Bank stocks have been on a tear this month because of potential earnings tailwinds tied to deregulation, tax reform, and rising interest rates. Despite the recent run-up, there's likely still more running room ahead for the industry, so if you're hunting for bank stocks to add to your portfolio, it could be a good time to consider buying First Hawaiian (FHB 1.06%), M&T Bank (MTB -0.01%), and Synchrony Financial (SYF -0.97%).
A bank with few competitors
Jordan Wathen (First Hawaiian Inc.): This bank benefits from a near-duopoly in the remote U.S. state of Hawaii. First Hawaiian controls about 37% of all deposits there. Its peer, Bank of Hawaii , comes in second place with 31% of the state's deposits. Only two other banks top 10% market share.
Limited competition and high population density lead to a banker-friendly market. First Hawaii covers the entire state with just 57 branches that, on average, hold more than $280 million of customer deposits, nearly twice the deposits of the average U.S. bank branch.
Deposit-rich branches beget substantial economies of scale. The company recently reported an efficiency ratio of 47%, below the 60% level many banking analysts view as an imaginary line separating the "best" banks from the merely "good" banks. It also has a leg up on deposit costs, thanks to the fact that about one-third of its deposits are noninterest-bearing.
Unfortunately, shares rarely trade cheaply. The bank's conservative underwriting culture and No. 1 position in one of the most attractive markets in the country make it a favorite among bank investors. That said, a combination of rising rates and potential corporate tax cuts could make this a great bank stock to buy and hold, even at a premium valuation of 2.7 times tangible book value.
Returns you can bank on
Sean Williams (M&T Bank): Considering that the Federal Reserve has taken a tightening stance and hiked its federal funds target by 100 basis points since December 2015, and President Trump has given the impression that banking regulations will be loosened, the banking industry is far from cheap nowadays. Nevertheless, long-term bank-stock investors might be wise to take a closer look at M&T Bank in December.
Like most Northeastern banks, M&T Bank struggled following the Great Recession. In particular, it recently settled litigation stemming from its subsidiary Wilmington Trust Corporation back in 2009 and 2010, prior to its acquisition by M&T. The $60 million settlement is a long-term drop in the bucket for M&T Bank, but it had been an overhang that, along with a three-year delay in its Hudson City Bancorp acquisition, had held the company's share price back.
What's more exciting is what the future might hold for M&T, which has shown the ability to grow on an organic and inorganic basis. With the U.S. economy finally firing on all cylinders, a steady tightening of monetary policy seems likely. According to M&T Bank, as of the third quarter, it generates about 68% of its income from interest-based loans and real estate assets, meaning higher rates will really a boon to its bottom line. The company estimates that a 100-basis-point increase in long- and short-term rates would increase in interest income by nearly $97 million, or about 10% from current levels. That's free money for basically doing nothing.
M&T has demonstrated that it can also grow its deposit, loan, and consumer base through acquisitions. Its purchase of Hudson City Bancorp built its network by 135 branches, mainly in New Jersey, and it aligns well with M&T's ethos of remaining a community-oriented bank for consumers and businesses.
With a healthy return on assets of nearly 1.2%, M&T Bank has the potential to deliver substantial long-term returns for patient investors.
Internet banking and credit card exposure make this stock a buy
Todd Campbell (Synchrony Financial): There are three reasons why investors might want to tuck this banking stock into their portfolios this holiday season: growing credit card use, rising internet banking deposits, and Warren Buffett.
Before getting to the Buffett connection, let me explain how this company makes its money. Synchrony Financial is the market share-leading issuer of private-label credits, such as retail store cards, and it funds those credit card loans via a combination of borrowings and savings deposits.
Private-label credit has been a good business to be in lately because tight employment markets are helping boost wages and rising interest rates nationally are allowing the company to increase the interest rates it charges its customers for using its credit cards more quickly than the rates it's paying to its depositors.
In Q3, the company's loan receivables were 9% higher year over year, so there's already solid momentum for growth. Importantly, rising interest rates and falling funding costs have expanded net interest margin and profitability. Its net interest margin grew 40 basis points to 16.74% in the quarter and net interest income increased 11% year over year to $3.9 billion. An expected 3% to 4% increase in holiday spending should provide a nice tailwind to Synchrony Financials' loan book heading into 2018.
Synchrony's online banking business has been a boon to its bottom line and should continue to support its profit growth. Because it doesn't have to operate expensive branches and its credit cards yield more in interest than traditional loans, such as mortgages, it can outcompete other banks for deposits by offering higher interest rates on savings accounts. This strategy's providing it with an increasingly larger source of low-cost capital. For example, savings deposits fulfilled 73% of its funding needs last quarter, up from 71% one year ago.
Clearly, this is an intriguing business model and that brings me to the Buffett connection. The Oracle of Omaha's Berkshire Hathaway has taken a liking to Synchrony Financial this year. It acquired 17.5 million shares in Q2, and it increased its holdings to 20.8 million shares in Q3. With credit card use growing, low unemployment supporting credit card use, and a cheap source of deposits, I think there's plenty of reason to follow in Buffett's footsteps and own shares in this company, too.