Growth Regional Banks

We believe the opportunity in growth regional banks remains compelling. We believe investors are missing three things by not buying regional banks at these valuations: 1) margins may widen or shrink, but they will settle down once the Federal Reserve (the “Fed”) stops raising rates, 2) loan growth is very good and is the main earnings driver over any time period greater than 2 years, and 3) loan credit quality is likely to be better than sell-side estimates for 2023 and 2024.

Bank stocks had a disappointing year in 2022. During January and February, banks outperformed the broader market. It looked like the thesis of banks benefitting from higher interest rates was going to be the story of 2022. Then, in March, the tone around bank stocks changed with the Russian invasion of Ukraine and the tougher talk from Fed Chairman Powell. Instead of banks operating in a goldilocks environment of higher rates and growing economy, investors priced in higher credit losses due to a possible recession. Also, in March, the Federal Reserve became more hawkish in response to rising inflation numbers. With the Fed rapidly raising interest rates, the positive story for banks of higher interest rates leading to wider margins shifted to rapidly increasing rates causing deposit costs to rise faster than expected.

Now, regional bank stock valuations are at the bottom end of the historical range. According to Stephens, the median price-to-earnings ratio (“P/E ratio”) of regional banks is less than 9x forward estimates. This is an unusually low valuation. Historically, banks have traded at this low valuation or cheaper just 5% of the time. When the banking industry has traded at this low of a valuation, the forward returns have been very strong on average. We think investors are concerned about potential credit quality issues in banks’ loan portfolios and rising deposit costs. However, we think select regional banks, such as AX, WAL, WBS, and CNOB, are attractive due to their loan growth outweighing near-term margin pressures.