Morgan Stanley picks the superior bank stock to buy in a low interest rate environment

Last month, the Federal Reserve issued its first interest rate cut since 2020, cutting its key interest rate by 50 basis points. The cut was twice as large as conventional wisdom had expected, and markets skyrocketed in the aftermath.

Morgan Stanley banking expert Betsy Graseck watches both Fed policy and the banking sector, and in her view the Fed has only just begun to cut interest rates.

Looking at what the future likely holds for Fed policy and the outlook for U.S. banks in general, Graseck writes, “The rate cuts are here, and the Fed is moving even faster than expected.” After a 50 basis point cut In September, our economists expect another 150 basis points of rate cuts by mid-2025, allowing the U.S. economy to avoid a recession.”

With this in mind, Graseck has identified “which banks are likely to see the greatest net interest margin (NIM) expansion/compression by the end of 2025, assuming short-term interest rates decline by 200 basis points, in line with our economists' forecast.”

The analyst believes that a lower interest rate environment will not have a uniform effect on bank stocks. As an example of this outlook, she took different views on USB (NYSE:USB) and JPMorgan Chase (NYSE:JPM), picking one as the best bank stock to buy as interest rates continue to decline. Let's take a closer look.

US Bancorp

US Bancorp, the first stock on our list, is the Minneapolis-based parent and holding company of US Bank. With total assets of approximately $680 billion, USB is the seventh largest banking company in the United States and its roots date back to 1863. Today, the company employs more than 70,000 people in over 2,000 stores in 26 states with a concentrated presence in the Midwest and West of the country.

Customers can find a wide range of banking services through US Bank, the company's operating arm. These include checking and savings accounts, credit cards, CD accounts, mortgages, investments, and other financial instruments, all of which are available to individuals, businesses of all sizes, and even high-net-worth individuals. The bank can be reached through its branches, ATM network and online apps.

USB shares saw an uptick in July after the company reported second-quarter revenue and profits that both beat consensus estimates, as well as solid growth in deposit and loan activity.

Overall, USB's revenue was $6.876 billion in 2Q24. Although revenue fell more than 4.5% year-over-year, it beat forecast by $70 million. GAAP net income was 97 cents per share, 2 cents above estimates. The bank's average deposits increased from $503.1 billion to $513.9 billion quarter-on-quarter, and average total loans increased from $371.1 billion to $374.7 billion from Q1 to Q2 . Both factors should have a positive impact on USB's interest income and margins.

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In her coverage of USB, Morgan Stanley's Graseck focuses on the bank's net interest margin and how that is likely to impact investors' perception of the stock. She writes: “USB has a relatively high concentration of interest-bearing deposits, the price of which is likely to change quickly as interest rates fall. This is likely to lead to a robust NIM expansion in 2025, which is not currently reflected in the consensus. Our analysis suggests that USB's NIM will grow by 20 basis points through Q4 2025, which is the second highest in our coverage. Among large-cap banks, USB 2025e NII is 4.8% above consensus (highest) and 4Q25 NIM is 10 basis points above consensus (second highest).”

Given these comments, it's no wonder Graseck upgraded USB shares from Equal Weight to Overweight (Buy). Graseck also raised her price target to $57 from $54, suggesting a one-year upside potential for the stock of 28%. (To view Graseck's track record, click here)

Graseck's view represents the Street's most optimistic view. The stock receives a Moderate Buy consensus rating based on 16 reviews, including seven Buys and nine Holds. The share price is $44.46, with the average price target set at $46.13, representing a gain of 4% over the next year. (See USB stock forecast)

JPMorgan Chase

The second stock we'll look at is JPMorgan Chase, a storied name in the US banking industry – and currently the largest bank in the US market with over $4 trillion in total assets. JPM is based in New York City and traces its roots back to the founding of the Bank of Manhattan Company in 1799. Its modern incarnation is the result of the merger of Chase Manhattan and JPMorgan banks in 2000. Today, JPM is one of the “Big Four” banking companies and one of the largest in the world. JPM had an average of $2.4 trillion in deposits and $1.3 trillion in loans in the second quarter of this year.

The combination of JPM and Chase brings together a range of banking services and makes them available to millions of customers worldwide. While its focus is on business services, investment banking, commercial banking, and wealth and asset management, the bank also offers consumer and community banking services and serves approximately 80 million individual and small business customers.

That's big business, of course, and in its most recent reported quarter – 2Q24 – JPM posted revenue of $50.2 billion. This was an increase of more than 21% year-over-year and beat forecast by $4.54 billion. The company's non-GAAP bottom line came in at $4.40 per share, but missed estimates by 11 cents per share.

JPM's net interest income reached $22.9 billion in the quarter, a solid turnaround from the $1 billion reported in 2Q23. The bank expects net interest income of $91 billion for the full fiscal year 2024, an estimate it said is “market dependent.”

Looking at JPM, analyst Graseck sees that this major bank is treading water as the Fed changes its interest rate policy. She writes: “While the analysis resulted in a 2% increase in JPM's 2025 earnings per share, the chances of positive surprises in NIM in 2025 are lower than in the majority of our coverage, particularly as JPM management Street has continually reminded them that they are asset sensitive and beyond.” -Earning on NII. We expect the deposit revaluation alone to add only 53 basis points gross to JPM's NIM, which is below the large cap bank's average of 61 basis points. As a result, we forecast a 13 basis point decline in JPM’s NIM in 2Q24 and 4Q25 as the Fed cuts rates, representing the largest decline in our large-cap bank coverage.”

Graseck further explains why this big bank stock's risk-reward ratio is no longer favorable, adding to her comments: “We see fewer positive surprises for JPM after it has experienced a strong rally over the last two years… Stock trading is at 2.2x.” Given the tangible book value versus an ROTCE of 18% in 2025 and a decline in ROTCE from here, the risk/reward appears to be more balanced at current valuations.”

The Morgan Stanley analyst downgrades her stance on JPM from Overweight to Equal-Weight (Hold), although interestingly her price target is raised from $220 to $224, implying a potential upside of 8% within a year.

The consensus rating here is also “Moderate Buy,” based on 20 reviews, which are 14-6 in favor of “Buy” over “Hold.” The stock has a trading price of $207.04 and an average price target of $224.84, suggesting the stock will gain 8.5% in the coming months. (See JPM stock forecast)

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Disclaimer: The opinions expressed in this article are solely those of the featured analyst. The content is for informational purposes only. It is very important to do your own analysis before investing.