimates continue going down both ytd and since the earnings season start. Thus, 2Q23 EPS estimates were revised down by 2.8% starting from April 13, 2023 till the end of the month (the median of BKX index members) and it was -10.3% ytd, FY23 EPS estimates decreased by 2.5% since the start of the earnings season, or -10.7% ytd, while the median change of FY24 EPS estimates was -3.5% since April 13, 2023, or -14.3% ytd. Median revenue FY23 decline was 1% since the start of 1Q23 earnings season, or -2.6% ytd.
Banks are trading with a significant discount to both their historical averages and relative to S&P 500 again. Thus, banks are trading at -3.0/-2.8 std on P/E CY and at -2.6/-2.2 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 April 28, 2023). As for relative to S&P 500, banks are currently trading at -2.2 std and -2.0 std from the sample mean (2010-current moment) for P/E CY and P/E NY, respectively. On P/B, banks are trading with a discount of -1.0 std from the sample mean (2010-current moment) vs SPX with +1.4 std (despite ROE premium are roughly the same, at least at the moment).
Unlike to US peers, EU banks increased noticeably in nominal terms in April 2023 on a monthly basis, and outperformed the broad market again, for the 8th month over last 9. Thus, SX7P went up by 2.3% MoM within the month, or +0.3 std from the mean, and it is in the top 41% of absolute monthly performance of SX7P index. In turn, relative monthly performance was just +0.4% MoM, or +0.2 std, and it was in the top 40% of relative monthly performance in the SX7P index history. So, EU banks outperformed the broad market by 4.0% since 2Q22 despite to banking selloff in March 2023. On the other hand, SX7P index underperformed in each of 2018-2020 years. Thus, it is still 19% lower than it was at the end of 2017, underperforming STOXX 600 index by 32% over this period.
Dynamics of EU banks weren’t uniform in April 2023 again due to a start of the earnings season and consequences of the bank run in the month prior. In result, the best performers were the banks with better quarterly figures which increased by 9%+ MoM. In turn, the worst performers, UBS, Santander and Caixa, decreased by more than 6% MoM.
Compared to US peers, the regional banking crisis had a limited impact on EU banks, which continued to enjoy normal rate environment to the full after operating for a long time in the negative rate environment. Even despite forced takeover of Credit Suisse by regulators, funding issues are not acute for EU banks so far, partially thanks to a stickier deposit base. As a result of the more hawkish ECB comparing to expectations of a few quarters ago, profit estimates continue going up. Thus, median growth of FY23 NI of EU banks was +10.7% ytd, while median growth of FY24 NI was +5% ytd. Nonetheless, the forward yield curve moved noticeably back in recent months, implying that NIM peak is not very far from us, while risks for asset quality, for example for CRE loans, continue going up. Moreover, EU banks don’t look obviously cheap, at least vs US peers. Thus, a discount to their historical averages is 27% at the moment (-1.5 std from the 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 just 14% as of April 28, 2023 vs the average since 2010 of 20%, or +0.7 std. In turn, a discount to the broad EU market widened to 49% vs the average of 32%, or -1.7 std. So, even despite to quite attractive total capital return yields, we remain neutral on EU financial institutions, given their significant outperformance during last two quarters, higher uncertainty and growth of downside risks for fundamentals.