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  • Writer's pictureArbat Capital

US Banking Sector Report - December 2023

US banks outperformed the broad market significantly in November 2023, after noticeable underperformance in October. But it was just the 4th month of outperformance since the start of the year. Banks ended the month in the green for the first time over the last 4 months.


EXECUTIVE SUMMARY


US banks outperformed the broad market significantly in November 2023, after noticeable underperformance in October. But it was just the 4th month of outperformance since the start of the year. Banks ended the month in the green for the first time over the last 4 months. Thus, BKX index soared by 14.9% MoM in November vs +8.9% MoM of SPX index. Absolute November 2023 performance was +2.0 std from the mean monthly performance, and it was in the top 3% of absolute monthly performance in the index history. Relative November 2023 performance was +5.5% MoM. It is +1.1 std from the mean monthly performance, and it is in the top 9% of relative performance vs SPX index since the inception of BKX index. But given quite weak performance in the first half of the year, absolute performance in the first 11 months of 2023 was almost as bad as during the previous year with BKX index losing more than 15% ytd as of the end of November. Western Alliance, KeyCorp and Fifth Third Bancorp were among the best performers in November, having increased by more than 21% on MoM basis, driven by significant decline of rate expectations. Volatility remained quite high so far, and it even increased in November despite substantial growth of US banks and an impact of the earnings season in October. Thus, a difference of monthly price changes between the best and the worst performers of our sample of banks was 25.4% in November, the highest figure over the last 4 months. So, an average difference for the first 11 months of 2023 was 27.9% vs an average for 2022 year of 19.9%. However, correlation between price changes ytd and EPS FY24E changes ytd among BKX index members were roughly unchanged during the last two months after its small increase in September.

US banks continue trading with a significant discount both to historical averages and to S&P 500 Index, given still quite weak performance of US financial institutions on absolute and relative basis ytd, even despite noticeable decline of profit and revenue estimates. However, the discount narrowed notably in November. Thus, median P/E 23E of our group of banks increased from 7.6x (as of October 31, 2023) to 8.6x (as of November 30). In turn, median P/E 24E went up from 7.8x to 9.1x for the same period of time. Nonetheless, banks are still trading at -2.1/-2.0 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 November 30, 2023). As for relative to S&P 500, banks are currently trading at -1.9 std and -1.5 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 0.91x (as of October 31, 2023) to 1.04x (as of November 30), still remaining noticeably below historical averages. On P/B, banks are trading with a noticeable discount, -0.8 std from the sample mean (2010-current moment) vs SPX with +1.5 std, despite the 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 regional banking crisis impact. In turn, dispersion decreased somewhat in recent months. Thus, WAL’s P/E estimates for the next years are around 6-7x while NTRS’s figures are around 12-13x.

US macro indicators revealed in November 2023 weren’t strong, but GDP growth forecasts continued going up. So, despite noticeable deceleration of economic activity after quite strong 3Q23, US GDP growth will remain positive in the coming quarters. According to the Fed’s September projections, the ‘soft landing’ remains the baseline scenario, at least at the moment, even despite a number of indicators still pointing to a recession. Moreover, the dovish Fed’s meeting in November accompanied by lower inflation data allows us to hope that rates will not be so high for longer as it has been implied more recently. So, rate expectations for the following years moved significantly down in November, implying possible easing of the funding pressure on NII/NIM as well as lower unrealized losses on HTM/AFS. Nonetheless, it is too early to say that the US economy has already been out of the woods and a battle against high inflation has already been over, from our point of view. Even the Fed continues to adhere to the data-dependent paradigm, emphasizing at each meeting that risks are tilted to the downside and that inflation still remains unacceptably high. Moreover, payrolls missed estimates in October, for the first time over the last three months. Of course, the overall employment situation still remains quite strong and the miss was small. Nonetheless, there are more and more signs of gradual softening of the labor market in recent months while consumer spending growth, whose strength was the key reason of the resilience of the US economy ytd, continues going down.

November brought additional positive for mid-term dynamics of banking fundamentals after better 3Q23 results in October. Nonetheless, it doesn’t mean that the worst is completely over, especially in case of weaker than expected economic growth. Moreover, revenue environment will remain challenging in the nearest quarters. Also, 4Q23 EPS will decline significantly on a qoq basis for majority banks from our sample because of the FDIC special assessment to recover the loss to the Deposit Insurance Fund (DIF) after the failures of Silicon Valley Bank and Signature Bank, which could hurt 4Q23 net income approximately by a third. The FDIC estimates that the cost of these failures for DIF is currently around $16.3 Bn. But even before this news, estimates continued going down qtd but at notably lower rate. Despite the dovish Fed meeting in November as well as lower than expected CPI/PPI figures and higher probability of ‘soft landing’, NIM will keep going down in the nearest future, loan growth will inevitably decelerate further while credit quality will go on deteriorating. Nonetheless, mid-term earnings visibility has improved meaningfully in recent quarters, from our point of view, and we expect that estimates will turn more positive in the coming months, unless there is no noticeable deterioration of GDP growth projections. Moreover, current fundamentals do not look any weak so far even after some deterioration in recent quarters, remaining even slightly better than the averages for the previous cycle. Thus, median ROE of our group of banks is still double-digit while ROA remains higher than 1%. So, estimates decline decelerated recently but remained substantial as a median decline of 4Q23 revenue estimates of our sample of banks was -7.2% ytd (as of November 30, 2023) while median declines of EPS FY23/24E were 14%/23.2% ytd, respectively.

Short-term perspectives of US banks still look challenging but risks have already decreased noticeably. Despite investors remain cautious, and they still expect that banks will continue underperforming, a notable decline of rate expectations in November caused rally in banks. The key open question is whether it was a “dead cat bounce” or the beginning of US banks rebound after significant underperformance during the last two years. On the one hand, the rule of thumb implies that banks aren’t the best investment opportunity in case of recession. On the other hand, a mild recession is already more than priced in quotes, from our point of view, while its probability continues going down. We believe that banking quotes bottom of the cycle has already fallen behind and that that estimates downward cycle is near the end. Hence, we still remain cautiously optimistic on the sector and expect further outperformance of US banks in the next year.


AC - US Banking Sector Report - Dec-2023
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