KRE - Q1 Bank Earnings Preview: What To Buy Sell And Hold

2023-04-05 13:22:40 ET

Summary

• Q1 earnings season begins in earnest after the holiday weekend. By and large, the early reporters tend to be banks, while companies with physical inventory take longer to report.
• Bank earnings will offer clues as to the state of the banking system and the economy after the March episode of banking unrest.
• Bank stocks are cheap, but buying the dip in the wrong stocks will earn traders a one-way ticket to losses.
• What bank stocks to buy, sell, and hold before earnings.

After the holiday weekend, Q1 earnings season kicks off in earnest with reports from some of America's largest banks. With investor concerns over recession mounting, banks are among the cheapest stocks in the market. In contrast to big tech stocks trading for 30-50x earnings, America's largest banks mostly trade for under 10x earnings and have dividend yields of 3%-6%. Additionally, bank stocks tend to have both common and preferred stocks, creating opportunities for savvy investors to find relative value .

Retail investors are rushing to buy the dip in the weakest banks, but I believe you can find better value in the common and preferred shares of too-big-to-fail banks. In general, I believe that America's largest banks are buys, most regional/small banks are holds, and banks that have seen runs or credible rumors of runs are sells. Moreover, handicapping the relative value of preferred stock vs. common puts you in a better position to align your bets with your own investment thesis.

Sell:

One of the regionals that came under pressure back in March was Phoenix-based Western Alliance Bank ( WAL ). The stock had recovered nicely, but today they put out a financial update that actually omitted to disclose their deposit outflows , and the stock is tanking after it. This is actually fairly scary, as it implies they have a bigger problem than was previously known.

San Francisco-based First Republic ( FRC ), according to numerous online earnings calendars, reports earnings next week, and we'll see what kind of skeletons they have in their closet. FRC's credit rating is now in junk territory and falling, while depositors, employees , and shareholders have largely made for the exits. Turnarounds can sometimes be attractive, but with their business crippled and deposits gone, I think their best option is a sale to a stronger bank. In general, because banks' ability to do business depends on their reputation and creditworthiness, buying the dip in bank stocks that are seeing legitimate runs or panics is not advisable.

Beverly Hills-based PacWest ( PACW ) is another bank in deep trouble after seeing a run on deposits and ultimately losing about 20% of its deposits . They declined to do a capital raise in late March, but with the stock trading under $10 per share, it's not clear whether they're in a strong enough financial position to continue to do business normally.

Hold:

Charles Schwab ( SCHW ) is another battleground stock, with the stock having taken out its previous closing low in March. This time around, there are the same concerns over interest rate exposure and potential deposit outflows, as well as concerns over the company's future earnings power. I don't have a strong opinion on this one, but it's clear that there's strong disagreement among traders as to whether Schwab is a good buy here. If new information comes out about Schwab, the stock could move to either a buy or sell. If you like Schwab but aren't sure how their earnings will shake out, I'd argue their preferreds are a much better bet than the common.

Most other bank stocks will fall into the "hold" category as they're down YTD but may not have any serious problems with deposits. This is a fairly efficient way for the market to price uncertainty that may or may not come to pass. After they report earnings, there will be much more clarity about which banks are okay and which banks are actually in trouble.

Buy:

Bank of America ( BAC ) common stock has sold off nearly 20% this year and yields over 3%. Moreover, the company is (in theory) a beneficiary of higher rates. Various classes of BofA preferreds still trade a bit below par (yields over 6%), while bond yields have plunged. I like both the common and preferred stock.

JPMorgan ( JPM ), considered the rock of the banking industry, also offers over a 3% yield on its common stock. They're the biggest bank in America, and they report earnings next Friday. Here I like the common stock. Jamie Dimon's recent letter to shareholders leaned bearish, so waiting until after earnings may be the play.

Morgan Stanley ( MS ) yields closer to 4%, and its preferred shares trade at a 20% discount to par, offering nearly a 7% yield. Morgan Stanley owns Etrade, which massively benefits from higher rates, and from market volatility as its customers trade more. I like the common and preferred shares here as well.

Truist ( TFC ) is interesting as well because it's considered a regional bank by some, but it's actually a too-big-to-fail bank, one of the largest in the country. The common stock yields 6.5%. The market hates the common stock, but the preferreds are indicating no extra level of stress. I think the common is a good buy.

Bottom Line

Deposit outflows are the key question here to pay attention to as banks report earnings. Without deposits, banks can't make loans. As such, banks that are losing deposits are in trouble, while banks that are holding steady or gaining deposits are likely to continue to do well. These are especially important at the weaker regional banks, where bad news could drive rapid selloffs in excess of 50%. Overall, the banking system is seeing steady deposit outflows to money market funds (no one wants to earn 0% on their money!), but I view this more as something that will eat into profits for big banks rather than cause a crisis.

What are you buying/selling? Share your thoughts in the comments below!

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