Best Bank Stocks to Buy in 2016

Best Bank Stocks to Buy in 2016

With the Federal Reserve all but certain to start a slow sequence of interest rate hikes next week, investors are sure to wonder – which bank stocks stand to do best in 2016? 

No one knows for sure, of course, but a few big names look promising. Many analysts think prospects for the banking sector are good, though not necessarily stupendous.

"U.S. banks have outperformed the broader U.S. equity market in 2015. Credit quality has been excellent, and investors once again are optimistic about the prospect of rising interest rates and their impact on the banking sector," says Morningstar analyst Robert Goldsborough, writing in an analysis of SPDR S&P Bank ETF (ticker: KBE), an exchange-traded fund that tracks U.S. banks. "Banks also have enjoyed relative calm, with no bad news, no major credit issues in energy and most financial crisis-related settlements concluded."

Rising interest rates could lift bank revenues and earnings, some analysts say, though they caution against expecting too much given the Fed's plan to raise rates very, very gradually. A strengthening economy, strong job creation and falling unemployment should minimize default rates on loans. And improving economic conditions should raise demand for mortgages, car loans and other consumer loans.

At the same time, some banks have struggled to pass the stress tests imposed after the crisis, and satisfying tougher post-crisis regulations is costly. So a bet on banking is, well, a bet. And the good news and expectations may already be reflected in bank stock prices.

Good performance isn't the only way to make money on bank stocks. Christopher Marinac, director of research at FIG Partners LLC, a research, market making and investment-banking firm, believes that mergers and acquisitions among small banks could produce some nice gains for investors in 2016.

"The average premium to current price in a merger transaction is over 25 percent, which is enticing," he says. "But investors have to be patient and careful. We advocate buying banks on their fundamental merits and not just for their M&A franchise potential."

Investors, then, might be wise to keep alert for takeover murmurs.

Here are the best bank stocks to buy in 2016:

Wells Fargo & Co. (WFC). The positive view of Wells Fargo boils down to something quite simple: It dominates its market. "We estimate that more than one-third of the bank's deposits come from markets in which Wells Fargo is the pre-eminent player, and more than two-thirds are gathered in markets in which the company ranks among the top three," Morningstar analyst Jim Sinegal writes in a report. The bank has steady management, good cost control and close relations with customers, he says. If you want a good reference, note that Wells Fargo is one of the largest holdings of Warren Buffett'sBerkshire Hathaway. (BRK.A, BRK.B)

Bank of America Corp. (BAC). Size and dominance also make Bank of America attractive, which put its crisis-era problems behind it, Sinegal says. Like Wells Fargo, Bank of America is strong at getting customers to try other products and services.

Citigroup (C). Citigroup had more than its share of problems from the financial crisis, Sinegal says. "Yet we believe Citigroup's progress over the past five years is underappreciated. The bank has raised capital, shed assets and bulked up its board of directors and management team with experienced bankers."

Bank of New York Mellon Corp. (BK). Another big name drawing attention is Bank of New York Mellon, which specializes in holding assets for institutional clients, such as pensions and mutual funds. Some activist investors have been gathering up shares and pressing for improvements to drive up the stock. While its future is somewhat iffy, buying now would be a chance to ride the coattails of activist crowd pressing for a turnaround.