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  • Writer's pictureArbat Capital

EU Banking Sector Report - January 2024

EU banks underperformed the broad market slightly in December 2023 after small outperformance in November. Nonetheless, it was the 4th time of underperformance over the last 17 months. Moreover, SX7P index ended the month in the green, for the 11th time over the last 15 months.



EXECUTIVE SUMMARY


EU banks underperformed the broad market slightly in December 2023 after small outperformance in November. Nonetheless, it was the 4th time of underperformance over the last 17 months. Moreover, SX7P index ended the month in the green, for the 11th time over the last 15 months. The index increased by 3.7% MoM in December vs +3.8% MoM of STOXX 600 index. Absolute December 2023 performance was +0.5 std from the mean monthly performance, and it was in the top 29% of absolute monthly performance in the index history. Relative December 2023 performance was -0.1% MoM. It is +0.03 std from the mean monthly performance, but it is in the bottom 48% of relative performance in the SX7P index history. So, EU banks outperformed the broad market by 21.8% over the last 17 months, but just by 6.7% yoy in 2023 because of their 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 9.2% lower than it was at the end of 2017, underperforming STOXX 600 index by 25.4% over this period. Despite weaker economic projections and higher geopolitical risks, more than 70% 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 three months. But an average difference of monthly price changes between the best and the worst performers among our banks sample 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 notably, from 68% in November to 50% as of the end of December. Due to significant growth in November and December, UBS remains the biggest outlier after relatively bleak dynamics in September and October. Thus, it increased by 52% yoy in 2023 while its FY24 EPS estimate was revised down by 40% yoy (vs 24.4% ytd as of the end of July).

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 23E of our group of banks decreased from 6.4x (as of December 6, 2023) to 6.1x (as of December 29). So, median P/E 24E also went down from 6.2x (as of December 6, 2023) to 6.1x (as of December 29). Both ratios remained noticeably lower vs the end of 2022. So, banks are still trading at -2.0/-2.1 std on P/E CY and at -1.6/-1.6 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 -1.9 std from the sample mean (2010-current moment) for P/E CY and -1.9 std for P/E NY. Moreover, a discount to US banks also remains much wider than on average, -2.1/-1.6 std for P/E CY/NY as of December 29. Median P/B of our group of banks was roughly flat in December, ending the year at 0.8x. 3Q23 ROE was the highest one since the pre-GFC era, and it would remain quite high in the coming years vs average ROE of post-GFC times, albeit a few percent below the 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 nearest years are around 2-3x while UBS’s average figure is around 16x for 2024 year but 9.6x for 2025 year (still much higher than an industry average). 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 historical averages.

Recent EU macro data weren’t strong but the EU economy should return to growth in 4Q23. The good news is that it is expected to continue gradually recovering in 1H24. The bad news is that its growth will still remain quite weak, at least in 2024 with ongoing relatively high risk of falling into recession. Thus, EU macro data published in December 2023 weren’t strong again with worse than expected retail sales, industrial production and PMIs, but slightly better unemployment and consumer confidence. So, the downside scenario as yet implies that the EU economy could continue shrinking, especially in case of further growth of geopolitical risks, while estimated recession probability still remains quite high, at 65%. In turn, both ECB’s staff projections and the market consensus estimates of EU economy growth were revised up in recent months. But manufacturing activity still remains quite weak despite slight growth in 4Q23, and its impact is spilling over to other sectors. Hence, even services activity, which was the main driver of GDP growth until recently, continued weakening relatively fast. However, we believe that the EU economic momentum should pick up later due to some easing of the energy crisis, the still strong labor market with low unemployment and solid wage growth as well as recovering of foreign demand. Moreover, inflation was moving in the right direction so far, and even faster than it was expected few quarters ago, implying less pressure of high interest rates on the economic activity in the nearest months. But it is too early to say that the inflation battle has already been over. At least, CPI increased slightly in December after a notable decline in November, driven by higher energy prices.

4Q23 earnings will remain strong but we expect that earnings momentum will continue deteriorating. 4Q23 earnings season of EU banks will start on January 19, 2023, when Spanish Bankinter reveals its quarterly report. After that, all members of SX7P index except for PKO and AIB Group will release quarterly earnings till the end of February. Due to very fast monetary tightening and skyrocketing rates growth in 2023, ROE of EU banks reached the highest level since the pre-GFC era, returning again to a double-digit territory in 1H23 and even exceeding 13% in 3Q23. NII and NIM were the key drivers of quite strong profit dynamics. So, ROE will stay near its multi-year highs as of 4Q23 but future dynamics of the ratio doesn’t look cloudless given expected challenging NII/NIM trajectory in the near future because of significant decline of rate expectations. Indeed, ECB’s rate hiking cycle is over. Rate expectations decreased meaningfully in the recent months while the first rate cut would be expected as early as in 1Q24 (at the March meeting) – more than a half-year earlier than it was expected just 3 months ago. Thus, 3M Euribor (Dec 2024) decreased by 58 bps MoM to 2.3% (as of the end of December 2023), -78 bps yoy. While 3M Euribor (Dec 2025) went down by 57 bps MoM to 1.9%, -106 bps yoy. So, loan rates have already started to go down. Average EU corporate loans rate (new business) decreased by 5 bps MoM in November, the first monthly decline over the last 16 months. In turn, credit impulse remained quite weak in 2H23, reaching the levels not seen since GFC. Moreover, asset quality will continue deteriorating in the near term, given still high interest rates and weak GDP growth. On the other hand, the safety margin of EU banks is still quite high. Recall that under adverse scenario of EBA’s 2023 stress test, despite combined losses of €496 Bn, EU banks remained sufficiently capitalized. Nonetheless, given not very strong start of the US earnings season as well as negative revisions of EPS estimates of EU banks recently, we think that FY24 outlooks will be much more important than 4Q23 figures. So, even strong 4Q23 earnings won’t be a guarantee of positive price dynamics near term in case of weaker than expected guidance although median sell-side upside is higher than 20% at the moment while valuations are still quite low. 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 - Jan-2024
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