We recently compiled a list of the 10 Best Local Bank Stocks To Invest In Now. In this article, we are going to take a look at where Webster Financial Corporation (NYSE:WBS) stands against the other local bank stocks.

As investors shift their focus from artificial intelligence to the labor market and its impact on potential interest rate cuts, the banking industry of 2024 is quite different from the one in 2021. Interest rates are at a 24 year high in America as of early September, which means that not only do the costs of borrowing money increase for consumers but banks also have to carefully monitor their loan portfolios to ensure liquidity and manage insolvency risks.

One consequence of this has been a growth in private capital, which covers loans made to firms by non banking entities. According to data from the International Monetary Fund (IMF), the private credit market crossed a whipping $2.1 trillion in 2023 through its assets and capital commitments. 75% of this was in the US as investors such as pension funds and others drove to funds that offered higher returns while corporate borrowers flocked to private lenders due to the relatively simpler process of acquiring capital and relaxed risk requirements when compared to banks.

In fact, private credit is one of the best performing investment vehicles when it comes to returns according to the IMF. The fund uses December 2000 as a base value of 100 to show that as of June 2023, private credit was up to almost 800 points. In comparison, the flagship S&P index, which was also assigned an index value of 100 for December 2000, was up to roughly 460 points by June 2023, while global stocks delivered the least returns as they sat at 400 points.

The IMF believes that while the risks from this shift from local banks to private capital are not immediate, they are still important particularly due to the opacity of private capital. Private borrowers are riskier than those who borrow from banks. For instance, while the debt to operating income ratio of private borrowers is roughly 4.75, the median firm size is roughly $500 million. On the other hand, firms that rely on investment grade bonds have a median value of $16 billion and a debt to operating income ratio ranging between 2.8 to 3.6.

Shifting gears, the growth in private capital isn’t the only disruption that banks are facing. While high interest rates create the opportunity for banks to earn more through interest income, they also increase interest expenses. In fact, according to research from S&P Global, the banking sector will see some benefits from the higher rates this year as the aggregate efficiency ratio (non interest expenses/revenue) can sit at 60.30 this year for a three point gain over 2023’s 57.25. However, this might be the only good news in store. This is because the sector’s net interest margin, return on average assets (ROAA), and return on average equity (ROAE) are all expected to drop in 2024. In 2023, the three respective metrics were 3.22, 1.09, and 11.52, while in 2024, they are expected to sit at 3.18, 0.97, and 11.52.

Additionally, two other ways in which the banking industry has evolved in today’s era of high interest rates are through growth in competition for deposits and the corresponding high deposit costs. Not only did the high rates start to fully make their mark in Q4 2023 as deposits grew by 1.4% after six consecutive quarterly declines, but the difference between the Fed funds rate and the rate paid to depositors also dropped in Q4. This was because banks enticed customers by increasing their deposit costs, and the difference between the two rates had sat at roughly 3.2% in Q2 2023 and dropped to roughly 2.9% in the fourth quarter. The S&P believes that by 2026, this should sit at roughly 1% as the Fed funds rate drops to a little above 2%.

The increasing competition for deposits in banks that spurred the smaller gap has also caused large drops in the banking industry’s non interest deposits. As of 2023 end, non interest deposits accounted for 21.8% of the US banking industry’s total deposits a sizeable drop over the 28.9% figure for 2021. This fall came when non interest bearing deposits dropped by 28% over the past two years while interest bearing deposits grew by 5%. Keep in mind that the growth figure for the interest bearing deposits is lower due to their larger volume. Looking at the future, the banking industry’s net interest margin is expected to grow to 3.26 and 3.35 in 2025 and 2026 when the deposit beta falls to at least 27%.

Finally, the boon in internet usage and the accompanying growth in consumer electronics and personal computing is also impacting the banking industry. As per McKinsey, 60% of US banking consumers under the age of 70 are using digital channels for their wealth management. At the same time, some of the richest banking consumers, i.e. those aged above 70 are also increasing their use of digital banking products. This usage has grown by 5% within this age group, with the broader trend allowing banks the ability to bring their cost to income ratios below 25% and cost to asset ratios below 50%. In short, digital banking is offering banks the ability to become quite light operationally.

Our Methodology

To make our list of the best local bank stocks to buy according to hedge funds, we ranked the 40 most valuable regional US banks in America in terms of market capitalization by the number of hedge funds that had bought their shares in Q2 2024 and picked out the top stocks.

For these stocks, we have also mentioned the number of hedge fund investors. Why are we interested in the stocks that hedge funds pile into? The reason is simple: our research has shown that we can outperform the market by imitating the top stock picks of the best hedge funds. Our quarterly newsletter’s strategy selects 14 small-cap and large-cap stocks every quarter and has returned 275% since May 2014, beating its benchmark by 150 percentage points. (see more details here).

Webster Financial Corporation (NYSE:WBS)

Number of Hedge Fund Holders In Q2 2024: 42

Webster Financial Corporation (NYSE:WBS) is a Connecticut based regional bank that provides consumer, commercial, and other banking services. Like KeyCorp, it also has a diversified loan portfolio which has a total value of $51.5 billion. Within this, $14.1 billion is from commercial real estate, $9.8 billion comes through consumer loans and another $16.7 billion is from non mortgage commercial loans. Additionally, Webster Financial Corporation (NYSE:WBS) has also efficiently managed its deposit base by not relying on a single category for a large chunk of liabilities. Out of the bank’s $62 billion in deposits, $9.9 billion are non interest bearing demand deposits, which help reduce its interest costs. Another $1 billion are time deposits that are due for maturity in 2025 and beyond, and Webster Financial Corporation (NYSE:WBS) also benefits from $8.5 billion in health savings deposits, which are among the few of their kind in the banking industry. The HSA accounts are specialized entities that enable businesses and consumers to take tax advantages to manage their and their employees’ healthcare needs, and given the growing elderly population in America, they could offer Webster Financial Corporation (NYSE:WBS) a key competitive edge.

Webster Financial Corporation (NYSE:WBS)’s management also shared key details for its exposure to the troubled commercial real estate sector during the Q2 2024 earnings call:

“There were no significant changes to the performance characteristics of our rent regulated multifamily portfolio, where our conservatively underwritten portfolio’s performance has held up really well, as you can see by consistently low levels of classified and non-accrual loans. The portfolio is granular, has conservative LTVs and debt service coverage ratios was underwritten to property cash flows at the time of origination and has limited maturities in the next two years. For office, we also have a portfolio that is granular with conservative underwriting characteristics. As the sector continues to be challenged, we did have several loans moved to non-accrual, which was the primary driver of the increase in our overall NPLs this quarter.

Office balances were $950 million at the end of the second quarter, down from just over $1 billion last quarter. In our office portfolio, approximately 75% of the remaining loan balances have some form of credit enhancement which adds significant value in mitigating potential losses. A few important comments to make as it relates to overall credit. Even with the negative risk rating migration, our NPL ratio, classified loan ratio and annualized charge-off rate in the quarter all remain proximate to or better than pre-pandemic Webster levels, meaning these metrics remain consistent with a more normalized credit environment. As we continue to aggressively and proactively manage and review the portfolio, after the material change in the environment or unforeseen surprises, we don’t see this rate of upgrade migration continuing in Q3.”

Overall WBS ranks 7th on our list of the best local bank stocks to invest in. While we acknowledge the potential of WBS as an investment, our conviction lies in the belief that some AI stocks hold greater promise for delivering higher returns and doing so within a shorter timeframe. If you are looking for an AI stock that is more promising than WBS but that trades at less than 5 times its earnings, check out our report about the cheapest AI stock.

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Disclosure: None. This article is originally published at Insider Monkey.