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  • Writer's pictureArbat Capital

EU Banking Sector Report - February 2024

EU banks underperformed the broad market slightly again in January, for the second consecutive month. Nonetheless, it was just the 5th time of underperformance over the last 18 months. Moreover, SX7P index ended the month in the green, for the 12th time over the last 16 months.



EXECUTIVE SUMMARY


EU banks underperformed the broad market slightly again in January, for the second consecutive month. Nonetheless, it was just the 5th time of underperformance over the last 18 months. Moreover, SX7P index ended the month in the green, for the 12th time over the last 16 months. The index increased by 1.1% MoM in January vs +1.4% MoM of STOXX 600 index. Absolute January 2024 performance was +0.1 std from the mean monthly performance, though it was in the bottom 49% of absolute monthly performance in the index history. Relative January 2024 performance was -0.3% MoM. It is -0.03 std from the mean monthly performance, and it is in the bottom 47% of relative performance in the SX7P index history. So, EU banks outperformed the broad market by 21.4% over the last 1.5 years, but just by 6.4% since the end of 2022 because of significant decline in March 2023. 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 7.2% lower than it was at the end of 2017, underperforming STOXX 600 index by 25.6% over this period. Despite still weak economic projections and not very strong start of 4Q23 earnings season, 60% of our sample of banks ended the month in the green, mainly driven by positive 2024 outlooks. The key driver of positive dynamics of the quotes so far, namely a growth of EPS estimates, is gradually slowing down, which is generally confirmed by the last earnings seasons. Nonetheless, volatility of monthly price changes decreased noticeably in January, even despite the start of 4Q23 earnings season. An average difference of monthly price changes between the best and the worst performers among our sample of EU banks was 27.8% in 2023 vs an average for 2022 year of 30.7%. However, correlation among EU banks between price changes ytd and EPS FY24E changes ytd decreased significantly in January, mainly driven by investor reaction on 4Q23 earnings. Due to significant growth in three recent months, UBS remains the biggest outlier. Thus, it increased by 34% yoy as of the end of January while its FY24 EPS estimate was revised down by 55% yoy.

Despite noticeable outperformance of EU financial institutions in 2023, 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 24E of our group of banks decreased from 6.4x (as of January 5, 2024) to 6.1x (as of February 8). In turn, median P/E 25E went up from 6.1x (as of January 5, 2024) to 6.2x (as of February 8). Both ratios remained noticeably lower vs the end of 2022. So, banks are still trading at -2.0/-2.0 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) relative to historical averages. As for relative to STOXX 600 Index, banks are currently trading at -1.8 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, -2.0/-1.5 std for P/E CY/NY as of February 8. Median P/B of our group of banks was roughly flat in January, being at 0.7x as of February 8. 4Q23 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 nearest years, albeit a few percent below the 4Q23 figure. As for individual names, multipliers are still quite different, but dispersion across banks has decreased recently. Thus, RBI’s P/E estimates for the coming years are around 3-4x while SHBA’s average ratio is around 10x and industry’s average ratio is 6x. In turn, an average discount of P/E of British banks to P/E of other EU banks is more than 30%, much higher than a historical average.

Although recent macro data wasn’t strong, the EU economy should return to positive growth in 1Q24, driven by the still strong labor market. The good news is that the EU economy continues gradually gaining momentum. The bad news is that the growth will remain quite weak at least in 2024 with ongoing relatively high risk of falling into recession. Thus, EU macro data published in January wasn’t strong again with slightly worse than expected composite and services PMI’s as well as notably weaker consumer confidence but slightly better unemployment and GDP growth. So, the downside scenario still implies that the EU economy could continue shrinking, especially in case of further growth of geopolitical risks while estimated recession probability remained quite high, at 65% in January. In turn, both ECB’s staff projections and market consensus estimates of EU economic growth were revised up in recent months. But manufacturing activity still remained quite weak despite slight acceleration in 4Q23, and its impact was spilling over to other sectors. Hence, even services activity, which was the main driver of GDP growth until recently, continued weakening in 2H23. On the other hand, we see some first signs of turnaround even in manufacturing at the moment, despite still quite high interest rates, the impact of which has been manageable, at least so far. Moreover, inflation was moving in the right direction, and faster than it was expected few quarters ago, implying less pressure of high interest rates on the economic activity already in the nearest months. It doesn’t mean that the ECB will cut rates very quickly, especially taking into account resilience of the EU economy, but it definitely gets much-needed leeway.

The start of the 4Q23 earnings season wasn’t strong for EU banks but profitability remained at a multi-decade high. Thus, less than half of the banks from our sample that have reported so far have been able to exceed revenue expectations. Around 2/3 of banks reported higher EPS figures but estimates had been cut notably before. Moreover, the earnings momentum continued deteriorating. Thus, growth of both revenue and operating income decelerated significantly in 4Q23. Nonetheless, it was the 12th quarter of positive yoy revenue growth in a row, but the days of double-digit growth are already behind us. However, it is still expected that revenue growth will remain positive in 2024, even taking into account weaker 4Q23 revenues and more challenging environment, especially for NII/NIM. Indeed, interest rates were the key driver of EU banks revenue growth for a long time, but times have changed as the ECB’s rate hike cycle is over and the first rate cut is already expected as early as in 1H24 with total rate cut of 150 bps till the end of the year. Hence, asset yields have already started to decline while cost of funding still continues going up. Thus, Eurozone’s average corporate loan yield (new business) decreased by 5 bps MoM in December, the second consecutive month of decline. In turn, total cost of deposits (new business) remained roughly flat. Moreover, credit impulse still remained quite weak albeit the second derivative of both deposit and loan growth improved in recent months. Hence, taking into account that the yield curve will remain inverted in the nearest quarters and further decline of interest expectations, we expect that NII growth will be bleak in 2024. The NII tailwind has already disappeared, and it means relatively high probability of EPS/revenue estimates downgrades in the near term. In other words, uncertainty remains high, and 4Q23 earnings season hasn’t convinced investors otherwise. Restrained market reaction to 4Q23 results only confirms this, from our point of view. The scenario of EPS downgrades does not imply any significant re-rating of EU banks even despite their quite low valuations after substantial outperformance in 2023. On the other hand, we don’t expect substantial decline of EU banks either, given still positive and improving GDP growth, quite low valuations and very high capital returns. 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 - Feb-2024
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