EU banks underperformed the broad market notably in June, for the first time over the last 5 months. However, it was just the 6th time of underperformance over the last 23 months. Also, EU banking index (SX7P) ended the month in the red, for the first time over the last 8 months.
EXECUTIVE SUMMARY
EU banks underperformed the broad market notably in June, for the first time over the last 5 months. However, it was just the 6th time of underperformance over the last 23 months. Also, EU banking index (SX7P) ended the month in the red, for the first time over the last 8 months. The index decreased by 4.4% MoM in June vs +1.3% MoM of the broad market (STOXX 600 index). Absolute June 2024 performance was -0.6 std from the mean monthly performance, and it was in the bottom 20% of absolute monthly performance in the index history. Relative June 2024 performance was -3.1% MoM. It equated to -0.9 std from the mean monthly performance, and it was in the bottom 16% of relative performance in the SX7P index history. So, EU banks outperformed the broad market by 31.4% over the last 23 months, but just by 3.3% since February 2022 because of their significant drop in March 2023. Despite stronger dynamics over the last two years, SX7P index underperformed the broad market significantly in each of 2018-2020 years. Nonetheless, as of the end of June, it was already 5.7% higher than it was at the end of 2017, but still underperforming STOXX 600 index by 22% over this period. Given still relatively weak economic projections, a start of the rate cut cycle, roughly flat EPS estimates ytd as well as growth of political uncertainty in France, around 80% banks from our sample ended the month in the red, but the majority of them still remained positive on ytd basis as of the end of 1H24. The worst performers of the month were French banks. Thus, each of GLE FP, ACA FP and BNP FP decreased by more 10% MoM in June. Nonetheless, variability of monthly price changes decreased again in June, for the third consecutive month, even despite growth of political uncertainty. Thus, a difference of monthly price changes between the best and the worst performers was 24.9% in June vs 27.9% in May, 34.7% in 1Q24 and 34.6% in 4Q23. However, correlation among EU banks between price changes ytd and EPS FY24E changes ytd decreased slightly again in June, for the second consecutive month after a growth in April. UBS still remains the biggest outlier especially after significant growth of its quotes in May.
Despite a noticeable outperformance in recent years, 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. Nonetheless, median P/E 24E of our group of banks decreased from 7.7x (as of May 31, 2024) to 7.0x (as of June 28). In turn, median P/E 25E went down from 7.3x (as of May 31, 2024) to 7.1x (as of June 28). But both ratios are still not very far from levels of the end of 2022. Nonetheless, banks are still trading at -1.47/-1.46 std on P/E CY and at -0.94/-0.91 std on P/E NY (on the basis of samples from 2006 and 2010 years) relative to historical averages. As for performance relative to STOXX 600 index, EU banks are currently trading at -1.43 std from the sample mean (2010-current moment) for P/E CY and -1.11 std for P/E NY. Moreover, the discount to US banks also remains much wider than on average, staying at -1.5/-0.9 std for P/E CY/NY as of June 28. Median P/B of our group of banks also decreased slightly during the last month, falling from 0.87x as of May 31, 2024 to 0.84x as of June 28. 2H23-1Q24 ROE were the highest figures since the pre-GFC era, and it would remain quite high vs average ROE of post-GFC in the nearest years, albeit a few percent below current levels. As for individual names, multipliers are still quite different, but dispersion across banks has decreased recently. However, RBI’s P/E estimates for the nearest years remains just around 3x at the moment while UBS’s ratios are varying from 22x for 2024 year to 8.6x for 2026 year comparing to industry’s average ratio for the next three years of 7.1x.
Growth of the EU economy continues accelerating even despite weaker than expected hard data in June. Moreover, the momentum should improve further, taking into account the first rate cut by ECB at the June meeting. Nonetheless, it doesn’t mean that the easing cycle will be any fast one. Although inflation continues moving in the right direction, the wording about inflation in the June statement was more cautious than in the April one. Moreover, according to ECB’s projections revealed in June, inflation forecasts for 2024 and 2025 years were revised up by 20 bps vs March projections. So, despite the permanent declaration of a data-dependent and meeting-by-meeting approach over the past 1-1.5 years, it seems that the rate cut in June was at least partially dictated by expectations, not hard data. Given the fact that late monetary easing doesn’t look costless, even taking into account remarkable resilience of the EU economy to elevated interest rates so far, a rate cut on expectations doesn’t look completely illogical. On the other hand, it reduces the transparency of a potential rate path for market participants to a certain extent. According to the current market expectations, we will see less than three rate cuts with total cut of around 75 bps in 2024 (less than two more till the end of the year) vs expectations of almost 7 rate cuts with total cut of around 170 bps in the beginning of 2024. Anyway, estimated recession probability continues decreasing relatively fast, falling to only 20% in June, the lowest figure over more than 2.5 years. Nonetheless, EU macro data published in June were worse than expected, especially PMI figures, unequivocally confirming the validity of the ECB's downside concerns.
Fundamentals of EU banks remain strong, and the 2Q24 earnings season should confirm it. The key event for EU banks in the next 2 months will be the 2Q24 earnings season which will be kicked off by quarterly report of DNB NO on July 11, 2024. Given recent growth of political uncertainty as well as the first rate cut by ECB in June, it seems that outlooks will be more important for investors than quarterly earnings by themselves. At least, both events simply couldn’t have any significant impact on the banking fundamentals yet. So, given steady acceleration of the EU economy, operating results of EU banks will remain quite strong but the momentum will continue deteriorating gradually. We expect the 14th consecutive quarter of positive revenue growth on a yoy basis, albeit days of a double-digit growth have been already behind us. NII will be the key driver of revenue growth deceleration, especially after the start of the rate cut cycle. It already returned to a single digit growth rate in 1Q24, for the first time in two years. On the other hand, lower doesn’t mean weak. Despite a still inverted yield curve as well as a small decline of interest rate expectations in June, NII perspectives improved recently, from our point of view. Yes, NII isn’t a tailwind any more, but it will not also be a headwind, what the investors has been so afraid of until recently. The current baseline scenario is that it will remain flat/slightly positive in the nearest years. Moreover, loan growth stopped decelerating in 2Q24, fee income dynamics continued gradually improving while asset quality was still quite strong albeit deteriorating. In other words, earnings visibility of EU banks is still uncertain but improving. At least, fundamental estimates upgraded slightly in 2Q24 after relatively weak dynamics in 1Q24. So, ROE of EU banks will remain double-digit, not very far from a multi-decade high, and it, among other things, will allow EU banks to continue maintaining a very high capital returns (double-digit yields for the majority of EU banks in the upcoming years). We expect that EPS will continue going up, albeit at much slower rate than in 2023. So, positive EPS growth, still attractive valuations as well as quite high capital returns provide a solid downside protection for EU banks, from our point of view. Further acceleration of economic recovery, especially in case of ongoing resilience to high interest rates, could act as a catalyst for re-rating of the sector. So, we still remain neutral on EU banks but gradually becoming more optimistic.
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