3 Top Bank Stocks to Buy in October

Third-quarter earnings season is upon us and the big banks will be among the first major companies to report their latest results. With that in mind, here's why three of Motley Fool contributors think that Bank of America (NYSE: BAC), Wells Fargo (NYSE: WFC), and JPMorgan Chase (NYSE: JPM) are worth a look before the numbers hit the newswire.

Poised to benefit from rising rates

Matt Frankel, CFP (Bank of America): One bank stock I have my eye on as we approach earnings season is Bank of America, which I believe was the winner of the second-quarter earnings season among the big banks. With strong revenue growth, incredible improvement in profitability, and impressive efficiency, Bank of America didn't give investors much to be disappointed about.

I wouldn't be surprised to see similar strong results when the bank reports its third-quarter earnings, but a big reason I'm keeping my eye on Bank of America right now is because after several Federal Reserve interest rate hikes, it finally looks like long-term interest rates are beginning to rise as well.

Generally speaking, when interest rates rise, banks tend to achieve better profit margins. Fed rate hikes increase the interest banks earn on credit cards and HELOCs, but interest rates on loans such as auto loans and mortgages aren't directly tied to the Fed's moves and haven't increased nearly as much in the current rate-hike cycle. Now, it looks like that could be swinging in the banks' favor -- for example, the average 30-year mortgage rate just surpassed 5% for the first time in eight years.

Bank of America is in a better position than most to benefit, and here's why. The bank has $435 billion in noninterest-bearing deposits, a higher proportion than the other big banks. So while lending interest rates go up, Bank of America's cost of capital on this part of its deposit base stays constant -- great for margin expansion. In fact, Bank of America estimates that a 100-basis-point parallel shift in the yield curve would translate into an additional $2.8 billion in annual profit.

To be clear, the interest rate spike has largely taken place after September ended, so the effects won't be visible in the third-quarter report. However, if rates continue to go up, Bank of America could be a big beneficiary for years to come.

Bank on a buyback binge

Jordan Wathen (Wells Fargo): When everyone else is snubbing their nose at a bargain-bin stock, it may be time to hold your nose and dive in.

Wells Fargo isn't the perfect bank. Scandals surrounding its sales practices have damaged its brand, and its profitability. Regulators took the unusual action of capping its size, forcing Wells Fargo to fix its problems before it is allowed to get any bigger.

But the problems coming out of Wells Fargo aren't the kind of problems bank investors typically lose sleep over. Loan losses are few and far between (the bank charged off 0.26% of loans on an annualized basis in the most recent quarter), and it is overcapitalized by almost any measure.

Earlier this summer, Wells Fargo received the green light from regulators to return more capital to shareholders. Its plan calls for repurchasing as much as $24.5 billion of stock, or roughly 10% of shares outstanding. Best of all, it comes at a time when its shares are especially cheap, trading for roughly 12 times earnings and 10 times the consensus estimate for 2019.

Wells Fargo stock is priced as if it will never grow again, meaning that it's all upside for shareholders when regulators finally remove its $2 trillion asset cap. It may not be tomorrow, or even next year, but at 12 times earnings, investors are paying a price that implies Wells Fargo will never, ever grow again. That outcome seems almost improbable.

Chasing even better performance

Dan Caplinger (JPMorgan Chase): It's almost time for the latest set of results from big bank stocks, and hopes are high at JPMorgan Chase that the banking giant will be able to keep pace with the rest of the industry during a period of improving fundamental business conditions. Investors expect that JPMorgan will see a sizable 5% jump in revenue in the third quarter compared to the year-ago period, with a much larger earnings boost of nearly 30%. Tax reform will be responsible for a substantial part of JPMorgan's bottom-line success, but rising interest rates and strong conditions in the financial markets should also help add to its income as well.

One of the most bullish views on JPMorgan Chase comes from the bank itself. The company has gotten the go-ahead from the Federal Reserve to make massive repurchases of its stock, and the roughly $19 billion it has used to buy back shares puts it ahead of its banking peers and also surpasses the amount of capital that all but the single biggest technology company in the market has returned to its shareholders.

With rising interest rates potentially helping to expand net interest income, many shareholders are hopeful that JPMorgan will be able to sustain further growth throughout the rest of 2018 and beyond. For those who remember the pressures a decade ago during the financial crisis, it's amazing just how far JPMorgan has come since those dark days.

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Dan Caplinger has no position in any of the stocks mentioned. Jordan Wathen has no position in any of the stocks mentioned. Matthew Frankel, CFP owns shares of Bank of America. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.