Morningstar - Q3 2021 - 84

Investors
Another part of the turnaround is working through
a bloated expense base. One reason expenses are
bloated is because of spending on all these
regulatory initiatives. So, some of that spending
should come down. Also, as they've been working
on these regulatory items, they haven't made
much progress on increasing the overall efficiency
of the bank. I think they'll start making some
progress going forward. Wells came out with their
first expense guidance under new management
back in Q4 of 2020, which was another sign
that this expense turnaround is finally going to
start to happen. The final part of the turnaround is
strengthening the franchise and restoring its
reputation. I think they'll be able to make some
progress on that in 2022.
You don't want to be in a stock and have it sit
around for three years, which has been
the case with Wells to some extent. Now we're
getting more tangible signs of the timing
of this progress, and that's been a reason shares
have traded up.
They still trade at a slight discount. Right now,
I have them at 10% undervalued-while I have the
overall sector as roughly 10% overvalued.
Finding any discount on my coverage list right now
is about the best you can hope for, whereas
a year ago, some names were under 50% of my fair
value. Wells is one of the few that I think still
has some potential upside.
Lallos: Any regionals still looking like something
of a value?
Compton: The only regional to me that looks
5% to 10% undervalued or more is Huntington
Bancshares HBAN. It isn't as obvious a
story as Wells. It's more difficult to tell exactly why
the market doesn't believe in them as much
as I think it should.
Part of it is that we are giving them some extra
value for their merger with TCF Financial.
I think that's a catalyst. They're going to gain scale
and maybe the market isn't giving them full
credit for that. Also, Huntington has had decent
loan growth in the past, and that's slowed down a
bit for the whole sector. Maybe when that
starts to pick up, it will help. But otherwise, I'd say
that they're a pretty normal regional bank
84
Morningstar Q3 2021
with a nice mix of consumer and commercial
business. They're spread out, particularly
throughout the Midwest and they're decently run.
Lallos: Valuations aside, who are the standouts on your
coverage list in terms of moat or as capital allocators,
names investors should keep an eye on?
Compton: The number-one franchise in pretty
much anyone's mind these days when it
comes to U.S. banks is JPMorgan JPM. They're not
only the largest, but they have a history of
excellent management. Jamie Dimon's basically
a celebrity among managers of large corporations.
They have a complete franchise. Whether
it's asset management, wealth management,
investment banking, trading, retail banking,
cards, they have it all. They have a very strong U.S.
presence and they're building out their
international presence.
Being large can be an impediment to being
innovative or changing infrastructure or
technology. But they try to make up for that with
the largest tech budget in the industry. They're
investing billions of dollars in this kind of
stuff. As banking becomes more digital, more
about fintech, that's going to matter more. If you
had to pick a bank among the banks, JPMorgan's
one I would keep an eye on. They tend to
not get cheap, because they're so highly respected.
During the pandemic was one of the few times
they traded materially below my fair value.
Among the midsize regionals, I would highlight
M&T Bank MTB. They have a strong commercial
real estate operation in the Northeast,
particularly in New York City. They have a history
of good management and credit costs have
been exceptional for them over the decades.
They have a merger catalyst as well: They are
acquiring People's United Financial PBCT
at a decent price. It's going to offer a nice
expansion of the geography they service as well as
the types of customers they service. There
will be some expense synergies, as well. They still
seem about fairly valued to me. So, that's
a quality franchise that isn't too expensive yet.
The final one I would highlight is the smallest
bank I cover, Cullen/Frost Bankers CFR. This is a
classic old-school bankers' bank; it's very
relationally driven. They're a Texas-only bank and
they take a lot of pride in that, in knowing
their local markets. They have a long history of
good management and have survived many
downturns when many banks, particularly in Texas,
have failed-whether during the financial
crisis, or the energy downturn prior to that, or the
S&L crisis.
They, coincidentally, are also in the middle
of an expansion. They aren't doing it by acquiring
a competitor, but rather purely through organic
expansion. They've opened a number of new
financial centers, and they just announced plans to
do a whole new wave of openings in new
geographies in Texas. That's another nice lever for
growth. They, unfortunately, do look fairly
pricey to me at this point.
These three companies all have Exemplary
capital allocation ratings-which is rare among
my coverage.
Lallos: Any final words of advice for investors?
Compton: Valuations are not anywhere as cheap
as they used to be, so the easier money has
already been had. And banks are cyclical. If you
buy a company like a bank more at the
peak of a cycle or the peak of cyclical valuations,
you're probably not going to see excess
returns. I can't tell you how good the economic
boom's going to be, how long it's going to
last, or the timing of rate changes. There are a lot
of things that could turn out better than anyone
expects. Just keep in mind that valuations
are reaching up toward the higher end
of what we've seen historically, and these are
cyclical companies.
They could keep going up in the short term,
especially with people worried about inflation.
A lot of industries aren't a natural hedge
to inflation, and there's no telling how long this
sentiment of excitement about banks as an
inflation hedge will last. But at these prices, you
are counting on a fairly positive outlook. K
Laura Lallos is managing editor of Morningstar magazine.
https://www.morningstar.com/authors/44/laura-lallos

Morningstar - Q3 2021

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