Federal Reserve Chair Janet Yellen, speaking in Jackson Hole, WY last Friday, said that regulations of the central bank sanctioned after the 2008 market meltdown have made the financial system resilient to economic upheavals. These regulations have compelled banks to hold much higher levels of capital to cushion against losses from bad loans; the adequate capital cushion can also be used for paying out dividends and repurchasing stocks.
Big banks have enough capital buffers to keep on trading through an economic meltdown, thanks to the positive annual “stress test” results. Such a promising outcome comes at a time when the Fed is forging ahead with the 25-basis point rate hike amid inflation worries. Given such positive trends, investing in sound bank stocks seems judicious.
Yellen Defends Bank-Reform Efforts, Open to Easing Volcker Rule
Yellen emphasized that the sweeping regulations enacted in the past decade have helped restore the financial system. In particular, she noted that the U.S. financial systems were “in a dangerous place 10 years ago,” plagued by the collapse of Lehman Brothers, the government taking over Fannie Mae and Freddie Mac, and taxpayers bailing out large banks. During that crisis, Americans lost around 9 million jobs.
However, the Dodd-Frank Act produced a safer banking system and insisted higher capital requirements that promoted loan growth. She defended the financial regulations put in place after the 2008 financial crisis, and said that any rollback of such reforms should be “modest,” and the Trump administration shouldn’t flip-flop on such reforms.
However, she agreed that “there may be benefits to simplifying” the Volcker rule that restricts big banks’ ability to trade with their own money. She also believes that regulations should be closely scrutinized to ensure that they do not harm community and regional banks.
The Republican bill, better known as 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 sit well with banks. Needless to say, now with more capital in hand, businesses are more likely to innovate and take higher risks.
Banks Pass Annual Stress Tests
In addition to higher capital requirements, Yellen said that the financial system is protected by regulations requiring the banks to undergo annual stress tests. These tests ensure that banks have enough capital to bear any severe U.S. and global recession.
All of the 34 large U.S. banks have already made it through the Fed’s stress test this year. The Fed figured out that all these banks have the minimum capital requirement and leverage ratio under severe adverse situations. In a hypothetical severely adverse situation, where the jobless rate is at 10%, home prices have tanked 25%, and the equity market has plummeted around 40%, these banks will have to bear a combined loss of $383 billion. But, that’s way below the $526 billion loss tested for last year.
Yellen’s Brief Reference to the Economy
Yellen remained mum on interest rate plans but mentioned that “substantial progress has been made toward the Federal Reserve’s economic objectives of maximum employment and price stability.” Headway in both these criteria is essential for further rate hikes. While the labor market remains ultra-tight and the unemployment rate sits at a 16-year low, inflation remains below the Fed’s preferred target level of 2%.
Nevertheless, 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 average, the rate on savings accounts are a meager 0.08%. This has helped the net interest rate margin (NIM) improve, especially after it had hit a 60-year low last year.
5 Best Bank Stocks to Buy Now
The post-crisis financial reforms have made the banking system safer and more resilient to downturns. Thus, investing in solid bank stocks seems to be a prudent choice. We have selected five such stocks that flaunt a Zacks Rank #1 (Strong Buy) or #2 (Buy).
State Street Corp (STT - Free Report) , through its subsidiary, State Street Bank and Trust Company (State Street Bank), provides a range of financial products and services to institutional investors. The company has a Zacks Rank #2.
The Zacks Consensus Estimate for its current year earnings increased 3.9% over the last 60 days. The company’s estimated growth rate for the current and next year are 17.5% and 13.8%, respectively. The company has outperformed the industryon a year-to-date basis (+20.2% vs +9.3%).
First Merchants Corporation (FRME - Free Report) has a bank charter, First Merchants Bank (the Bank), which is opened for business in Muncie, IN. It operates through a community banking business segment. The company has a Zacks Rank #2.
The Zacks Consensus Estimate for its current year earnings increased 1.3% over the last 60 days. The company’s estimated growth rate for the current and next year are 8.5% and 8.49%, respectively. The company has surpassed the industry on a year-to-date basis (+5.8% vs -6.5%).
Wintrust Financial Corp (WTFC - Free Report) offers community banking services to individuals, small to mid-sized businesses, local governmental units and institutional clients. The company has a Zacks Rank #2.
The Zacks Consensus Estimate for its current year earnings increased 5.1% over the last 60 days. The company’s estimated growth rate for the current and next year are 16.8% and 16.9%, respectively. The company has outperformed the industry on a year-to-date basis (+0.7% vs -6.5%).
First Connecticut Bancorp Inc (FBNK - Free Report) operates through its subsidiary, Farmington Bank, which is a full-service community bank with branch locations throughout Central Connecticut and Western Massachusetts. The company has a Zacks Rank #2.
The Zacks Consensus Estimate for its current year earnings increased 2.3% over the last 60 days. The company’s estimated growth rate for the current and next year are 45.8% and 33.3%, respectively. The company has outperformed the industryon a year-to-date basis (+7.9% vs -6.5%).
Triumph Bancorp Inc (TBK - Free Report) offers traditional banking services, as well as commercial finance products. The Company operates through four segments: Banking, Factoring, Asset Management and Corporate. The company has a Zacks Rank #1. You can see the complete list of today’s Zacks #1 Rank stocks here.
The Zacks Consensus Estimate for its current year earnings soared 32% over the last 60 days. The company’s estimated growth rate for the current and next year are 40.6% and 44.7%, respectively. The company has outperformed the industryon a year-to-date basis (+6.7% vs -6.5%).
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