Source: Barron's
Author: Al Ruth

Most people on Wall Street didn't anticipate the arrival of the current banking turmoil, and analysts' previous ratings and comments on the two recently bankrupt banks of America did not bring much reference value to investors. However, this isn't necessarily the analyst's fault; understanding the reasons may help investors in the future.

The parent company of a bankrupt Silicon Valley bank$SVB Financial (SIVB.US)$with$Signature Bank (SBNY.US)$They have all made a lot of money before, and are expected to be profitable in 2023. To be fair, regulators also failed to anticipate the current turmoil.

Six months ago, 75% of analysts covering SVB Financial's stock gave a “buy” rating. At the beginning of March, 50% of analysts still gave a “buy” rating. Six months ago, all analysts covering Signature Bank's stock gave a “buy” rating. By March of this year, 56% of analysts still gave a “buy” rating.

Before the bankruptcy incident, both banks were above average in popularity on Wall Street. In comparison, the average purchase rating ratio of S&P 500 constituent stocks was about 58%.

One thing to note is that the stock ratings given by analysts are relative to all the stocks they cover. Thus, the S&P 500 index's average buy-rating ratio of 58% can be understood to mean that if an analyst covers 10 stocks, he would prefer 6 of them over the other 4. After entering 2023, the average purchase rating ratio for all bank stocks was about 50%, which meant that, to a certain extent, bank stock analysts viewed the banking industry slightly more pessimistic than the average of Wall Street analysts.

However, investors still have reason to ask what happened. The job of analysts is to thoroughly understand the industries and companies they cover. Why did such people misjudge these stocks?

To better understand Wall Street's recent ratings of bank stocks, Barron's analyzed the ratings obtained by 73 banks in the KBW Bank Index, which tracks America's largest banks. According to Bloomberg's data, “Barron's” compared the purchase rating ratio a year ago with the performance of bank stocks during the same period. The analysis showed thatThere is no correlation between stock performance and ratingsBank stocks with a buying rating ratio of less than 50% actually performed better than other more popular bank stocks, outperforming by 2 percentage points on average. As of last week, the average decline in these bank stocks over the past 12 months was about 23%.

One thing investors should also keep in mind is that a “hold” rating is not the same as a “buy” rating. Wedbush analyst David Chiaverini (David Chiaverini) has been taking a wait-and-see stance on SVB Financial since June 2022. At the time, he downgraded the stock's rating from “buy” to “hold”. The target price was $450. Chiaverini said at the time that the risk of nearly 20% of SVB's loans during the economic downturn was higher than average. By the end of February, Chiaverini lowered the target price to $250.

At the beginning of March, out of all 42 ratings obtained by SVB and Signature, there were only 18 “hold” ratings, and there were even fewer “sell” ratings. Each of the two stocks had 1 “sell” rating. According to FactSet's data, Morgan Stanley (Morgan Stanley) analyst Manan Gosalia (Manan Gosalia) downgraded the SVB rating to “sell” in December last year. This is the only bearish sign since entering March. Autonomous Research analyst David Smith (David Smith) rated Signature as “sold.”

On the face of it, this seems like a major oversight for most Wall Street analysts, but there are other factors behind it.

First, the banking industry is very different from other industries. They have no factories or tools to manufacture equipment, etc. Banks have assets on paper, and the financing they obtain is also on paper. Depositors can withdraw their deposits at any time. There is a lot of financial leverage in the form of deposits and debts, soConfidence is far more important to banks than any other industry.

In an interview with Barron's, Smith said, “Trust is very important to banks. Once this trust is lost, or even just shaken, it's very difficult to regain trust, and it's hard to build a model for it.”

Barron's reached out to three other Wall Street analysts, who either did not respond immediately or did not comment.

Furthermore, it is impossible to fully understand what is happening within a bank just by studying financial reports. There are things many investors cannot understand about bond portfolios, loan quality, loan stock, how well loans match the liabilities that fund them, and more.In addition to the confidence that is important to all banks, investors' trust in management's ability to manage risk is also important to all banks.

Second,Once something happens to the bank, things will develop very fast.Bloomberg reported last week that Signature Bank had an outflow of $20 billion in deposits in one day. Judging from the bank's recent quarterly report alone, this could not be anticipated.

Nicholas Colas (Nicholas Colas), a former automotive industry analyst and co-founder of DataTrek Research, said:“Bank crowds and other black swan events are very difficult to predict. Analysts tend to be bullish on the stocks they recommend. This is always better than being a disaster predictor.”

Colas pointed out that one reason for this bullish trend is that stocks tend to rise over time. This is also the reason why stocks are recommended.

Another reason is that institutional investors, analysts, colleagues in the investment banking department, and covered companies don't like “sell” ratings: investors hold stocks recommended by analysts, colleagues in the investment banking department try to win business (investment banking departments are not allowed to influence ratings), and covered companies want to show their positive side.

At a time when the banking industry is in turmoil, people ask this question:How can analysts, regulators, and banks themselves better predict those unpredictable black swan events, or at least incorporate risk into stocks or businesses before extreme events occur.This is the idea behind the Federal Reserve Bank Stress Test. The purpose of the test was to inject confidence into the banking system, but the tests of regional banks did not alarm the panic currently facing the banking industry.

The above reasons are not meant to make excuses for bank stock analysts, but they help investors better understand the nature of analysts' research and ratings.

Analysts in every industry are good at many things, including comparing management teams and spotting industry trends, but they aren't necessarily the best stock pickers.

Editor/Somer