Sentiment is too negative, JPMorgan upgrades three regional banks to overweight

It has been a tough week for smaller US banks. KRE (NYSE:), the ETF that tracks regional banks, has declined about 16% since Monday when trading resumed after First Republic entered FDIC receivership and was sold to JPMorgan (NYSE:).

PacWest (NASDAQ:) has suffered the most. Its stock was down over 65% since Monday, amid reports the company is considering strategic alternatives. Rumors stoked concerns it too could suffer the same fate as First Republic, Silicon Valley Bank, and other recent failures.

Shares of Western Alliance (NYSE:) also suffered, falling 51%. At one point its stock was lower by nearly 70%. Shares later recovered after it denied reports that it is considering a sale. It later blasted the Financial Times for publishing the rumor, claiming the publisher was, “used as an instrument of short sellers and as a conduit for spreading false narratives about a financially sound and profitable bank.”

The chaos prompted calls for a moratorium on short selling of banks. So far, the SEC hasn’t taken such steps, but a report from Reuters suggests US officials are assessing the possibility of market manipulation being behind big moves in the banks.

With concerns about the banking sector so intense, some on Wall Street think now is the time to take the other side of the trade.

This morning, analysts at JPMorgan made a bold call, upgrading three regional banks to Overweight – Western Alliance, Comerica (NYSE:), and Zions Bancorp. (NASDAQ:).

“…regional bank stocks have seen intense shorting/selling pressure tied to a mismatch of (1) short-sellers feeling empowered post FRC being placed into receivership and (2) many long-only funds rethinking their capital allocation strategy into regional banks given concerns over NIM, credit and, new to the equation, deposit runs. To this end, we believe a sell-off in regional banks has become a catalyst itself to cause further fear and selling pressure,” wrote the analysts.

The analysts think sentiment has shifted too far to one side.

“As a result of substantial selling pressure since 1Q23 earnings season, our average regional bank stock is now trading at 6.6x 2023e EPS, 0.9x 2023e TBV, and at a 16% implied cost of equity. Despite that industry headwinds remain, this valuation tells us that investors (as well as short-sellers) are predominantly bearish. With sentiment very negative and a potential sector re-rating on the horizon, we now move to the middle of the boat and adopt a neutral sector stance.”

The JPMorgan analysts concluded, “With sentiment this negative, in our view it won’t take much to see a significant intermediate-term favorable re-rating of regional bank stocks.”