Is It Time To Add U.S. Banks To Your Portfolio?

1/16/14 10:59AM EST

Is It Time To Add US Banks To Your Portfolio Is It Time To Add U.S. Banks To Your Portfolio?

Image via Rob Wilson/Shutterstock

Since the financial crisis, US banks have groaned under the weight of increased scrutiny. However, it appears as if banks may finally be putting the crisis behind them. Not only is the negative sentiment fading away, but banks continue to show strong commitment to reversing their fortunes. These efforts have been felt on the stock market. Wells Fargo (NYSE:WFC), for instance, has gained more than 50 percent on the stock market since the beginning of 2009. Bank of America (NYSE:BAC) gained 34.6 percent in 2013, outpacing the broader market.

Cost Cutting Drives Banks’ Earnings

Bank of America announced Wednesday that its profit rose from $367 million in Q4 2012 to $3.18 billion in fourth quarter of 2013. The positive earnings were staged against the backdrop of continued cost cutting at the bank. Brian Moynihan, the bank CEO, seems to be making headway with his 2010 plan to save the bank $8 billion per year. Along with this, operating costs in the fourth quarter fell by 6 percent to $17.3 billion. Likewise, credit costs continue to shrink. Over the quarter, the bank reserved $336 million to cover bad loans. This pales in comparison to the $2.2 billion that was set aside for the same purpose a year earlier.

Interestingly, Wells Fargo, which also recently reported Q4 earnings, similarly increased its margins through cost cutting.

Wells Fargo, which earned $5.61 billion in Q4 2013, up from $5.09 billion a year earlier, improved its efficiency ratio, the measure that places costs as a percentage of revenue. The efficiency ratio improved to 58.6 percent from 59.1 percent in the third quarter. However small the improvement might seem, it translates into continued profitability.

Cost Cutting Will Cushion Banks From Mortgage Losses

Although cost cutting doesn’t do anything to highlight banks’ long-term strategies for sustainable growth, they are very much needed at this time.

Ever since the Federal Reserve broke news of plans to unwind the stimulus program, interest rates have increased, suppressing mortgage demand and bringing an end to the refinancing frenzy that was previously prompted by low interest rates. Freddie Mac says that rates on 30-year mortgages, for instance, averaged 4.51 percent last week, up from 3.35 percent in early May 2013.

As the Fed continues to taper bond buying, interest rates will continue to rise. This will effectively reduce demand for mortgages. As is, the effects are already being felt by banks.  Wells Fargo, for instance, in its recent earnings, revealed that applications fell by half from year-ago levels and 23 percent on a quarterly basis.

Cost cutting by banks thereby presents an opportunity to mitigate the effects of waning mortgage demand. It will allow banks to get past this phase and reestablish strong growth pillars for future business. Investors should rethink their stance on banks and add them to their portfolios. There could be great upside potential.

Disclosure: Author represents that he has no position in any stocks mentioned in this article at the time this article was submitted.

 
 

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