Raising Uncertainty Ratings on Regional Bank Stocks Over Funding and Regulatory Concerns

We are increasing our Morningstar Uncertainty Rating on our U.S. regional banking coverage (excluding U.S. Bancorp USB and PNC Financial Services PNC) to High from Medium, to reflect the increased uncertainty associated with predicting what the deposit base, funding costs, and regulatory costs will look like in the future. We’re leaving the Uncertainty Ratings on the largest banks unchanged, as we believe they are less likely to experience deposit base volatility.

(An explanation of the Morningstar Uncertainty Rating and how investors can use it to apply a margin of safety to a stock can be found here.)

Bank Stocks With Uncertainty Ratings Being Raised to High

• Truist Financial TFC
• KeyCorp KEY
• Comerica CMA
• Huntington Bancshares HBAN
• Zions Bancorp ZION
• Cullen/Frost Bankers CFR
• Regions Financial RF
• M&T Bank MTB

First Republic Bank’s FRC ratings are currently under review but we also plan to raise the Uncertainty Rating for First Republic to Very High once we resume full coverage.

Too-Big-to-Fail Banks Appear More Secure

We believe incremental pressure on deposit bases is most likely to materialize for regional banks, as depositors potentially consider sending some of their money to larger banks that are considered “too big to fail,” which include the global systemically important banks, or GSIBs (J.P. Morgan JPM, Bank of America BAC, Citigroup C, and Wells Fargo WFC). This could also include the largest regional banks on the margin (U.S. Bancorp, PNC, and Truist), as we don’t think it is unreasonable to assume the government would not let these banks fail either, although this is a less-certain implicit backing than that enjoyed by the GSIBs.

We also emphasize that no one knows for sure how many deposits will move and from whom. This is indeed an increase in uncertainty. We think there are realistic paths for most (if not all) of the regional banks we cover to be fine, although there are paths where things get more difficult as well.

Regulatory Responses to Bank Issues a Risk

Another source of uncertainty is related to regulatory pressure. Nothing is official yet, but we would not be surprised if regulators create rules that crack down harder on those banks that have the largest unrealized losses on their securities portfolios. This is why we’ve added Truist into the High Uncertainty Rating mix, as the bank has a higher unrealized loss percentage than peers, even as we admit the bank screens better on the estimated percentage of deposits at risk (42% versus an average of 47%), and so is perhaps in a better position to defend its deposit base.