EU Banking Sector Report - July 2023
EU banks outperformed the broad market again in June 2023, for the third consecutive month and for the 10th time over the last 11 months. Moreover, SX7P index ended the month deeply in the green after decline in May.
EU banks outperformed the broad market again in June 2023, for the third consecutive month and for the 10th time over the last 11 months. Moreover, SX7P index ended the month deeply in the green after decline in May. The index soared by 7.3% MoM in June vs +2.3% MoM of STOXX 600 index. Absolute June 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 June 2023 performance was +4.9% MoM. It is +1.3 std from the mean monthly performance, and it is in the top 8% of relative performance in the SX7P index history. So, EU banks outperformed the broad market by 16.3% over the last 11 months, but just by 1.9% ytd because of significant decline in March 2023. However, despite stronger dynamics in last two years, SX7P index underperformed the broad market significantly in each of 2018-2020 years. So, it is still 15.4% lower than it was at the end of 2017, underperforming STOXX 600 index by 29% over this period. Despite a technical recession in EU, the more hawkish ECB and higher rate expectations remain the key positive drivers for EU banks. So, EU banks increased again noticeably in June after a short pause in May, and only 2 out of 36 banks from our sample ended the month in the red. Volatility of monthly price changes wasn’t high for EU banks ytd. Thus, an average difference of monthly price change between the best and the worst performers among our banks sample is 25.3% for the first six months of 2023 vs the average for 2022 year of 30.7%. Unlike to US peers, there was relatively high correlation among EU banks between price change ytd and EPS FY24E change ytd. And it even increased to approximately 66% in June.
Despite recent outperformance of EU financial institutions, EU banks continue trading with a significant discount both to historical averages and to STOXX 600 Index as EPS estimates growth remains quite high. Thus, median P/E 23E of our group of banks increased from 6.5x (as of May 26, 2023) to 6.55x (as of June 30). In turn, median P/E 24E increased from 6.0x (as of May 26, 2023) to 6.35x (as of June 30). Both ratios remain noticeably lower vs the end of 2022. Nonetheless, banks are still trading at -2.0/-2.1 std on P/E CY and at -1.5/-1.6 std on P/E NY (on the basis of samples from 2006 and 2010 years to the current moment) relative to historical averages (as of June 30, 2023). 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 -1.6 std for P/E NY. Moreover, discounts to US banks also remain much wider than averages, -2.1/-1.6 std for P/E CY/NY as of June 30, 2023. Median P/B of our group of banks increased from 0.63x (as of May 26, 2023) to 0.64x (as of June 30), roughly in line with a historical average despite significant growth of ROE in the recent quarters. 1Q23 ROE was the highest one since the GFC, and it will remain roughly flat in coming years. 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 3x while UBS’s average figure is around 9x. Given high RBI's exposure to Russia and the fact that a Russian part of RBI’s profit is a ‘paper’ profit, a certain discount looks justified, but not as high as it is at the moment, from our point of view.
Contrary to initial estimates, the European economy failed to avoid a recession during the last winter. Thus, EU GDP decreased by 0.1% qoq in both 4Q22 and 1Q23. Nonetheless, taking into account initial forecasts and realized risks, the European economy dynamics was noticeably better than it had been expected. Moreover, due to an easing of the energy crisis it is expected that the EU economy will resume to grow in 2Q23, albeit at a relatively low speed. But it is too early to say that the EU economy is already out of the woods given recent macro data, especially PMIs. Thus, EU composite PMI decreased by 2.5 pts MoM to just 50.3 pts in May 2023, the lowest figure in 6 months. On the other hand, the EU labor market was quite strong so far, and the unemployment rate remained at a new historical low of 6.5% in May. Despite the strong labor market, the decline of energy prices and markedly lower inflation, consumer sentiment and retail sales remained relatively weak over the last months. So, ECB’s June 2023 projections were roughly flat vs March 2023 forecasts, while risks are still tilted to the downside, from our point of view, especially taking into account the more hawkish ECB at two recent meetings.
European banks reported markedly better results in 1Q23 with positive surprises on both revenue and net income, while FY23 EPS estimates increased noticeably in 2Q23, adding 8% qoq. Earnings momentum still remains strong, and operating profit growth continues accelerating. Nonetheless, despite quite strong fundamentals so far, we expect that earnings momentum will start deteriorating in the near future. At least, EU banks reported that their access to retail and wholesale funding had deteriorated in 1Q23, while deposits growth decelerated significantly in recent months. So, credit impulse was quite weak in 2Q23 and deteriorating. Moreover, deposits dynamics continued worsening. Thus, total EU deposits increased just by 1.3% yoy in May 2023 vs +4.7% a year ago, while it was already negative in Spain and Italy. So, loans growth has decelerated noticeably either. In such conditions, deposit beta will inevitably go up. Taking into account that the hiking cycle is near its end, even despite the more hawkish ECB recently, and not very strong LT rates dynamics, we expect that NII growth will top in 2H23. So, we could see NII estimates downgrades in the near future, as it is already happening with NII estimates of US/UK peers. At least, it is expected currently that NII will remain roughly flat yoy in 2024. So, a NII tailwind could turn to a headwind as early as the next year, accompanied by ongoing costs growth because of still elevated inflation as well as higher provisions caused by weaker economic growth. Such a scenario does not imply any significant growth of banking quotes, especially taking into account outperformance of EU banks both yoy and ytd. On the other hand, we don’t expect substantial decline of EU banks either, given still quite low valuations and very high dividend yields. So, we remain neutral on EU banks at the current moment.