While the S&P 500® has been setting records, the bank stocks included in the index have underperformed most other industries. Some haven't even returned to their peaks of more than a dozen years ago. But there may be a hidden catalyst that could bring better times for at least some banks.
“Several banks could be positioned to reward shareholders by returning more capital to them this year, potentially attracting more investors to the industry,” says Matt Reed, portfolio manager of Fidelity® Select Financial Services Portfolio (FIDSX).
Reed notes that despite low interest rates, tough fundamental conditions, and COVID-19, many banks have bolstered their capital positions, continuing a trend dating to the end of the Great Recession.
The strength of these banks' balance sheets, he says, is reflected in the latest round of bank stress tests, released in December 2020. The Federal Reserve tested banks under several hypothetical recessions, including a global market shock. Reflecting the generally favorable test results, the Fed modified some of its capital deployment restrictions for banks, allowing them to return additional amounts of capital to shareholders by buying back outstanding shares.
“I think this could be the start of a positive trend and it may be just a matter of time before capital-return restrictions are eased further if the economy continues to improve,” Reed says.
Another point in banks' favor, Reed points out, is that loan delinquencies and defaults remain lower than many investors had feared at the start of the pandemic and could improve further as the economy recovers.
Reed says Bank of America (BAC), Wells Fargo (WFC), and Citigroup (C) all passed their respective stress tests with flying colors, even though the Fed designed a harder version of the test for the largest US banks.
“This suggests to me that these banks have excess capital that could eventually find its way to shareholders,” he says.
Fidelity® Select Financial Services Portfolio held securities mentioned in this article as of its most recent holdings disclosure. For specific fund information, including holdings, please click on the fund trading symbol above.