Banks Reserved and Ready

Banks have underperformed YTD as the KBW Bank Index is down 16.9% while the S&P 500 is up 13.4% through Friday 12/11. U.S. banks entered the COVID period with a low level of loan loss reserves and needed to add reserves because the lockdowns led to a recession and associated drop in loan quality.

I highlighted this issue back in March/April with two posts, one showing the low reserves and the other was the response by the largest banks to boost their reserves through large provisions starting with Q1 results.

The top chart includes the bank reserves as a percentage of loans/leases (light orange) and the net interest margin (blue). Both are key metrics for bank profitability. The lower chart shows the KBW Bank Index (dark orange) and how it has done vs. the S&P 500 (ratio of KBW/S&P).

While the net interest margin has been on a downward trajectory, putting pressure on profits, reserves ebb and flow with the economy. Note that bank stock outperformance has occurred when reserves fall ('95-97, '00-03, '11-13). Conversely, relative performance suffered when banks built reserves ('08-09 and 2020).

With stronger reserves and an economy that will likely improve in 2021, bank stocks may be able to outperform.