Weekly Review & Outlook: April 22, 2024

A full week of bank earnings delivered consistent beats to EPS expectations. Economic data lifted the Atlanta Fed GDPNow projection of 1Q24 annualized GDP growth to 2.9% ahead of this week’s report from the BEA. Continued longer maturity Treasury selling decreased yield curve inversion between the 10-year and 3-month yields to its flattest level since October through the bear-steepening path.

Bank earnings provided a full week of consistent outperformance with roughly 4 EPS beats to every miss across 38 banks. A look at key metrics shows EPS higher linked quarter by a median 0.3% with the average result coming in higher by about 6% compared to consensus sell-side estimates. Net Interest Income (NII) and Net Interest Margin (NIM) continue to contract down about -2% from December. Non-interest bearing deposit migration, excess liquidity and lower loan demand are generally contributing to the contraction.

NII and NIM improvement is developing more quickly among the smaller banks. So far, 42% of banks with less than $100B have reported higher sequential NII and 23% have reported higher sequential NIM.

Other key metrics observed are flat loan balances and increased reserve coverage despite lower provision. I also note improved capital ratios despite various levels of Available for Sale securities marks. More banks have reactivated share repurchase as capital builds with generally stable funding and good performing credit.

Focusing on credit quality commentary, Commercial Real Estate (CRE) continues to be discussed in detail on calls. Banks are methodically working through Office CRE that is stressed with reserve levels at some banks already supporting nearly 25% default rate with -50% severity. Office CRE is generally recognized to make up about 1/6 of the overall CRE mortgage market in the US. Office CRE can be further segmented between Owner Occupied and Non-Owner Occupied properties. Most community bank Office CRE takes the form of Owner Occupied buildings, e.g. dentist offices. Headlines breathlessly concerned about the stress in CRE typically cite non-owner occupied office which is a fraction of the overall CRE market.

I don’t want to be accused of being Polyannish in my expectations. The impact of increased interest rates diminishes the value of assets with obvious downward adjustments in price working through all markets, but I see a lot of potential bad credit already reserved on bank balance sheets. I refer to comments from Citizens Financial Group (CFG) on their earnings call in which CFO John Woods stated, “you can see some of the key assumptions driving the general office reserve coverage level. We feel these assumptions represent a severe scenario that is much worse than we’ve seen in historical downturns, so we feel the current coverage is very strong.”

Fortunately the other major headwind of a cultural demand shift is mostly limited to segments of the office market. When I think of segments such as Multi-family which makes up just under half of the overall CRE market, I am comforted that “sleep from home” is still popular with most people.

In the interim bank EPS are poised to again start growing after a year of shrinking lower. Increasing EPS in the industry  could be a catalyst for stocks which still trade well below longer period median valuations.

Mid-Cap Banks

The mid-cap bank group gained 2.07% on average last week. The median group 2024 P/E is now 10.42x which is a 8.14% premium to the recent comparable period average P/E of 9.57x. The earnings yield spread (a modified version of equity risk premium) closed at a 21.67% premium to my assessment of neutral. The valuation estimate equates to a price premium of 12.24%.