The U.S. Federal Reserve’s most recent round of stress tests, conducted in June, showed the nation’s largest banks have more than enough capital to handle a severe market downturn, notes Fidelity’s Matt Reed.
“The good news for investors is that banks are regaining a measure of autonomy regarding their capital-allocation practices, something that’s been missing since the Great Recession of 2007–2009,” says Reed, portfolio manager of Fidelity® Select Financial Services Portfolio (FIDSX).
Reed believes that many banks will take advantage of increased flexibility in doling out dividends and buybacks, as a recent rule change enables management teams more discretion than the prior annual approval requirements.
On October 1, Reed says the Fed enacted a new “stress capital buffer” for each of the 34 banks that underwent stress testing. This is a required amount of capital each firm needs to hold to guard against losses. Notably, it varies by bank, based on the Fed’s periodic review of their balance-sheet strength and operations.
Under this new rule, he expects banks should be able to better decide how much capital they need to support lending growth versus how much can be returned to shareholders, provided they maintain the required capital buffer.
For example, Morgan Stanley (MS) doubled its dividend in the third quarter and repurchased more of its shares as part of a $12 billion stock buyback program through June 2022. The fund held an outsized stake in Morgan Stanley as of August 31.
Reed notes that State Street (STT), Wells Fargo (WFC), and Capital One Financial (COF)—all overweight positions within the portfolio at the end of August—also moved ahead on plans to return more capital to shareholders.
“I think the increased flexibility can help banks better manage their businesses while retaining a capital cushion above their regulatory minimums and still supporting long-term growth of the business,” Reed says. “I’m positioning the fund with these factors in mind.”
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