Watch out for the short squeeze in mid-cap banks, warns Morgan Stanley

Morgan Stanley analysts warned investors to watch out for the short squeeze in mid-cap banks in a note Tuesday.

The analysts explained that the group is down 11% month-to-date and 31% since March 8, but the “recent declines seem overdone as QTD deposit outflows are tracking in-line with seasonality.”

The decline “is being driven by concerns that deposit outflows are reaccelerating into 2Q23, given recent headlines on deposit outflows at PACW (not covered), and the acquisition of FRC by JPM,” they wrote. “The decline suggests investors are most concerned about the risk to forward estimates.”

With sentiment overly negative, Morgan Stanley doesn’t think it would take very much to drive a potential short squeeze here. In addition, the analysts say that there is no evidence that deposit outflows are accelerating.

“While industry-wide ‘Small Bank’ deposits are down 0.7% QTD per the Fed H.8 data, this is actually in-line with normal seasonal declines during the second quarter,” they stated. “At earnings, several banks like CBSH, HBAN, WBS indicated balances were higher vs. March 31. Updates from management teams since then have also indicated that deposits are holding up better than feared.”