Deutsche Bank Comments on Sell-Off in Banks (BAC) (C) (JPM) (GS) (MS)

Banks are down 25% since their July highs, twice the decline of the S&P 500, noted Deutsche Bank analyst Matt O'Connor. In a research note, he discussed weakness in bank stocks and lowered price targets across the sector. He also commented on how bad bank EPS could be in severe conditions.

Overall the Deutsche Bank analyst thinks investors should stick with quality names like JPMorgan (NYSE: JPM), though he called the decline in Bank of America (NYSE: BAC) “overdone.”

“It’s not surprising that bank stocks have lagged, but the amount of underperformance makes us wonder what stocks are pricing in/worried about,” said O'Connor. “From a macro point of view, we believe the sell off mostly reflects fears of a slowing economy and tighter monetary policy/reduced liquidity. From a bottom’s up point of view, we see two main sources of downside to bank EPS—higher credit costs and weaker capital markets revenue.”

The analyst continued, “In total, we estimate a severe commercial credit cycle could reduce EPS by 25%. A material short fall in capital markets could reduce EPS by another 15-20% at BAC, C and JPM—implying total potential downside of 40-45%. In this scenario, we find 50% downside at GS and MS. Large regional banks could be 30-35% once we factor in other drivers. We view these as a very stressed EPS downside scenario, rather than a base case or a mild downside scenario (which we also discuss in this note). But with stocks down 25%, we’re trying to figure out what’s being priced in/feared.”

O'Connor added, “High quality banks (JPM, MTB, PNC, USB and WFC) have outperformed the BKX by 670bps since the July 22nd highs (with JPM outperforming market sensitive peers by 12% over this period). Despite this strong relative performance, we stick with our overweight quality bank call that we made in early September given our more cautious macro view. Of the above names, MTB, PNC and USB are our favorites as they have the least amount of risk to weaker credit and market sensitive revenues. CFG also seems oversold.”

Discussing market sensitive banks, the analyst said. “These stocks are down 30% since July highs and valuations on book are low at 0.8x 12/31 TBV. However, the 500bps of underperformance vs. the overall bank group is not necessarily outsized given macro and earnings risks are higher for these cos vs. large regionals in our view. Given these, we remain selective in this group. JPM is our favorite, but BAC is overdone in our view.”

For an analyst ratings summary and ratings history on Bank of America click here. For more ratings news on Bank of America click here.

Shares of Bank of America closed at $12.96 yesterday.

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