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  • Writer's pictureArbat Capital

US Banking Sector Report - July 2024

US banks underperformed the broad market again in June 2024, for the second consecutive month. Moreover, it was the 11th time of underperformance over the last 17 months. Also, banks ended June in the red after a notable growth in May, but it was just the third time of decline over the last 8 months.



EXECUTIVE SUMMARY


US banks underperformed the broad market again in June 2024, for the second consecutive month. Moreover, it was the 11th time of underperformance over the last 17 months. Also, banks ended June in the red after a notable growth in May, but it was just the third time of decline over the last 8 months. Thus, BKX index decreased by 0.4% MoM in June vs +3.5% MoM of SPX index. Absolute June 2024 performance was -0.2 std from the mean monthly performance, and it was in the bottom 40% of absolute monthly performance in the index history. Relative June 2024 performance was -3.8% MoM. It was -0.7 std from the mean monthly performance, and it was in the bottom 16% of relative performance vs SPX index since the inception of BKX index. June was the worst month on a relative basis over the last 4 months. So, BKX index has been continuing to underperform the broad market ytd, -4.9% ytd or -0.2 std. If the situation doesn’t change in 2H24, this year will be the third consecutive year of underperformance of BKX index. So, around 70% banks from our sample ended June in the red but the decline was insignificant for majority of them. In turn, RF and TFC were the best performers in June, but both of them increased just around 3% MoM. Given the more hawkish Fed at the June meeting, regional banks were key underperformers again. A difference of monthly price changes between the best and the worst performers of our sample of banks was just 8.9% in June vs 30.4% in May. June was the least volatile month for US banks over the last 70 months. In turn, 1Q24 was the most volatile start of the year since GFC. Nonetheless, correlation between price changes yoy and EPS FY24E changes yoy increased slightly MoM in June, still remaining relatively high, staying at 67% as of the end of the month.

US banks continue trading with a significant discount both to historical averages and to S&P 500 Index, given quite weak performance of US financial institutions on absolute and relative bases in two recent years, even despite a noticeable decline of profit and revenue estimates. However, the discount was roughly flat but volatile in the first half of 2024. Thus, median P/E 24E of our group of banks increased from 10.8x (as of May 31, 2024) to 10.9x (as of June 28, 2024). In turn, median P/E 25E went down from 9.5x to 9.4x for the same period of time. Hence, banks are still trading at -0.8/-0.6 std on P/E CY and at -1.2/-0.9 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 28, 2024). As for relative to S&P 500, banks are currently trading at -1.3 std and -1.4 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 was roughly flat in 2Q24, hovering around 1.17x. So, the ratio increased just by 0.002x MoM in June comparing to 1.197x as of May 31, 2024. Thus, on P/B, banks are trading at just -0.1 std from the sample mean (2010-current moment) vs +2.1 std as for SPX index, despite current adj. ROE premiums to historical averages are roughly the same for both BKX and SPX indexes. As for individual names, multipliers are still quite different. But dispersion across banks remained roughly flat ytd, still remaining lower than a year ago. Nonetheless, WAL’s P/E estimates for the nearest years are around 5-8x while NTRS’s ratios are 11-12x at the moment.

The cost of inflation fight is gradually increasing. Indeed, after revision, 1Q24 GDP growth rate was notably lower than even the initial estimate, which had missed expectations considerably. Moreover, if, at first, the headline miss was mainly driven by inventories and trade while the key driver of GDP growth – consumer spending growth – remained quite strong, then after the revision consumer spending growth was revised from 2.5% to just 2.0%, raising questions regarding sustainability of the US economic growth to higher for longer interest rates, especially in case of further cooling of the labor market, which continued sending mixed signals in June. So, despite both hard and soft data ytd imply that the economic growth still remains solid and even higher than expected, at least so far, the most recent data points to growing imbalances in the US economy, from our point of view. Unsurprisingly, FOMC economic projections revealed at the June meeting were slightly weaker vs the March forecasts. Nonetheless, the Fed continues to worry primarily about inflation risks, reiterating again at the June meeting that there was no rush for the Fed to start the cutting cycle as soon as possible. So, the June dot plot implies only one rate cut in 2024 vs 3 expected cuts in March. Nonetheless, chair Powell assured that the Fed would respond to more than expected weakening on the labor market. In turn, despite the decline in June, federal funds (FF) rate expectations still remain significantly higher on both ytd and yoy bases, implying around two rate cuts in 2024 while it is also expected that the FF rate will remain near 4.0% at least till the end of 2026 while the yield curve will remain roughly flat even in two years.

The 2Q24 earnings season should answer the question whether improving momentum of banking fundamentals remains intact. The 2Q24 earnings season will be kicked off by the reports of largest US banks – JPM, C, WFC – on July 12, 2024. We still believe that US banks are near the inflection point with ongoing improvement of the second derivatives of majority fundamentals albeit still remaining negative. Moreover, despite underlying results were better than expected again in 1Q24, EPS/revenue estimates didn’t improve significantly in 2Q24 while banking outlooks in recent weeks were less optimistic than they were during the 1Q24 earnings season. In particular, it was noted that loan growth was a bit lighter than expected, and NIBD outflows were slightly higher than projected. So, taking into account the scenario of high interest rates that has become almost a reality as well as still inverted both current and forward yield curves, NII outlooks were also more pessimistic recently. According to the Fed H8 data, total loans increased just by 2.5% yoy (as of June 12, 2024) vs 2.4% yoy at the end of 1Q24 and +2.2% yoy at the end of 2023. In turn, deposits (ex. large-time) decreased by 1.3% yoy, but were flat MoM. Nonetheless, FY24/25 NIM estimates increased slightly in 2Q24, even despite relatively weak NIM figures in 1Q24. Moreover, less optimistic banking outlooks doesn’t mean the cancellation of the fact that majority banks from our sample either have already reached NIM’s trough of the current cycle or will do it in the near future. Even more so, the main drivers of better revenue and EPS figures in 1Q24 were higher fee income and lower provisions. And we expect that both drivers remain relatively strong in 2H24, partially offsetting a negative impact of weaker than expected (but not weak at all) NII/NIM dynamics. Despite reported OpEx missed expectations significantly in 1Q24, it was driven mainly by one-timers. So, US banks will probably manage to return to positive operating leverage as early as in 2H24. In turn, credit quality remains strong and much better than feared albeit still deteriorating but at slower pace in recent weeks. Hence, allowance for loans and lease of domestically charted US banks decreased by 0.6% MoM, just +7.4% yoy (as of June 12, 2024).

Mid-term earnings visibility of US banks continues improving, but it is still a bumpy road ahead, at least in the near quarters. We expect that FY EPS of US banks will return to growth in 2025 after 3 straight years of negative dynamics. So, improved EPS growth implies gradual re-rating of US banks, which continue trading at a large discount to SPX index. Given still high and growing interest rates, US banks may remain volatile in the near future, but we believe that the banks will end 2024 year in the green, at least on a relative basis. So, we remain bullish on the sector but recognize elevated risks.


AC - US Banking Sector Report - Jul-2024
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