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  • Writer's pictureArbat Capital

EU Banking Sector Report - December 2023

EU banks outperformed the broad market slightly in November after noticeable underperformance in October. Moreover, it was the 13th month of outperformance in the past 16 months. Also, SX7P index ended the month in the green, for the 10th time over the last 14 months.


EXECUTIVE SUMMARY


EU banks outperformed the broad market slightly in November after noticeable underperformance in October. Moreover, it was the 13th month of outperformance in the past 16 months. Also, SX7P index ended the month in the green, for the 10th time over the last 14 months. The index increased by 7.0% MoM in November vs +6.5% MoM of STOXX 600 index. Absolute November 2023 performance was 1.0 std from the mean monthly performance, and it was in the top 11% of absolute monthly performance in the index history. Relative November 2023 performance was +0.5% MoM. It is +0.2 std from the mean monthly performance, and it is in the top 39% of relative performance in the SX7P index history. So, EU banks outperformed the broad market by 21.9% over the last 16 months, but just by 6.8% ytd because of significant decline in March. However, despite stronger dynamics in the last two years, SX7P index underperformed the broad market significantly in each of 2018-2020 years. So, it is still 11.4% lower than it was at the end of 2017, underperforming STOXX 600 index by 25.3% over this period. Despite weaker economic projections and higher geopolitical risks, more than 80% of our sample of banks ended the month in the green, driven by lower rate expectations. The key driver of the quotes so far – growth of EPS estimates – is gradually slowing down, which is generally confirmed by the 3Q23 earnings season. Unsurprisingly, volatility of monthly price changes increased noticeably in the last two months. But, an average difference of monthly price changes between the best and the worst performers among our banks sample was 26.7% for the first 10 months of 2023 vs an average for 2022 year of 30.7%. Moreover, correlation among EU banks between price changes ytd and EPS FY24E changes ytd increased notably, from 54% in October to 68% as of the end of November. Due to significant growth in November, UBS remains the biggest outlier after relatively bleak dynamics in September and October. Thus, it increased by 43.2% ytd while its FY24 EPS estimate was already revised down by 35.4% ytd.

Despite noticeable outperformance of EU financial institutions ytd, EU banks continue trading with a significant discount both to historical averages and to STOXX 600 Index as EPS estimates growth also remains quite high. Thus, median P/E 23E of our group of banks increased from 5.9x (as of October 31, 2023) to 6.4x (as of November 6, 2023). So, median P/E 24E also went up from 5.9x (as of October 31) to 6.2x (as of November 6). Both ratios remain noticeably lower vs the end of 2022. So, banks are still trading at -1.9/-1.9 std on P/E CY and at -1.5/-1.5 std on P/E NY (on the basis of samples from 2006 and 2010 years to the current moment) relative to historical averages. As for relative to STOXX 600 Index, banks are currently trading at -1.7 std from the sample mean (2010-current moment) for P/E CY and -1.7 std for P/E NY. Moreover, a discount to US banks also remains much wider than on average, -1.9/-1.6 std for P/E CY/NY as of November 6. Median P/B of our group of banks increased from 0.77x (as of October 31, 2023) to 0.80x (as of November 6), roughly in line with historical averages despite significant growth of ROE in the recent quarters. 3Q23 ROE was the highest one since the pre-GFC era, and it would remain quite high vs average ROE of the post-GFC times in the coming years, albeit a few percent below 3Q23 figure. Multipliers are still quite different across our banks, but dispersion across our sample has decreased slightly ytd. Thus, RBI’s P/E estimates for the next years are around 3x while UBS’s average figure is around 15x. Also, an average discount of P/E of British banks to P/E of other European banks is currently around 30%, much higher than a historical average.

EU economic activity was weak in 3Q23, and it would remain subdued at least in the nearest quarters with relatively high risk slipping into recession. Thus, EU GDP decreased by 0.1% qoq, but +0.1% yoy, in 3Q23 vs the consensus of flat qoq, or +0.2% yoy. EU macro data published in November still remained weak with worse than expected retail sales, industrial production and slightly higher unemployment rate. On the other hand, current consensus GDP growth forecasts for the next 3 years imply that economic recovery will remain weak but a recession will be avoided. Nonetheless, risks of the energy crisis during the second consecutive winter have increased recently due to growth of geopolitical tensions while the effects of the ECB’s very tight monetary policy are becoming more pronounced. Thus, credit impulse has already decreased to the levels that were not observed since GFC. Manufacturing activity remains quite weak, and the impact is spilling over to other sectors. Also, consumer spending wasn’t strong in the recent months despite resilience of the labor market. Moreover, even the services sector, which was the main driver of GDP growth until recently, continued weakening relatively fast. In turn, inflation was moving in the right direction so far, and even faster than it was expected few quarters ago. Hence, the first rate cut is already expected as early as in 2Q24 while LT rate expectations have decreased notably in the recent weeks. But risks still remain tilted to the downside while the ECB’s room for maneuver looks very limited under the current conditions, especially in case of further growth of geopolitical uncertainty.

EU banks reached a multi-year profitability high in 3Q23 but ROE would remain double-digit in the nearest years despite NIM tailwinds almost run out. Indeed, the ECB’s rate hike cycle is over. Rate expectations decreased meaningfully in the recent months while the first rate cut would be expected in 1H24 – around half-year earlier than it was expected just 2 months ago. In turn, deposit beta continues going up albeit slowly. So, NII/NIM estimates growth also decelerated. Moreover, it is already expected that NII will decline slightly on a yoy basis in 2024 after a growth of 20%+ in 2023. Despite EU banks again reported markedly better than expected quarterly results in 3Q23, the earnings season reiterated that fundamentals still remained quite strong, but the outlook continued gradually deteriorating albeit rather slowly. Thus, ROE of EU banks reached the highest level since the pre-GFC era, returning again to the double-digit territory in 1H23 and even exceeding 13% in 3Q23 vs around 8% in 2H19. Even earnings momentum still remains strong. Thus, median growth of operating profit of our group of banks (which has already revealed results) was +34% yoy in 3Q23 vs +43% yoy in 2Q23 and +46% yoy in 1Q23. Median growth of revenue was +16.9% yoy in 3Q23 vs +20% yoy in 2Q23, the 11th quarter of positive yoy growth in a row. Nonetheless, the momentum has already deteriorated slightly. We expect even more pronounced deterioration in 4Q23 and negative momentum already in 2H24. On the other hand, all of the above does not mean that fundamentals will inevitably deteriorate to a significant extent in the coming quarters. Nonetheless, profit growth will be quite weak in the nearest years for the majority of EU banks. And such a scenario does not imply any significant re-rating of EU banks, especially after their substantial outperformance in recent years. On the flipside, valuations remain quite low while capital ratios are rather high. Given still very high profitability, it will allow the majority of EU banks to maintain double-digit total yields in the coming years, which doesn’t imply substantial decline of EU banks either even despite growth of the recession risks. So, we remain neutral on EU banks since the benefits are largely offset by the risks, which, however, continue to grow.


AC - EU Banking Sector Report - Dec-2023
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