Those of you that follow me on X (Follow Me On X) or are fortunate (or unfortunate) enough to talk to me regularly know that I rarely short bank stocks. I am biased to the long side and am much less active than most. I prefer fewer, larger sized positions within the bank space (and in general). I look for banks that have superior revenue/share, earnings/share, and TBV/share track records over time which tends to be the secret to investing success, so long as you pay at least a fair price. I prefer buying larger more liquid names. I rarely do small caps. And I measure my bank stock returns not only by beating BKX or KRX, but also by comparing it to larger indices like the SPX.
Where am I going with this? If I were to short bank stocks this is how I would think about things today.
An Eventful 12 Months For Bank Stocks.
A boring review of bank stocks over the past 12 months would say we’re up about 22%, which would be true. The reality is we’ve experienced quite a bit of whiplash. Almost a snip snap, Michael Scott feeling in the Office.
May of 2023 to August of 2023 saw the end of the world end for banks and a fairly vicious rally took place with 27% coming in under 3 months.
That August high would turn out to be a bit of a head fake as the relief that came with guaranteed deposits, the BTFP, and plenty of Fed talk gave way to a 22% downdraft as 10-year UST rates took off and ticked 5% towards Halloween in 2023. That was one of the single best times I’ve seen to buy duration in 15 years and yet very few did, lesson in there.
We wouldn’t know it at the time, but that 5% rate would be the local top in yields and with a 120bps rally in long bonds, KRX would see an even more vicious 37% rally. People thought they were geniuses …
Until Christmas came and rates started ticking back up from the 3.80% lows as inflation fears came back, the Fed Dots said we’d have 7 cuts in 2024, and most banks mis-budgeted accordingly. Things were squishy, but we all felt fine until February came and NYCB dropped an absolute nightmare on all of us. When it was all said and done, we were down 16% from the highs and people started selling again and the doomers crawled back out from their caves to tell us about the end of regional banks, again.
Recently we’ve had some boring but good earnings and this nice little 10% rally off the April 2024 lows gave us a mini breakout of the range we saw post NYCB. From a purely technical standpoint, this rally and the potential for it to keep going towards the December 2023 highs in KRX provide an interesting opportunity to look at shorts.
Why lean short? Well to start, banks here feel fairly valued from a fundamental earnings standpoint given a high-rate environment. That’s of course unless rates change and head lower on the short end or steepen, and I have never been a big rate guesser. That is because I have learned that I can’t predict rates and thanks to Jim Bianco, you should realize this sooner than later too. The track record of the Fed Funds Futures market versus what has actually happened to rates is all you need to see to know that over time you can’t predict rates. Shoot, even the Fed Dot Plots got it wrong in 2022, comically wrong in fact.
Speaking of bank earnings, since 2019 earnings in the KRX are basically flat. It didn’t feel that way given the COVID bust and the COVID stimulus & PPP response boom, but we’re kind of back to square one and earnings are down roughly 30% since the peak in Q1/Q2 of 2023. While the pace of declines might be slowing, the overall trend is not our friend for banks. I need not tell you about all the potential for CRE or credit risks in the system, but that is not going to go away any time soon. And so from a purely fundamental standpoint, if you believe earnings are what drive price, it’s hard to get full bore long banks unless you have a view on non-bank factors: tax cuts, M&A & anti-trust policy easing, rates going down, etc. Those all may come to fruition, but like in poker, you do have to play the cards you’re dealt not long for the ones you didn’t get.
Another reason why I could lean short is related to multiples and valuations. If you look back to 2011 you could absolutely argue that banks are cheap on a P/E basis. I would actually agree with you there. Using averages, one could infer there’s a couple more turns of multiple expansion that would take us to 117 on the index which would be a 15% bump to returns. Maybe we even go to 15x earnings (before earnings improve) which would take the index to 126 and would be a 23% bump to returns. But for this to happen, I do think you would need to see some resolution on who will be present and what will happen to inflation (relevant given commodities are flying lately).
Looking instead at more recent history and going back to 2019, we’re pretty fairly valued. To be honest, given some of the price action lately I could absolutely see us trending a bit higher. But I think there is a relative lid on valuations at round 13x or 110 on the KRX which is basically the December 2023 highs. And that’s for the index overall, I’m not even talking about individual names that have worse EPS or credit situations than the index at large. This fair value starting point plus a pretty robust rally of late does give shorts a good place to layer in should they want to. For me, I haven’t owned regional banks overall since December of 2023 opting instead for a few larger positions in big banks like C. I do own some WAL as I think growth is mispriced and they will outperform in rates down largely due to Amerihome.
The Short List
And now what you’ve been waiting for. This is for all banks under $50 billion in assets and is ranked by market cap. And while I’m hesitant to give out names that I’d short, I hope that the logic I laid out will help you find your next target if you should choose. I know I’m missing a few key things, but this is a good start. Also, as you go down in market cap the data gets spottier.
One caveat: given the recent interest in M&A it is entirely possible that some short candidates are actually takeout targets. The best way I know to mitigate this is to look for younger management teams who are less likely to take the money and run than their older and wiser cohorts. From a risk to shorting standpoint the IBTX deal today does give you a good sense of how much someone is willing to pay for your banks. IBTX was a mid-single digit ROE type bank with $19b in assets and sold to SouthState for 147% of TBV.
Another caveat: for a lot of these banks, a surprise rate cut, or rates down will hurt as a short, so consider funding shorts against KRX overall or against another liability sensitive name you like.
Logic Behind the Screen:
High short interest was called out and while I didn’t look into borrow rate for any of these, it will let you know if others are shorting the stock also. OZK, AX, TBBK and BOH are all popular shorts already.
YTD percentage change is an interesting one. I’ve noticed a trend of the worst performers through the March Madness episode to have rallied the most of late. So, in theory you do want someone that has been beaten up, but one that has rallied a lot off of the recent April lows. FFWM and DCOM are good examples.
Valuation should always factor in and honestly some people care a lot about it. I don’t care as much about it and have too many stories of people shorting high valuation names just because, and it didn’t work out. Take everyone’s favorite “short on valuation” FFIN as an example. Always at a big premium, always hated, always performing.
EPS change needs to be looked at in the context of one-time type items, but of course the worse the decline in EPS, the better the target should look as a short. KRNY, FFWM, CZFS, and ACNB show big declines in EPS YoY.
NIM & COF kind of play into this EPS decline. One thing to be careful about with a high COF is that these banks will be more reactive to long rates and really just perceptions of what could happen to interest rates. Or put simpler, high COF banks should outperform in rates down. HIFS probably wins for thinnest margin here.
NPLs & L/D ratio are obvious ones. So is CRE concentration. You want people whose loan book is deteriorating behind the scenes. You also want someone who has a higher L/D ratio because credit deterioration will impact them more. It also contributes to margin squeezes as every dollar of new growth should be funded at 5.5% or higher. EGBN, BY, TBBK, OSBC and LOB all flag higher for different reasons.
Dividend payout ratio for the last year and for the last quarter are another important & obvious one. Banks traditionally attract dividend investors and as NYCB proved, when you mess up and need to cut the dividend to preserve capital things go south. ASB, BOH, and FIBK are larger examples of the group below.
The last two I added were Institutional ownership and Insider ownership. The caveat being it is sometimes hard to short banks that have low institutional ownership. High insider ownership can mean different things, but what it does make is decisions will be made with shareholders in mind. MBIN, BOKF, and FBK all have higher insider ownership.
The Screen:
So, there you have it. If you want to talk about any of these please send me a note and Follow Me On X.
A last word, I appreciate you all. Having you all follow & interact means a lot to me. But one small note, most content like this will be going behind a paywall going forward. It’s time. But if you are a free subscriber; I am going to give a discount, so make sure you’re at least a free subscriber by signing up now. And spread the word to any of your friends that like bank stocks. Not everything will be paywalled, but certainly heavy data or actionable idea type stuff will be.
Happy Monday, have a great week, and a have a great Memorial Day. The USA is the greatest country on Earth, and we are blessed to have the opportunity to live free. Do everyone a favor and thank a veteran or pay respects to veterans that have given their lives so we can live free. Thank you to all of you that have served, to all that have given their lives for the USA, and to all of the families of veterans for sacrificing so much.
Gratefully,
Aurelius