Formerly bullish bank investor turns contrarian, saying stocks are 'out of gas'

While a number of investors are looking for higher interest rates to drive bank earnings and stocks higher, not all investors are sold on the prospect.

Bank stocks kicked off 2022 continuing the strong performance sustained in 2021 when the S&P Regional Bank ETF rallied more than 35% from year-ago levels. However, since mid-January, bank stocks have erased those early gains. Concerns over the broader economy, stemming from persistently high inflation and fallout from Russia's invasion of Ukraine, have weighed on the bank group.

Even with the recent sell-off, Brad Rinschler, managing partner at Down Range Capital Management, said in the latest "Street Talk" podcast that he believes valuations of many regional banks remain too high. In the episode, Rinschler and Connor Labozzetta, a partner at Down Range, discussed year-to-date performance of bank stocks, why they think many bank stocks could face pressure in the future and their favorite banks to own.

Rinschler believes the Street's growth assumptions are overly optimistic and include too many rate hikes from the Federal Reserve. He further argued that investors have not taken into account the potential for slower economic growth or slippage in credit quality.

"It's just the bar is way too high," Rinschler said in the episode. "If you sold community bank stocks at 13x forward earnings, you made money every time."

Rinschler's fund launched in the summer of 2020 when bank stocks were under notable pressure at the height of the pandemic. Down Range took a contrarian view at the time and believed the bearish sentiment was overblown.

Down Range has adopted a contrarian view once again and now has a more negative view of the bank group at a time when valuations have recovered.

Rinschler believes that elevated inflation will put more stress on the consumer and could lead to broader issues in the economy. He further noted that the yield curve briefly inverted on March 28, when the yield on the 5-year Treasury traded at a higher yield than the 30-year Treasury. Such an inversion has not occurred since 2006 and historically has suggested that a recession could lie on the horizon.

Beyond fundamental performance, Rinschler said bank stocks lack other positive catalysts. He said the bank group has not recently attracted new bank-focused funds or large generalist investors. He noted that close to 80% of bank stocks currently have "buy" ratings from sell-side analysts, implying that a large round of upgrades is unlikely to occur in the near term.

"The economic issues that we're seeing may not set into the bank's earnings until 2023, but it might not matter because they're fully valued. They're fully valued in a declining economy without a clear buyer for the stocks," Rinschler said. "I think the group is kind of out of gas here."

Down Range does own close to 20 banks in its portfolio. Rinschler said those names likely have not earned their cost of capital and are trading cheap enough that they would represent an attractive target to a regional bank. He pointed to the recent sale of Randolph Bancorp Inc. to Hometown Financial Group Inc. for nearly a 30% market premium as an example of a smaller bank fetching an attractive takeout offer.

"Street Talk" is a podcast hosted by S&P Global Market Intelligence.

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While Down Range owns names that it thinks could eventually sell, the fund's top three ideas are institutions they believe will grow at a quicker clip. The firm's top pick is Las Vegas-based GBank Financial Holdings Inc. The Down Range team noted that the GBank has partnered with Sightline, a payments technology provider that works with casinos and online gaming companies, to gather deposits and has achieved a 2%-plus return on assets through the institution's traditional banking offering. They further noted that the board — which includes a former Western Alliance Bancorp. director, the CEO of MGM Resorts International and former depository investment banker Mike Voinovich — owns more than 50% of the company's stock.

Separately, Rinschler said investors should look closer at Provident Financial Services Inc., which recently named Anthony Labozzetta its CEO. Rinschler said his firm is restricted from trading in Provident Financial because Anthony Labozzetta is the father of Down Range Partner Connor Labozzetta, but noted that the new CEO has a strong track record and could eventually double the size of the franchise.

Rinschler also recommended Bankwell Financial Group Inc. and touted its improved profitability profile over the last few years, during which the bank's return on assets rose to 1.17% in 2021 from 0.97% in 2019. He noted that the bank recently hired a new lending team, could benefit from the fallout associated with the pending sale of in-market competitor People's United Financial Inc. to M&T Bank Corp. and has a well-known activist, Larry Seidman, on its board.

"We think that management is there, the new lending team has done great, and there's parental supervision at the Board level, which we love. We love parental supervision because as you all know, a lot of these banks need it," Rinschler said.