Big U.S. Banks in Best Shape in 20 Years

Over the short term, prices of U.S. bank stocks have been overwhelmed and pushed to the downside by the Brexit vote, the subsequent meltdown in European bank prices and the sharp drop in U.S. interest rates. However, once the dust settles (and it will), share prices again will be influenced by fundamentals. On that basis, the big U.S. banks have had very positive news in the past week. We believe favorable stress test results, better-than-expected capital plans and the allowance of return of capital to shareholders argue that banks are in their best financial shape in the last 20 years. We believe the combination of favorable regulatory results, strong capital ratios, solid loan portfolio and very attractive valuations all argue for substantially higher stock prices. We believe this will be the case even if interest rates remain depressed. However, if and when rates do go higher, this will be the icing on the cake and would just add to our bullish outlook. The following gives some highlights from this week's Comprehensive Capital Analysis and Review (CCAR) results: Overall, U.S. banks did well on CCAR, with none failing. The largest banks such as JPMorgan Chase (JPM), Citigroup (C), Bank of America (BAC) and Wells Fargo (WFC) all performed either in line with or better than expectations. Citi and Bank of America experienced the largest proportional increases in their dividends, but these were off low levels to begin with. JPM held its dividend steady but had a greater-than-expected buyback authorization. It's important to note that JPM already raised its dividend 9.1% in May, so we weren't expecting another increase. Wells Fargo maintained its net payout ratio at 55% to 75% of earnings instead of giving specific numbers. The key investment banks Goldman Sachs (GS) and Morgan Stanley (MS) both boosted their dividends and were given authorization to repurchase shares, which shows the Fed's confidence in their business models. In Morgan Stanley's case, it did get a little black eye in that it must resubmit its plan based on weakness in its capital planning process. Meanwhile, trust banks such as Bank of New York (BK), State Street (STT) and Northern Trust (NTRS) all reported solid dividend hikes and buybacks, although Northern Trust's buyback was miniscule at $275 million. Big regional banks such as BB&T (BBT), PNC (PNC), SunTrust (STI) and U.S. Bancorp (USB) all reported good results on the tests. The Fed gave all of these institutions healthy allowances to boost their dividends and repurchase their own shares in the coming period. Lastly, consumer credit-related organizations such as American Express (AXP), Capital One Financial (COF) and Discover (DFS) performed well. American Express and Discover both were allowed to increase their dividends and buy back stock (although AXP's buyback was less than many expected), while Capital One held its dividend steady but received a large buyback authorization. Banks and financial-related stocks have had a rough go in the market over the past week due to Brexit fears, Europe and falling interest rates. The shares trade at high single-digit and low double-digit price/earnings multiples. Investors should use the recent share price weaknesses to step up and buy high-quality financial institutions. As the recent stress test and CCAR results have shown, these institutions are in their best financial shape in a long time. The companies continue to be very profitable even in this anemic interest rate environment, and it should be just a matter of time before these stocks report strong performance gains.

Big U.S. Banks in Best Shape in 20 Years

Strong capital ratios, solid loan portfolios and attractive valuations argue for higher prices for financials.

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