It was a little more than a year ago that banks suddenly rocketed to the top of news headlines, when Silicon Valley Bank quickly collapsed after an old-fashioned bank run. That failure sparked concerns among some investors about the banking sector more generally—and even some unpleasant memories of the 2008 to 2009 period—as the closure of Signature Bank followed just 2 days after SVB and stocks of regional banks experienced volatility.
Although 3 more US banks eventually closed over the remainder of 2023, the worst-case fears of follow-on effects and contagion never materialized. Bank stocks generally returned to greater stability as the year progressed. Financials even ended up finishing the year with a positive return, as measured by the S&P® Financial Select Sector Index.
But the first months of 2024 had some investors again questioning the stability of the sector, as volatility in the share price of New York Community Bancorp, the holding company for Flagstar Bank, N.A., highlighted potential concerns about banks' exposure to underperforming commercial real estate.
Where the banking sector goes from here will undoubtedly depend in part on the broader economy, with a soft landing likely supporting the sector but a recession potentially hurting it. But investors should remember that banking is a diverse industry. While some banks have faced specific headwinds, others may be well positioned with much stronger asset bases and loan books. Read on for a closer look at the recent state of the sector.
Closed institutions faced distinct risks
Put last year's closures into broader context and it actually wasn't a remarkable year in terms of the number of closures. As the chart below shows, the year's 5 closures shrink in comparison to years like 2009 and 2010, which experienced 140 and 157 closures, respectively. That said, it was the most significant year on record in terms of the total assets of the institutions involved, largely due to the sizes of Silicon Valley Bank, First Republic Bank, and Signature Bank.
It's important to note that the 5 banks that closed last year each faced specific risks that left them particularly vulnerable. For example, SVB and First Republic focused much of their lending activity on startups, many of which ran into trouble when interest rates began rising rapidly in 2022. These banks also had significant exposure to long-dated securities and loans, which quickly lost value when rates spiked. Signature Bank had an unusually concentrated deposit base, as opposed to the diversified deposit base that is more common among regional banks. The 2 smaller institutions that closed later in the year faced similarly idiosyncratic issues—one due to alleged fraud and the other due to losses on a narrow portfolio of loans.1
Those banks were also disproportionately funded by uninsured deposits—due to a high percentage of customers with deposits of more than $250,000 (the FDIC deposit-insurance account limit). Those uninsured deposits created additional risk when volatility hit the sector, as many of these high-balance customers grew fearful and began withdrawing their money.
Volatility this year in the stock of New York Community Bancorp has generally stemmed from challenges with its commercial real estate portfolio and investor concerns over governance risks. While exposure to commercial real estate impacts many banks, NYCB has particularly significant exposure to these loans compared with competitors. NYCB has also been in a unique position due to the number of acquisitions it has made in recent years—including the purchase of one of the banks that came under pressure last year. A number of actions have been taken to help stabilize the bank since the start of volatility, including an investment of more than $1 billion by a group of private equity investors and the addition of board members and executives with deep backgrounds in banking and government.
Outlook and potential risks
Fortunately, most regional banks have a considerably more diversified deposit base than SVB, First Republic, and Signature Bank did, as well as a lower percentage of uninsured deposits, which should help reduce the risk of bank runs even if volatility returns.
Of course, risks do remain. Some lenders could be vulnerable to headwinds from their commercial real estate exposure. If the US economy were to dip into recession—which is always still possible, even though at this stage a soft landing appears potentially more likely—then banks could see weaker loan demand and an increase in nonperforming loans. If interest rates were to spike higher—which, again, is possible although perhaps not the most likely scenario—then worries about the value of banks' long-dated bonds could resurface.
With that said, if the US can avoid a recession, the outlook for many banks may be bright. In general, banks tend to benefit from higher interest rates, because their net interest margin (the difference between what they pay on deposits and what they earn on loans) can expand. Although dislocations can occur when rates move very quickly—as they did with the rate increases over the past 2 years—over time the asset and liability sides of banks' ledgers can adjust and position them for stronger earnings growth.
Fund top holdings2
Top-10 holdings of the Fidelity® Select Financials Portfolio (
- 10.2% – Mastercard Inc. (
) - 8.0% – Wells Fargo & Co. (
) - 5.4% – Bank of America Corp. (
) - 3.9% – Reinsurance Group of America (
) - 3.3% – Chubb Ltd. (
) - 3.0% – Citigroup Inc. (
) - 2.6% – Apollo Global Management Inc. (
) - 2.4% – Morgan Stanley (
) - 2.2% – Marsh & McLennan Companies Inc. (
) - 2.1% – Moody's Corp. (
)
(See the most recent fund information.)
Potential opportunities
I believe there have been attractive bargains among regional banks due to most lenders being tarred with the same brush as the few that shuttered. While regulators are watching the group closely, the best defense, in my view, will be a stock-by-stock approach to finding banks with diverse deposit bases, strong balance sheets, and attractive growth prospects.
M&T Bank (
Another example is Popular (
Looking ahead with cautious optimism
In summary, I believe that carefully chosen regional bank stocks are worthy of inclusion in a diversified equity portfolio. Risks remain, but even in the event of a recession, the best lenders may be expected to participate in the economic recovery that follows.
Matt Reed is a research analyst and portfolio manager in the Equity division at Fidelity Investments. Fidelity Investments is a leading provider of investment management, retirement planning, portfolio guidance, brokerage, benefits outsourcing, and other financial products and services to institutions, financial intermediaries, and individuals.
In this role, Mr. Reed is responsible for the research and analysis of the financial sector. Additionally, he manages Fidelity Advisor Financial Services Fund, Fidelity Select Banking Portfolio, Fidelity VIP Financial Services Portfolio, and Fidelity Select Financial Services Portfolio.
Prior to assuming his current responsibilities, Mr. Reed covered a variety of sectors, including banks and diversified financials, global financials, financial services and tech, health care, and metals and mining. In this capacity, he was responsible for recommending securities across the capital structure for Fidelity’s High Income division.
Before joining Fidelity as a summer intern in the High Income division in 2008, Mr. Reed was director of Asia Pacific strategy and planning at MetLife, and director of finance at Travelers Group. He has been in the financial industry since 2008.
Mr. Reed earned his bachelor of arts degree in finance from Bentley College and his master of business administration degree from Harvard Business School.