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  • Writer's pictureArbat Capital

US Banking Sector Report - July 2023

US banks underperformed the broad market again in June 2023, for the 7th time over the last 8 months. On the other hand, BKX ended the month in the green for the first time over the last 5 months.


EXECUTIVE SUMMARY


US banks underperformed the broad market again in June 2023, for the 7th time over the last 8 months. On the other hand, BKX ended the month in the green for the first time over the last 5 months. The index decreased by 5.3% MoM in June vs +6.5% MoM of SPX index. Absolute June 2023 performance was +0.7 std from the mean monthly performance, and it was in the top 22% of absolute monthly performance in the index history. Relative June 2023 performance was -1.1% MoM. It is -0.2 std from the mean monthly performance, and it is in the bottom 41% of relative performance vs SPX index since the inception of BKX index. Nonetheless, despite quite weak performance in the first half of last year, absolute performance in the first half of 2023 was slightly better than a year ago, but in both years BKX index lost more than 20% in the first half of a year. US banks remain quite volatile, especially regional peers, which were more affected by the bank run. Thus, Comerica was the best performer in June, having added 17.3% MoM, although it was among the key underperformers in May, having decreased by 16.8% MoM. Average difference of monthly price change between the best and the worst performers among BKX index members was 23.3% for the first half of 2023 vs an average for 2022 year of 15.8%. However, correlation among BKX index members between price change ytd and EPS FY24E change ytd decreased significantly in June as a result of estimates decline.

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 bases ytd as well as relative resilience of profit estimates. Thus, median P/E 23E of our group of banks increased from 7.95x (as of May 26, 2023) to 8.6x (as of June 30, 2023). In turn, median P/E 24E went up from 7.59x to 8.1x for the same period of time. Nonetheless, banks are trading at -2.4/-2.2 std on P/E CY and at -2.2/-1.8 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 June 30, 2023). As for relative to S&P 500, banks are currently trading at -2.0 std and -1.9 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 1.02x (as of May 26, 2023) to 1.06x (as of June 30, 2023), still remaining noticeably below historical average. On P/B, banks are trading with a discount of -0.6 std from the sample mean (2010-current moment) vs SPX with +1.6 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 4x while CFR’s figures are higher than 11x.

Fed’s stress test results confirmed that US banks remain strong and resilient even under severe recession scenarios.We expect that 2Q23 earnings season, which will start on July 14, when 1Q23 results are provided by JP Morgan, Wells Fargo and Citigroup, will allow investors to establish themselves in the thought that the recent regional banking crisis passed without very disruptive consequences for the industry. At least, according to the Fed, all 23 banks tested remained above their minimum capital requirements during the hypothetical recession, despite total projected losses of $541 Bn. Under stress, aggregate capital ratio is expected to decline by 2.3% to a minimum of 10.1% vs 2.7% decline of 2022 capital exam. It should be noted that stress test implied 40% decline in CRE prices, 38% decline in house prices as well as growth of unemployment ratio of 6.4 p.p. to a peak of 10%. Recall that June FOMC projections imply that unemployment ratio will increase to just 4.5% in 2024 and 2025 years from the most recent print of 3.7%. And in general, it is worth noting that the recent macro data only confirm that the economy remains noticeably stronger than it could have been, taking into account all the risks realized over the past 12 months. Moreover, a recession does not look so inevitable at the moment. At least, FOMC economic projections for 2023 year were revised up noticeably at the June meeting vs the March one. However, in all fairness, it just means that banking fundamentals will deteriorate not so rapidly as it could be. Thus, loan growth still remains strong but deteriorating, having added 6.6% yoy as of June 14, 2023. Credit quality indicators are still noticeably lower than historical averages, and it will not be any threat from expected credit quality deterioration for the bottom line under current economic scenarios. On the other hand, due to better dynamics of the US economy, the Fed remains quite hawkish, which in turn suggests worse NII/NIM pattern, especially taking into account slope of the both current and forward yield curves. Unsurprisingly, EPS estimates for FY23/24 years continue going down, having accelerated the decline in 2Q23. We tend to agree with the opinion that there are almost no positive drivers for US banking quotes left except for valuations, at least at the moment. But the latter is very important, from our point of view, especially in the conditions of not realizing the scenario of a deep recession, and the fact that BKX index has already halved from its 2022 high. Taking into account that ripple effects of the March 2023 banking turmoil still continue to spread even despite the acute phase of the crisis is already over, we expect that banking quotes will remain volatile in the near term. And although in the current conditions we find few reasons for a long-term rally, we believe than banking quotes have already groped the ground, and 2Q23 results could be a trigger for a short-term rally, taking into account a limited impact of the banking crisis on the sector fundamentals and very positive banking quotes reaction on the stress test results.


AC - US Banking Sector Report - Jul-2023
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