Morgan Stanley just made this sleeper bank stock its top pick after acing its stress test

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Most of the largest banks in America took a hit last week when they performed worse than last year on the Federal Reserve’s stress test to see how they’d react to a financial crisis. One winner was Buffalo, New York-based M&T Bank (MTB), which wasn’t just the highest scoring regional bank to be tested but was today moved to the top position on Morgan Stanley’s midcap banks earnings preview.

With a market cap of $26 billion, M&T is currently trading at $150.08, an increase of 0.17% today, and 7.95% so far this year. In the report, Morgan Stanley equity analyst Manan Gosalia attributes the decision to move M&T to the bank’s top slot to a successful stress test, improving credit, and stable deposit costs supporting an increase in net interest margins.

“MTB trades in line with peers,” writes Gosalia. “But deserves to trade at a premium given better underwriting quality versus peers, tailwinds in a higher for longer rate environment, and higher excess capital.” Overall, the midcap banks Morgan Stanley covers—defined as banks between $2 billion and $10 billion—underperformed last quarter’s, down 6%. Midcap banks are still cheap though, according to the report, trading at a discount of 5x on their price/earning ratio relative to historical levels.

Every year the Federal Reserve tests globally important banks to see how they’d perform in a variety of crises. This year, the central bank tested 31 large banks, in large part to see if they had enough assets in reserve to absorbe $685 billion in losses, among other struggles. Citibank was the best performing bank, with an estimated 30 basis point reduction in its stress capital buffer, with M&T coming in a close second with a 10 basis points reduction, according to a Wells Fargo report last week.

Today, Morgan Stanley refined those estimates, predicting that M&T will have almost 300bps of excess capital as a result of the reduced capital requirements and is expected to grow by 25bps more each quarter. A conservative approach to defining risky assets has also led the bank to a higher quality portfolio, according to Gosalia, and the excess liquidity resulting from an expected increase in net asset margin is expected to be deployed into longer dated securities.

M&T Bank’s stock is among four midcap banks listed as overweight in the Morgan Stanley report, meaning the researchers expect it will perform better over the next year. Other banks are Huntington Bancshares Incorporated (HBAC), which M&T replaced for the top spot, East West Bancorp (EWBC), and Webster Financial Corporation (WBS).

M&T’s second quarter earnings call is scheduled for July 18.

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