Thumbnail in modern highlighted content web part

There is no documentation on how exactly it works, but it uses the first image when there is no banner image used. The news web part works better than using Highlighted content web part as it will use the focal point on the banner if you use it but it's still just best that i've found is making sure you have a "rectangle" shape to use for your news if you really need it to show up correctly.

Also if your on Targeted Release, you might find it a better experience using news webpart and now changing the "Source" option to rollup news by selecting multiple sites possibly. Not sure how many you have, that or creating a hub, it's been a much better experience than using Highlighted content, which I used to use for news rollup as well.