Banks are Stronger and More Attractive – Even as Regulatory Relief Hasn't Arrived Yet

The Dodd-Frank Act – Three words that make the financial industry cringe. Banks, credit unions, and the big dogs on Wall Street have been struggling to keep up with the law, and fighting it on many fronts, since its enactment in 2010.

So will they finally get some relief? And in the meantime, what kind of shape are banks (and bank stocks) in?

Well, let’s start by making something clear about Dodd-Frank: Its purpose was a noble one — to stabilize the financial industry after one of the worst financial collapses in history. And it actually worked because the U.S. banking industry is in pretty good shape these days.

According to the FDIC’s First Quarter 2017 Banking Profile, the industry’s bottom line grew 12.7% year-over-year. In addition, non-performing loans fell for the 27th time in the last 28 quarters, declining 5.3% during Q1 alone.

Not content with the good news on income and bad loans? The FDIC problem bank list also continued to shrink, dropping down to only 112 banks. That’s the smallest number since the first quarter of 2008. However, the overall number of banks continued to decline, too. There were 5,856 banks in Q1 2017, a 23.5% decline since 2010 when there were 7,657 banks in operation.

That brings us to the negative side effect of Dodd-Frank. Banks are closing doors, but not due to failures. There were only three bank failures in the first quarter of 2017 and five during all of 2016. More likely, it’s because some are struggling to keep up with regulations.

Regulatory requirements such as keeping extra capital and performing additional audits can be very expensive. This hurts many smaller financial institutions — to the point where some end up selling their businesses and disappearing as a result of mergers.

Although fewer in numbers, banks have shown improvement in their Weiss Ratings over the years. As you can see in the graph below, banks rated “B+” or higher by our firm have risen from 1,226 in Q1 2014 to 1,543 in Q1 2017. That’s a 25.9% increase!

So the bank safety ratings are on the upswing … but what’s the story with their investment ratings (in case you decide you want to put some cash to work in bank stocks)? We have good news there, too.

The average returns for bank stocks overall are quite impressive — 10.8% year-to-date, and 33.3% for one year. But using the Weiss Ratings Stock Screener tool, I looked for BUY-rated bank stocks with even bigger gains — at least double the averages for both time periods. Here are the results:

Ten bank stocks reported these kinds of impressive gains this year, with total returns ranging from 28.6% to 69.2%. The best performer, Walker & Dunlop (WD, Rated “B-”), racked up gains of as much as 106.8%!

Impressive returns are great. But which banking stocks provide the best value at this time, according to our research and Ratings?

Undervalued Bank Stocks

*Data as of 7/27/2017

I zeroed in on the two stocks above, using an analysis of revenue, stock price, and price-to-earnings ratios, along with other things. Note that the list includes JPMorgan Chase’s preferred shares, rather than the common stock. As for Royal Bank of Canada, you can either buy it on the Toronto Stock Exchange or the New York Stock Exchange under the ticker symbol “RY”.

So there is good news all around. But a significant driver behind the rise in bank stocks has been the Trump administration’s promises to repeal Dodd-Frank. It appears that so far, we’ve only heard the talk and no action. What is actually happening in Washington?

The “Financial CHOICE Act of 2017” is the name of the replacement legislation. It would allow banks to opt-out of certain provisions of the Dodd-Frank Act. That includes the so-called Volcker Rule, which prevents government-insured banks from making risky investments.

It would also no longer require retirement advisers to put their clients’ interests ahead of their own. Plus, it aims to reduce the authority of the Consumer Financial Protection Bureau, which regulates large banks and payday lenders.

The proposal passed the House of Representatives on June 8 with no Democratic support. The next step is the Senate, where it will require a filibuster-proof 60 votes to pass.

It’s already clear that the Democrats in the Senate will not support the act. With the difficulty the Senate had last week in repealing and replacing the Affordable Care Act, it would appear that the chances of this proposed act being adopted are slim.

Investors on Wall Street are well aware of the almost-impossible task of repealing Dodd-Frank in the immediate future. But despite that, they’re certainly bullish on bank shares. That speaks to the underlying strength and health of the sector a decade after the Great Recession and credit crisis.

Whatever happens next, Weiss Ratings is here to provide you with an unbiased opinion on bank safety. So make sure you look up your bank and see what we have to say about it.

Think Safety,

Remi Lukosiunas

Money and Banking Edition, By Remi Lukosiunas, Financial Analyst Remi Lukosiunas, a Financial Analyst, joined Weiss Ratings in 2014 with a financial services background in internal audit and the credit union industry. Remi conducts banking, credit union, insurance and investment research. He has also written extensively on stocks and investing using ratings as a guide. Remi is a graduate of Florida State University with a degree in multinational business.