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Are U.S. Banks on the Verge of a New Golden Era?

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The massive changes that took place in the past year and those that are well underway could actually help the banking industry enter a new golden age. Thus, the prospects for bank stocks look bright.

The key factors that could drive the industry’s growth are a new tax regime, a rising interest rate environment and rolling back of tough post-financial-crisis banking regulations.

Primarily, a continuation of interest rate hikes, reinforced by rising inflation expectations, and the Fed’s unwinding of its giant balance sheet, have the potential to lift banks’ profitability to levels not achieved since the last recession. And, if history is any guide, the high rate environment that the economy is reaching will last long and continue to help the industry thrive.

Secondly, the new tax legislation will significantly reduce the effective tax rates for some of the nation's biggest banks, helping them pocket more profit. Moreover, the tax cuts are expected to provide a major impetus to the economy, which will indirectly increase business for banks.

Finally, the initiative to reduce the strictness of post-crisis strict banking rules (aka Dodd-Frank) will bring the much-needed relief to small and mid-size banks, primarily helping them reduce fixed costs.

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

Banks Capable of Standing on Their Own Feet

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 expected ease of capital restriction in the near term 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 a challenging backdrop, the results depict banks’ efforts to pair aggressive actions (like creating new revenue sources) with defensive measures (like efficient expense management) 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.

(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 muted 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 continued rise in interest rates should increase demand for loans in the near term, as borrowers will tend to avoid a higher cost of borrowing later on.

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. While the trend so far has been to cap the cost of funding by keeping the rates on deposits almost unchanged, higher rates will eventually increase the cost of maintaining deposits.

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

Banks No Longer Lag In Terms of Technology

Beyond adopting technologies to enhance cyber security, banks have significantly reshaped products and distribution systems with the help of technology and artificial intelligence to drive efficiency. This has been helping them better formulate strategies and enhance performance of business segments.

While the ongoing adoption of technology, including efforts to create their own cryptocurrencies, will elevate their expenses in the quarters ahead, concerted efforts to cut expenses and better revenues through high-tech products and services should be enough to strike a balance.

Stocks Worth Buying Right Now

The optimism over changes related to policy, regulation and technology should keep propelling bank stocks higher. But to ensure better bets, one may consider buying stocks that carry a favorable Zacks Rank.

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

Citigroup Inc. (C - Free Report) : This Zacks Rank #2 (Strong Buy) stock has rallied 6.3% over the past six months versus the S&P 500’s gain of 10.8%. The stock’s earnings estimates for the current year have been revised roughly 4.7% upward over the last 60 days.

BB&T Corporation (BBT - Free Report) : This Zacks Rank #2 stock has gained 23.5% over the past six months. Earnings estimates for the current fiscal year have been revised nearly 6.5% upward over the last 60 days.

First Financial Bancorp. (FFBC - Free Report) : A 7.7% upward revision in earnings estimates for the current year over the past 60 days lead to a Zacks Rank #1 (Strong Buy) for this stock. The stock has gained more than 16% over the past six months.

Heritage Commerce Corp (HTBK - Free Report) : This Zacks Rank #1 stock gained more than 24% over the past six months. Earnings estimates for the current year have been revised nearly 11% upward over the last 60 days.

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