Why Wall Street Analysts Missed the Banking Turmoil

Six months ago, 75% of analysts covering shares of SVB Financial rated them Buy. Coming into this month, 50% of analysts still rated SVB at Buy. As for Signature Bank, 100% of analysts covering the stock rated it Buy six months ago. Coming into March, 56% still had bullish ratings.

Until recently, both banks were more popular than average on Wall Street: The average Buy-rating ratio for stocks in the
S&P 500
is about 58%.

However, investors also need to remember that analysts’ stock ratings are relative to their entire coverage list. So the average S&P Buy-rating ratio of 58% for stocks can be read that if an analyst covers 10 stocks, they prefer six to the other four. Coming into 2023, the average Buy-rating ratio for all bank stocks was about 50%. That means, in one way, bank analysts were slightly more negative on their sector than the average Wall Street analyst.

Nonetheless, investors would be right to ask what happened and how could such a big percentage of Wall Street analysts got these stocks wrong. It is the analyst’s job to know the industries and companies they cover in depth.

To better gauge how Wall Street’s recent ratings on the banking sector have done, Barron’s looked at ratings for 73 banks from KBW Bank indexes that track the largest U.S. banks. We compared Buy-rating ratios from one year ago with how the bank stocks did over the past 12 months, using Bloomberg data. Our analysis showed that there was no correlation between how the stocks did and their ratings. The bank stocks with Buy-rating ratios below 50% actually outperformed the remaining more popular stocks, by an average of 2 percentage points. Coming into this week, the average drop for these bank stocks was roughly 23% over the past 12 months.

Investors should also remember that Hold ratings aren’t Buy ratings. Wedbush analyst David Chiaverini has been on the sidelines for SVB Financial since June 2022, when he downgraded the stock to Hold from Buy. He pointed out at the time that almost 20% of SVB’s loans were at above-average risk in a downturn.

“An economic contraction may negatively impact early-stage credit quality, which represents 2% of the loan portfolio, while its growth-stage loans represent 6% of loans, and its innovation [commercial and industrial] represent 11% of loans,” he wrote at the time. Back then, his price target was $450 a share; the stock had recently broken below $400. His stock price forecast has since come down: Chiaverini’s target was $250 at the end of February.

At the start of this month, the total number of Hold ratings for SVB and Signature was 18 out of 42 combined. Sell ratings were even rarer, with two overall—one for each stock.
Morgan Stanley
analyst Manan Gosalia downgraded SVB to Sell in December, making that the lone bearish call on the stock going into March, according to FactSet. Autonomous Research analyst David Smith had the Sell rating on Signature.

There are a few other factors behind what, on the surface, appears to be a major oversight by most Wall Street analysts.

First, banking is very different than other businesses—there are no plants and equipment-making widgets. Banks assets are paper, and they are financed with more paper. Deposits can leave at any time. There is so much financial leverage—in the form of deposits and debt—that confidence in banking is simply much more important than in practically any other business.

“Trust is so important for a bank, and hard to get back when it gets lost, or even shaken,” Autonomous’ Smith tells Barron’s. It’s “very hard to model this.”

Barron’s reach out to four other Wall Street analysts, who either didn’t immediately respond or declined to comment.

What’s more, a bank’s published financial reports still can’t fully tell anyone exactly what’s going on inside the bank. There is too much extra detail about bond portfolios, loan quality, loan warehouses, the match between loans and the liabilities that fund the loans, and more that isn’t transparent. Just as confidence is key for any bank, trust in management to manage all bank risks is critical for an investor in any bank.

Secondly, things can happen fast at banks. Bloomberg reported this week that $20 billion in deposits fled Signature bank in a day the previous week. No one could have guessed that would’ve happened from looking at the bank’s most recent quarterly report.

Lastly, no one is really good at predicting so-called black swan events—things that happen so rarely they are almost unpredictable. This week’s panic in the banking sector is certainly raising the question of how regulators, analysts, and banks themselves could be better at foreseeing such events—or at least at factoring in what happens to a stock or franchise when extreme events occur. That is the idea behind the Federal Reserve’s bank stress tests, which are designed to instill confidence in the banking system. But the tests for regional banks didn’t sound the alarm for the panic facing the sector now, either.

None of these reasons are designed to completely lets bank analysts off the hook, but they will hopefully help investors better understand the nature of bank analysts’ research and ratings.

Across sectors, analysts are good at many things, including comparing management teams and identifying industry trends. They aren’t always the best stockpickers, though.

The
SPDR S&P Regional Banking ETF
(KRE) fell 6% in Friday trading. The S&P 500 and
Dow Jones Industrial Average
dropped 1.1% and 1.2%.

The ETF is down about 40% from its 52-week high and down roughly 30% from its March high.

Write to Al Root at allen.root@dowjones.com