US banks underperformed the broad market again in September 2024, for the 4th time over the last 5 months. Moreover, it was the 12th time of underperformance over the last 20 months. Also, the banks ended September in the red, for the first time over the last three months.
EXECUTIVE SUMMARY
US banks underperformed the broad market again in September 2024, for the 4th time over the last 5 months. Moreover, it was the 12th time of underperformance over the last 20 months. Also, the banks ended September in the red, for the first time over the last three months. But it was just the 4th time of decline over the last 11 months. Thus, BKX index decreased by 1.3% MoM in September vs +2.0% MoM of SPX index. Absolute September 2024 performance was -0.3 std from the mean monthly performance, and it was in the bottom 35% of absolute monthly performance in the index history. Relative September 2024 performance was -3.2% MoM. It is -0.6 std from the mean monthly performance, and it is in the bottom 20% of relative performance vs SPX index since the inception of BKX index. Given weak performance in the recent months, BKX index again underperforms the broad market ytd, -1.3% but +0.1 std. If the situation doesn’t change in 4Q24, 2024 will be the third consecutive year of underperformance. Just around a third of our sample ended September in the green. Thus, WAL and BK, the best performers in September, increased by 5.9% MoM and 5.3% MoM, respectively. But regional banks were among the worst performers again in September, driven by quite fast decline of rate expectations recently. Difference of monthly price changes between the best and the worst performers of our sample of banks was just 12.3% in September vs 28.2% in July. In turn, 1Q24 was the most volatile start of a year since GFC. Moreover, correlation between price changes yoy and EPS FY24E changes yoy decreased slightly again MoM in September, but still remaining quite high, staying at 74% as of the end of the month.
US banks continue trading with a discount both to historical averages and to the broad market, given their quite weak performance on absolute and relative bases in two recent years, even despite a noticeable decline of profit and revenue estimates. However, the discount narrowed considerably in July and August after roughly flat but volatile 1H24. Thus, median P/E 24E of our group of banks decreased from 12.1x (as of August 30, 2024) to 12.0x (as of September 30, 2024). Also, median P/E 25E went down from 10.8x to 10.7x for the same period of time. Hence, banks are still trading at just -0.3/-0.1 std on P/E CY and at -0.5/-0.2 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 September 30, 2024). As for valuations relative to S&P 500 index, banks are currently trading at -1.3 std and -1.2 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 in 2Q24, hovering around 1.17x. However, the ratio increased notably during the last quarter, rising from 1.17x (as of June 28, 2024) to 1.32x as of the end of September. So, on P/B, banks are trading already at +0.4 std from the sample mean (2010-current moment) vs SPX with +2.2 std, 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. But dispersion across banks (excluding NYCB) decreased notably ytd. Nonetheless, OZK’s P/E estimates for the nearest years are around 6-7x while MS’s ratios are 13-15x at the moment.
The easing cycle has begun finally, and the rate was cut by 50 bps at once. The size of the cut was somewhat surprising, given market forecasts were divided approximately equally between 25 bps and 50 bps cut. Moreover, there was one member of FOMC, namely Michelle Bowman, which voted against the decision (the first dissenter since 2005), as she preferred to lower rate by 25 bps. Given the polarity of opinions as well as high uncertainty about the upcoming elections, the meeting rather left more questions than answers, even despite Jerome Powell’s confidence about economic growth. At least, if everything is really as good as Mr. Powell convinced us at the press conference, then why the rate was lowered by 50 points at once, especially at the very beginning of the cutting cycle. Although the labor market continues gradually cooling, it hasn’t looked as inevitable falling of the economy into recession, while inflation is still above the Fed’s target, albeit continues moving in the right direction. So, despite the rate trajectory is absolutely clear, the speed of decline is quite uncertain, especially after so poorly explained 50 bps rate cut in September. Nonetheless, rate expectations continued going down even after the meeting. And it is now expected 2 more rate cuts till the end of the year (with an overall decline of 70 bps) and 4-5 more in the next year with the federal funds (FF) rate below 3% at the end of 2025 (it was 4.3% as of the end of May). In turn, key macro data revealed in September were mixed again with stronger retail sales and much better industrial production, in-line inflation but weaker labor market data across the board. So, the US economy still continued growing well above expectations but risks also began to go up in the recent months, even despite recession probability remained relatively low.
US banking fundamentals have already reached an inflection point. The start of the easing cycle will only accelerate profit growth, as recession isn’t the baseline scenario so far, even despite ongoing labor market cooling. Despite lower rates mean decline of asset yields, it also means less funding pressure and a more normal slope of the yield curve, which was inverted for the last two years. Thus, the 10yr/2yr spread became positive again in early September (already +14 bps as of the end of the month) for the first time since July 2022. According to Bankrate.com, loan yields continue going down. Thus, 30yr average monthly mortgage rate decreased by 23 bps MoM in September, -127 bps from the peak in October 2023. Deposit costs moved down either as well as wholesale funding. But it is still uncertain whether deposit costs will decline as fast as they went up during the last monetary tightening, when cumulative deposit beta finally exceeded 50% vs just 35% during the previous hiking cycle. Banking expectations regarding deposit beta remain widely different at the moment. But banks remain optimistic, forecasting positive qoq growth of NII in 3Q24 but roughly flat NII on a yoy basis in 2024. As for FY25 NII, it is slightly lower than previously expected as a result of a sharp rates decline and a still anemic loan growth. Thus, according to the Fed H8 data, total loans increased just by 2.4% yoy (as of September 18, 2024) vs +2.2%/+11% yoy at the end of 2023/2022. Nonetheless, expectations of gradual NIM/NII improvement remains intact, although not as fast as it was supposed a couple of quarters ago. Also, sharp rates decline means further decrease of securities losses, which already almost halved from the peak of 2022. The latter among other things implies growth of capital returns, especially after regulators cut proposed capital hike for US banks. Also, the start of the monetary easing cycle impacts positively on the financial health of both consumers and corporates, implying less pressure on credit quality, which remained stronger than feared even without it. Given a mid-single digit growth of OpEx, operating leverage will turn positive again in 4Q24. So, 3Q/4Q24 and FY25 EPS estimates remained roughly flat on qtd basis as of the end of September even despite a significant decline of interest rates.
Revenue environment still remains challenging for US banks in ST but LT prospects are less impacted by the rates decline. So, we still expect that FY EPS of US banks will return to growth in 2025 after three consecutive years of negative dynamics. In turn, positive EPS growth implies gradual re-rating of US banks, which continue trading at a notable discount to SPX index. Given still high but rapidly declining interest rates, US banks may remain volatile near term, but we still believe that banks may 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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