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  • Writer's pictureArbat Capital

US Banking Sector Report - May 2024

US banks outperformed the broad market slightly in April 2024, for the second consecutive time. However, it was just the 6th month of outperformance over the last 15 months. Moreover, banks ended April in the red for the first time over the last three months, but it was just the second time of decline over the last 6 months.



EXECUTIVE SUMMARY


US banks outperformed the broad market slightly in April 2024, for the second consecutive time. However, it was just the 6th month of outperformance over the last 15 months. Moreover, banks ended April in the red for the first time over the last three months, but it was just the second time of decline over the last 6 months. Thus, BKX index decreased by 3.5% MoM in April vs -4.2% MoM of SPX index. Absolute April 2024 performance was -0.6 std from the mean monthly performance, and it was in the bottom 23% of absolute monthly performance in the index history. Relative April 2024 performance was +0.7% MoM. It was +0.2 std from the mean monthly performance, and it was in the top 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 season. However, just two banks from our sample managed to end the month in the green despite relatively strong 1Q24 results. Thus, Wells Fargo and Goldman Sachs were the best performers in April, but having increased just by 2% on MoM basis. On the other hand, the key underperformers were regional banks, driven by ongoing NYCB’s negative news flow even despite positive perception of its 1Q24 earnings. Hence, NYCB tumbled by 18% MoM in April after a decline of 33% MoM in March, translating into a severe 74% drop ytd. A difference of monthly price changes between the best and the worst performers of our sample of banks was just 20% in April while an average figure of the first 4 months of 2024 was 37.8% vs 48.4% in March. But 1Q24 was the most volatile start of the year since GFC. In turn, correlation between quotes and EPS FY24E changes yoy increased slightly MoM in April.

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 their profit and revenue estimates. Hence, the discount continued narrowing gradually. However, median P/E 24E of our group of banks decreased from 11.3x (as of March 28, 2024) to 10.6x (as of May 1, 2024). In turn, median P/E 25E went down from 9.7x to 9.0x for the same period of time. Hence, banks are still trading at -1.0/-1.0 std on P/E CY and at -1.5/-1.1 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 1, 2024). As for relative to S&P 500, banks are currently trading at -1.2 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 decreased from 1.22x (as of February 29, 2024) to 1.17x (as of May 1), already being roughly at the historical average. On P/B, banks are trading at just -0.3 std from the sample mean (2010-current moment) while SPX index is trading at +2.0 std, despite current adj. 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 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 higher US GDP growth means higher for longer US interest rates. At least, inflation prints were higher than expected in each month of the first quarter, which was partly due to the faster growth of the economy. The state of affairs has at least shaken officials' confidence that inflation is definitely moving in the right direction. So, the tone of recent statements by the Fed’s officials has become noticeably more hawkish, which could not but affect the dynamics of interest rate expectations. Thus, FF rate expectations increased for the third consecutive month in April, skyrocketing by more than 100 bps ytd. At the moment, it is expected just around one rate cut in 2024. Moreover, it is also projected that FF rate will remain above 4.0% at least till the end of 2026 while the yield curve will remain roughly flat even in next two years. Hence, US banks will continue to operate in the challenging revenue environment. At least, risks of NII/NIM projections downgrades are gradually increasing. 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 22 months. Correspondingly, GDP growth forecasts continue going up. Thus, according to March staff projections, the US GDP CAGR for the next three years will exceed 2% yoy, implying less pronounced pressure on financials of both consumers and corporates in high interest rates environment. The latter haven’t had a significant negative impact on the US economy yet but the key word here is ‘yet’. So, the balance of risks is still shifted towards inflation, at least from the Fed’s point of view.

1Q24 EPS/Revenues beat estimates, despite weaker NIM. However, 1Q24 reported profits were again distorted by one-timers such as negative impacts of DIF assessment, albeit not as significantly as in 4Q23. But underlying fundamentals were better than expected again, confirming our belief that 2024 could be a turning point for banking fundamentals, however provided that the rate expectations do not increase much compared to the current ones. Thus, 18 out of 30 banks from our sample reported better than expected EPS. A 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 a median surprise of +0.1% vs +0.3% in 4Q23. 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 albeit FY24 projections weren’t quite encouraging, which really didn't come as a surprise. Thus, 17 out of 30 banks from our sample reported better than expected NII. A median surprise was +2.0%. In turn, NIM of just 12 out of 28 banks for which estimates were available exceeded estimates in 1Q24 with a median surprise of -2.6 bps. Nonetheless, NII of our sample of banks decreased by 8.5% yoy in 1Q24 while median NIM tumbled by 43 bps yoy to 2.88%, the 5th consecutive quarter of decline. And NIM continues going down in 1H24. But even despite NIM estimates decreased ytd, we still expect that a minimum of the ratio will be reached in mid-2024 but the further prospects of the indicator at the moment look less rosy than a quarter ago. In turn, 1Q24 fees were notably stronger than expected, and FY24 outlook continued improving. Reported OpEx missed expectations significantly again, driven mainly by one-timers. Thus, median OpEx miss of our sample of banks was -2.3% in 1Q24. FY24 adj OpEx is expected to increase just by 1%, implying that US banks could return to positive operating leverage in 2H24. Credit quality remained strong but deteriorating with key metrics roughly in-line with expectations in 1Q24 – deterioration was driven mainly by cards and office CRE. So, due to better 1Q24 earnings, EPS/revenue estimates of our sample of banks were flat/up ytd.

Mid-term earnings visibility of US banks continues improving but it is still 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 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.


AC - US Banking Sector Report - May-2024
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