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What is Wells Fargo's Favorite Bank Stock?

Second-quarter bank earnings reports likely won’t be so hot, but then the outlook improves, Wells Fargo analysts said.
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Bank stocks have struggled so far this year, with the KBW Nasdaq Bank stock Index dropping 25%.

Second-quarter earnings reports likely won’t be so hot, said Wells Fargo analysts, led by the renowned Mike Mayo. But the second half of the year and next year look better, they wrote in a commentary.

They reduced second-quarter earnings estimates due to weak capital market revenue and loss reserve buildups.

“Thereafter, banks should benefit from the start of the best forecast net-interest-income (NII) acceleration in four decades and among the best pretax margin expansion in the S&P 500,” the analysts said.

“We believe this cycle is very different due to structural changes—more stable deposit funding (better NII growth), a technology revolution (better expense control), and de-risking (lower credit losses).”

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The analysts said the positives that will begin in the year’s second half include:

  • Better year-on-year earnings comparisons, with the end of reserve release distortion from 2021.
  • “NII to the sky,” thanks to “the fastest commercial loan growth in 14 years in the second quarter and recent Fed rate hikes.
  • “Expense controls. We forecast the second best pretax margin expansion in the S&P 500 out of 26 industries from 2022 to 2023. The biggest difference is only a modest growth in headcount today versus .. the 1970s. Further, employee costs … comprise more of bank expenses and are flattening.
  • “Relative risks. The $6 trillion investment-grade bond market still says that banks are less risky than [regular corporate bonds].”
  • “The Fed stress test demonstrates strong bank balance sheets.
  • “The consensus is negative. The consensus seems to say wait until fall to own bank stocks, and only then if inflation and GDP visibility are improved. Bank stocks showed most of the year-to-date underperformance in the first quarter. The second quarter was less bad. More investors seem like they are outside the ‘bank stock store,’ even if they aren’t yet buying.”

Looking at different parts of the banking sector, “Main Street banking should continue to outpace Wall Street banking,” the analysts said.

“In the second quarter, regionals should fare better: Fifth Third Bancorp  (FITB) - Get Fifth Third Bancorp Report, PNC Financial Services  (PNC) - Get PNC Financial Services Group Inc. (The) Report and Truist Financial  (TFC) - Get Truist Financial Corporation Report. Bank of America  (BAC) - Get Bank of America Corporation Report remains the analysts’ top pick.

Morningstar’s Take on Bank of America

“Bank of America has emerged as one of the pre-eminent U.S. banking franchises,” Morningstar analyst Eric Compton wrote in a commentary.

It “now has one of the best retail branch networks and overall retail franchises in the U.S., is a Tier 1 investment bank, a top four U.S. credit card issuer, a top three U.S. acquirer, has a solid commercial banking franchise, and owns Merrill Lynch, which has turned into one of the leading U.S. brokerage and advisor firms.”