MW Three bank stocks to avoid - and 18 to buy - from analysts at Jefferies

By Philip van Doorn

Analysts at the firm rolled out their coverage of 32 regional banks ahead of annual regulatory stress tests in June

This is the time of year when bank-stock investors gear up for the results of federal regulators' two main annual events for the industry - stress tests and the review of banks' plans to deploy excess capital through dividend increases and stock buybacks. Analysts at Jefferies led by David Chiaverini rolled out coverage of 32 regional banks on Tuesday. Three stood out with "underperform" ratings.

In a 440-page report, the analysts laid out a positive scenario for U.S. regional banks overall, counting on a rebound for loan growth, the widening of net interest margins, strong credit quality, high levels of capital to support dividends and stock buybacks and "attractive" valuations.

Net buybacks - stock repurchases sufficient to lower a company's share count even as new shares are shoveled to executives - increase earnings per share, which can support higher stock prices over the long term.

For one year through Tuesday, banks in the S&P 500 returned 27.2%, compared with a return of 13.4% for the full S&P 500 SPX, according to FactSet. Those returns are weighted by market capitalization and include reinvested dividends.

This has been a good period for banks because their core business - earning a spread between their average yield on loans and investments and their average cost for deposits and wholesale borrowings - has improved. According to the Federal Deposit Insurance Corp., U.S. banks' combined net interest margin during the fourth quarter was 3.28%, which was the same as the year-earlier quarter. But a further look back underscores how much the landscape has improved for banks. The net interest margin was only 2.55% during the fourth quarter of 2021.

The Federal Open Market Committee cut the federal-funds target rate three times last year to its current range of 4.25% to 4.50%. Bank savings account and CD interest rates move quickly when the Fed adjusts its overnight rate target. The current federal-funds range might still be considered high, and further cuts by the Fed could bode well for banks' profitability.

Regarding bank-stock valuations, let's look at forward price-to-earnings ratios for three exchange-traded funds that track indexes, again weighted by market cap:

-- The SPDR S&P 500 ETF Trust SPY tracks the S&P 500 by holding all of its component stocks.

-- The Invesco KBW Bank ETF KBWB tracks the KBW Nasdaq Bank Index BKX of 24 large-cap bank stocks.

-- The Invesco KBW Regional Banking ETF KBWR tracks the KBW Regional Banking Index XX:KRX of 50 stocks.

Here is a look at how the three ETFs' forward price-to-earnings ratios have moved over the past year:

The SPDR S&P 500 ETF Trust's forward P/E is 21.5, while the Invesco KBW Bank ETF's forward P/E is 11.5 and the regional ETF's forward P/E is 11.2. So the large-cap banks trade at 53% of the S&P 500's valuation and the regionals at 52%.

The bank stocks appear to be cheap - or maybe it is just that the S&P 500, weighted so heavily to a handful of tech stocks - is expensive. Here's a further look at valuations:

   ETF                                 10-year avg. forward P/E  10-year avg. forward P/E to that of SPY  Current forward P/E  Current forward P/E to that of SPY 
   SPDR S&P 500 ETF Trust                                 18.30                21.51 
   Invesco KBW Bank ETF                                   11.44                                      63%                11.45                                 53% 
   Invesco KBW Regional Banking ETF                       12.97                                      71%                11.24                                 52% 
   Source: FactSet 

A comparison to longer-term valuation averages underscores the current value proposition for the banks.

Three negative ratings

The Jefferies analysts provided their clients with detailed analyses of all 32 regional banks in the report. They assigned buy ratings to 18 of them and underperform ratings, which are essentially sell ratings, to only three.

Negative ratings aren't very common among those assigned by analysts working for brokerage or equity research firms. One reason for this is that negative developments for a company are already likely to be reflected in its share price. Among the 74 banks in the KBW Nasdaq Bank Index and the KBW Regional Banking Index, 37 have majority buy or equivalent ratings among analysts polled by FactSet, while only one - Bank of Hawaii Corp. $(BOH)$ - has majority sell ratings. That bank wasn't included in the Jefferies report.

Here are the three regional banks the Jefferies team rated underperform:

   Company                      Ticker  City              May 20 price  Jefferies price target  Implied 12-month upside potential  Dividend yield 
   Cullen/Frost Bankers Inc.    CFR     San Antonio            $131.50                    $105                               -20%           3.04% 
   Comerica Inc.                CMA     Dallas                  $58.12                     $47                               -19%           4.89% 
   Zions Bancorp NA             ZION    Salt Lake City          $48.63                     $40                               -18%           3.54% 
                                                                                                                      Sources: Jefferies, FactSet 

Shares of Cullen/Frost $(CFR)$ trade at a forward P/E of 14. Chiaverini said the stock's valuation at "a substantial premium to peers" was difficult to justify in light of the bank's "below-average earnings growth expectations." Still, the analyst is "impressed by CFR's strong deposit base and capital position." He also wrote that the bank's loan credit quality had held up well despite "above-average exposure to higher-risk CRE [commercial real estate] subsectors."

Comerica $(CMA)$ of Dallas trades at 10.8 times the consensus earnings-per-share estimates for the next 12 months among analysts polled by FactSet. One reason Chiaverini cited for his "underperform" rating for the stock was that Comerica was replaced in January by Bank of New York Mellon Corp. $(BK)$ as the financial agent for the U.S. Treasury's Direct Express program, which distributes federal benefits through debit cards. Comerica said it would cooperate with the Treasury as part of a three-year transition to the new financial agent. Chiaverini estimated Comerica would lose about 15% of its non-interest-bearing deposits because of the switch.

There has been speculation that Comerica might be a candidate to be merged with a larger bank or even to accelerate its own growth by acquiring competitors. The bank had $78 billion in total assets as of March 31 and would face enhanced regulatory scrutiny and compliance expenses if it were to reach the $100 billion threshold. Then again, Chiaverini made the point that recent comments from Comerica's management team showed it wasn't "in any rush to participate in M&A on either side."

Zions Bancorp $(ZION)$ trades at a low forward P/E of 9.1, but Chiaverini initiated his coverage with an underperform rating because of its "below-average earnings growth outlook (6% EPS growth estimate for '26/'27 vs peers at 12%)," as well as lower capital ratios than peers and "vulnerability to credit deterioration with above-average CRE exposure."

18 buy-rated banks

Here are the 18 banks the Jefferies analysts rated buys, sorted by the 12-month upside potential implied by the firm's price targets:

   Company                           Ticker  City                  May 20 price  Jefferies price target  Implied 12-month upside potential  Dividend yield 
   First Foundation Inc.             FFWM    Dallas                       $5.30                      $7                                32%           0.75% 
   Banc of California Inc.           BANC    Los Angeles                 $14.31                     $18                                26%           2.80% 
   Western Alliance Bancorp.         WAL     Phoenix                     $75.60                     $95                                26%           2.01% 
   Huntington Bancshares Inc.        HBAN    Columbus, Ohio              $15.94                     $20                                25%           3.89% 
   Axos Financial Inc.               AX      Las Vegas                   $71.91                     $90                                25%           0.00% 
   First Horizon Corp.               FHN     Memphis, Tenn.              $20.06                     $25                                25%           2.99% 
   Webster Financial Corp.           WBS     Stamford, Conn.             $52.65                     $65                                23%           3.04% 
   Pinnacle Financial Partners Inc.  PNFP    Nashville, Tenn.           $109.85                    $135                                23%           0.87% 
   East West Bancorp Inc.            EWBC    Pasadena, Calif.            $94.34                    $115                                22%           2.54% 
   Atlantic Union Bankshares Corp.   AUB     Glen Allen, Va.             $30.37                     $37                                22%           4.48% 
   SouthState Corp.                  SSB     Winter Haven, Fla.          $90.58                    $110                                21%           2.38% 
   M&T Bank Corp.                    MTB     Buffalo, N.Y               $185.74                    $225                                21%           2.91% 
   Citizens Financial Group Inc.     CFG     Providence, R.I.            $41.30                     $50                                21%           4.07% 
   Fifth Third Bancorp               FITB    Cincinnati                  $39.07                     $47                                20%           3.79% 
   Flagstar Financial Inc.           FLG     Hicksville, N.Y             $12.49                     $15                                20%           0.32% 

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