Regional Bank Rebound
#61: In advance of 2Q 2023 earnings, we make the case for regional bank outperformance and handpick a basket of winners.
Regional banks have come under significant pressure. After a period of balance sheet expansion, the rapid increase in interest rates over the past year has impaired the value of long-term asset portfolios while increasing bank funding costs. Meanwhile, steadily declining deposits have forced banks to liquidate assets at a loss or replace cheap deposits with expensive borrowings.
The sudden collapse of Silicon Valley Bank and its collateral damage highlighted the existential risk that these dynamics pose to poorly positioned institutions and has caused investors to rethink bank valuations.
Since the week of SVB’s failure, regional banks have been among the worst performing stocks in the market. The S&P Regional Bank ETF (KRE) is down 34%, with nearly every holding down meaningfully over the period1. Publicly traded mid-cap banks have massively underperformed both the broad market and the large U.S. money-center banks since March.
While there are legitimate headwinds for the sector, the share price declines have pushed the cohort to extremely low valuations as measured by book values or forward earnings estimates.
At the same time, real-time data shows improvement in aggregate banking sector metrics during the second quarter. Deposits have remained stable, liquidity has improved, and borrowings have declined. The failure of First Republic (FRC) in April did not appear to reignite contagion or spur a run on adjacent institutions.
As banks begin to report second quarter earnings this month, we expect an overarching message of stability.
Given the cloud of uncertainty that has hung over the sector, mere signs of improvement and stability provide the catalyst for outperformance in the near term.
This week, we analyze sector-level data and 30 individual regional bank stocks to build the case for upside in regional banks. Then, we select a basket of the highest quality regional banks positioned to outperform through the second quarter and the longer term.
Let’s dive in.