4 Top Banks to Buy for 2018 as Interest Rates Go Higher

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Few industries like to see interest rates go higher. That increases the cost of borrowing and the input costs to many companies. However, one segment that likes increases in interest rates is the top banks. In many cases, the increases help them make more money via net interest income. That is the difference between revenues generated by interest-bearing assets and the cost of servicing (interest-burdened) liabilities. For banks, the assets typically include commercial and personal loans, mortgages, construction loans and investment securities.

With rates creeping higher, and most of the banks finished with third-quarter reporting, the path forward looks good, especially if the administration’s tax proposals are pushed through. Interest rates across the board look to be breaking a long-term downtrend, and a new report from RBC notes that 12 of the top 20 banks exceeded both their estimates and the consensus numbers. The report noted this:

The top 20 banks’ third quarter results reflected strong year over year earnings growth, robust capital positions, strong credit quality, net interest margin expansion, and continued expense management. We believe there are three catalysts that could move profitability meaningfully higher; 1) continued increases in short term interest rates and a steeper yield curve, 2) large bank M&A, and 3) significantly higher returns of excess capital.

Here we focus on four top banks that look like they could have the biggest upside potential. The sector has run hard this year, and with overall market valuations high, these four may hold the best potential now. All are rated Outperform at RBC.

Bank of America

This company posted solid third-quarter results. Bank of America Corp. (NYSE: BAC) is a ubiquitous presence in the United States, providing various banking and financial products and services for individual consumers, small and middle market businesses, institutional investors, corporations and governments in the United States and internationally. It operates some 5,100 banking centers, 16,300 ATMs, call centers, online and a mobile banking platform.

The third-quarter results beat Wall Street expectations despite a slowdown in its fixed-income trading business. Here’s how the company’s results fared against Wall Street expectations: Earnings per share of $0.48 versus $0.45 forecast by Thomson Reuters. Revenue: $22.079 billion versus $21.976 billion.

Bank of America investors are paid a small 1.86% dividend. The RBC price target for the shares is $28, and the Wall Street consensus target is $28.05. The shares traded early Monday at $27.60 apiece.

Citigroup

This top bank has broken out of a long trading range and could push even higher. Citigroup Inc. (NYSE: C) has approximately 200 million customer accounts and does business in more than 160 countries and jurisdictions. It provides consumers, corporations, governments and institutions with a broad range of financial products and services, including consumer banking and credit, corporate and investment banking, securities brokerage, transaction services and wealth management.

Trading at a still very cheap 10 times estimated 2018 earnings, the bank looks very reasonable in what has become a pricey stock market. A continuing stock buyback program is a big positive. The company’s institutional clients group appears to be holding its ground and the stock is cheap at this level.

This company also reported better-than-expected quarterly results, as its global consumer business showed further revenue growth. Here’s how the banking giant’s results fared against Wall Street estimates: Earnings per share $1.42 versus $1.32 expected by a Thomson Reuters survey. Revenue: $18.173 billion versus $17.896 billion expected. Plus, fixed income trading was $2.877 billion, versus a projected $2.84 billion.

Citigroup investors are paid a 0.95% dividend. RBC has a $79 price target for the stock. The posted consensus price objective is $76.05. Shares traded Monday morning at $73.35.