Banking sector jitters returned as 'market was looking for a hint of rate cuts': Analyst

KBW Head of U.S. Bank Research Christopher McGratty discusses the state of the U.S. banking system as the market reacts to the decline in shares of PacWest Bancorp and Western Alliance amid the ongoing banking crisis.

Video Transcript

SEANA SMITH: What has been a wild week for regional banking sector. Let's run you through what just happened. Regulators seized control of First Republic Bank early Monday, making it the third regional bank to fail in less than two months.

JPMorgan then agreed to buy First Republic. And it's the second largest bank failure in US history. On Wednesday, Fed Chair Jerome Powell tried to reassure skeptical investors, saying in part that the US banking system was, quote, "sound and resilient," and the sale of First Republic was, quote, "an important step to toward drawing a line under the banking stress."

But investor jitters did return after PacWest confirmed late Wednesday that it was exploring a range of strategic options, including a sale. That sent shares plunging and triggered another round of selling in regional banks, including Western Alliance, Zions Bancorp, and Comerica. So what's next for this sector?

We want to bring in Chris McGratty, who's been watching the action play out all week-- the Head of US Bank Research for KBW, a Stifel company. Chris, it's great to speak with you again. So we're seeing a rebound today off of some of those very depressed levels. But as we wrap up the week, what's your takeaway? Is the worst behind us?

CHRISTOPHER MCGRATTY: Yeah, thanks for having me back. We thought this week was going to be fairly boring and quiet. Last week, we obviously saw First Republic close. I would characterize that as an orderly resolution. JPMorgan, the country's most prestigious bank, takes it over-- the least costly solution to the FDIC.

That's been an obstacle that investors have been flagging for the last three or four weeks. So we thought going into the week that things were going to turn back to the fundamentals and the fear. And obviously, that didn't happen. I think one of the reasons the jitters returned Wednesday with the Fed, I think the market was looking for a hint of rate cuts. We didn't get that. I think there's a timing mismatch there, but certainly a volatile week for the market.

AKIKO FUJITA: We also got that note from JP Morgan today, which seemed to help boost confidence in the regional banks-- the upgraded Western Alliance, Zions Corp, as well as Comerica. I mean, at the end of the day, though, does that really matter? It doesn't seem like these stocks are trading on fundamentals at all anyway.

CHRISTOPHER MCGRATTY: Right. We're seeing some really solid companies trade well below intrinsic value, below tangible book. Certainly, select upgrades, and we've done some ourselves throughout this, that helps. But you need broader sentiment for the group to improve.

You're seeing investors, these long only clients, they're underweight financials. Their view is that this is late cycle. And the typical of the book is to not buy financials. But everything has a price.

I think valuations will matter. But again, we've got to get back to distancing ourselves from March, moving away from that March 9 and getting back to looking at the real core operations of these banks. And the balance sheets look very good.

If you look at the-- if you look at the balance sheet and you didn't look at your screens, you would not think that you're in a solvency liquidity issue. You would say there's a margin issue, there's some earnings headwinds, but not a solvency.

SEANA SMITH: Chris, then I guess, what do you think is the pathway forward specifically for PacWest? Because even though the fundamentals look OK with their deposits-- their percentage of deposits insured right around 75%, do you think this bank is going to be OK as a standalone bank?

CHRISTOPHER MCGRATTY: The company-- this is a turnaround story at the start of the year. So this is new management. They came in. They took a pretty aggressive approach to the business and a holistic approach. In January, the stock was $25.

This was a good plan. The company's had to accelerate the plan, given the market stress. But, certainly, this company has valuable assets on the balance sheet. Now, we're market perform the stock. We are not recommending it.

But, certainly, the market is placing a real deep discount on the balance sheet. And we don't see the level of losses on this balance sheet compared to some of the others.

AKIKO FUJITA: Are there any regionals that you're particularly bullish on? I mean, if you are brave enough to get in, even after the kind of selloff that we saw this week, are there potential opportunities on the back of that?

CHRISTOPHER MCGRATTY: Yeah, there's always opportunities. We are neutral on the group. So we're being pretty selective. But I would say-- I would give it to you like this-- New York Community, which is the Bank that we've talked about before with you, we upgraded that stock after they did the Signature deal.

They bought Signature from the FDIC. They were paid multiple billions of dollars to take it off the FDIC's hand. So they immediately grew tangible book. That's a stock that had a great quarter.

The stock was up very, very nicely last week as recently. And so that's a stock with a 7% yield trading at book value, and the balance sheet is in great shape. One of the names we've talked a lot about is Western Alliance. That is your deep value play.

That's 70% of tangible book, very volatile stock. So those are two. And then in between, we like-- we really like East West. East West is a bank in California. It's about $60, $65 billion in assets.

They have a tremendous amount of capital. Now, they've been building capital over the last 15 years following the financial crisis. This is a stock that trades just above tangible book. They've got 13% common equity tier 1. They do not have the bond loss problem that others do.

And they've been waiting for moments like this to deploy that capital. I don't know if it's in the next six months, but this is a balance sheet that's really, really well positioned.

SEANA SMITH: Chris, despite a lot of the reassurance that we got from some of the big bank CEOs this week, despite what we heard from Powell, investors still clearly very nervous, very worried about what has been playing out within regionals. How long do you think it's going to take to restore that confidence?

CHRISTOPHER MCGRATTY: It'll take time. We know that we will emerge from this crisis. We always do. I think investors are really trying to identify when-- when is the regulation-- when are the regulators and the government going to step in? What is their max pain point from a bank perspective?

Because what we're seeing now is we're seeing this spread and this contagion, fear, really just permeate the market. And what they don't want to do is create more of an issue, because the banks have great balance sheets. They have a lot of capital. They have a lot of liquidity. The deposits have stabilized.

And what they don't want to do is create another wave of failures. That's not what's necessary. This is not a capital problem. This is a confidence problem.

AKIKO FUJITA: Well, Chris, we appreciate you joining us on this Friday.