The U.S economy has been on a mend from the beginning of this year, backed by higher investor and business confidence, generous government and federal stimulus packages, economy reopening, and continued progress on the vaccination front.

These have not only bolstered prospects of the U.S. economic outlook but have also driven market gains. In the year-to-date period, the S&P 500 Index has gained 20.7% and has already exceeded 18.5% growth witnessed in 2020.

Major regional banks have undoubtedly been the prime beneficiaries of the economic recovery. The KBW Bank Index (BKX) — which tracks the performance of large U.S. national money centers, regional banks and thrift institutions — has been up 34.6% so far this year.  

Factors Aiding Banks’ Stellar Performances & Future Prospects

The Federal Reserve signaled an earlier-than-expected interest rate hike in the June FOMC meeting, indicating the probability of two rate hikes by the end of 2023. Higher interest rates would be instant gratifications for banks, propelling them to increase lending activities. This is expected to drive net interest income (NII) and margins, which have been dampened due to businesses being flushed with liquidity.

Continued expectations of an impressive economic rebound led to bullish investor sentiments. The S&P Global Economics has upped its real GDP growth forecast for 2021 and 2022 to 6.7% and 3.7%, respectively.

Lower rates and declining credit card loan volumes have been the major headwinds. Overall loan growth seems to be in the cards for banks. Going by Fed’s H8 loan data, the demand for consumer loans has been improving since the second-quarter end. Given high consumer spending and economic reopening, the encouraging trend brightens loan growth prospects.

While investor skepticism is warranted, given the concerns of the new Delta variant of COVID-19; a recap of 2020 lockdowns is unlikely, considering the effectiveness and availability of the vaccines.  This might support a return to normal economic conditions, driving prospects of the banking sector.

However, fee income growth is likely to get less support from mortgage banking and capital market segments as activities normalize. After a bumper 2020, curtailed market volatility and continued low mortgage rates are likely to lose charm, which were previously luring investors toward elevated trading, and mortgage borrowings and refinancing.

As banks continue to invest in technological transformations and digitalization of operations, there is room for improvement on the operating leverage front. As companies continue with these efforts, the efficiency ratio is likely to feel the heat in the near term.

Banking on the aforementioned catalysts, we remain optimistic about the near-term growth prospect of the major regional bank stocks. The industry has rallied 29.7%, outperforming the S&P 500 in the year-to-date period. Over the past year, the industry’s earnings estimates for the current year have moved up 70%.

Our Picks

Considering the above-mentioned impressive prospects of the industry, we have handpicked three fundamentally sound stocks from this space that have outperformed the S&P 500 Index and carry a Zacks Rank #3 (Hold) at present. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Image Source: Zacks Investment Research

Wells Fargo & Company (WFC Quick QuoteWFC - Free Report) : One of the largest financial services companies in the United States, it has more than $1.9 trillion in assets and $1.4 trillion in deposits as of Jun 30, 2021.

Subsequent to the clearance of this year’s stress test, Wells Fargo doubled the dividend for third-quarter 2021 to 20 cents per share in July. Also, the company boosted its share-repurchase authorization to approximately $18 billion for the period between third-quarter 2021 and second-quarter 2022. Restarting buybacks, which were suspended last year, will reduce share count and make year-over-year comps easy for the company amid the persistently low interest rate scenario.

In remedial efforts to improve risk management and governance, and in response to a cap imposed by the Fed on asset growth in early 2018, the bank continues to invest in businesses.

Of late, the company has shifted its focus to rebuilt capabilities by investing in businesses core to its consumer and corporate client base, while monetizing stake in less attractive ones. These efforts have started to bear fruits by boosting efficiency, strengthening the balance sheet and leading to significant cost savings.

Wells Fargo expects to see modest growth in auto, other consumer, credit card and commercial real estate loans in 2021, while NII is expected to remain flat or decline 4%.

For the ongoing year, the Zacks Consensus Estimate for earnings of $4.37 has been revised 2.6% north over the past 30 days. The figure suggests a substantial improvement from 2020 earnings of 41 cents.

Fifth Third Bancorp (FITB Quick QuoteFITB - Free Report) : With assets of $205 billion as of Jun 30, 2021, Fifth Third Bancorp has 1,096 full-service banking centers in 11 states throughout the Midwestern and Southeastern regions of the United States.

This Cincinnati-based company continues to focus on core deposit growth in its retail and commercial franchises by improving customer satisfaction, building full relationships and offering competitive rates.

Focus on expansion in the southeast, and efforts to continually improving digital experience bodes well for the company. Also, a diversified and improving fee revenue base will help the company to hold ground as market condition normalize.

Its capital deployment efforts remain encouraging, with the company’s intention to hike the quarterly dividend by 3 cents, effective third-quarter 2021, and buy back shares totaling $850 million in the second half of 2021. For 2021, management expects NII to be down 1%, while non-interest income is likely to increase 7-8%. However, non-interest expenses are expected to rise 2-3%.

For 2021, the Zacks Consensus Estimate for earnings of $3.66 has been revised 2% north over the past 30 days. The figure suggests 69.4% growth from the prior year’s reported number.

U.S. Bancorp (USB Quick QuoteUSB - Free Report) : With $559 billion in assets as of Jun 30, 2021, U.S. Bancorp is the parent company of U.S. Bank — the fifth-largest commercial bank in the United States.

The company has made a number of acquisitions to expand operations and geographical presence. In August, its subsidiary inked an agreement to acquire Bento Technologies, a FinTech company that provides payment and expense-management services to small and mid-size businesses. Such buyouts combined with ongoing investments in innovative product enhancements, services and people have strengthened the company’s balance sheet and fee-based businesses beside increasing market share.

The company has announced its intention to hike the third-quarter 2021 dividend by 9.5% to 46 cents per share. Such efforts to reward shareholders boost investor confidence in the stock.

However, as U.S. Bancorp continues to invest in its technology platform, owing to its business initiatives, we believe that such costs might weigh on its expense base to some extent in the upcoming quarters.

For the ongoing year, the Zacks Consensus Estimate for its earnings of $5 has been revised marginally north over the past 30 days. The figure suggests 63.4% growth from the prior year’s reported figure.