Morgan Stanley Downgrades Banks, Taking ‘Chips Off the Table’

(Bloomberg) -- Morgan Stanley downgraded its view of large-cap banks after the group had rallied 23% so far this year, and as the Federal Reserve’s stress tests are over, which probably translates into fewer positive catalysts ahead.

The next six to 18 months “look tougher,” too, analyst Betsy Graseck wrote in a note. She reduced her industry view to “in-line” from “attractive,” and double-downgraded trust banks State Street Corp. and BNY Mellon Corp. to underweight from overweight, as they’re “most exposed to the curve,” with about half of their earning assets in securities and fewer “expense levers,” with “no branches to cut or call centers to cull.”

“Global GDP is slowing, inflation expectations are dimming, and the bond market is pushing the Fed to cut rates in 2019 and 2020,” Graseck said. If Europe were to provide more stimulus, that would add pressure to the U.S. Treasury yield curve, while U.S. jobs growth “appears to be topping,” she added. “A parade of rate cuts,” as per expectations, would make it “much harder for bank stocks to deliver positive surprises in operating leverage,” an important driver of bank stock alpha.

On the flip side, she’s not turning outright negative, “as credit remains strong,” with no signs of accelerating deterioration. Heading into earnings season, which starts next week, Graseck prefers companies that are “liability-sensitive/less exposed to rate cuts,” including American Express Co. and Discover Financial Services, and expects banks will drop their net interest income outlooks.

Read more: Bank Investors Should Brace for Earnings Misses, Atlantic Says

Bank stocks slipped in early Monday trading, with the KBW Bank Index shedding 1%. Shares of BNY Mellon fell 2%, the most intraday since May 30, while State Street dropped 3%; both were among top decliners. Deutsche Bank AG’s woes may be contributing, as its shares tumbled as investors reacted to its restructuring, though analysts said U.S. banks may capture market share as the German firm retreats.

SVB Financial Group was also among top bank decliners, falling as much as 2.9%, after it was downgraded at Raymond James and KBW. A “challenging rate outlook” will likely keep the Silicon Valley lender’s stock “at bay” for now, KBW analyst Christopher McGratty wrote in a note.

To contact the reporter on this story: Felice Maranz in New York at fmaranz@bloomberg.net

To contact the editors responsible for this story: Catherine Larkin at clarkin4@bloomberg.net, Steven Fromm

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