Bank stocks have gotten off to a great start in 2021. Both the KBW Nasdaq Bank Index and the SPDR S&P Regional Banking ETF are up nicely through the first two months of the year, and are trading at higher levels than they did prior to the pandemic.
And there could still be more in store after an extremely difficult 2020. Here are three near-term events that should continue to support stock prices and valuations in 2021.
1. Biden's stimulus plan
President Joe Biden's $1.9 trillion stimulus plan is very important to the continued success of bank stocks in 2021. The mere news of it has contributed to the yield on the U.S. 10-year Treasury note jumping to levels not seen since early last year, which is impressive considering that the Federal Reserve's federal funds benchmark lending rate is near zero. The yields on longer-term bonds tend to tick up as expectations of inflation and Fed rate hikes increase, and some think all of the stimulus and pent-up savings and demand could lead to that.
The increase in the 10-year yield is good for banks right now because banks like to borrow short-term money and lend or deploy it long-term. So, while the fed funds rate for short-term money stays low and the yield on the 10-year increases, a situation also referred to as a steepening of the yield curve, banks tend to become more profitable.
Stimulus is also important right now for banks' credit quality. When the pandemic first began, banks projected lots of loan losses. Early rounds of stimulus that included individual paychecks, enhanced unemployment benefits, and the Paycheck Protection Program put money into the pockets of consumers and businesses, which played a role in helping many borrowers stay current on their loan payments. While many banks believe a worst-case credit scenario has been averted, another big round of stimulus could further stave off more potential loan losses. This would make it more likely that banks will release money currently reserved for losses back into their profits, which would further boost earnings this year.
2. Relief on the supplementary leverage ratio
While most of the pandemic has been a struggle, one positive the banking sector experienced in 2020 was a huge influx of deposits. This has created massive excess liquidity and ballooned balance sheets. But this positive has turned into a bit of a negative for certain banks.
Banks have to abide by lots of different regulatory capital ratios, and one of those is called the supplementary leverage ratio (SLR), which looks at a bank's capital compared to its total leverage exposure. Total leverage exposure includes total assets and off-balance sheet items such as derivatives, repurchase agreements, and other lending commitments or exposure.
Deposits have caused the total leverage exposure at some banks like JPMorgan Chase (JPM 1.41%) to jump because the bank's assets have grown significantly. This has put pressure on some SLR ratios, sending them downward and closer to their regulatory minimum thresholds.
In March 2020, bank regulators saw the issue unfolding and approved an exclusion that would allow banks to exclude U.S. Treasury securities and deposits held at Federal Reserve banks from the total leverage exposure. This has helped contain the leverage exposure, but the exclusion is expected to expire at the end of the first quarter on March 31, 2021. If it does, JPMorgan executives said they could quickly be faced with some very difficult decisions. Those include reducing or turning away deposits, issuing preferred stock, or retaining more common equity than the bank would normally need to.
A decision is coming soon, and I think there is a good chance the Fed will extend the exclusion, but this will be an interesting issue to watch this year because a more permanent solution will likely be needed.
3. Easing limits on capital distributions
In the back half of 2020, the Federal Reserve restricted large banks from conducting stock buybacks and also limited dividend payouts to no more than the trailing four-quarter average of net income. Following banks' second round of stress testing toward the very end of last year, the Fed lifted its ban on buybacks for the first quarter of 2021. However, it limited total capital distributions, including share repurchases and dividends, to not exceed a bank's trailing four-quarter average net income.
The Fed specifically said in its statement following the second round of stress testing that these limits are for the first quarter of 2021. So, I think the Fed will likely say whether or not it plans to extend the limit to the second quarter sometime soon. If the Fed does extend the limits for another quarter, it will probably have another chance to be lifted when the Fed releases 2021 stress test results in the middle of the year. Obviously, removing limitations on dividends and share repurchases would be a huge benefit for banks.