Opportunities in financials

Banks' strong capital position leaves them in good shape to return even more capital to shareholders in 2021.

  • By Matt Reed, Sector Portfolio Manager,
  • Pierre Sorel, Sector Portfolio Manager
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Key takeaways

  • US banks spent the years following the Great Recession of 2007–2009 repairing and rebuilding their balance sheets.
  • When the COVID-19 pandemic struck earlier this year, banks were well-positioned to manage the stress and to support customers during the downturn.
  • Although we expect them to sustain some losses connected with the pandemic, we believe banks are not only in a position to withstand the damage but also—if regulators and economic conditions permit—to return more capital to shareholders going forward.
 

Bank shares have struggled since the COVID-19 pandemic’s low on March 23, 2020, as the crisis brought about much lower interest rates, along with concern about a possible surge in nonperforming loans. Although bank stocks have fallen well behind the broader market so far in 2020, we believe, heading into 2021, that banks should be in a position to reward shareholders with increasing capital return.

A combination of government stimulus and loan forbearance have helped keep net charge-offs (NCOs)—loan delinquencies and defaults that are unlikely to be recovered, aka “bad debt”—from rising significantly year to date (see chart, gray line). Meanwhile, banks have been bolstering their balance sheets by already booking expected future losses (loan loss ratio, or LLR; green line) and maintaining capital at levels in excess of regulatory requirements tangible common equity ratio, or TCE ratio; blue line). Moreover, most banks have still managed to pay a dividend, thus rewarding shareholders for their patience. And while extremely low interest rates admittedly present a headwind, it’s important to keep in mind that some banks are better situated than others when it comes to their level and variety of fee income.

Banks have worked hard since the Great Recession to strengthen their capital positions, to good effect. This past June, the Federal Reserve performed its latest round of stress tests on the nation’s biggest banks. In addition to normal stress testing, the Fed included a sensitivity analysis to assess the resiliency of large banks under 3 hypothetical recessionary scenarios that might result from the pandemic. The Fed concluded, “The banking system has been a source of strength during this crisis, and the results of our sensitivity analyses show that our banks can remain strong in the face of even the harshest shocks.” That said, the Fed plans to soon conduct an unprecedented (and more extreme) second-round-in-a-year stress test, but at this point banks appear prepared to deliver another strong report.

All of this should leave most banks well-capitalized as we approach year-end. And so, heading into 2021, I think banks are in a good position to increase shareholder remuneration via stock dividends and buybacks while, at the same time, supporting their customers—and a broader economic recovery—to the extent that conditions and regulators allow. This could be good news for investors.

Next steps to consider

Research the Fidelity® Select Financial Services Portfolio (FIDSX).

Get more investing ideas and sector insights.

Go back to the full 2021 sector outlook.

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