Our Top Bank Stock Picks

Eric Compton: Despite all the positivity on the street about bank stocks, we were negative on bank valuations at the beginning of the year, with many of the names under our coverage trading above our fair value estimates. With total returns flat to down so far this year for the industry, we believe our thesis has proven correct. With the recent drop in many bank stocks, we are now more positive on the sector and believe investors can expect acceptable returns at these levels.

Despite the below average total returns for the stocks, fundamentals in the industry remain strong. Credit costs are at historical lows, and with strong GDP growth and low unemployment levels, we see no signs that the positive credit environment is about to turn. GDP growth tends to be a leading indicator for loan growth, and despite nonbank players taking share on the margin, higher paydowns from excess cash, and more companies leaning on the fixed-income markets for funding, we still see higher loan growth for our banks over the next couple of years. Most banks are investing in new technology and rationalizing current branch footprints and employee bases, and we expect cost control to continue for the industry as well. Finally, with rising interest rates and all banks under our coverage being asset-sensitive, we see continued gains for net interest margins and net interest income as well, although we do expect NIM expansion to slow as funding costs begin to catch up with asset yields. All of this, combined with a more friendly regulatory environment and tax cuts spell a positive environment for banks.

Our top pick within the traditional banking sector is Wells Fargo. We believe the underlying fundamentals for Wells remain strong, and eventually the bank will move past the negative headlines and legal charges. For those looking outside the traditional banks, Capital One is a top pick, where we see the company's technology advantages leading to solid returns for years to come.