This Week in Banks
Back to banks for this week
What a week it was. The Federal Reserve, led by Chair Powell, cut interest rates by half a point. 50 big basis points. The market's response has been mixed and unpredictable, with the S&P 500 initially climbing to a record high before retreating a bit. What’s funny for the “rates down” crowd was the ever so obvious and predictable outcome of long-term bond yields drifting higher, seemingly at odds with the Fed's actions. This inversion has been a grind on banks in the US, and so at least they are breathing a sigh of relief. But be careful what you wish for when you ask for “steepening” in the curve. It is entirely possible (probable?) that this faster short end easing leads to a resurgence in inflation down the road.
In European banks, UniCredit (UCG.IM) an $850 billion in assets balance sheet trading around 7x forwards and 111% of book value, is making waves with its ambitious/hostile plan to increase its stake in Commerzbank (CBK.GY) to up to 30%, pending ECB approval. Commerzbank is a $600 billion in assets balance sheet trading at 8x forwards and 64% of book value. This move could significantly reshape the European banking landscape, though the regulatory hurdles remain unclear. Over the weekend, Germany came out that they are shutting down their planned sales of Commerzbank stock until further notice. People inside Commerzbank also hit the newswires saying “2/3 of our staff” would be let go in a takeover. Let the fun begin on this one.
In Canada, TD Bank Group's CEO Bharat Masrani announced his retirement. This leadership change comes at a delicate time, as the bank faces a U.S. investigation. The impact on TD's strategy and operations is yet to be seen. TD seems to be American bank regulators new favorite punching bag replacing Wells Fargo and Citi despite recent small hiccups by both. That hasn’t stopped TD from rallying hard of late, burning shorts in the process, up about 15% in the past 60 days.
And lastly, the FDIC is reportedly tightening its scrutiny of U.S. bank merger deals. This shift in regulatory approach could have far-reaching implications for the banking industry's consolidation trends. This would be a very bad thing for banks longer term (as probably a bad thing for the Investment Banks as well). Jeffries, Piper Sandler, Evercore, and Lazard are all up north of 50% YTD riding high on the potential for an M&A wave with Trump in office. While the bank space has seen decent activity, the Equity Capital Markets and M&A space should also disappoint this quarter as tough comps to Q3 and a slowdown in activity flow through. These names have been absolute fire this year.
Cross Markets Scoreboard
During the week, markets responded to the 50 bp cut with broad-based gains across various indices. Banking-related indices led the pack, with the KRX Index and the BKX Index showing the strongest performances, returning 2.95% and 4.74% respectively. Oddly regionals did tail off at the end of the week. The broader market indices also posted positive returns, with the S&P 500 (SPX) up 1.39%, the Nasdaq-100 (NDX) gaining 1.44%, and the Russell 2000 (RTY) rising 2.10%. Gold futures also participated in the upward trend, increasing by 1.36%. This pattern of returns suggests a particularly strong week for the banking sector, outpacing the already positive performance of the broader market indices.
Regional Bank Scoreboard & Theme
Among the regional banks, performance varied widely. New York Community Bancorp led the gainers with a 7.92% return, followed closely by Webster Financial Corp at 7.47%. The top 10 performers all posted returns above 3.70%, with Valley National Bancorp, Columbia Banking System Inc, and Pinnacle Financial Partners rounding out the top 5.
This “dash for trash” (no offense meant bank friends or management teams) highlights the rotation into some of the worst set up balance sheets. Any of these “trashy” names should have tailwinds behind them and if you’re looking for names with “torque” I think any of these are good ones: NYCB, WBS, VLY, COLB, and BANC. And again, I think these are all great banks and great management teams, but the rates up funding pressure and CRE stress made their balance sheets “trash”. The main reason why is now that 5 Year Rates have been “confirmed” to be temporarily in place, it makes the outlook for refinancing CRE much better. This shouldn’t have been surprising, but it seems like these were either short unwinds waiting on the final Fed confirm or people realizing that the macro back drop for these type banks is now much better. A bit of math on CRE in general was available to readers on August 10th. This is a big deal and a death knell for the doomers in the space.
The Week That Was in the Nasdaq Bank Index
Looking deeper into the banking universe to the Nasdaq Bank Index a few things jumped out to me. Dime rallied on an upgrade by the sell side realizing what I highlighted on 8/10, that lower 5-year rates and a Fed easing cycle are a pretty substantial tailwind to challenged banks. Sterling was the biggest loser (other than Kaspi who puked on a short report and is based out of Kazakhstan) as they were “taken under” in a long-overdue but equally disappointing M&A deal. It again should go to show everyone that bank M&A does not mean “value creation” and at least with some names is more like “put them out of their misery”. On the Kaspi front, their rebuttal to the short report was lacking substance but was at least firm in saying, “our reputation speaks for itself”. I need to dig into these Culper Research people more. I’m also going to ask my homie Blondesnmoney for his thoughts, he’s been all over Kaspi and is a great follow for all things investing, banks, carpetbagging, rants, and is insanely funny. He’s also a good soul behind it all.
The Week That Was Large Cap Banks
In large cap banks, Capital One got an upgraded price target to $190 and August figures showed outperformance on the credit side counteracting the weakness in recent Ally news on the consumer side. COF also probably loved the rates down 50 for its future impact on default rates and charge-offs. Barring a recession, it is fairly formulaic to these banks how rate decreases the risk and/or amount of losses coming down the pike.
Citibank outperformed likely on the down 50 bps headline, but also probably had some impact from the American Airlines credit card partnership deal. This deal is important for Citigroup as it would secure an exclusive partnership with a major airline that earned $5.2 billion from its credit card partnerships last year. The potential 7-10 year contract would significantly expand Citigroup's customer base and revenue stream, building on its existing higher-value American Airlines cardholders who spend more and have lower default rates than Barclays' customers. This aligns with CEO Jane Fraser's strategy to improve card business profitability. The exclusive arrangement would give Citigroup a competitive edge in the co-branded credit card market, where rivals like Delta earned nearly $7 billion from its American Express partnership in the same period. It also opens up opportunities for innovation in tailored products and services for American Airlines' customers, potentially helping Citigroup close the gap with competitors in the lucrative airline loyalty program market. The rates down 50bps by Jerome also helps their go forward consumer NCO numbers and eases the tension (RIP Chubbs) on the earnings side of the world while they take out costs. I still like them here & wonder if they’ll continue beating like they have 7 of the last Quarters.
And Western Alliance people realized what I’ve been saying since the $55 dollar price, that a no-recession world plus an easing environment will be massive, plus Amerihome is a beast. You can go back and find the original write up, but for now I would exercise caution as they are getting to be a bit expensive to forwards around 12x. I’m not saying there isn’t more to come and I’m not saying I don’t like them, it’s just that at some point valuations in the bank space matter and there are cheaper names available. I’d be cautious of any bank names (growth or not) trading in the 12x to 14x range to forwards.
Speaking of valuation type plays, the movement in Comerica & Key solidify my thinking that the market may be shifting towards allocating capital to the banks that have been most beaten down by this environment. As a factor change, the banks that have been terrible at growing key metrics as rates went up 400 basis points may now be great with the potential for rates to come down for an extended period of time. I wrote about this in June here and maybe what was bad can become what’s good.
Those banks like KEY and CMA that struggled to grow RPS, EPS, and TBV/S over the past few years may now outperform. If I were really trying to get nerdy, I would look at those that had the hardest time growing EPS over the past 3 years (since that correlates best to the rates up 400 environment) and I would try to find ones with the highest COF and the highest potential for NIM expansion. KEY is a fun one because they did take a big swing raising a few billion of equity and selling $7 billion in bonds and no one cared. But at any rate, in large cap land and small cap land, you want exposure not only to great banks (FCNCA & WAL), but also banks that have had a hard time (C). KEY Takes A Big Swing And No One Cares
European Banks Are Still Cheap
And lastly the Commerzbank & UniCredit hostile shenanigans got me looking back into European banks. And yes, they are still cheap. For those of you that don’t play around with European banks here’s my succinct take at why.
European banks typically trade at lower valuations than US banks due to slower economic growth, lower (and at one point negative) interest rates, and more stringent regulatory conditions. By stringent I mean, literally I think the EU regulators hate making money or anything that resembles proactive thinking. Additionally, US banks generally have higher profitability and stronger capital positions, benefiting from a more favorable economic environment. Market perception also plays a role, with investors viewing European banks as riskier, leading to lower price-to-earnings ratios compared to their US counterparts.
Oddly enough there are actually more banks in Europe (roughly 4800) than there are in the US (roughly 4600). And when you factor in credit unions, the US has the edge (roughly 4600) over the Europeans (roughly 1000). And on the total assets in the system side of the equation European banks hold about $32 trillion in assets to the US bank $24 trillion in assets. So roughly the same number of banks, fewer overall financial institutions to choose from, and more assets overall.
Over the past 10 years US banks have actually outperformed Europe substantially in local currency terms, but both have been crushed by Japan. Japan has returned about 9.50% annualized versus the US at 7.95% and Europe at 4.11%, hardly anything to write home about.
Unsurprisingly to some, in USD terms that edge goes away for Japan and gets worse for Europe. Jerome’s dollar wrecking ball has certainly impacted global financial markets quite a bit and made taking overseas vacations a little bit cheaper.
But taking the longer view, US banks have absolutely crushed Europe and Japan. That’s what higher rates, a friendlier regulatory system, and a more capitalistic environment will do.
Where are we today though? Again, European banks are still cheap. I am likely going to do a full Relative Growth Score ranking for European banks because I think that it is worth doing. If you are interested, please let me know.
My general thoughts on European banks are twofold. First from Barclays, earnings momentum is slowing and Banks relative price performance to the broader European indices has lagged what it “should have”. This is not a great set up at a time when everyone expects EPS to plateau and maybe even fall. And I tend to not like to buy things before EPS turns over and there are few catalysts. To make matters worse, there is and has been little economic growth in Europe and most of this EPS run up has been balance sheet related, which you can see below for thought number two.
And second, from Deutsche Bank NII is slowing QoQ. In general, European banks are more asset sensitive and so the rate cutting cycle will be more punitive to them. There is nothing good about a low growth industry like banks in Europe where balance sheets are positioned to benefit from rates up and rates are set to go down. With everyone trying to manage their currencies to not blow-up exports and Jerome doing 50 bps I think it is increasingly likely that other Central Banks speed up cutting plans. If you are forced to own European banks, then I am positive you’ll want to own ones that have non-interest income revenue above and beyond their peers.
The Almighty Dollar & Chinese Banks
It’s anyone’s guess where we go from here, but the Dollar has weakened substantially. Historically speaking we all know that when the dollar materially weakens international equities, commodities, and emerging market equities perform really well. And given what a disaster Chinese banks have been this got me thinking, could the “dash for trash” be alive in well in China? In short, the answer looks to be yes. This is DXY vs. the Goldman Chinese Banks index and to me it’s pretty clear that in major dollar devaluation cycles, that Chinese banks outperform. And it’s also pretty clear that the rate hiking cycle and dollar strengthening cycle in 2022 decimated Chinese banks.
It probably warrants a more serious look, but for now put it in the bucket of interesting and for another day. All I can say for now is these banks may be cheap for a reason but look at those multiples!
I hope you all are prospering and enjoying crisper fall weather.
The best is ahead,
Victaurs