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  • Writer's pictureArbat Capital

US Banking Sector Report - September 2023

US banks underperformed the broad market significantly in August 2023, after meaningful outperformance in July. So, it was the 6th month of underperformance over the last 7 months. However, BKX index ended the month in the red for the first time over the last three months.


EXECUTIVE SUMMARY


US banks underperformed the broad market significantly in August 2023, after meaningful outperformance in July. So, it was the 6th month of underperformance over the last 7 months. However, BKX index ended the month in the red for the first time over the last three months. The index tumbled by 8.8% MoM in August vs -1.8% MoM of SPX index. Absolute August 2023 performance was -1.3 std from the mean monthly performance, and it was in the bottom 8% of absolute monthly performance in the index history. Relative August 2023 performance was -7.1% MoM. It is -1.4 std from the mean monthly performance, and it is in the bottom 7% 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 8 months of 2023 was slightly better than a year ago, but in both years BKX index lost more than 19% ytd as of the end of August. US banks remain quite volatile, especially regional ones, which were more affected by the bank run. Thus, Western Alliance was again among the best performers in August, but even the best performers ended the month in the red. Volatility remained quite high so far, but it decreased noticeably in August 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 12.3% in August, significantly lower than it was in July. Nonetheless, average difference for the first 8 months of 2023 was 30.6% vs an average for 2022 year of 19.9%. So, correlation between price change ytd and EPS FY24E change ytd among BKX index members increased slightly in August, but it remained relatively low.

US banks continue trading with a significant discount both to historical averages and to S&P 500 Index, given significant underperformance of US financial institutions both on absolute and relative basis 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 9.2x (as of July 28, 2023) to 8.4x (as of August 31). In turn, median P/E 24E went down from 9.1x to 8.5x for the same period of time. Nonetheless, banks are trading at -2.2/-2.2 std on P/E CY and at -1.9/-1.5 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 August 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 1.13x (as of July 28, 2023) to 1.05x (as of August 31), still remaining noticeably below historical averages. On P/B, banks are trading with a discount of -0.9 std from the sample mean (2010-current moment) vs SPX with +1.5 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 remains quite resilient even despite skyrocketing rates growth, which have already reached multi-decade highs. Thus, real GDP increased by 2.4% qoq on an annualized basis in 2Q23 vs consensus estimate of 1.8% and 1Q23 growth of 2.0%. Moreover, July macro data implies that it could even accelerate in 3Q23. The US labor market remains quite tight, but there were more and more signs of gradual softening in recent months. Thus, payrolls increased by 187K in July vs the consensus of 200K (and the revised down June figure of 185K). However, it was the second consecutive miss after more than a year of positive surprises. So, an average monthly figure of 1H23 of 258K is still much higher than an average figure of 2010-2019 years. Inflation also continues decelerating slightly faster than it was expected few quarters ago. Nonetheless, inflation is still higher than the Fed’s target, and it is too early to even think about possible easing of the monetary policy in any foreseeable future, from our point of view. Moreover, to be fair, not all macro indicators were strong recently, especially in manufacturing. Nonetheless, economic sentiment improved significantly in recent months. So, more and more market participants think at the moment that a recession can be avoided, even despite inverted yield curve has never been wrong before. At first sight, a soft-landing scenario should be more favorable for banks than a 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 3% at least for the next 3 years and flat yield curve, 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. 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. On the other hand, the key driver of strong results over the last year – NIM – was quite weak with positive surprises only for 6 banks. However, NIM/NII prospects is getting better, from our point of view, due to the less hawkish Fed, lower deposit headwinds and the still strong economy. At least, deposit costs were roughly flat in August while NIM estimates stopped going down. Yes, risks are still tilted to downside, but the second derivatives of majority of fundamentals are the source of optimism for us. The massive downgrade of US banks' ratings in August 2023 should not be misleading, especially taking into account stress test results published not so long ago. Relatively fast credit quality deterioration of consumer portfolio isn’t a big risk until significant growth of unemployment ratio even in case of high rates environment. So, EPS/Revenue estimates continue going down, but at much lower pace in August. Thus, median declines of EPS FY23/24E of our sample of banks were 16.0%/21.4% ytd, respectively (as of August 31, 2023).

After the August correction, 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 has already been shown in early May 2023. Moreover, 2Q23 earnings season 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 downgrade 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 - Sep-2023
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