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  • Writer's pictureArbat Capital

EU Banking Sector Report - October 2023

EU banks outperformed the broad market again in September 2023, for the 12th time over the last 14 months. Also, SX7P index ended the month in the green for the third time over the last 4 months. So, it was the 9th month of positive absolute performance over the last year.


EXECUTIVE SUMMARY


EU banks outperformed the broad market again in September 2023, for the 12th time over the last 14 months. Also, SX7P index ended the month in the green for the third time over the last 4 months. So, it was the 9th month of positive absolute performance over the last year. The index increased by 2.6% MoM in September vs -1.7% MoM of STOXX 600 index. Absolute September 2023 performance was +0.3 std from the mean monthly performance, and it was in the top 22% of absolute monthly performance in the index history. Relative September 2023 performance was +4.4% MoM. It is +1.2 std from the mean monthly performance, and it is in the top 9% of relative performance in the SX7P index history. So, EU banks outperformed the broad market by 23.9% over the last 14 months, but just by 8.6% ytd 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 12.2% lower than it was at the end of 2017, underperforming STOXX 600 index by 24.1% over this period. Despite weaker economic projections and the slightly more dovish ECB, more than 70% of our sample of banks ended the month in the green. The key driver of the quotes remains growth of EPS estimates, which, however, is gradually slowing down. Nonetheless, volatility of monthly price changes decreased noticeably in September. So, an average difference of monthly price changes between the best and the worst performers among our banks sample was 25.5% for the first nine months of 2023 vs an average for 2022 year of 30.7%. However, correlation among EU banks between price changes ytd and EPS FY24E changes ytd increased slightly, to 58% in September from 50% in August. Despite MoM decline in September, UBS remains the biggest outlier after its skyrocketing growth in August. Thus, it increased by 31.9% ytd while its FY24 EPS estimate was already revised down by 30.7% ytd.

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 decreased from 6.2x (as of September 1, 2023) to 6.1x (as of October 5). In turn, median P/E 24E decreased from 6.2x (as of September 1, 2023) to 6.1x (as of October 5). Both ratios remain noticeably lower vs the end of 2022. So, banks are still trading at -2.1/-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 to the current moment) relative to historical averages. As for relative to STOXX 600 Index, banks are currently trading at -1.4 std from the sample mean (2010-current moment) for P/E CY and -1.3 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 October 5. Median P/B of our group of banks increased from 0.73x (as of September 1, 2023) to 0.74x (as of October 5), roughly in line with historical averages despite significant growth of ROE in the recent quarters. 2Q23 ROE was the highest one since the pre-GFC era, 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 forthcoming years are around 3x while UBS’s average figure is around 13x. Given high RBI's exposure to Russia and the fact that the 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.

EU economic activity was relatively weak in 3Q23, and it would remain subdued at least in the nearest months. EU macro data published in September 2023 were soft with worse than expected industrial production, retail sales, consumer confidence and lower final 2Q23 GDP figures, but better services PMI and inflation. So, ECB’s staff GDP growth forecasts for the next 3 years were revised noticeably down in September to 0.7%/1.0%/1.5% yoy for 2023/24/25 years, respectively (from 0.9%/1.5%/1.6% yoy in June). Nonetheless, given the acute energy crisis that broke out last winter, the European economy dynamics was noticeably better than it had been expected for 4Q22 and 1Q23. But it is too early to say that it is completely out of the woods given substantial growth of key rates, still quite high uncertainty and weak PMIs dynamics in recent months. At least, “the services sector, which had so far been resilient, is now also weakening” while corporate loan growth has already turned negative on a yoy basis. Moreover, Europe's largest economy, the German one, is still in recession, and it is expected that Germany’s GDP growth will remain negative in both 3Q and 4Q of 2023. Unsurprisingly, the ECB still believes that risks to economic growth are tilted to the downside – “growth could be slower if the effects of monetary policy are more forceful than expected, or if the world economy weakens, for instance owing to a further slowdown in China”. The good news is that inflation is moving to the south. So, the ECB ended the hiking cycle, at least for the near term, but the rates would remain higher for longer with negative lag effects of very fast monetary tightening on the EU economy, e. g. further deterioration of credit impulse.

ROE of EU banks reached the highest level since the GFC due to skyrocketing rates growth during the last year, returning again to the double-digit territory in 1H23. NII and NIM remain the key drivers of quite strong fundamentals dynamics. Thus, European banks reported markedly better results again in 2Q23 with positive surprises on both revenue and net income. Thus, 28 out of 33 banks from our group of banks for which consensus estimates were available reported better EPS figures, while revenue exceeded estimates for 28 out of 33 banks in 2Q23. A median revenue surprise was +2.9%, markedly better than a median quarterly surprise over the last 10 years of +1.2%. Moreover, earnings momentum still remains quite strong, and it even continues improving so far, but the rate of its growth has decelerated. Thus, median growth of operating profit of our group of banks was +43% yoy in 2Q23 vs +47% yoy in 1Q23. Median growth of revenue was +20% yoy in 2Q23 vs 21.1% yoy in 1Q23. So, we expect that 3Q23 earnings season of EU banks, which will start in the second decade of October, will confirm the emerging trend and the results will remain quite strong with high ROE/ROA, but momentum will continue fading. At least, the hiking cycle has already ended, and the yield curve is still inverted, implying limited growth of asset yields in coming years, while cost of funding will continue going up due to inevitable growth of deposit beta, which has been at an extremely low level until now. It is no wonder, EU banks reported that their access to retail and wholesale funding had deteriorated in 1H23 while both deposit and loan growth decelerated significantly in recent months. So, credit impulse was quite weak in 2Q23, and it continues deteriorating in 3Q23. Thus, total EU deposits decreased by 0.2% yoy in August vs +4.6% a year ago, and growth was negative in all major EU economies except for Germany. Corporate loans decreased by 0.3% yoy in August while consumer loans went up just by 0.6% yoy. So, we expect that NII growth will peak in 2H23, and NII will remain roughly flat in the next two years. Hence, EPS growth will be also weak. Such a scenario doesn’t imply any significant growth of banking quotes. On the other hand, we don’t expect substantial decline of EU banks either, given still positive GDP growth, quite low valuations and high capital returns. So, we remain neutral on EU banks at the current moment.


AC - EU Banking Sector Report - Oct-2023
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