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  • Writer's pictureArbat Capital

US Banking Sector Report - August 2023

US banks outperformed the broad market significantly in July 2023, for the first time over the last half year. Moreover, it was just the second month of outperformance over the last three quarters.


EXECUTIVE SUMMARY


US banks outperformed the broad market significantly in July 2023, for the first time over the last half year. Moreover, it was just the second month of outperformance over the last three quarters. On the other hand, BKX index ended the month in the green for the second consecutive time after 4 months of negative dynamics in a row. The index soared by 11.4% MoM in July vs +3.1% MoM of SPX index. Absolute July 2023 performance was +1.5 std from the mean monthly performance, and it was in the top 6% of absolute monthly performance in the index history. Relative July 2023 performance was +8.0% MoM. It is +1.6 std from the mean monthly performance, and it is in the top 5% of relative performance vs SPX index since the inception of BKX index. Nonetheless, despite quite weak performance in the first half of the year, absolute performance in the first seven months of 2023 was modestly better than 1 year ago, but in both years BKX index lost more than 10% ytd. US banks remain quite volatile, especially regional peers, which were more affected by the bank run in March and April. Thus, Western Alliance and Zions Bancorp were the best performers in July, having added more than 42% MoM. In turn, these banks were among the key underperformers as the end of June, having decreased by more than 38% ytd. Average difference of monthly price change between the best and the worst performers of our sample of banks for the first 7 months of 2023 was 26.2% vs average for 2022 year of 15.8%. However, correlation among BKX index members between price change ytd and EPS FY24E change ytd increased significantly in July, driven by noticeable outperformance of regional banks after 2Q23 earnings season.

US banks continue trading with a significant discount both to historical averages and to S&P 500 Index, given significant underperformance of US financial institutions both on absolute and relative basis ytd as well as relative resilience of profit estimates. But the discount decreased noticeably in recent months. Thus, median P/E 23E of our group of banks increased from 8.6x (as of June 30, 2023) to 9.4x (as of July 28). In turn, median P/E 24E went up from 8.1x to 9.1x for the same period of time. Nonetheless, banks are trading at -1.9/-1.8 std on P/E CY and at -1.5/-1.2 std on P/E NY (on the basis of samples from 2000 and 2010 years to the current moment) relative to historical averages (as of July 28, 2023). As for relative to S&P 500, banks are currently trading at - 1.8 std and -1.6 std from the sample mean (2010-current moment) for P/E CY and P/E NY, respectively. Median P/B of our group of banks increased from 1.06x (as of June 30, 2023) to 1.14x (as of July 28), still remaining noticeably below historical average. On P/B, banks are trading with a discount of -0.2 std from the sample mean (2010-current moment) vs SPX with +1.7 std, despite current ROE premium to historical averages are roughly the same for both BKX and SPX indexes. As for individual names, multipliers are still quite different, and dispersion across banks has increased noticeably ytd, which is not surprising given the recent regional banking crisis. Thus, WAL’s P/E estimates for the nearest two years are around 6-7x while CFR’s figures are higher than 11x.

US economy remains quite resilient even despite skyrocketing rates growth, which have already reached multi-decade highs. Thus, real GDP increased by 2.4% qoq on annualized basis in 2Q23 vs consensus estimate of 1.8% and 1Q23 growth of 2%. Labor market remains quite tight but there were more and more signs of gradual softening of the labor market in recent months. Thus, payrolls increased by 209K in June vs the consensus of 230K (and the revised down May figure of 306K). It was the first headline miss over more than year. So, average monthly figure of 1H23 of 278K is still much higher than average figure of the 2010-2019 years. Inflation also continues decelerating slightly faster than it was expected a few months ago. Despite higher LT inflation expectations component of Michigan sentiment index, both CPI and PPI prints were a bit lower than expected in June. To be fair, not all macro indicators were strong recently, especially in manufacturing. Nonetheless, economic sentiment improved significantly in 2Q23, and more and more market participants think at the moment that a recession can be avoided. At first sight, soft landing scenario should be more favourable for banks than the recession one, due better asset quality and higher loan growth. On the other hand, it means that inflation will keep higher that the Fed’s target for the nearest years. So, the key rates will remain higher for longer with the FF rate above 3% at least for the next 3 years and flat yield curve, implying quite challenging revenue environment for US banks.

US banks reported quite mixed 2Q23 earnings. On the one hand, it confirmed that the US regional banking crisis wasn’t as disruptive for the industry as it had initially been sought – deposit balances stabilized in the second half of the quarter with the higher than expected deposit volumes for 18 out of 24 BKX index members as the end of 2Q23. Moreover, EPS surprises were relatively strong with higher figures for 16 out of 24 BKX index members. Revenue was also better than expected for 15 BKX index members, driven by fee income. A little earlier, stress test results confirm that US banks remain strong and resilient even under severe recession scenarios. On the other hand, the key driver of strong results over the last year - NIM - was quite weak with positive surprises only for 6 banks while loan growth continued deteriorating relatively fast as well as credit quality was still on a normalization path with clear deterioration in office CRE, credit cards and auto. So, revenue environment remains challenging, even despite high rates juncture which has already turned from a tailwind into a headwind as a result of faster deposits repricing and ongoing NIBD outflows, which accelerated in 2Q23. Recession risks decreased recently but remained relatively high, implying that fundamentals would continue deteriorating in the coming quarters albeit from quite strong level. Unsurprisingly, EPS/revenue estimates for FY23/24 years continue going down, having accelerated after 2Q23 earnings season. Thus, median declines of EPS FY23/24E of our sample of banks were 15.9%/21.2% ytd, respectively (as of July 31, 2023).

We still tend to agree with the opinion that there are almost no positive drivers for US banking quotes left except for valuations, at the moment. But despite expected further deterioration of fundamentals, we are now more positive in the aspect vs 1 quarter ago as the second derivative for the most important banking drivers such as NIM/NII should turn positive in the nearest future, from our point of view. So, we continue to believe that the trough of banking quotes for the current cycle was already been seen in early May. On the other hand, BKX index increased by 25% since then as a result of ST rally driven by 2Q23 earnings season as we had expected. Given negative EPS/revenue estimates dynamics and recent rally, we expect that banking quotes will remain quite volatile in the near term with limited upside until more favourable revenue environment.

So, we are again Neutral on the sector but recommend to buy the dips.


AC - US Banking Sector Report - August -2023
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