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Bearish bank investor turns bullish

While many investors have taken a decidedly negative view on bank stocks and punished the group, one formerly bearish investor believes current valuations represent a buying opportunity.

Several large bank failures have sparked broad concerns over banks' liquidity and credit quality and discouraged many generalist investors from investing in the group. Those dynamics have resulted in a sharp selloff in bank stocks — which are down more than 30% in 2023 — and have left the sector trading near the same levels witnessed during the height of the pandemic.

Brad Rinschler, managing partner at Down Range Capital Management, said in the latest "Street Talk" podcast that he believes valuations of many banks are attractive. In the episode, Rinschler and Connor Labozzetta, a partner at Down Range, discussed year-to-date performance of bank stocks, why they think failed institutions were not representative of many banks, the opportunity they see to invest at current levels, and their favorite banks to own.

Down Range adopted a negative stance toward the group early in 2022, saying that stocks were "out of gas" because they believed valuations were simply too high. Rinschler's fund launched in the summer of 2020 when he believed the bearish sentiment toward bank stocks at the height of the pandemic was overblown. Rinschler said in the episode recorded on May 16 that valuations are now back to similar levels and that has prompted Down Range to pivot its portfolio from short many banks to long a number of institutions with strong liquidity.

Rinschler said he is investing in names he knows in the Northeast and Mid-Atlantic, with a variety of funding characteristics: loan-to-deposit ratio of 95% or lower; 80% core funded, and noninterest-bearing deposits in excess of 25%. He also said the bank needs to be trading significantly below book value and have a share buyback and dividend in place.

"We're starting to find names that are trading under 75% of book that had a yield at the beginning of the quarter of 3. It's yielding 7. They're buying back stock, they have excess liquidity," Rinschler said in the episode.

Labozzetta said Down Range is no longer short banks beyond a few special cases. He said the fund's short book currently consists of digital lenders and commercial mortgage REITs and noted that Down Range expects significant deterioration in those companies over the next 12 to 18 months. Rinschler and Labozzetta acknowledged that banks will also face challenges from their commercial real estate exposures and said that institutions that grew those portfolios considerably in 2021 and 2022 will face problems. But ultimately, they see commercial mortgage REITs facing bigger problems from the CRE market.

"The biggest change we've made is we own a lot more banks on the long side than we did three weeks ago. We believe that despite the issues we've seen in some of these institutions, the industry as a whole has been oversold. And we're finding quality banks down here at, frankly, ridiculous valuations," Labozzetta said.

Early in 2023, Labozzetta said Down Range invested in banks with strong deposits and good management teams and geographies that they believed would not be as exposed to significant increases in interest rates. Meanwhile, Labozzetta said the fund shorted some of the "problem child banks," including Silvergate Bank, Silicon Valley Bank, Signature Bank and First Republic Bank. Labozzetta added that the fund pressed the shorts of the four institutions that either ultimately failed or wound down operations as more issues came to light.

Rinschler said it seemed like some of those banks took undue interest rate risk even though the Federal Reserve had signaled that it would begin raising interest rates. He noted that bank regulators often shock institutions' balance sheets by assuming rates increase 300 basis points in a year but actions by the central bank over the last 12 months have been far greater than that. He further said that many of the banks that failed were once darlings of the Street, especially in the generalist investor community that now feels burned by their closures. While those institutions once traded at elevated multiples, Rinschler noted that they either had exposure to less tested businesses like cryptocurrencies or had disclosed in their public filings that higher rates had pushed their balance sheets underwater.

"I think you got to get your head out of your model and start connecting dots," Rinschler said.

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

Listen on SoundCloud, Apple Podcasts and Spotify.