Since the pandemic began, bank deposits -- which are typically among the most important things bank investors focus on when analyzing bank stocks -- haven't really mattered as much as they normally do.
That's because interest rates were at or near zero and the Fed was pumping trillions of dollars into the economy, which led to deposits flooding into the banking system. But now that time is over. The Fed is pulling liquidity out of the economy, and interest rates have shot up this year as the Fed tries to get inflation under control.
Suddenly, deposit costs are rising. According to the Federal Deposit Insurance Corp.'s (FDIC) quarterly banking profile, average funding costs rose to 0.64%, which is up by 38 basis points (1 bps = 0.01%) from the second quarter. Banks with low-cost, sticky deposit bases will be able to grow their margins in 2023 and outperform.
With that in mind, here are five bank stocks to buy.
1. Bank of America
The first name on this list is industry favorite Bank of America (BAC -0.96%), which also happens to be the second-largest bank in the U.S. by assets. Bank of America regularly outperforms its peer group in terms of deposit betas, which represent the amount that a bank has to increase the interest it pays on deposits in response to the Fed's interest rate hikes.
Bank of America has also continued to build its deposit franchise and now has more than $1 trillion of low-cost consumer deposits. Paired with its strong commercial lending franchise, Bank of America should be able to continue to grow net interest income (NII), the money the bank makes on loans after funding those assets, in 2023.
2. Wells Fargo
Wells Fargo's (WFC -0.78%) deposit betas have widely outperformed the industry this year and performed even better than Bank of America so far. That's because Wells Fargo is still operating under an asset cap, which the Fed imposed in 2018 as punishment for the bank's phony-accounts scandal.
As bank balance sheets ballooned in 2020 and 2021 due to the influx of deposits into the system from quantitative easing and excess savings, Wells Fargo couldn't grow its balance sheet because of the asset cap. It had to be very selective about which deposits it accepted, particularly on the wholesale side.
This allowed the bank to choose customers it has better relationships with and who won't leave the bank at the first sign of better yield elsewhere. It will be interesting to see if Wells Fargo will be able to maintain this outperformance this year. Regardless, I would still expect it to perform well.
3. Regions Financial
The nearly $158 billion asset bank Regions Financial (RF -0.46%) was one of the best-performing larger bank stocks in 2022, with its stock only falling about 4.5% and widely outperforming the broader market and the banking sector. At the end of the third quarter, more than 40% of Regions' deposits were in non-interest-bearing deposits, which are those the bank doesn't pay any interest on.
Management also said in its Q3 earnings materials that there is no near-term expectation to have to bring on higher-cost wholesale deposits. Many banks will need to do that this year as lower-cost deposits funnel out of the system. Management has also done a good job of managing the balance sheet so the bank can perform well in a variety of different interest rate environments. The bank is not cheap, trading at about 300% of its tangible book value, or net worth, but investors are clearly impressed.
4. Eastern Bankshares
A much smaller bank based in Boston, the $22 billion asset Eastern Bankshares (EBC -1.68%), has an excellent deposit base. Roughly 62% of all deposits are in checking account products, which are among the stickiest and lowest-cost deposit products in banking. In Q3, Eastern only saw the total cost of its deposits rise from 0.06% to 0.10%, despite the Fed hiking its benchmark overnight lending rate, the federal funds rate, by 150 basis points in the quarter.
Eastern did see deposits decline by about 2% in Q3, but it probably chose to let those roll off and didn't think it was worth it to pay up for them. The bank also has a strong commercial lending franchise and really strong credit quality.
5. Banner
Another smaller bank, Banner (BANR -1.66%), has about $16.4 billion in assets and is based in Washington. Like Eastern, this is another bank with an elite deposit base. Total deposit costs at the end of Q3 were just 0.07%. More than 45% of total deposits come from non-interest-bearing sources.
While the bank does have a decent amount of exposure to construction loans, which are more susceptible to loan losses during a downturn, management does seem aware of the risk on its balance sheet. The bank also benefits greatly from a rising interest rate environment and should see NII move meaningfully higher.
