Why Wall Street analysts didn’t see the banking sector turmoil coming

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Wall Street hasn’t covered itself in glory through the turmoil of the banking sector. Analyst ratings and commentary related to the two banks that collapsed this month have not been helpful to investors. It’s not all analysts’ fault though, and understanding why may help investors in the future.

Most people on the street did not see these bank failures coming. Both

SVB Financial

(ticker: SIVB)—the parent company of the failed —and the collapsed Signature Bank (SBNY) were previously making a lot of money and expected to turn profitable in 2023. In fairness, the regulators also failed to predict the current turmoil.

Six months ago, 75% of analysts covering SVB Financial’s shares had a Buy rating on them. Coming into the month, 50% of analysts still rate SVB a Buy. For Signature Bank, 100% of analysts covering the stock rated it a buy six months ago. Coming into March, 56% still had a bullish rating.

Until recently, both banks were more popular on Wall Street than the average: average buy-rating ratio for the stock.

S&P 500

is about 58%.

However, investors also need to remember that analysts’ stock ratings are relative to their entire coverage list. So the average S&P buy-rating ratio of 58% for stocks can be read as if an analyst covers 10 stocks, they prefer six over the other four. Coming into 2023, the average buy-rating ratio for all bank stocks was around 50%. This means that, in a sense, bank analysts were slightly more negative on their sector than the average Wall Street analyst.

Still, investors are right to ask what happened and how can such a large percentage of Wall Street analysts get these stocks wrong. It is the analyst’s job to know the industries and companies they cover in depth.

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To better assess how Wall Street’s recent ratings on the banking sector have performed, Baron’s Looked at ratings of 73 banks from the KBW Bank Index, which tracks the largest US banks. compared the Buy-Rating ratio from a year ago with the performance of bank stocks over the past 12 months, using Bloomberg data. Our analysis showed that there was no correlation between how stocks performed and their ratings. Bank stocks with buy-to-rating ratios of less than 50% actually outperformed the remaining more popular stocks by an average of 2 percentage points. Coming into this week, the average decline for these bank stocks over the past 12 months was about 23%.

Investors should also remember that Hold ratings are not Buy ratings. Wedbush analyst David Chiaverini has been bullish on SVB Financial since June 2022, when he downgraded the stock to hold from buy. He reported at the time that about 20% of SVB’s loans were at higher than average at the time of the recession.

“An economic contraction could negatively impact the credit quality of early-stage loans, which represent 2% of the loan portfolio, while its growth-stage loans represent 6% of loans, and its innovation. [commercial and industrial] representing 11% debt,” he wrote at the time. Back then, his price target was $450 per share; the stock recently broke below $400. His stock price forecast has since come down to: Feb. Chiaverini had a target of $250 at the end of .

Earlier this month, the total number of hold ratings for SVB and Signature was a combined 18 out of 42. Sell ​​ratings were even more rare, two in total — one for each stock.

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Morgan Stanley

According to FactSet, analyst Manan Gosaliya downgraded SVB to a sell in December, leading to the lone bear call on the stock going into March. Autonomous research analyst David Smith has a Sell rating on Signature.

There are other factors behind this, which on the surface appears to be a major oversight by most Wall Street analysts.

First, banking is very different than other businesses – there are no plants and equipment making widgets. Banks’ assets are paper, and they are financed with more paper. Deposit can be left at any time. There is so much financial leverage – in the form of deposits and loans – that trust in banking is far more important than in practically any other business.

“Trust is very important to a bank, and when it is lost, or even shaken, it is difficult to get back,” tells Autonomous’ Smith Baron’s, It’s “very hard to model it.”

Baron’s Approaches to four other Wall Street analysts either did not immediately respond or declined to comment.

What’s more, a bank’s published financial reports still can’t tell anyone completely what’s going on inside the bank. There are many additional details about the bond portfolio, loan quality, loan warehouses, matches between loans and liabilities funding the loans, and more that is not transparent. Just as trust is important for any bank, it is important for an investor in any bank to have confidence in the management to manage all the risks the bank is facing.

Secondly, things can happen faster in banks. Bloomberg reported this week that $20 billion in deposits fled Signature Bank in one day last week. Looking at the bank’s most recent quarterly report, no one could have guessed that this would have happened.

Finally, no one is really good at predicting so-called black swan events – things that happen so rarely that they are almost unpredictable. This week’s panic in the banking sector is certainly raising questions about how regulators, analysts and the banks themselves can get better at predicting such events – or at least factoring in what happens when extreme events happen. . That’s the idea behind the Federal Reserve’s bank stress tests, which are designed to instill confidence in the banking system. But the tests for regional banks did not sound the alarm for the panic facing the sector.

None of these reasons are designed to completely shut out bank analysts, but hopefully they will help investors better understand the nature of bank analysts’ research and ratings.

In all sectors, analysts are good at many things, including comparing management teams and identifying industry trends. However, they are not always the best stockpickers.

SPDR S&P Regional Banking ETF
(KRE) fell 6% in Friday’s trading. S&P 500 and

Dow Jones Industrial Average

fell 1.1% and 1.2%.

The ETF is down nearly 40% from its 52-week high and nearly 30% from its March high.

Write to Al Root at [email protected]