The Market Has the Wrong Perspective on Bank Stocks
May 12, 2023
Bank stocks have been hammered by the market, and it hasn’t always been apparent why.
Since the March failure of Silicon Valley Bank, practically all bank stocks have fallen about 30%. According to a Tuesday report from Morgan Stanley bank analysts, deposit losses remain the main concern, and investors appear to be running three types of stock screens to forecast the next bank run. These are the levels of uninsured deposits, bond losses as a percentage of capital, and commercial real estate loans.
These are the wrong screens, writes analyst Manan Gosalia of Morgan Stanely. “We disagree with this approach,” he says. “This recent stock reaction is overdone as there is currently no evidence of accelerating deposit outflows.”
Accounts with balances of more than $250,000 that are guaranteed by the Federal Deposit Insurance Corp. are frequently used by firms as operational accounts, and such accounts are sticky and difficult to relocate, according to the Morgan analyst. According to him, the paper losses on a bank’s bond holdings would eventually flow back into the bank’s capital. And, while losses on commercial real estate loans are certain, they will take time to appear on the bank’s books.
According to Gosalia, bank revenues will be constrained this year and next as banks pay more to attract deposits, offer fewer loans, and reserve for commercial real-estate loan losses. Morgan Stanley cut its 2024 profit predictions for regional banks by an average of 27% following the industry’s March quarter reporting.
Morgan Stanley’s stock recommendations demonstrate why the firm believes the three most often utilized screening criteria might be misleading. Cullen/Frost Bankers (CFR) has an Overweight rating from Morgan Stanley, but the Texas bank had one of the lowest March quarter levels of insured or collateralized deposits – 50% of its deposits — among the 30-odd institutions evaluated. According to the most recent report, Cullen/Frosts’ unrealized securities losses were 87% of its tangible book value – one of the biggest in the group. Commercial real estate loans accounted for 17% of assets at the end of 2022, putting the Texas lender at the group’s median.
Nonetheless, Morgan Stanley is confident about Cullen/Frost since the bank has a pile of cash equal to 18% of its assets. Cullen/Frost should be able to support loan expansion and deposit drawdowns with this stockpile.
M&T Bank (MTB), Morgan Stanley’s top selection, benefits from the liquidity provided by a pile of cash. The Buffalo, New York-based bank has one of the highest levels of commercial real estate exposure in the industry, but it may also be one of the few banks with enough liquidity to undertake a stock buyback.
Morgan Stanley expects all of the midsize banks it follows to drastically limit loan growth, from 9% year on year in the March quarter to just 2% by December.
This might become a concern felt well beyond the confines of bank stocks. Small enterprises in the United States are financed through regional and community banks.
We spoke with Philip Harrison, who heads research at Visible Alpha, a data service that combines the research of many sell-side firms to show the average forecast for granular aspects of a public company’s operations, to get a sense of loan-growth forecasts by all of Wall Street, not just Morgan Stanley.
Visible Alpha investigated Wall Street’s projections for loan growth at midsize bank stocks. Several banks, notably Valley National Bancorp (VLY), Bank OZK (OZK), and Comerica (CMA), shocked analysts with robust year-over-year loan growth in the March quarter.
But lending at most regional banks fell short of March quarter hopes, including some whose stock drops have made headlines, such as Western Alliance Bancorp (WAL) and PacWest Bancorp (PACW). The Visible Alpha data show that Wall Street has steeply reduced forecasts for loan growth in 2023 and 2024 for most regional banks.
Morgan Stanley’s analysis on Tuesday highlighted two things that could quickly improve the outlook for banks. The F.D.I.C. and other regulators could push Congress to expand deposit insurance for banks below the few who are too big to fail. And the Federal Reserve could start discussing interest-rate reductions.
Given how far bank stocks have sunk, Morgan’s Gosalia says, “We believe even a discussion around these topics in the coming months could drive a rebound in the group.”