"All animals are equal, but some animals are more equal than others.”
George Orwell
Animal Farm (1945)
April 1, 2024 | Last week, S&P downgraded five regional U.S. banks due to their commercial real estate (CRE) exposures, Reuters reports, “in a move likely to reignite investor concerns about the health of the sector. The ratings agency downgraded First Commonwealth Financial (FCF), M&T Bank (MTB), Synovus Financial (SNV), Trustmark (TRMK) and Valley National Bancorp (VLY) to ‘negative’ from ‘stable,’ it said.”
Regional and large community banks have been getting shellacked since New York Community Bank (NYCB) dropped a restatement earlier in Q1 2024. If you look at the results for the WGA Bank Top 10 Index, it is tracking the Invesco KBW Bank ETF (KBWB) but the WGA Bank Top 25 Index is underperforming. Why? Wall Street prefers size (aka "liquidity") to quality. The fact that the ratings community and the media are all in favor of big is no surprise.
Source: CapIQ/Thematic
Looking at the three month total return for the 110 names in Peer Group 1, who are the top three stocks? Citigroup (C), American Express (AXP) and Wells Fargo (WFC), a name we have been writing about and accumulating since the start of the year.
Source: Bloomberg
As you can see, a number of the banks in the WGA Bank Top Ten Index are in the group above, but so are some very large chronic underperformers. The major ratings agencies add a full notch of uplift for large banks on the assumption that they will be bailed out by the US Treasury in the event of default. Investors know this and select stocks accordingly.
What is the message? When the wheels are coming off the wagon and the rating agencies are dropping the guillotine on small banks, size matters, no matter how ugly or mediocre the large issuer. The top rating agencies have a bias in favor of size (aka “market share”) visible for all to see in their ratings criteria, even if market share can lead to outsized credit losses as we discussed earlier (“Small Banks Have Big CRE Risk? Really? | Bank of America Update.")
The distribution of banks based upon three-month total return tells the tale of size, but it also tells a story about stress. The bottom 60 banks in the group had negative total returns in Q1 2024. Some of the lowest rated banks in the WGA Bank Top 100 managed to run into the top quartile because of the fears of equity managers and the related passive strategies. Fact is, when the share prices of large crappy banks start to rise, the passive strategies buy more of the same crap. The chart below shows the WGA Bank Top 100 sorted by three-month total return.
Source: Bloomberg/WGA LLC
While the bottom quartile is tiny relative to the other groups in terms of market cap, the sharp downward moves of some names were enough to pull down the performance of the WGA Bank Top 25 and Top 50 Indices over the past three months. So while the WGA Bank Top Indices still outperform the KBWB over the past year, the trend is for smaller banks to underperform their larger peers in 2024.
Source: Bloomberg/WGA LLC
NYCB, for example, is the large skew at the far right side of the chart. The bank's share price dropped almost 70% over the past three months, but the performance for other small banks is far better. The large downward skew in NYCB had a disproportionate negative impact on the entire WGA Index.
At the start of 2024, NYCB ranked 26th out of 100 in the WGA Bank Top 100 Index. Based upon the three-month returns through Q1 2024, NYCB ranked at the bottom of the 108 public banks in Peer Group 1. Because of the bank's restatement, poor fundamental factors and appalling market performance, it's a pretty good bet that NYCB will drop out of the WGA Bank Top 100 in Q2 2024.
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