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  • Writer's pictureArbat Capital

US Banking Sector Report - March 2024

US banks underperformed the broad market notably again in February 2024, for the second consecutive time. Moreover, it was the 9th month of underperformance since the start of the last year. Banks ended the month in the green but it was just the third time of growth over the last 7 months.



EXECUTIVE SUMMARY


US banks underperformed the broad market notably again in February 2024, for the second consecutive time. Moreover, it was the 9th month of underperformance since the start of the last year. Banks ended the month in the green but it was just the third time of growth over the last 7 months. Thus, BKX index increased by 1.0% MoM in February vs +5.2% MoM of SPX index. Absolute February 2024 performance was +0.05 std from the mean monthly performance, and it was in the top 50% of absolute monthly performance in the index history. Relative February 2024 performance was -3.9% MoM. It is -0.8 std from the mean monthly performance, and it is in the bottom 15% of relative performance vs SPX index since the inception of BKX index. In turn, despite skyrocketing growth in the last two months of the year, relative performance in 2023 was near multi-decade lows with BKX index underperformed SPX index by more than 23% yoy vs -25.7% yoy in 2020 and 30-yr average relative performance of -1.6% yoy. Wells Fargo and JP Morgan were among the best performers in February, having increased by more than 6.5% on MoM basis. WFC’s dynamics was driven by OCC’s consent order termination. Volatility remained quite high so far, and it even skyrocketed in the first two months of 2024 due to mixed 4Q23 earnings. Thus, a difference of monthly price changes between the best and the worst performers of our sample of banks was 36.7% in February and 45.9% in January vs 22.1% in December, mainly driven by significant decline of NYCB. Thus, it was the most volatile start of the year since GFC. Nonetheless, correlation between price changes yoy and EPS FY24E changes yoy among members of our sample increased notably MoM, still remaining quite high, staying at 84% as of the end of the February.

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 basis in two recent years, even despite noticeable decline of profit and revenue estimates. However, the discount continued narrowing gradually. Thus, median P/E 24E of our group of banks decreased from 10.2x (as of January 31, 2024) to 10.1x (as of February 29, 2024). In turn, median P/E 25E went down from 9.1x to 8.9x for the same period of time. Nonetheless, banks are still trading at -1.3/-1.2 std on P/E CY and at -1.6/-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 February 29, 2024). As for relative to S&P 500, banks are currently trading at -1.4 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 decreased from 1.14x (as of January 31, 2024) to 1.11x (as of February 29), already falling approximately to the historical average. On P/B, banks are trading with a marginal discount, -0.5 std from the sample mean (2010-current moment) vs SPX with +1.9 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 impact of the 4Q23 earnings season. However, dispersion decreased somewhat in recent quarters. Nonetheless, WAL’s P/E estimates for the nearest years are around 5-7x while NTRS’s ratios are 11-13x at the moment.

‘Soft landing’ probability continues going up despite a notable growth of rate expectations ytd, driven by higher than expected inflation data in January. Thus, it is already expected that a recession in the next 12 months will occur with a probability of just 40%, the lowest figure over the last 18 months. Moreover, both hard and soft data qtd imply that the GDP growth rate will be much stronger in 1H24 than it has been expected until recently, even despite weaker than expected retail sales, industrial production and housing data released in February. Thus, according to the January Fed’s minutes, “the staff continued to view the uncertainty around the baseline projection as elevated but noted that this uncertainty had diminished substantially over the past year”. So, according to the current market expectations, FY GDP growth is expected to remain solid in the nearest years: +2.1% yoy in 2024, +1.7% yoy in 2025 and +2.0% in 2026. Nonetheless, every medal has its reverse. So, higher GDP growth implies that a much bumpier road to the 2% inflation target awaits us than previously thought. Hence, rate expectations increased substantially ytd. Thus, it is already expected that the first rate cut will take place only in 2Q24 while there will be just 3 rate cuts in 2024. So, FF rate is expected to remain just a bit below 4% at the end of 2025. In other words, the current economic scenarios do not imply any meaningful improvement of banking fundamentals in the nearest quarters. Nonetheless, we believe that the worst is over for the US economy, and in any case, it is a great news for US banks.

February 2024 was mixed for US banks as, indeed, the whole beginning of the year. From the one hand, 4Q23 earnings weren’t quite strong as reported figures were distorted by one-timers. On the other hand, underlying fundamentals were better than expected, confirming our belief that 2024 is the turning point for banking fundamentals. Nonetheless, market perception of the results was clouded by poor reported figures of NYCB, thanks to which passions about potential CRE losses flared up with renewed vigor. And although the big miss was more related to the notorious one-timers, the market once again reminded NYCB’s management that some things are not very appropriate to do at certain points in time, even if underlying fundamentals look much better, at least at the moment. In other words, uncertainty is still relatively high, and for any pros there will be cons, which, however, is very typical for inflection points. Indeed, higher GDP growth implies, all other things being equal, better credit quality (but still gradually deteriorating) and faster loans growth (albeit relatively weak) but it also implies the more hawkish Fed and higher rates which will continue to impact negatively on both NIM and NII through ongoing pressure on deposit costs. Moreover, higher rates are a priori adverse factor for the credit quality and loan growth. Even the bad and good news on one topic go hand in hand in the recent months. Thus, WFC informed in mid-February that the OCC terminated a consent order it issued in 2016. In turn, a few days earlier it became known that there were claims of regulators against Citigroup regarding measuring default risk of its trading partners. In such circumstances, even release of CCAR scenarios went almost unnoticed despite they were as severe as in the last year’s stress test. Long story short, unsteady dynamics of US banks ytd had good reasons, especially taking into account quite strong rally in banks during the last two months of 2023, but it wasn’t surprise for us. Nonetheless, the second derivatives of majority banking fundamentals continue improving, even if not always as fast as expected, while the risks, albeit growing, remain quite manageable.

Mid-term earnings visibility of US banks continues improving but it is still a bumpy road ahead, at least in 1H24. 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 risks and ongoing decline of EPS/revenues, US banks may remain volatile in 1H24, but we believe that banks will end 2024 year in the green on a relative basis. So, we still remain bullish on the sector but recognize elevated risks.


AC - US Banking Sector Report - Mar-2024
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