EU banks outperformed the broad market notably in December, for the third time over the last 4 months. So, it was the 4th time of outperformance over the last 6 months or the 21st time over 29 months. The SX7P index was in the green Mtd as of December 26, for the 11th time over the last 14 months.
EXECUTIVE SUMMARY
EU banks outperformed the broad market notably in December, for the third time over the last 4 months. So, it was the 4th time of outperformance over the last 6 months or the 21st time over 29 months. The SX7P index was in the green Mtd as of December 26, for the 11th time over the last 14 months. The index increased by 2.7% Mtd vs -1.3% Mtd of the STOXX 600 index. The absolute December performance was +0.3 std from the mean monthly performance, and it was in the top 37% of absolute performance in the index history. The relative December 2024 performance was +4.0% Mtd. It is +1.1 std from the mean, and it is in the top 13% of relative performance in the SX7P index history. So, EU banks outperformed the broad market by 43.2% over the last 29 months, but just by 12.6% since February 2022 due to their significant decline in March 2023. Despite stronger dynamics in 2022/23 years, the SX7P index underperformed the broad market significantly in each of 2018-2020 years. Regardless of still relatively weak economic projections, the start of the rate cut cycle and roughly flat EPS estimates qtd, around 60% banks from our sample were again in the green Mtd as of December 26, driven by still quite cheap relative valuations. Moreover, all members of our sample except for BNP/DNB/NDA remained positive on a yoy basis as of December 26. The worst performers of December, UBS and DNB, decreased by 4.9% Mtd and 4.4% Mtd, respectively. In turn, the best performers – EBS AV, KBC BB and GLE FP – increased by more than 5% Mtd in December. But the variability of monthly price changes decreased slightly again in December, for the third consecutive time, even despite a pretty news-packed quarter. Nonetheless, the correlation among EU banks between price changes ytd and EPS FY24E changes ytd increased notably in December, +20% Mtd to 40%, but still remaining much lower vs US banks.
Despite noticeable outperformance in recent years, EU banks continue trading with a significant discount both to historical averages and to the broad market as EPS estimates growth also remains quite high. Thus, median P/E 24E of our group of banks increased from 7.1x (as of November 29, 2024) to 7.4x (as of December 26). In turn, median P/E 25E went up from 6.9x (as of November 29, 2024) to 7.3x (as of December 26). But both ratios are not very far from the levels of the end of 2022. Hence, the banks are still trading at -1.28/1.25 std on P/E CY and at -0.85/-0.8 std on P/E NY (on the basis of samples from 2006 and 2010 years) relative to historical averages. As for valuations relative to the STOXX 600 index, the banks are currently trading at -1.21 std from the sample mean (2010-current moment) for P/E CY and -1.05 std for P/E NY. Moreover, the discount to US banks also remains much wider than on average, staying at -1.25/-0.8 std for P/E CY/NY as of December 26. Median P/B of our group of banks also increased slightly during the last month, rising from 0.82x as of November 29, 2024 to 0.85x as of December 26. In 2H23-3Q24, ROE figures were the highest since the pre-GFC era, and they would remain quite high vs average ROE of the post-GFC times in the nearest years, albeit a few percent below current levels. As for individual names, multipliers are still quite different, but the dispersion across the banks has decreased recently. Nonetheless, RBI’s P/E estimates for the nearest years remain just around 4x at the moment while UBS’s ratios are ranging from 16.1x for 2024 year to 8.7x for 2026 year, comparing to the industry’s average ratio for the nearest three years of 7.3x.
The EU economy will accelerate in 2025, despite weaker momentum in 4Q24 and higher uncertainty. At least, according to December ECB staff projections, EU GDP will increase by 1.1% yoy in 2025 and by 1.4% yoy in 2026 vs +0.7% yoy in 2024. The estimates were revised slightly down vs September projections, but it seems that the revision still does not fully reflect the significant increase in uncertainty over the last quarter, both political and economic. Thus, potential effects of Trump’s economic policy changes on global GDP growth, and particularly on EU GDP growth, look quite menacing. Of course, the impact is unlikely to be long lasting. Nonetheless, tariffs on EU exports only, which could be increased up to 20%, may cost around 1% of EU GDP. Moreover, the German economy will again be the worst hit in this case, which continuing to teeter on the brink of recession until so far. And the recent growth of political uncertainty in this country unlikely imply acceleration of economic recovery, especially given the calls for austerity from one of the chancellor candidates. The second biggest EU economy also doesn’t look as a potential growth driver in the near future, given ongoing political uncertainty and recent growth of concerns about sovereign debt. Thus, French sovereign premium has already increased to a 12-year high, exceeding even the Spanish one currently. So, EU macro data published in December weren’t strong again, pointing to still weak GDP growth in the nearest quarters. Thus, composite PMI still remained below the threshold of 50 pts in December, for the 4th consecutive time, while retail sales missed expectations. Even the EU labor market, which continues to be quite healthy, begins to demonstrate first signs of cooling with decline of the vacancy ratio as well as less optimistic surveys. And only inflation still continues to move in the right direction.
EU banks have already lost earnings momentum, and risks still tilted to the downside. The key near-term headwind is further NII decline, driven by relatively fast monetary easing. Thus, NII of EU banks turned already negative on a yoy basis in 3Q24, for the first time over more than 3 years. Moreover, given current interest rate expectations as well as subdued loan growth, it is expected that it will remain negative at least most of 2025. The banks have some opportunities to mitigate negative impacts of rates decline on NII, due to hedges, possible loan growth acceleration, lower funding costs etc., but it still won't be enough. Hence, risks are rather tilted to downside. Thus, in case of weaker economic recovery or, even worse, recession, the ECB will cut rates more aggressively, and it will be accompanied by weaker loan growth as well as poor asset quality with all the consequences for EPS dynamics that follow from this. In turn, fee income growth will remain strong near-term, offsetting the most of NII decline. Moreover, we expect that it will be strong amid the income lines and geographies. Fee income increased by 7.7% yoy in 3Q24 vs +8.5% in 2Q24. And due to strong fee income growth, more than 78% of banks from our sample beat revenue expectations in 3Q24. Nonetheless, the median revenue growth was just 2% in 3Q24. Moreover, it is expected that it will remain roughly flat in the next two years under the baseline economic scenario, which doesn’t imply recession. So, operating leverage will be negative most of this year, even despite unexpected positive gauge in 3Q24, due to still well controlled OpEx, partly because of the gradually easing pressure of wage inflation. Credit quality also remains quite strong, and we don’t expect any significant deterioration even in case of weaker economic recovery. At least, earnings power of EU banks will manage to cover credit losses even under severe adverse economic scenarios. Nonetheless, EPS growth will remain quite weak in the nearest two years: around 1.5% p.a. in 24-26 years vs 16% p.a. in 22-24 years. As risks of EU economic growth still tilted to the downside, fundamentals will continue to deteriorate rather than vice versa. Under such circumstances, further re-rating of EU banks looks unlikely. On the other hand, EU banks remain cheap with high internal capital generation, which implies that expected double-digit total yield is sustainable even in case of economic deterioration, which, in turn, implies limited risks of significant sell-offs, at least all other things being equal. So, we still remain neutral on EU banks, given lack of drivers in the near-term perspective.
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