The Long and Short

Single ‘A’ regional banks still attractive

Dan Bruzzo, CFA | July 21, 2023

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

Big money center and regional bank paper have both lagged far behind the spread performance in broader financials over the past few weeks, as well as the overall investment grade market. Blame it on potential supply. With the prospect of enhanced capital requirements for large US banks and lingering fears from the spring banking crisis, many expected banks to aggressively raise public debt after reporting second quarter results. Despite potential supply pressures and ongoing operating challenges, the broad banking sector still remains undervalued with opportunity among the single ‘A’ regional banks.

A week into the earnings reporting season, the money center banks have largely delivered on expectations for increased issuance, bringing over $21 billion in debt over the past week. More could follow, and the large regionals are still expected to potentially join in. At the tail end of the regional banking crisis that gripped the markets throughout most of the spring, we highlighted the attractive relative value for single ‘A’ credit, and in particular some of the regional banks within that specific segment of the market. Those issues with better relative value included bank level debt obligations for KeyCorp (KEY: Baa1/BBB+/A-, bank level: A3/A-/A-), all debt obligations for M&T Bank (MTB: A3/A+/A) and bank level obligations for Huntington Bancshares (HBAN: Baa1/BBB+/A-, bank level: A3/A-/A-). While all three appear to be potential candidates to issue debt over the intermediate term, there still appears sufficient discount versus the peer group and the broader market to offer opportunity for outperformance in secondary securities.

Exhibit 1. Single ‘A’ rated domestic regional banks – intermediate debt maturities

Source: SanCap, Bloomberg/TRACE BVAL G-spread indications

So far, the second-quarter bank earnings reported have been somewhat mixed due to inherent challenges, but largely have come within expectations. Closely watched among regionals have been how deposits fared during the quarter and how the banks have been managing the challenging rate environment and projections for interest income going forward.

In the case of M&T, the bank reported deposits at period end of $162.06 billion, which was up almost 2% from the previous quarter and ahead of the consensus estimate of $157.76 billion. Average deposits throughout the quarter declined by about 1% sequentially to $159.4 billion. Management acknowledged that competition for deposits had shifted the deposit mix to higher costs deposits, a challenge faced throughout the peer group, mainly as demand deposits are shifting to time deposits and consumers search for more competitive rates.

MTB’s net interest income remained essentially flat versus the previous quarter, declining slightly to $1.8 billion, which was slightly ahead of expectations. The net interest margin declined 13 bps versus the prior quarter to 3.91%, which was in-line with estimates, as the competitive environment for interest bearing deposits impacted profitability. Management acknowledged that these pressures would likely persist over subsequent quarters but kept their guidance intact for $7 billion in net interest income for the full year.

KEY delivered similar operating results when it reported later in the week. Period end deposits increased roughly $1 billion sequentially to $145.1 billion, while average deposits were down about 3% for $502 billion from the prior quarter to $142.9 billion.

Net interest income declined 10.8% or $120 million sequentially to $986 million. The net interest margin was down 35 bp to 2.12% versus 2.47% the prior quarter and from 2.61% the previous year period. Likewise, the changes reflected the impact in a shift of funding mix to higher cost deposits throughout the quarter, only partially offset by higher yields from lending. KEY expects next quarter net interest income will be down a manageable 4 to 6%, with a subsequent 0 to 2% quarter-over-quarter drop in the final quarter of the year. Despite these near-term guidance revisions, management largely kept longer-term expectations intact.

HBAN’s top-line performance slightly edged out expectations in the second quarter. End-of-period deposits increased 1.9% to $148.0 billion from $145.3 billion in the first quarter of the year, well ahead of the consensus estimate. Meanwhile, average deposits throughout the quarter fell sequentially to $145.6 billion from $146.1 billion. The percentage of non-interest bearing deposits declined to 23% from 25% in the prior quarter.

Net interest income was $1.349 billion down slightly from $1.418 billion in the prior quarter, but actually increased 7% year-over-year. Net interest margin was 3.11% down from 3.4% in the first quarter and fell short of expectations. Management revised down 2023 guidance for net interest income, but it still remains in positive territory for the year at 3-5% growth versus 6-9% growth in the prior period.

Dan Bruzzo, CFA
dan.bruzzo@santander.us
1 (646) 776-7749

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