Heading into 2018, we remain bullish on the financial sector, as rising interest rates should continue to bolster banks’ net interest margins and solid economic growth should support commercial and industrial lending.
Bank stocks tend to track the market’s expectations for rate increases; for example, the sector pulled back between late July and mid-September, when futures priced in lower odds that the Federal Reserve would bump up interest rates at its Dec. 13, 2017, meeting. The increasing odds of a rate hike have sent bank stocks soaring.
Rising expectations for at least two rate hikes in 2018 should support further outperformance in 2018.
Since March, bigger banks have outperformed (based on expectations for regulatory relief) alongside the smallest banks (acquisition targets). Investors have rewarded names that can reduce expenses to drive growth, offer significant leverage to rising interest rates, and trade at below-average valuations.
Comerica (NYSE: CMA) has outperformed the S&P 500 and the KBW Regional Banking Index by a sizable margin since we added the stock to the Wealth Builders Portfolio in February.
The Texas-based bank exhibits a high level of asset sensitivity, with 90 percent of its loans carrying floating or variable interest rates. In the third quarter, Comerica’s net interest margins surged by 26 basis points sequentially; rising interest rates accounted for about 14 percentage points of this improvement. Management also expects its “Gear UP” initiative to drive $90 million in annualized revenue enhancements and $215 million in expense benefits by 2019.
With assets of $72 billion (versus the $50 billion threshold), Comerica is exposed to higher regulatory scrutiny under the Dodd-Frank Act; however, regional banks near the $50 billion limit are most likely to see regulatory relief over the next few years.
Already, the bank passed its stress test and pays an annualized dividend of $1.20 per share—up from $0.92 a year ago. The bank has also authorized a $605 million stock repurchase program. In light of these macro- and company-specific upside drivers, we’ve increased our buy target for Comerica.