It was less than six months ago when talks of a regional banking contagion drove down bank stocks. Even large financial institutions experienced major corrections despite having more insulation.
Silicon Valley Bank closed for good on March 10, 2023, and First Republic Bank’s failure soon followed, leading to JPMorgan Chase & Co. (ticker: JPM) acquiring the bank’s assets on May 1.
The main culprit of the recent regional bank closures has been rising interest rates. The Federal Reserve has been raising interest rates since March 2022 to combat inflation. In less than 18 months, the federal funds target rate went from the 0%-to-0.25% range to the 5.25%-to-5.5% range.
Government data in late August so far has pointed to a soft landing for the economy, with the labor market slowing as job openings and quit rates have declined significantly. This could mean that the Fed’s interest rate-hiking campaign is nearing an end, though Fed Chair Jerome Powell’s comments of late have indicated otherwise.
How Higher Interest Rates Affect Banks
But how do interest rate hikes affect banks in particular? Win Murray, director of research at Diamond Hill Capital Management, says higher interest rates have pros and cons for banks: “Theoretically, rate hikes are good for banks because the interest rates they charge for loans increase more than the interest rate they need to pay for deposits, which widens their net interest margin and improves their cash flows. In practice, you need to make sure the existing loan books weren’t established at such low interest rates that the bank ends up paying more for deposits than they earn on their existing loan books.”
Higher interest rates have improved banks’ profit margins. JPMorgan Chase, for example, reported 67.3% year-over-year net income growth in the second quarter. That’s a much higher growth rate than usual and reflects how higher interest rates can strengthen financial institutions.
However, many banks have long-term bonds on their books with lower interest rates. As interest rates increase, the value of their existing bond portfolios decreases. When banks run out of cash, they have to sell these bonds at a loss to cover withdrawals.
When a bank has to sell assets at a loss to cover withdrawals, customers get nervous and request their money. This chain reaction forces banks to continue selling bonds at losses, incites more panic and ultimately leads to bank failures.
Banks also have to consider how higher interest rates will affect demand for their products and borrowers’ ability to repay variable-rate loans.
What to Look For in a Regional Bank Stock
Many investors are understandably hesitant to jump into regional bank stocks now. However, some banks are more insulated from the disadvantages of rising interest rates than others. Effective safeguards allow banks to benefit from the wider profit margins these interest rates provide. Investors should analyze a bank stock’s financials and stay on top of industry-related news.
Murray recommends a specific metric for regional bank investors: “The most important consideration is the price you’re paying versus what the company is worth, and for bank stocks, the relevant valuation metric is tangible book value. The higher a regional bank’s valuation relative to their tangible book value, the more upside is already embedded in the stock price.”
A price-to-book ratio lower than 1 can indicate that a stock is undervalued and worth a closer look for value investors. Murray also recommends looking for regional bank stocks with diversified deposit bases and a prudent bank management team.
Investors looking for exposure to regional banks may want to consider these seven stocks:
|Regional bank stock||P/E ratio (TTM)||Dividend yield|
|Comerica Inc. (CMA)||5||5.9%|
|Truist Financial Corp. (TFC)||6.9||6.9%|
|M&T Bank Corp. (MTB)||7.4||4.1%|
|PNC Financial Services Group Inc. (PNC)||8.2||5.1%|
|Regions Financial Corp. (RF)||8||5.1%|
|Huntington Bancshares Inc. (HBAN)||7.1||5.6%|
|Citizens Financial Group Inc. (CFG)||6.4||5.9%|
Comerica shares have fallen by about 30% since the regional banking crisis took shape. Despite the uncertainty, Comerica’s business has continued to deliver. The financial institution reported 8.8% year-over-year revenue growth and 4.6% year-over-year net income growth in the second quarter. And Comerica stock has gained about 54% from its May 2023 lows.
The bank did face some challenges during the regional banking crisis. Comerica reported a $3.5 billion decline in deposits from Q1 2023 to Q2 2023, a 5.2% drop. That also represented a 20.7% year-over-year decline.
Nonetheless, the underlying business has been growing due to higher interest rates, and shares currently trade at a price-to-earnings ratio, or P/E, of 5. Comerica also supplies investors with a forward dividend yield of 5.9%.
Truist Financial Corp. (TFC)
Truist Financial shares are down by over 30% since the regional banking crisis unfolded in March. TFC has a P/E ratio of 6.9 and a dividend yield of 6.9%. Shares currently trade at a 0.71 price-to-book ratio, which implies a discount.
Truist experienced year-over-year declines in revenue and earnings that were partially offset by record-breaking insurance sales. Still, the company has announced its plans to maintain its 52-cent quarterly dividend ($2.08 per share annually). It is often a good sign if a company maintains the dividend and raises it each year.
Truist CEO Bill Rogers Jr. recently touted the company’s successful Federal Reserve stress test that “highlighted (the bank’s) capacity to respond to all scenarios.”
M&T Bank shares have done a better job of recovering from the regional banking crisis than some other banks’ shares. The bank’s executive management has plenty of experience, with an average tenure of 18 years. M&T’s stock is only down by 9.9% year to date as of Aug. 29, and it is valued at a P/E of 7.4. The company also pays a 4.1% dividend yield.
Second-quarter GAAP earnings per share for M&T came in at $5.05, representing a significant jump from $1.08 GAAP EPS in the second quarter of 2022 and $4.01 GAAP EPS in Q1 2023. Revenue jumped by 45.9% year over year. Plus, M&T Bank has a price-to-book ratio of 0.89.
In addition, M&T’s net deposits fell by a limited 1% from Q1 2023 to Q2 2023. Quarterly stabilization in deposits can help M&T navigate future challenges more effectively.
PNC Financial Services Group Inc. (PNC)
PNC shares are down by 21.1% year to date as of Aug. 29 and trade at a P/E of 8.2. PNC’s dividend yield is currently 5.1%. PNC held onto year-over-year revenue and net income growth in the second quarter, but by slim margins.
Deposits decreased by 2% from the first quarter to the second quarter. Like many bank stocks, PNC maintained its dividend but is taking a more defensive approach with its dividend hikes. It recently boosted its quarterly dividend on common stock by 3.3% to $1.55 per share, a lower growth rate than in previous years. PNC trades at a 0.97 price-to-book ratio.
Regions Financial Corp. (RF)
Regions Financial has been a top-performing regional bank stock. It’s only down by 10.6% year to date, which is similar to Bank of America’s performance as of Aug. 29. RF stock trades at a P/E of 8 and has a dividend yield of 5.1%.
The financial institution reported 12% year-over-year revenue growth in the second quarter, tallying $2 billion in revenue. Diluted earnings per common share stayed the same year over year, at 59 cents. Deposits decreased by only 1.4% from the first quarter to the second quarter, indicating some stability in this area.
Huntington Bancshares Inc. (HBAN)
Huntington Bancshares is down by 18.7% in 2023 as of Aug. 29, but it has exhibited a strong recovery since the regional banking crisis. Shares have gained about 22% from their May 2023 lows and now trade at a P/E of 7.1 and a 0.99 price-to-book ratio. HBAN pays current investors a 5.6% dividend yield.
The company’s second-quarter earnings were flat from Q2 2022, with $88 billion in cash, cash equivalents and contingent borrowing capacity as of June 30. This figure represents 205% of uninsured deposits. Deposits in Q2 increased year over year and from the first quarter to the second quarter.
Huntington CEO Steve Steinour highlighted the bank’s “aggregate moderate-to-low-risk appetite.” He views this stance as a position of strength that enables the bank to capitalize on future opportunities that can emerge in this environment.
Citizens Financial Group Inc. (CFG)
Founded in 1828, Citizens Financial Group is headquartered in Providence, Rhode Island, and has 1,100 branches and 3,400 ATMs. In the second quarter, Citizens Financial generated 31% net income growth and 4.8% revenue growth year over year. The financial institution has maintained its commitment to its quarterly dividend of 42 cents per share.
CFG stock is down by 25.4% year to date as of Aug. 29, and it has a P/E of 6.4. It has a 5.9% dividend yield and a 0.62 price-to-book ratio.
Citizens Financial has a brighter outlook amid stabilizing deposits. Period-end deposits were up by 3% from the first quarter to the second quarter, and they were down only 1% year over year.