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U.S. Bank Stocks Set to Rally Despite Decelerating Earnings

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Continued weakness in earnings results due to an unfavorable operating backdrop may not keep U.S. bank stocks from rallying. This is because there are a number of short- and long-term factors that will keep investors’ optimism alive.

Primarily, an expected continuation of interest rate hikes has the potential to lift banks’ profitability to levels not achieved since the last recession, whether or not the Trump administration’s proposed reforms to lower corporate taxes and ease banking regulations materialize (or take too long to come into effect).

Moreover, chances of stagnation are dim, as the industry has gained enough footing on its underlying structure to enhance business returns after dealing with challenges in the past several years.

Higher interest rates would allow banks to charge more interest on all types of loans — primarily, in the areas of mortgage, credit cards and autos. This will expand their net interest margins and reduce dependence on uncertain non-interest revenue sources.

Also, while a full-scale regulatory reform is unlikely due to significant political opposition, smaller adjustments that the Trump administration will be allowed to make (or could implement through alternate routes) would help banks to lower their fixed costs.

In any case, there are underlying factors to help banks thrive in the future.

Banks Are Capable of Running Growth Engine

Business reorganization post-financial crisis, effective expense management, enhanced focus on non-interest revenue sources, technical affluence, ability to grab cross-selling opportunities with economic improvement and many more positive factors could support banks in augmenting profits steadily.

With increasing capability of consumers and businesses to borrow money, prospects of loan growth are rising. So, in case the industry doesn’t get significant support from the rate environment, high loan volume would back revenue growth.

Moreover, sound capital levels that banks generated by meeting strict regulatory requirements should help easily absorb likely credit costs related to their exposure to the troubled sectors. High credit risk in banks’ loan portfolios led to high loan-loss provisions in the past, but provisions are currently at very low levels. While the likely ease of capital restriction with Trump’s success in deregulating the industry could weaken banks’ credit profile, any possible disorder should be manageable for a decent period with the existing capital power.

Though the earnings performance over the last few years has failed to more than offset the negatives arising from challenging backdrop, the results depict banks’ efforts to pair aggressive actions (like creating new revenue sources) with defensive measures (like expense control) to stay afloat.

Moreover, banks have learned how to adapt to a changing landscape and deal with crises. They are now capable of dodging pressure from the operating environment more easily.

Banks are trying to reorganize risk management practices to address potential solvency issues from rising interest rates. Asset-quality troubles are also being addressed by divesting segments containing nonperforming assets.

(Check out our latest U.S. Banks Stock Outlook for a more detailed discussion on the business trends.)

Loans and Deposits Should Keep Growing

While loan growth remained sluggish in the last several quarters due to apprehensions related to the actions of the Trump administration and the Fed, lower unemployment, wage growth and higher disposable income as a result of an improving economy should eventually push up demand for consumer, real estate and small business loans.

Further, the expectation of a continuous rise in interest rates will drive borrowers to quickly apply for loans in order to avoid higher cost of borrowing later. This should increase demand in the near term.

On the deposit side, less-levered consumers and businesses will continue to support strong deposit levels. Also, high levels of corporate cash holdings remain favorable for deposit growth. However, higher rates will increase the cost of maintaining deposits.

Moreover, the Fed’s move to unwind its giant balance sheet will increase banks’ competition for deposits.

Adaption of Technology Makes Business More Efficient

Along with the adoption of advanced technologies to enhance cyber security, banks are resorting to increased use of analytics to drive efficiency. This could help them to better formulate strategies and enhance performance of business segments.

While analytics and technology will elevate their expenses in the quarters ahead, concerted efforts to cut expenses and better revenues should be enough to strike a balance.

FDIC’s List of Problem Banks Shrinks  
The second quarter of 2017 witnessed continued improvement in the FDIC's "Problem Bank List." The list contained 105 names as of Jun 30, 2017, down from 112 as of Mar 31, 2017. This is the smallest number since Mar 31, 2008, and represents nearly 90% decline from the post-crisis high of 888 on Mar 31, 2011.

While the number is still high considering the occurrence of the financial crisis nearly nine years back (there were only 76 banks on the Problem List at the end of 2007), the current level doesn’t spell any major concern.

Stocks Worth Buying Right Now

The optimism over long-term benefits might push bank stocks higher despite the weak earnings picture in the last few quarters. While the concerns should not be overlooked, one can consider buying stocks that carry a favorable Zacks Rank.

Here are a few top-ranked bank stocks you may want to consider:

CNB Financial Corp. CCNE: This Zacks Rank #1 (Strong Buy) stock rallied about 18% over the past six months versus the S&P 500’s gain of 7.6%. The stock’s earnings estimates for the current year have been revised roughly 4.4% upward over the last 30 days.

ConnectOne Bancorp CNOB: This Zacks Rank #1 stock gained 18.5% over the past six months. Earnings estimates for the current fiscal year have been revised nearly 6% upward over the last 30 days.

CoBiz Financial COBZ: A 6.6% upward revision in earnings estimates for the current year over the past 30 days lead to a Zacks Rank #1 for this stock. The stock gained more than 24% over the last six months.

First Bancorp (FBNC - Free Report) : This Zacks Rank #1 stock gained more than 26% over the past six months. Earnings estimates for the current year have been revised nearly 10% upward over the last 30 days.

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