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  • Writer's pictureArbat Capital

US Banking Sector Report - November 2023

US banks underperformed the broad market noticeably again in October 2023, after insignificant outperformance in September. It was the 7th month of underperformance since the start of the year. Moreover, BKX index ended the month in the red for the third consecutive month.


EXECUTIVE SUMMARY


US banks underperformed the broad market noticeably again in October 2023, after insignificant outperformance in September. It was the 7th month of underperformance since the start of the year. Moreover, BKX index ended the month in the red for the third consecutive month. Thus, BKX index decreased by 5.6% MoM in October vs -2.2% MoM of SPX index. Absolute October 2023 performance was -0.9 std from the mean monthly performance, and it was in the bottom 16% of absolute monthly performance in the index history. Relative October 2023 performance was -3.5% MoM. It is -0.7 std from the mean monthly performance, and it is in the bottom 18% of relative performance vs SPX index since the inception of BKX index. So, given quite weak performance in the first half of the year, absolute performance in the first 10 months of 2023 was almost as bad as during the first year of pandemic – BKX index lost more than 26% ytd in both years as of the end of October. Regions Financial, NY Community and Bok Financial were among the worst performers in October, having decreased by more than 15% on a MoM basis, driven by weak 3Q23 results. Volatility remained quite high so far, but it decreased noticeably in the last three months despite significant decline of US banks. Thus, difference of monthly price changes between the best and the worst performers of our sample of banks was just 21.5% in October, substantially lower than it was in July, during 2Q23 earnings season. Nonetheless, an average difference for the first 10 months of 2023 was 28.2% vs the average for 2022 year of 19.9%. However, correlation between price changes ytd and EPS FY24E changes ytd among BKX index members was roughly unchanged in October.

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, even despite noticeable decline of profit and revenue estimates. Moreover, the discount widened again to the year high. Thus, median P/E 23E of our group of banks decreased from 7.9x (as of September 29, 2023) to 7.6x (as of October 31). In turn, median P/E 24E went down from 8.1x to 7.8x for the same period of time. Nonetheless, banks are trading at -2.6/-2.5 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 October 31, 2023). As for relative to S&P 500, banks are currently trading at -2.0 std and -1.7 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 0.96x (as of September 29, 2023) to 0.91x (as of October 31), still remaining noticeably below historical averages. On P/B, banks are trading with a noticeable discount, -1.6 std from the sample mean (2010-current moment) vs SPX with +1.1 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 regional banking crisis impact. However, dispersion decreased somewhat in recent months. Thus, WAL’s P/E estimates for the nearest years are around 4.5-5.2x while CFR’s figures are higher than 10-11x.

The US economy continued growing above expectations, but recent indicators suggested that economic activity would decelerate noticeably in 4Q23. Nonetheless, the Fed increased FY23 GDP growth forecast significantly at the September meeting. Thus, it is implied that GDP will increase by 2.1% yoy in 2023 (vs just +1.0% yoy implied growth a quarter ago). It is implied that GDP growth will decelerate to 1.5% yoy in 2024, and the soft landing is the Fed’s baseline scenario at the moment, even despite a number of indicators still pointing to a recession while higher rates will remain for longer. Indeed, given the still tight U.S. labor market, robust consumer spending as well as waning inflation pressure, a recession does not look so inevitable at the moment. On the other hand, there were more and more signs of gradual softening of the labor market in recent months, while manufacturing activity remained relatively weak, housing activity decelerated after resumed growth of the long end and inflation was still noticeably higher the Fed’s target. So, it is too early to say that the US economy has already been out of the woods, especially taking into account growth of geopolitical risks in October. So, we still think that risks are tilted to the downside. The soft-landing scenario should be more favorable for banks than the recession one, due better asset quality and higher loan growth. On the other hand, given current inflation expectations, the key rates will remain higher for longer with the FF rate above 4% at least for the next 3 years and flat yield curve, implying quite challenging revenue environment for US banks.

3Q23 earnings season affirmed that US banks fundamentals deterioration was gradually bottoming out. Thus, 23 out of 30 banks from our sample reported better than expected EPS with a median surprise of +5.8%. Revenue of 21 out of 30 banks from our sample exceeded estimates in 3Q23 with a median surprise of +0.6%. It was driven by better both NII and fees. Even NIM was higher than expected in 3Q23 with a median beat of +2 bps. Nonetheless, median NIM decreased by 16 bps qoq to just 2.94% in 3Q23 vs 3.2% in 2H19. So, it doesn’t mean that the worst is over, especially in case of weaker than expected economic growth. At least, NIM will continue going down in the coming quarters but at much slower rate, loan growth will inevitably decelerate further while credit normalization is still on the agenda. But, if you like, all these processes look manageable, from our point of view. Anyway, the current dynamics of fundamental indicators is much better than the one that could be assumed based on all the risks that have been realized to the moment and the one which has already priced in quotes. At least, the second derivatives of many fundamentals are either already positive, or they will soon become so. Moreover, the current fundamentals do not look any weak so far despite some deterioration in recent quarters, remaining even slightly better than the averages for the previous cycle. Thus, median ROE of our group of banks is still double-digit while ROA remains higher than 1%. So, estimates decline decelerated recently – median decline of 4Q23 revenue estimates of our sample of banks was 1.7% qtd, or -26% ytd (as of October 31, 2023), while median declines of EPS FY23/24E of our sample of banks were 14%/22.8% ytd, respectively.

Short-term perspectives of US banks still look challenging, but risks have already decreased noticeably. Nonetheless, investors remain cautious, and they still expect that banks will continue underperforming even despite noticeable improving of economic projections during the last months. Given recent growth of geopolitical uncertainty, it is quite questionable whether stronger 3Q23 earnings will be able to change the opinion. At least, the rule of thumb implies that banks aren’t the best investment opportunity in case of recession, which is still quite possible. Nonetheless, we continue believe that banking quotes are near the bottom of the cycle. Moreover, we expect that that estimates downward cycle is near the end too, while a number of catalysts, such as steady disinflation, the end of the hiking cycle and the soft-landing paradigm, are almost ready to capture the minds of market participants. So, we are still cautiously optimistic on the sector and recommend to buy the current correction.


AC - US Banking Sector Report - Nov-2023
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