Baird sees favorable risk/reward in US bank stocks into earnings

Baird models ~3 basis points of net interest margin expansion for Q1 2026 and notes large/mid-cap banks trade near 6x second NTM pre-provision net revenue. H8 loan growth was 0.6% as of March 18; MBA mortgage applications rose ~18% q/q and ~49% y/y, supporting modest sector revenue upside. M&T Bank (MTB) reported record 2025 earnings of $2.88B, ~6% LTM revenue growth, a new $5B share repurchase authorization (replacing $4B), a $1.50 quarterly dividend (2.85% yield), and trades at P/E 12.32, PEG 0.72—indicating discounted valuation with upside potential. Baird views sector headwinds as contained, suggesting an acceptable quarter and a favorable risk-reward for select bank equities.

Analysis

Regional banks are entering a phase where idiosyncratic capital return programs and cyclical mortgage/fee flows create asymmetric outcomes: modest positive drift in earnings if funding costs remain stable, but rapid downside if credit or deposit dynamics re-price. As a rule of thumb, every 20–30bp of net interest margin expansion on a $50–150bn loan book translates into tens-to-hundreds of millions of dollars of incremental pre-tax income — enough to move P/E multiples materially when share issuance is neutral or buybacks accelerate.

Second-order winners include mortgage servicing and fintech vendors that capture recurring fee income as mortgage activity rebounds; they see revenue uplift without the same balance-sheet sensitivity. Conversely, private-credit providers and lightly collateralized CRE lenders are exposed to a compressed liquidity window if macro volatility triggers spread widening — that spillover shows up with a lag in loan-loss provisioning rather than headline NIM numbers.

Key near-term catalysts are earnings prints (surprise NII or LLP beats), monthly mortgage application trends, and Fed signaling on rate path; these operate on different cadences — days for prints, weeks for data flows, months for realized NIM and buyback execution. The main tail-risks are a) a shock to CRE/consumer credit that forces mark-to-market provisions, b) a short, sharp deposit flight, or c) a rapid yield-curve flattening that kills spread income; any of these can wipe out expected buyback-driven EPS accretion within a single quarter.

Key Decisions for Investors

• Long MTB equity (6–12 month horizon): initiate a 7–10% position size in core book with active downside protection — buy 9–12 month 10% OTM puts on 40–50% of position. Risk/reward: target 25–35% upside if NIM and buyback execution remain intact; capped downside to ~10–12% with hedge; primary risks are a credit shock or deposit outflow.
• Relative-value pair (3–6 months): long high-conviction regional bank stock (e.g., MTB) vs short regional bank ETF (KRE) sized 1:1. Rationale: isolate idiosyncratic buyback/dividend optionality and management execution; expected relative outperformance 8–12% if execution is clean. Risk: systemic rerating of the group will hurt both legs and can produce losses beyond 15% if liquidity dries up.
• Rate-curve steepener (3 months): add a small notional 2s/10s steepener (via swaps or futures spread) to capture upside from a steeper curve that benefits NIM. Risk/reward: a 25–40bp steepening materially boosts NII for regional lenders; a 25bp flattening is plausible and should be sized to limit P&L drawdowns to 2–4% of book.
• Avoid momentum gadgets for this rotation: stay flat/underweight SMCI and APP in bank rotation trades — their low correlation to bank fundamentals makes them poor hedges and dilutes capital allocated to idiosyncratic bank alpha.