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  • Writer's pictureArbat Capital

US Banking Sector Report - October 2023

US banks outperformed the broad market slightly in September 2023, after meaningful underperformance in August. However, BKX index ended the month in the red, for the second consecutive month.


EXECUTIVE SUMMARY


US banks outperformed the broad market slightly in September 2023, after meaningful underperformance in August. However, BKX index ended the month in the red, for the second consecutive month. Thus, BKX index decreased by 3.9% MoM in September vs -4.9% MoM of SPX index. Absolute September 2023 performance was -0.6 std from the mean monthly performance, and it was in the bottom 22% of absolute monthly performance in the index history. Relative September 2023 performance was +1.0% MoM. It is +0.2 std from the mean monthly performance, and it is in the top 41% of relative performance vs SPX index since the inception of BKX index. Nonetheless, despite quite weak performance in the first half of the year, absolute performance in the first 9 months of 2023 was slightly better than a year ago, but in both years BKX index lost more than 22% ytd as of the end of September. US banks remain quite volatile, especially regional peers, which were more affected by the bank run. Thus, Comerica and First Horizon National were among the worst performers in September, having decreased by more than 10% on a MoM basis. Volatility remained quite high so far but it decreased noticeably in August and September 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 15.3% in September, significantly lower than it was in July. Nonetheless, an average difference for the first 9 months of 2023 was 28.9% vs an average for 2022 year of 19.9%. Moreover, correlation between price change ytd and EPS FY24E change ytd among BKX index members increased significantly in September, and it was again quite high.

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 both on absolute and relative bases ytd as well as relative resilience of profit estimates. But the discount narrowed noticeably from the year highs. However, median P/E 23E of our group of banks decreased from 8.4x (as of August 31, 2023) to 7.9x (as of September 29). In turn, median P/E 24E went down from 8.5x to 8.1x for the same period of time. Nonetheless, banks are trading at -2.4/-2.4 std on P/E CY and at -2.1/-1.7 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 September 29, 2023). As for relative to S&P 500, banks are currently trading at -2.0 std and -1.6 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 1.05x (as of August 31, 2023) to 0.96x (as of September 29), still remaining noticeably below historical averages. On P/B, banks are trading with a meaningful discount, -1.3 std from the sample mean (2010-current moment) vs SPX with +1.3 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 recent regional banking crisis. Thus, WAL’s P/E estimates for the nearest two years are around 5-6x while CFR’s figures are higher than 10-11x.

The US economy continued growing above expectations, and recent indicators suggested that economic activity even accelerated in 3Q23. So, 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 expected 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 labor market, robust consumer spending as well as picking up housing activity and 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, manufacturing activity remained relatively weak while 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. Moreover, we still think that risks are still tilted to the downside, at least because the inverted yield curve has never been wrong before, while the lag effects of the very tight monetary policy on the economic activity may not be fully taken into account in current forecasts, from our point of view. At first sight, 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, implying quite challenging revenue environment for US banks.

Fundamentals deterioration is gradually bottoming out, driven by higher probability of a soft landing and faster disinflation. So, we expect that the upcoming earnings season of US banks, which will start on October 13, 2023, when JPM, WFC, C and PNC will reveal 3Q23 reports, will confirm the emerging trends. Recall that US banks reported quite mixed 2Q23 earnings, but these results couldn’t be called weak. Thus, EPS surprises were relatively strong with higher figures for 16 out of 24 BKX index members. Revenue was also better than expected for 15 BKX index members, driven by fee income. Moreover, deposit balances stabilized in the second half of the quarter with higher than expected deposit volumes for 18 out of 24 BKX index members as of the end of 2Q23, implying that that the US regional banking crisis wasn’t as disruptive for the industry as it had initially been sought. Moreover, US banks guidance during several financial conferences in September weren’t weak. At least, majority trends of fundamentals were better/in-line with expectations, even NII/NIM and deposits. Definitely, NII/NIM will continue going down in 2H23 while credit quality will continue worsening as well as loan growth will continue decelerating even in case of ‘soft landing’. But, if you like, all these processes look manageable. Moreover, the second derivative of many fundamentals are either already positive, or they will soon become so. Consequently, estimates decline decelerated recently. Thus, median decline of 3Q23 revenue estimates of our sample of banks was 1.5% qtd, or -5.5% ytd (as of September 29, 2023), while median declines of EPS FY23/24E of our sample of banks were 15.2%/20.6% ytd, respectively.

After the correction in two recent months, the downside is limited for US banks, from our point of view. We continue to believe that the trough of banking quotes of the current cycle was already been shown in early May 2023. Moreover, mid-quarter 3Q23 guidance of a number of banks and recent macro developments are increasingly convincing us that although the upside is also somewhat limited at the moment, but it is gradually growing, especially taking into account low valuations and noticeable underperformance of US banks during the last year. Nonetheless, bearish sentiment is still relatively strong among market participants primarily due to ongoing negative EPS/revenue estimates revisions and still relatively high recession risks. But we believe that estimates downward cycle is near the end while a number of catalysts, such as steady disinflation, end of the hiking cycle and the soft-landing paradigm, are almost ready to capture the minds of market participants. So, we are again cautiously optimistic on the sector and recommend to buy the current correction.


AC - US Banking Sector Report - Oct-2023
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