Bank Stocks To Outdo Broader Markets This Year: 5 Picks

Bank stocks have, so far, underperformed the broader market this year. Investment banking giant Goldman Sachs Group Inc (NYSE:GS) , however, believes that the banking sector will outdo the markets in the rest of this year on rising dividends and stock buybacks. And why not? Banks have cleared the Federal Reserve’s stress test with flying colors this year. They have adequate capital cushion, which can be used for paying out dividends and repurchasing stocks.

Also, a rising interest rate environment will make it a cakewalk for banks. Higher rates help banks charge more interest on all loans, which expands the net interest margin (NIM). The White House’s intention to ease banking regulations are, further, likely to spur lending activities, while relaxed rules will help banks make use of surplus funds and grow inorganically through mergers and acquisitions.

Decline in mortgage and trading revenues are, however, eating into bank’s profits. But, softer regulations bode well for refinancing activities, which will in due course drive mortgage revenues. Given such positive trends, investing in sound bank stocks seems judicious.

Banks to Outpace on Rising Dividends & Bigger Share Buybacks

Bank stocks are set to scale higher on rising dividends and bigger share buybacks, as per Goldman’s analysts. The financial behemoth expects the bank sector to ramp up its dividends by 17% on an annual basis over the next two years. Such acceleration in dividend growth will attract equity income investors.

When it comes to disbursement of capital to shareholders, most of the banks will be able to pay out 100% of their anticipated net income in the next four quarters, much higher than last year’s payout of around 65%. It will also turn out to be the first time since the financial crisis in 2008 that banks will be able to return almost the entire annual profit to shareholders.

In addition, strategist David Kostin stated that the recent positive Fed “stress test” results will help banks increase share buybacks, which in turn will improve earnings per share, return on equity and share prices (read more: Banks Boost Payouts after Clearing Fed Tests: 5 Great Picks).

Big U.S. Banks Strong Enough to Endure Recession

All of the 34 large U.S. banks made it through the Fed’s annual stress test. The findings have been promising, with big banks well-capitalized to withstand any severe U.S. and global recession.

The test was authorized by the Congress in the wake of the sub-prime crisis that has made the United States face the worst economic shocks since the Great Depression of the 1930s. The Fed figured out that in a hypothetical “severely adverse” situation, where jobless rate is at 10%, home prices tanked 25% and the equity market plummeted around 40%, the 34 banks will have to bear a combined loss of $383 billion. But, that’s way less than the $526 billion loss for the 33 banks tested last year (read more: Big Banks Pass Fed's "Stress Test": 3 Top Winners).

Banks Ride the Wave of Steepening Yield Curve

Sales at U.S. retailers, in the meanwhile, recorded the highest increase in seven months in July. This helped steepen the yield curve as market participants anticipate a pickup in growth and inflation, which have otherwise been sluggish. It also addresses the concerns expressed by the Fed officials in the Federal Open Market Committee’s July meeting. Some were cautious that a low inflation environment might dampen rate hike prospects. Nevertheless, there were hawkish members who stuck to their plans of another hike this year and issued forecasts that showed three more quarter point rate increases next year, similar to the projection issued in March.

Higher interest rates boost bank profits by increasing the spread between what banks earn by funding longer-term assets, such as loans, with shorter-term liabilities. Lenders have increased the interest charge for borrowers from 3.5% a year ago to 4.25%, while depositors have been pressed. On an average, the rate on savings account is at a meager 0.08%. This has helped the NIM improve, especially, after it had hit a 60-year low last year.

Regulators to Soften Rules – A Definite Boost for Lending Activities

The House of Representatives had passed the “crown jewel” of the GOP-led regulatory reform act, which effectively gutted the Dodd-Frank regulations of the Obama administration. The Republican bill, better known as the Financial Choice Act, would free up banks by giving more power to banking authorities and spurring lending activities.

The Financial Choice Act also repeals certain sections of the Dodd-Frank law, including the Volcker Rule. Such a rule is believed to have prevented the net accumulation of new assets, which didn’t go down well with banks. Needless to say, now with more capital in hand, businesses are more likely to take higher risks and innovate (read more: 5 Bank Stocks to Buy as House Cuts Dodd-Frank Reforms).

Bank Merger Poised to Gain Momentum

Under the old political regime, banks amassed a whopping $750 billion in capital to meet rules and regulations. However, with President Trump signaling at softer regulatory environment, it is expected that American banks will utilize the excess fund in deal making.

JPMorgan Chase & Co. (NYSE:JPM) is already considering acquiring a payment systems company Worldpay Group in Great Britain. U.S. credit card technology firm Vantiv Inc (NYSE:VNTV) has also expressed interest to buy Worldpay.

The following table shows the total size of equity market deals done by five of the largest U.S. investment banks since the second quarter of 2016.

(Source:Forbes)

Mortgage and Trading Revenues to Improve

Lackluster mortgage and trading revenues that had taken a bite out of bank’s second-quarter earnings are also expected to show signs of improvement. Jamie Dimon, chairman and CEO of JPMorgan Chase argued that a stringent regulatory environment has, in fact, reduced mortgage lending by around $300 billion, which is equivalent to 3 million home loans since the financial crisis. However, as mentioned above, softer regulatory requirements are expected to encourage refinancing activities in the near term.

Lack of activity on trading floors also seems to have hurt investment bank’s revenues. Markets remain more or less calm in the second quarter, which might have been responsible for sluggish trading activities. Investment pros, however, expect markets to be choppier in the second half of this year. Willie Delwiche, managing director and investment strategist for Robert W. Baird & Co. Inc, said that “historically when we’ve had that lack of volatility in the first half that leads to above-average gains in the second half”. This in turn could spur trading activities.

5 Solid Choices

Banking on such bullish trends, it will be prudent to invest in solid bank stocks. Hence, we have selected five such stocks that flaunt a Zacks Rank #2 (Buy).

First Connecticut Bancorp Inc (NASDAQ:FBNK) operates through its subsidiary, Farmington Bank, which is a full-service community bank with branch locations throughout central Connecticut and western Massachusetts. The Zacks Consensus Estimate for its current year earnings increased 2.6% over the last 60 days. The company’s estimated growth rate for the current year is 35.5%, higher than the industry and the S&P 500’s projected addition of 9.8% and 22.8%, respectively.

Orrstown Financial Services (NASDAQ:ORRF) is the bank holding company for Orrstown Bank engaged in commercial banking and trust business. The Zacks Consensus Estimate for its current year earnings rose 20.5% over the last 60 days. The company’s estimated growth rate for the current year is 66.7%, higher than the industry and the S&P 500’s projected addition of 9.8% and 22.8%, respectively.

Sandy Spring Bancorp Inc. (NASDAQ:SASR) is the bank holding company for Sandy Spring Bank. The company operates through three segments: Community Banking, Insurance and Investment Management. The Zacks Consensus Estimate for its current year earnings increased 1.2% over the last 60 days. The company’s estimated growth rate for the current year is 25.5%, higher than the industry and the S&P 500’s projected addition of 9.8% and 22.8%, respectively. You can see the complete list of today’s Zacks #1 Rank stocks here.

Sterling Bancorp (NYSE:STL) is a bank holding company that owns the Sterling National Bank, which offers a line of commercial, business, and consumer banking products and services. The Zacks Consensus Estimate for its current year earnings advanced 0.7% over the last 60 days. The company’s estimated growth rate for the current year is 25.2%, higher than the industry and the S&P 500’s projected addition of 9.8% and 22.8%, respectively.

Bancorp Inc (NASDAQ:TBBK) is a financial holding company and its primary subsidiary is The Bancorp Bank. The Zacks Consensus Estimate for its current year earnings increased 12.5% over the last 60 days. The company’s estimated growth rate for the current year is 137.2%, higher than the industry and the S&P 500’s projected addition of 9.8% and 22.8%, respectively.

One Simple Trading Idea

Since 1988, the Zacks system has more than doubled the S&P 500 with an average gain of +25% per year. With compounding, rebalancing, and exclusive of fees, it can turn thousands into millions of dollars.

This proven stock-picking system is grounded on a single big idea that can be fortune shaping and life changing. You can apply it to your portfolio starting today.

Learn more >>