US banks underperformed the broad market slightly in May 2024, for the first time over the last three months. Moreover, it was the 10th month of underperformance over the last 16 months. However, banks ended May in the green after a small decline in April, and it was the third time of growth over the last 4 months.
EXECUTIVE SUMMARY
US banks underperformed the broad market slightly in May 2024, for the first time over the last three months. Moreover, it was the 10th month of underperformance over the last 16 months. However, banks ended May in the green after a small decline in April, and it was the third time of growth over the last 4 months. Thus, BKX index increased by 3.7% MoM in May vs +4.8% MoM of SPX index. Absolute May 2024 performance was +0.4 std from the mean monthly performance, and it was in the top 33% of absolute monthly performance in the index history. Relative May 2024 performance was -1.0% MoM. It is -0.2 std from the mean monthly performance, and it is in the bottom 43% of relative performance vs SPX index since the inception of BKX index. Nonetheless, banks remained quite volatile ytd as a result of skyrocketing growth of interest rates as well as an impact of the recent earnings seasons. So, more than 80% of our sample managed to end the month in the green due to relatively strong 1Q24 results and more optimistic outlooks. Thus, NYCB and WAL were the best performers in May, but the first one remained the key underperformer both on yoy and ytd bases. Moreover, the key underperformers were regional banks again, including thanks to renewed CRE fears after Citi cut OZK to sell because of supposed problems with life science CRE loans. Hence, OZK decreased by 6.3% MoM in May. The difference of monthly price changes between the best and the worst performers of our sample of banks was just 20% in April while it increased to 30.4% in May vs an average figure of the first 5 months of the year of 36.3%. But 1Q24 was the most volatile start of the year since GFC. In turn, correlation between price changes yoy and EPS FY24E changes yoy decreased markedly MoM in May.
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 continued narrowing gradually. Thus, median P/E 24E of our group of banks increased from 10.6x (as of May 3, 2024) to 10.8x (as of May 31, 2024). In turn, median P/E 25E went up from 9.46x to 9.53x for the same period of time. Hence, banks are still trading at -0.9/-0.7 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 May 31, 2024). As for relative to S&P 500, banks are currently trading at -1.27 std and -1.29 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 during the last month, ending May at 1.2x, which was already near the historical average. On P/B, banks are trading at just -0.1 std from the sample mean (2010-current moment) vs +2.0 std 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, and dispersion across banks has increased noticeably ytd, which is not surprising given recent NYCB’s news flow. However, dispersion decreased somewhat in recent quarters. 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 US economic recovery remains intact albeit gradually decelerating. Despite real GDP growth missed expectations notably in 1Q24, it is expected the US economy to increase by more than 2% qoq in 2Q24. At least, the headline miss was mainly driven by inventories and trade while the key driver of GDP growth – consumer spending – remained quite strong. So, interest rates growth hasn’t had a devastating effect on the economy yet but the key problem is that rates will remain higher for longer. Moreover, it is not even excluded currently that the next move of key rates could be another hike. Despite Jerome Powell stressed during the last meeting that possible hikes were not on the agenda, the minutes showed that not all members of the committee unequivocally agreed with this statement, noting uncertainty regarding the degree of restrictiveness of current financial conditions. In any case, inflation has been remaining higher than expected in 2024, pushing interest rate expectations much higher ytd. So, despite the decline in early May, Fed Funds (FF) rate expectations remained significantly higher both on ytd and yoy bases, implying just around one rate cut in 2024. Moreover, it is also projected that the FF rate will remain above 4.0% at least till the end of 2026 while the yield curve will remain slightly inverted even in two years. On the other hand, the probability of a recession in the next 12 months is already estimated at just 30%, the lowest figure over the last 23 months. Correspondingly, GDP growth forecasts continue going up, even despite softer key macro data revealed in May and more and more signs of gradual cooling of the labor market.
Earnings momentum of US banks continues improving. US banks are near the inflection point, in our thinking, with ongoing improvement of the second derivatives of majority fundamentals albeit still negative. Underlying results were better than expected again in 1Q24 despite to significant growth of interest rate expectations in 2024. Thus, 18 out of 30 banks from our sample reported better than expected EPS. The median surprise was +3.9% vs +5.6% in 4Q23. Revenue of 19 out of 30 banks from our sample exceeded estimates in 1Q24 with the median surprise of +0.1% vs +0.3% in 4Q23. So, the outlooks are becoming more and more optimistic. The main drivers of better revenue and EPS figures were higher fee income and lower provisions despite NPLs miss. In turn, NII/NIM figures were roughly in-line with forecasts, but FY24/25 projections resumed to grow in 2Q24, which really didn't come as a surprise given significant deceleration of deposit/funding beta, acceleration of deposits growth as well as expectations of loan growth acceleration in 2H24. According to the Fed H8 data, total loans increased by 2.4% yoy (as of May 15, 2024) vs +2.2% yoy at the end of 2023. Total deposits increased by 1.6% yoy, or +0.8% MoM. Moreover, majority banks from our sample either have already reached NIM’s trough of the current cycle, or they will reach it in 2Q24. Also, 1Q24 fees were notably stronger than expected, and FY24 outlooks continued improving. Despite reported OpEx missed expectations significantly in 1Q24, it was driven mainly by one-timers. So, FY estimates were roughly unchanged on a yoy basis. And 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. Nonetheless, despite persisting areas of concern such as offices and low-end consumers, credit quality looks quite manageable, and a growth of NCOs continues decelerating. Moreover, regulatory pressure on US banks eased somewhat in recent months. So, due to better 1Q24 earnings, EPS/revenue estimates of our sample of banks have already started improving gradually, and we expect that upward revisions will accelerate in 2H24.
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 three consecutive years of negative dynamics. So, improved EPS growth implies gradual re-rating of US banks, which continue trading at a significant discount to SPX index. Given still high and growing interest rates, US banks may remain volatile in the near future, but we believe so far that banks will end 2024 year in the green on a relative basis. So, we remain bullish on the sector but recognize elevated risks.
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