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  • Writer's pictureArbat Capital

EU Banking Sector Report - September 2023

EU banks underperformed the broad market in August 2023, for the first time over the last 5 months and just for the second time over the last 13 months. Also, SX7P index ended the month in the red for the first time over the last 3 months. It was just the third month of negative absolute performance over the last 11 months.


EU banks underperformed the broad market in August 2023, for the first time over the last 5 months and just for the second time over the last 13 months. Also, SX7P index ended the month in the red for the first time over the last 3 months. It was just the third month of negative absolute performance over the last 11 months. The index decreased by 4.0% MoM during the month vs -2.8% MoM of STOXX 600 index. Absolute August 2023 performance was -0.6 std from the mean monthly performance, and it was in the bottom 22% of absolute monthly performance in the index history. Relative August 2023 performance was -1.2% MoM. It is -0.3 std from the mean monthly performance, and it is in the bottom 35% of relative performance in the SX7P index history. So, EU banks outperformed the broad market by 14.2% over the last 12 months, but just by 4.0% ytd because of significant decline in March 2023. 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 14.4% lower than it was at the end of 2017, underperforming STOXX 600 index by 27.3% over this period. Despite strong 2Q23 results, higher economic projections and the more hawkish ECB, more than 70% of our sample of banks ended the month in the red. The key driver of the quotes remained 2Q23 earnings season. So, volatility of monthly price changes increased considerably in August. However, average difference of monthly price change between the best and the worst performers among our banks sample was 25.8% for the first 8 months of 2023 vs an average for 2022 year of 30.7%. However, correlation among EU banks between price change ytd and EPS FY24E change ytd decreased slightly, to 48% in August from 50% in July. Moreover, UBS become an even bigger outlier after its skyrocketing growth during the last month. Thus, it increased by 36.6% ytd while its FY24 EPS estimate was already revised down by 28.7% 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 9.2x (as of July 28, 2023) to 8.4x (as of September 1, 2023). In turn, median P/E 24E decreased from 9.1x (as of July 28, 2023) to 8.5x (as of September 1, 2023). Both ratios remain noticeably lower vs the end of 2022. So, banks are still trading at -2.1/-2.2 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 of September 1). As for relative to STOXX 600 Index, banks are currently trading at -1.8 std from the sample mean (2010-current moment) for P/E CY and -1.6 std for P/E NY. Moreover, the discount to US banks also remains much wider than on average, -2.2/-1.6 std for P/E CY/NY as of September 1. Median P/B of our group of banks increased from 0.68x (as of July 28, 2023) to 0.73x (as of September 1, 2023), 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 the nearest years are around 3x while UBS’s average figure is around 12x. 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.

Slightly better macro data published in July and August of 2023 continue to push GDP forecasts up. Estimates revision wasn’t significant, but projections still imply that the EU economy will manage to avoid a recession even despite quite weak dynamics in Germany, ongoing decline in manufacturing and higher risks of slowdown in China. Thus, EU GDP increased by 0.3% qoq, or +0.6% yoy, in 2Q23 vs the consensus of +0.2% qoq, or +1.5% yoy, and 1Q23 growth rate of 1.1% yoy, but 0% qoq (up from the previous estimate -0.1% qoq), while current forecasts imply further growth of +0.3% qoq in 3Q23 and +0.5% qoq in 4Q23. So, taking into account initial forecasts and realized risks, dynamics of the European economy was noticeably better than it had been expected. But it is too early to say that it is completely out of the woods given substantial growth of key rates and still quite high level of uncertainty. At least, we have already seen substantial deceleration of the loan growth and quite weak credit impulse in recent months because of ongoing monetary tightening. According to the recent ECB’s introductory statement, the near-term economic outlook for the euro area has deteriorated, while the economy is expected to remain weak in the short run. Moreover, inflation is still quite high, implying very high rates for longer. In turn, retail sales, consumer confidence and PMI indices missed again in August 2023. Thus, composite PMI decreased on MoM basis for the 4th consecutive month, and it remained below the threshold of 50 pts for the third month in a row.

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 and 30 out of 33 higher net income figures. In turn, revenue exceeded estimates for 28 out of 33 banks with available estimates in 2Q23. A median revenue surprise was +2.9%, markedly better than a median quarterly surprise over the last 10 years of +1.2%. So, earnings momentum still remains quite strong, and it even continues improving so far, but the speed of improving have decelerated recently, pointing to gradually fading momentum. Thus, median growth of operating profit of our group of banks was +45% yoy in 2Q23 vs +46% yoy in 1Q23 and -0.5% yoy in 2Q22. Median growth of revenue was +20.1% yoy in 2Q23 vs 21.9% yoy in 1Q23, the 10th quarter of positive yoy growth in a row. 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. Thus, total EU deposits (corporate + retail) increased just by 0.2% yoy in July 2023 vs +4.6% a year ago (the lowest figure in the history of EU), while it was already negative in all largest EU economies except for Germany. In turn, corporate loans increased by 1.3% yoy in July 2023, while consumer loans went up by 0.8% yoy vs 6.8% yoy and 4.8% yoy a year ago, respectively. Taking into account that the hiking cycle is near the end, even despite the more hawkish ECB until recently, we expect that NII growth will peak in 2H23. Moreover, we could even see NII estimates downgrades in the near future, as it is already happening with NII estimates of US/UK peers. At least, it is already expected that NII will be negative 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 positive GDP growth, quite low valuations and very high dividend yields. So, we remain neutral on EU banks at the current moment.

AC - EU Banking Sector Report - Sep-2023
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