Bank stocks are benefiting from one of the best macroeconomic backdrops in recent memory. The economy is growing at the fastest pace in years, consumers are borrowing again, and the Federal Reserve has indicated its willingness to raise interest rates, giving lift to the banking industry's margins.
Below, three Motley Fool contributors lay the case for Cullen/Frost Bankers (NYSE:CFR), Morgan Stanley (NYSE:MS), and Synchrony Financial (NYSE:SYF) as ways to profit from a rising tide for bank stocks.
The best bank in one of the fastest-growing economies
Jordan Wathen (Cullen/Frost Bankers): Everything is bigger in Texas, including banking cycles. The state is infamous for being home to many of the largest banking booms and busts, a byproduct of the Texas economy's reliance on the energy sector.
But through these ups and downs, Cullen/Frost has proven its mettle as a risk manager and above-average underwriter. A true relationship bank, Frost Bank positions itself as the bank for clientele who prioritize service and a relationship over the best possible rate on their loans and deposits.
Evidence of Cullen/Frost's conservative culture is found right on the balance sheet. Whereas most banks seek to deploy the vast majority of their deposits into loans to earn higher yields, Cullen/Frost's assets are split roughly 50-50 between high-quality securities and higher-yielding loans. Loans with direct exposure to energy make up only 11% of the bank's total loans.
The bank's deposit base is attractive as it gets. Roughly 40% of its customer deposits are noninterest bearing, meaning it pays interest on only 60% of its deposits. A low-cost deposit mix enables it to earn high returns without taking outsize risk in its loan portfolio. Because short-term securities and floating-rate loans dominate its balance sheet, the benefit of higher investment and loan yields quickly flows into pre-tax profits as interest rates rise.
As a high-quality bank in a rapidly growing state, Cullen/Frost tops my list as one of the most attractive banks in the country at roughly 15 times consensus earnings estimates for 2018.
Look at Wall Street's finest
Dan Caplinger (Morgan Stanley): Many bank investors focus squarely on the consumer and retail side of the banking industry, because it's an area that they're most familiar with as a bank customer. Yet the investment banking business can be even more lucrative during favorable times for the industry, and Morgan Stanley has done an outstanding job lately of capitalizing on as many opportunities as it can.
Morgan Stanley's most recent quarterly results showed the efforts that the Wall Street giant has made toward maximizing its potential. Overall, its revenue from its investment banking division was up by 20%, with particularly strong levels of activity in the mergers and acquisitions field. Underwriting activity was also healthy, and Morgan Stanley did a good job of playing a key role in helping companies go public for the first time as well. Most importantly, Morgan Stanley's trading operations did extremely well, with the company exceeding expectations with both fixed-income and equity trading.
Going forward, Morgan Stanley has even more opportunities. It's looking at digital banking to see if it can play a bigger role on the retail side, complementing its wealth and investment management businesses. With a strong reputation and a relatively inexpensive valuation, Morgan Stanley looks promising for bank investors searching for good value.
This highly profitable bank is trading for a discount
Matt Frankel, CFP (Synchrony Financial): One of the top bank stocks on my watch list right now is Synchrony Financial, a leading store credit card issuer and growing online banking institution.
Synchrony has a massive credit card business and focuses on store credit card products -- that is, credit cards you can use at a particular retailer, but that don't have a Visa or MasterCard logo on them. Synchrony issues store credit cards for such household names as Amazon, Gap, PayPal, Lowe's, and more.
Store credit cards can be an extremely lucrative business thanks to their higher-than-average interest rates. Even though Synchrony's net charge-off rate of nearly 6% is rather high for the credit card industry, the company's high-yielding loan portfolio (average yield is more than 21%) generates a net interest margin of 15.3%.
This, combined with its highly efficient online banking business, produces some pretty impressive profitability metrics. Synchrony expects a full-year return on assets (ROA) of about 2.5%, while most banks would be happy with anything over 1%. And Synchrony's 31% efficiency ratio shows that it's nearly twice as efficient as the average bank.
To be fair, there's more risk when investing in Synchrony than most other banks. When economic times get tough, high-interest debts like those in Synchrony's portfolio tend to see default rates skyrocket. However, I feel that the risk-reward makes a lot of sense, especially since the stock recently pulled back after the company announced the upcoming dissolution of its Walmart partnership -- which is indeed a setback but not a long-term game changer.