Bank stocks have lagged the broad market through most of 2023, and the failure of three large institutions early in the year may have left a bad taste in investors’ mouths. But some bank stocks are attractively priced at the moment, and targeted investments in the sector may become profitable in 2024.
In a Dec. 6 report, analysts at Keefe, Bruyette & Woods wrote that they were confident the worst of the downward revisions to earnings estimates were behind the industry. Investors typically want to see a steady increase in earnings estimates to support stock prices. But the opposite was happening as many banks faced falling net interest margins — the difference between the interest rates they earn on loans and securities investments and what they pay for deposits or borrowing — as the Fed raised the short-term federal funds rate and pushed up longer-term interest rates. To rise by reducing its bond portfolio.
For 2024, KBW analysts recommend that investors hold stocks of banks with “inexpensive balance sheets,” as well as those banks that expect their tangible book value to increase significantly and banks with capital markets businesses that are “poised for a rebound.”
Setting the stage
The decision by the Federal Open Market Committee last week to hold interest rates steady and signal at the Fed Economic forecasts A three-fold cut in the federal funds rate in 2024 has fueled expectations that better times lie ahead for banks.
Here’s a summary of interest rate cut expectations from 12 economists.
Here’s a chart showing the performance of the KBW Nasdaq Bank BKX Index versus the performance of the S&P 500 SPX this year through Friday, with dividends reinvested for each:
FactSet
You can see the decline in early March for the KBW Nasdaq Bank Index and the rise that begins at the end of October and continues this month. The March action focused on the bankruptcy of Silicon Valley Bank in Santa Clara, California, on March 10, and Signature Bank of New York, on March 12. Then regulators shut down San Francisco’s troubled First Republic Bank on May 1.
The rapid rise in interest rates resulting from the Fed’s policy change in early 2022 has taken its toll as banks’ deposit costs rise. The three failed institutions faced specific problems:
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Silicon Valley Bank has for decades focused on lending and collecting deposits from venture capital firms. The bank faced a perfect storm of deposit outflow as venture capital firms’ cash sources dried up. The bank was forced to raise cash by selling securities at a loss after bond prices fell as interest rates rose.
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New York-based Signature Bank had a diversified business model, but its increasing focus on providing services to virtual currency exchanges and related businesses damaged its reputation and caused enough deposits to flow abroad that state regulators decided to shut down the bank.
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First Republic Bank focused on serving high-net-worth clients, including offering jumbo mortgage loans, which were too large for Fannie Mae or Freddie Mac to purchase. This meant that the bank was burdened with a large portfolio of loans at low interest rates, while deposit costs ballooned. This problem, coupled with paper losses in the stock portfolio, helped lead to a loss of confidence, a run on deposits, and ultimately a decision by government regulators to close the bank.
This part of history may stop affecting bank stocks, not only because of expectations of lower deposit costs next year, but because of the way the stock market reacts to the Fed and economic developments. The yield on the 10-year US Treasury note BX:TMUBMUSD10Y fell to 3.91% from 4.88% at the end of October. As interest rates fall, market valuations for bonds rise. This relieves pressure on banks and can boost their profits as well as regulatory capital ratios.
The best choices among large-cap bank stocks
David Conrad, managing director of equity research at KBW, prefers three big banks, which he discussed during an interview with MarketWatch.
Key Corp
KeyCorp KEY shares,
Cleveland shares are down 18% this year, excluding dividends. But the stock price rose 37% over the past two months, closing at $14.32 on Friday.
KeyCorp pays a quarterly dividend of 20.5 cents per share. An annual dividend of 82 cents results in a dividend yield of 5.73%, based on the stock’s closing price on Friday.
Conrad said the bank was “earning little on its balance sheet” and that its dividend payout ratio (dividends to earnings per share) was as high as 80%. For the third quarter, the bank’s net income available to common shareholders was 29 cents per share, down from 55 cents a year earlier. The bank reported a tax-adjusted net interest margin of 2.01% in the third quarter, down from 2.74% a year earlier.
“Approximately 30% of their balance sheet is getting 30 basis points and will be repricing by the end of 2024,” according to Conrad. KeyCorp loaded Treasuries for two years before the Fed started raising interest rates and before deposit costs rose. With a significant amount of those securities and $30 billion of interest rate swaps “underwater” due next year, Conrad expects KeyCorp’s profits to rise meaningfully. “The payment percentage will likely be cut in half,” he said.
He sees a good relationship between the stock’s “risk and reward” as we go through the first quarter. Then the capital risk subsides materially as earnings increase.
Conrad estimates KeyCorp will earn $1.82 per share in 2024, which beats the consensus EPS estimate of $1.29 among 23 analysts surveyed by FactSet. The stock’s price target is $15, which represents just 5% ahead of the stock’s closing price of $14.32 on Friday. The stock rose 8% last week.
Odeon Capital analyst Richard Boff also rates KeyCorp a buy, but with a higher 12-month price target of $15.45. In a note to clients on Thursday, Bove wrote: “It appears that KeyCorp will make significant operational adjustments in the fourth quarter. This will likely reduce earnings, so quarterly results may be disappointing.”
The bank is expected to take extensive measures to reduce its exposure to loans deemed high-risk under the new regulatory capital requirements. He also expects “higher severance and automation costs” through 2024 as the bank cuts expenses, in part by laying off staff.
These moves, an improving interest rate environment and “greater opportunities” in capital markets as companies “restructure their balance sheets,” should all help KeyCorp’s earnings “rise in 2025,” Bove wrote. Year 2024.
TRUE
Trust Financial Company TFC,
The Charlotte, North Carolina, company was founded when BB&T Corp. merged with… with SunTrust of Atlanta in December 2019. The stock is down 17% this year, but was up 29% from the previous two months to close at $36.70 on Friday. Truist pays a quarterly dividend of 52 cents per share for a yield of 5.67% at Friday’s close.
“Troist is in the camp of a few banks that added duration at the wrong time, which created market-to-market capital concerns [as the value of securities investments declined] “And a really low net interest margin,” Conrad said. The bank reported a third-quarter net interest margin of 2.95%, down from 3.12% a year earlier. Q3 EPS for common shareholders was $1.07, down from $1.54 in Q3 2022.
Earlier this year, Truist sold 20% of its insurance brokerage business to Stone Point, a private equity firm. according to Semaphore report In October, the two companies were negotiating to sell the remaining 80% for about $10 billion.
The completion of this transaction will not only increase Truist’s regulatory capital ratios by approximately 300 basis points, but will improve 2024 earnings per share to an estimated $4.40 from $3.70, Conrad said.
“So this can be viewed as short-term, but it also puts Truist in a position to grow,” he said.
Conrad has a $36 price target for Truist, which is now below the bank’s stock closing price of $36.70 on Friday. But Bove upgraded Truist to a buy rating on Monday morning, with a price target of $40.45.
Goldman Sachs
“Overall, we remain very optimistic about capital markets next year,” Conrad said. He pointed to “seven or eight quarters of lean levels” in the investment banking industry. “There is only so much time people can wait before making capital or strategic transactions or debt,” he added.
Shares of Goldman Sachs Group Inc. GS,
It closed at $380.51 on Friday, up 11% for 2023. The bank pays a quarterly dividend of $2.75 per share, yielding 2.89%.
According to FactSet, Goldman Sachs trades at 1.1 times tangible book value per share. This is lower than FactSet’s P/TBV ratios of 1.3 for KeyCorp and 1.5 for Truist. But it may be more important than shares of Goldman’s arch-rival Morgan Stanley MS,
It trades for about twice its tangible book value, according to FactSet.
Conrad sees “less downside risk” for Goldman due to its lower hold rating. He also believes that lower interest rates will support capital markets activity. Finally, he cited Goldman as a “restructuring story,” not only because of its exit from the consumer lending business, but also because it reduced the size of its balance sheet, to boost its regulatory capital ratios.
Conrad’s price target for Goldman is $400.
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