Analyst sentiment on the U.S. banking sector has turned more negative in recent months amid a run-up in valuations to end the year.
As of Jan. 15, equity analysts had 67 "sell" or "underweight" ratings on U.S. banks with at least three total recommendations, a 40% increase from Sept. 30, 2019, and the highest quarter-end level since March 31, 2018. Analysts largely attributed the shift to stock market gains that have caused a reassessment of the sector's valuation potential amid a difficult operating environment. With interest rates on the rise, analysts expect net interest margin compression to hamper earnings as banks report 2019 fourth-quarter results and into the first half of 2020.
"Things that were trading at 9x [earnings] are now trading at 12x or 13x, so how much incremental upside is there when year-over-year NIMs are going to be down?" said Stephen Scouten, an analyst for Piper Sandler.
The SNL U.S. Bank and Thrift Index rose 17.77% from Sept. 1, 2019, to Jan. 15.
While analyst sentiment has taken a turn downward following the recent stock gains, the vast majority of ratings remain neutral or positive with sell or underweight ratings constituting just 4.1% of all ratings in the sector. Commerce Bancshares Inc. has the greatest proportion of sell recommendations among banks with at least 10 ratings, followed by Wells Fargo & Co.
Beyond the valuation gains, analysts said a tepid view of the economy's overall potential is also weighing on sentiment. With U.S. economic expansion more than a decade old, the market has become increasingly concerned about a potential recession on the horizon.
"Given the stock run-up of 20% from the bottom, combined with [gross domestic product growth] slowing and the implications for loan growth as well as some possible credit quality deterioration — I think that's all leading some people to be a bit more cautious," said David Chiaverini, an analyst for Wedbush Securities.
Over the first week of earnings, some banks beat expectations while others posted results in line with analysts' concerns. First Republic Bank posted a notable beat, driven by loan growth that remains ahead of industry averages, while the bank's margin came in under expectations, according to a note from Baird Equity Research. JPMorgan Chase & Co. and Citigroup Inc. also posted better-than-expected earnings on the backs of robust results in their fixed-income divisions.
On the other hand, Bank OZK reported a credit quality issue that caused its stock to suffer. And most banks reporting during the week of Jan. 13 posted the sort of margin compression that analysts expected, with guidance for 2020 allowing little opportunity for expansion.
Earnings results so far have shown the large banks' "ability as a whole to meaningfully grow operating earnings is going to be more challenging in today's operating environment," Vining Sparks analyst Marty Mosby wrote in a research note. At the same time, he said large banks have shown an ability to absorb margin compression and still deliver solid returns.
The bank sector's gains toward the end of 2019 came at a time when analysts tend to take a step back and reassess their ratings, making room for the recent spate of downgrades, Scouten said.
"People tend to reassess ratings when they get to a new year," he said. "So there is some normal revaluation with the new year."