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Financial Stocks Swoon in June Despite Prospects for Big Capital Return to Shareholders

Broader concerns over profit margins, competition hinder confidence.

Investors have recently soured on financial stocks, even as big banks may be set to hand back cash to investors in the way of share buybacks or dividend increases.

Concerns over the shape of the yield curve, which partially impacts banking profits and has served in the past as an indicator of a slowdown in the economy, have, in part, pressured banking shares in recent weeks. The potential fallout from a broader trade war between the U.S. and China and other key trading partners hasn’t helped market sentiment either. Competition for retail and institutional assets is a concern, too.

The S&P 500 Financials Sector Index has fallen by 1.5% this month through June 26 and has declined by nearly 4.5% since the beginning of the year. And the index is down by 11.5% from its high in late January.

Since banks borrow short and lend long, the spread they earn from their lending benefits when the difference between short- and long-term interest rates is greater. That hasn’t been the case for much of this year.

The difference between two-year and 10-year U.S. government debt has flattened to about 33 basis points as of June 25, from as high as 78 basis points in early February, according to the Federal Reserve Bank of St. Louis. (A basis point is one one-hundredth of a percentage point.) The recent compression in the spreads between these two securities recently reached its flattest point since 2007.

Apart from how financial stocks have performed recently, executives in the banking sector are also increasingly concerned about the rising interest rate environment and likelihood that the Federal Reserve will continue on its current tightening path. In addition, they cite competitive forces as another concern, including competition from other banks.

In May, overall bankers’ confidence fell to its lowest level since Promentory Interfinancial Network began three years ago to track sentiment among banking CEOs, presidents and CFOs. The firm’s Bank Confidence Index fell to 45.7 – a contractionary level compared to an expansionary reading over 50.0 (50.5) in the previous survey. The index tracks bankers’ experiences based on access to capital, loan demand, funding costs and deposit competition.

A record number of respondents, or 76%, faced more competition for deposits during the past 12 months, and 81% reported higher funding costs. Although bankers expressed some concern about the outlook of the banking industry, a majority of bankers (54%) still feel confident about the direction of the economy over the next year, according to the survey.

This week, the second part of the Federal Reserve’s stress tests are expected and could pave the way for banks to approve a large return of capital to shareholders. The 25 largest lenders could announce dividends and buybacks representing $30 billion more than last year, or a 25% increase, according to estimates from analysts compiled by Bloomberg.

Following the results of the stress tests, announcements of capital return plans could serve as a short-term boost for banking and financial stocks, though the more pessimistic outlook for the operating environment that banks and financial institutions find themselves in will likely remain.

“[Stress test results] could be a catalyst for a day or two but it’ll still come back to the main driver, which is going to be the yield curve and loan growth, which has been OK but nothing to write home about,” Sameer Samana, global equity and technical strategist at Wells Fargo Investment Institute in St. Louis, said in a Reuters report on June 20.


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S&P 500 Financial Sector Index:

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