Bank Valuations Price In ‘Worst of All Worlds,’ Says Wells Fargo Analyst

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(Bloomberg) -- Bank stocks are being overly punished by investors in the wake of the regional banking crisis, according to Wells Fargo’s Mike Mayo. 

Current assumptions factor in the “worst of all worlds” and overlook opportunities in the uncertainty surrounding the sector, the veteran banking analyst wrote in a note to clients. While banks are facing increased regulation, lower rates and a potential recession, some lenders are in a “zone of attractiveness” that could see their multiples increase by a third, Mayo said.

“We do not believe the group is ‘uninvestable’ or has 30% to 50% EPS downside risk as some assert,” he added.

Mayo still favors the big banks  — including JPMorgan Chase & Co. (NYSE:JPM), Citigroup Inc (NYSE:C). and Bank of America Corp (NYSE:BAC). — which have seen business flow their way after a few smaller regional lenders failed. But, he says he’s also keeping a close eye on U.S. Bancorp and State Street Corp (NYSE:STT). after Well Fargo’s “kitchen sink” analysis of various 2025 scenarios showed upside surprises for those two firms.

Read more: Mayo Cuts Price Targets for Banks, Saying ‘Goliath Is Winning’

Mayo also argues that easing levels of inflation alone are enough to justify higher bank valuations.

He says data dating back to 1960 shows a strong correlation between lower inflation and higher multiples for bank stocks. “Based on the historical regression, if inflation averages 4% for 2023, banks should be trading at an 11x P/E compared to 8x our adjusted EPS,” he said.

Wells Fargo’s economists currently project inflation will drop to 4% in 2023 and 3% in 2024, according to Mayo.

Aside from inflation, Mayo notes at least three other possible catalysts that could lead to a “re-rating” of bank stocks. Among them, a shift in Federal Reserve policy that leads to lower deposit costs, lower long-term rates that could ultimately help fuel more buybacks and a so-called soft landing for the economy that would cut expected credit costs.

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