DialoguesFidelity : Les secteurs bancaire et des produits financiers en Amérique du Nord

[00:04:21] Pamela Ritchie: Hello, and welcome to Fidelity Connects. I'm Pamela Ritchie. With new regulatory landscapes taking shape, mainly in the United States but also across the global banking universe, how are financials poised to perform over the next few years? Has the lack of recession provided a bit of a bolster to the valuation story for financials? Just how much consolidation could be on the books, not only for U.S. banks but also, perhaps, their European brethren? Joining us in studio today to help paint this picture is Fidelity co-portfolio manager and senior equity analyst, Lee Sotos, and Fidelity equity research analyst, Thomas Goldthorpe. Warm welcome to you both. How are you?

[00:05:02] Thomas Goldthorpe: Good.

[00:05:04] Lee Sotos: Good to see you.

[00:05:04] Pamela Ritchie: Happy Friday to everyone here today. I'll invite everyone to send their questions in to put to both Lee and to Thomas here for the next half hour or so. Lee, if we could begin, if you don't mind, with the bank earnings story from the U.S. We've seen some big, big bank earnings.  When we spoke, I don't know, a week ago or so, you were expecting them to be pretty good. They meet your expectations?

[00:05:27] Lee Sotos: I think overall when you look at what the banks have been printing it's really a very encouraging quarter. We started with a tremendous amount of uncertainty, particularly in the U.S. and on a global basis.

[00:05:46] Pamela Ritchie: Second quarter was basically April 1st, April 2nd.

[00:05:48] Lee Sotos: Right. What we've been seeing is ... I think you could have ascertained that there was going to be solid capital markets but we've also seen investment banking starting to pick up, which was a bit unexpected if you turned the clock back two or three months ago. In addition, banks saw very good loan and deposit growth in the quarter. Now, there are some questions of the sustainability. A lot of that is inventory build and working capital but the outlooks have generally been pretty positive for back half loan growth. I think the U.S. consumer looks healthy. Office has been kind of one of the things that's stuck out the last couple years and that seems to be kind of muddling through. Businesses in general are pretty healthy. We really remain pretty constructive on the U.S. Earnings numbers are going up, not down.

[00:06:57] Pamela Ritchie: Just quickly on the consumer, we had retail sales out in the U.S. People are still spending. It's sort of surprising. It still makes you want to ask if the next shoe is going to fall but just your general thoughts on what it appears banks are doing in the U.S. Just follow up to what Lee said.

[00:07:11] Thomas Goldthorpe: I think it's just generally business as usual. As you saw through the quarter I think loan volume's picked up as the quarter progressed. There's still strong underlying, reasonably strong business fundamentals within the U.S. from whether it's the data centre buildout, whether it the reshoring and, generally, as slightly more certainty comes to market, whether it is the big, beautiful bill, on tariffs there's, theoretically, more certainty coming, you're starting to see people kind of come back to work. I think that's at least putting some level of economic activity into the U.S. economy.

[00:07:51] Pamela Ritchie: And certainly a floor. We'll talk more about deregulation as well and what that means, ultimately, for the financials, it means a lot for the financials. Wouldn't mind your thoughts on the discussions about Jerome Powell right now, Fed independency, really, as it goes to investors taking a look at whether they may have a premium on paying ... do yields go up, essentially, because there's uncertainty about whether there is Fed independence. That's really more the question from an investor perspective.

[00:08:21] Lee Sotos: I think what we have seen so far is, you know, I mean, there's a confluence of tariffs and rates. There's different interpretations as to what tariffs actually do. There are interpretations that tariffs are inherently inflationary, at least in the short term. Jerome Powell has taken the view, or sort of settled in with that view. There are other views that tariffs are a tax and will, ultimately, cause a slowdown in the economy. I think there's various viewpoints but there's also political pressure on him taking the view that tariffs would cause a slowdown. I think to date he's done a very good job navigating what has been a difficult political environment. We go tweet to tweet but I think, ultimately, the view is that President Trump will continue to listen to his advisors and while he may continue to jawbone the Fed will, ultimately, wait until year end to really move. Certainly, there is a risk that he would move faster and I think that would probably not be positive for long term rates. I think long term rates would be at risk.

[00:10:10] Pamela Ritchie: That's where [indecipherable] the currency as well. Is there any thoughts on that? We're all watching this unfold. From the investor perspective, what do they have to worry about, if anything?

[00:10:23] Thomas Goldthorpe: I guess it's just continued thought about what does higher for longer rates potentially mean and how do customers react, how does the housing market react and does that have any kind of negative consequences for the consumer, and then also how it flows through bank earnings because, obviously, there's some puts and takes that need to be considered in any investment decision.

[00:10:48] Pamela Ritchie: When you take a look at the conversations that we're having around whether there is or isn't a recession, it sounds like the picture that was painted from the bank earnings, and what you think, generally, the recession risk is on the side. Doesn't mean anything's ever diminished. What's it mean for the valuation story for some of the U.S. banks? We'll start there.

[00:11:09] Lee Sotos: I think we've taken away some of the tail risk. There's always some probability of a recession and we still don't know what the ultimate impact of tariffs will be. Obviously, the level of tariffs has some impact on that. Taking that aside, the outlook for U.S. banks is quite constructive. I mean, the tailwinds that we've discussed in the past, deregulation is real. You have a new head of supervision who has been so far quite aggressive in moving things forward. We're very optimistic about that. There's various parts of deregulation and I would call it more reregulation as opposed to deregulation, because it's not just a gift to the banks. It's more getting regulation right. In addition, you still have 4,000 banks in the United States, 1,000 that are publicly traded. This administration seems to be a little more pro allowing the banks to consolidate, which I think is needed in the United States. It's the least consolidated banking industry on the planet. Finally, you have a rate scenario right now which has been fairly stable for a period of time which continues to sort of support bank earnings.

[00:12:47] Pamela Ritchie: That's fascinating. The deals that you were talking about, the potential consolidation that's there, Thomas, we'll just ask you to comment. I mean, there are deals happening pretty much every day. It seems to be quite a pipeline at this moment, I mean, even outside of the banks but what about the banks themselves?

[00:13:04] Thomas Goldthorpe: For sure. We've definitely seen a lot of deals and the deals make a lot of sense. Everyone's trying to gain scale and the big things on scale is as the world gets more digital there's more benefits to scale there. There's more benefits from scale on AI implementation with increased regulatory focus. There's more benefits from scale to that as well. I think you're seeing in some of the larger players, like a J.P. Morgan, they're really pressing that scale advantage versus some of the regionals. The natural response to that is we need to get bigger. The interesting setup now is you have a more accommodative regulatory framework that looks more favourably on M&A. You're starting to see a wider valuation gap between the regional banks and the large banks because the regional banks used to trade at a premium to the large banks, now they trade at discount so there's more room to pay a premium and get accretion on valuation metrics. Then just intuitively you're seeing more willingness both on a strategic basis that an openness that, yeah, we need to get bigger, we need to gain this scale and this is how we're going to compete. You're seeing that progress. You're even seeing it this week. We've seen a larger deal earlier this week, smaller deal today. These deals just continue to happen and, obviously, with 4,000 banks and 1,000 publicly listed ones there's a long runway.

[00:14:37] Pamela Ritchie: That's sort of eye-watering when you think about 1,000 publicly listed and then another 3,000.

[00:14:43] Thomas Goldthorpe: It's just, yeah, where the world's going. When you think about any of these trends it's going to favour the larger guys.

[00:14:52] Pamela Ritchie: Will it always be a case of consolidation? Will some of those many thousand banks continue to exist, as you say, as the world becomes more digital? I mean, or will the customers just migrate elsewhere? Are they all good deals to be gobbled up, I guess is the question.

[00:15:07] Lee Sotos: Of course, there's always bad banks out there, and everything for a price. As a shareholder of banks you certainly don't want a bank you own to overpay. Tere's good banks and bad banks and good deals and bad deals. Part of that is financial, part of that is strategic. There's lots of deals, or sort of speculated deals, out there that make a lot of strategic sense.

[00:15:38] Pamela Ritchie: Do you see those moving quite quickly once deregulation, or reregulation, actually lands? I mean, the big, beautiful bill has gone through. The promises are there. We seem to know that it's coming. Tell us a little bit about the logistics of this rollout.

[00:15:55] Lee Sotos: As we've discussed, I mean, one of the issues we still have from a regulatory standpoint is the previous sort of Fed regime. The regulators really took a view on process over safety and soundness. In doing so they rated the banks, all the banks have various ratings, two-thirds of the top 50 banks were rated as not well managed. That could be small idiosyncratic processes that the regulators didn't like. The current supervisor has put out sort of guidance for the regulators, and that needs to be codified still, which will more focus on safety and soundness, liquidity and things like that, the things that actually matter to the system. Once you have the reratings I think a number of the banks will fall off the not well managed.

[00:17:01] Pamela Ritchie: That must have made them cross, to be called not well managed.

[00:17:04] Lee Sotos: Yes. You're talking about a lot of big, sophisticated banks that are well managed and have a ton of liquidity, plenty of capital, managed their credit very well but it became so process-oriented that it kind of felt the other way. I think a lot of the banks are just waiting for this rerating to happen before they move.

[00:17:36] Pamela Ritchie: Timeline, rough.

[00:17:37] Lee Sotos: Back half of this year maybe we start to see some bigger deals. The changes that would be made from the supervisor do not have to go through a huge process. It's really sort of a change in guidelines. It's for comment right now but it could be implemented fairly quickly.

[00:18:04] Pamela Ritchie: Lending looks good, actually. This should benefit lots of smaller companies, big companies too, but maybe companies that haven't had as much access. Rates have come down to an extent. We now don't know where they're going to go from here, really. Well, in Canada, they're, actually, pretty low. Just talk a little bit about the lending environment, what's shifted over the last year, probably.

[00:18:25] Thomas Goldthorpe:  I think big picture ... so there's still some uncertainty out there, for sure. I think there's some hesitancy to truly go all in on large new investment. At the same time there has been arguably an increase in uncertainty over the last three to six months, especially compared to a year ago. Now you have the election, it's out of the way.

[00:18:47] Pamela Ritchie: It was in Canada. Well, and the U.S. We can do both and then we'll [crosstalk].

[00:18:55] Thomas Goldthorpe: I think looking at it from a Canadian standpoint, loan growth, the here-and-now loan growth still remains relatively muted. The thinking is on the commercial side, again, you're getting a little more certainty. It's the same thematic so now you have an idea of the prime minister, you're getting a better sense of the regulatory framework, maybe a little more pro-business. There is some indication of ... and then a little more certainty around tariffs, especially with the CUSMA carve out. There's a little more certainty than there was a few months ago. Obviously, commercial demand was anemic at the bottom of the trough in April. Now that has rebounded but still below trend levels. There's some indications with the pipeline build and recent conversations that that should improve. The thing there is people are still doing the same day-to-day work, day-to-day banking continues. They're completing existing projects but they're still having a difficult time starting new projects. They just want a little more certainty.

[00:20:03] On the consumer side, again, consumer has been relatively muted. The housing market's slow and what you're seeing is just consumer behaviour changes. As the inflation kicks in, as unemployment picks up a bit, as various other factors come in, as rates are resetting on mortgages, consumers have adjusted spending behaviours. They have taken down their discretionary spending, they're less willing to take out the big loan to buy some big discretionary purchase. The retrenching, which has held up loan growth, though still positive but it's at kind of blow trend levels right now.

[00:20:48] Pamela Ritchie: I wanted to ask you about investment banking but anything to add to loans quickly there as a sort of a broad statement? You cover it most.

[00:20:54] Lee Sotos: I think in the U.S. there was really a dearth of lending for a period of time. What we're seeing is the consumer continues to borrow off credit card, which it's fine. That had been the engine of growth for U.S. loan growth for the last couple quarters. Now we're starting to see some commercial lending. Some of that, we'll see. The skeptical side would say it was just building inventories and was uncertainty focused. But when you listen to the banks they are starting to see, again, small businesses and middle market businesses are dealing with the uncertainty and starting to move again and starting to invest in their factories, et cetera. You are starting to see some core loan growth, which is investment related.

[00:22:04] Another area of loan growth that has been relatively low is just around deal making and advisory. You were going to ask about investment banking, it has picked up on a year-over-year basis. Pipelines are quite healthy. I think the one area where we have not seen much activity is out of the sponsors or sort of the private equity firms. Now as markets are at all-time highs again and pushing higher that's an area where we believe that you could see increased activity. It's starting to bear some fruit. I mean, we had a much better IPO market in the second quarter than expected. You're definitely starting to see the various areas of capital markets and investment banking get some traction where they haven't for a number of years.

[00:23:09] Pamela Ritchie: It's really interesting. I'll ask a little bit about the regulatory story within Canada, specifically. It's been much more noteworthy in the U.S. because of the one big, beautiful bill. Things here have sort of incrementally become more and more and regulated for quite some time now. We hear that that's tapering off. How would you describe that now?

[00:23:32] Thomas Goldthorpe: I think that's a fair take. Simple story is post-GFC there was a big regulatory push to increase capital levels at the banks. You saw kind of consistently increasing capital levels at the banks for, arguably, the last 15 years, from 2010 to 2024. Effectively, what higher capital does is, one, it lowers your free cash conversion because you have to actually reinvest in your business to increase the capital levels and it also lowers your return because you have to hold more capital versus your loans. Subsequent to that, starting maybe 6 months ago, 6 to 12 months ago, the regulators were initially wanting to be very proactive on the implementation of Basel III. They saw the rest of the world had actually slowed down that implementation and they decided to say, hey, if everyone else is slowing down we're going to slow down as well. Now you're in a position, which we haven't been in for a very long time, where the capital rules aren't getting worse, not necessarily getting better but they aren't getting worse, and we just finished it...

[00:24:39] Pamela Ritchie: That can mean a lot in valuation sometimes.

[00:24:43] Thomas Goldthorpe: Right. We just went through a period here where things got worse in capital for 14 years in a row. Things aren't getting worse and there is a greater openness and acceptiveness from OSFI in their public statements that they have to consider their capital rules in regards to where the rest of the world is to ensure the global competitiveness of Canadian banks. These are the types of things that they were not talking about a year ago and wouldn't even consider. Now they're talking about it and they're talking to the banks about it so the probable scenario is you don't get loosening but you just don't get things getting worse. That, actually, is a big incremental change from where we have been for literally 15 years.

[00:25:31] Pamela Ritchie: It was an era, literally, and it's perhaps slowed. Here comes a question that I was going to ask you. We'll swing back to sort of the global look at banks in just a minute but this question coming in, could the emergence of crypto deregulation impact banks, the industry? This is something we were speaking about off-air, stablecoins are everywhere, the discussion, the Genius Act, we know it's all there. I guess the question for you is, how do the banks, how do financial institutions either cotton onto this or put it on the side or make sure that they have avenues for it within. I'll ask you first, Lee.

[00:26:04] Lee Sotos: So yes, it is, certainly, a topic of conversation, actually. It comes up on every bank conference call now. Certainly, the banks are aware of it. Banks, historically, have been very adaptive to new technologies and taken on new technologies themselves. When we talk about stablecoins, the use cases for stablecoins tend to be probably most applicable to cross-border payments. When you think about domestic payments a lot of what stablecoins can offer is already within the banking system and so...

[00:26:52] Pamela Ritchie: Is it already within the dollar?

[00:26:55] Lee Sotos: You can already do tokenized deposits which are currency-backed, obviously. You have tokenized deposits, you have money markets which have a very similar function of moving money around. At this point stablecoins aren't paying interest, they don't pay rewards so when people talk about disrupting kind of the credit cards or those type of payments as well. Another thing is when you think of stablecoin, so let's say Amazon does a stablecoin, that stablecoin pretty much sits within the Amazon ecosystem. I think Thomas had called it something like a gift card. If Apple does a stablecoin, again, it sits within their ecosystem. There have been some questions about whether the banks would consider a consortium to do a banking stablecoin. Right now you have J.P. Morgan has done a stablecoin, B of A is talking about it, Citi is doing it but the banks have often acted in a consortium, kind of like Zelle, as a payments rail. It's always possible that the banks themselves kind of come up with a banking stablecoin in and of itself. Again, you kind of go back to cross-border. Where you would see an emphasis is just on the inefficiencies of the SWIFT system for international wire transfers and moving money. Outside of that it's really hard to see sort of massive disruption within the banking system.

[00:28:48] Pamela Ritchie: Anything to add to that? You hear about it in Canada, we talk about it in Canada. It's obviously a big week in the U.S. for the discussion of everything crypto and stablecoins but what about the Canadian story?

[00:28:59] Thomas Goldthorpe: I think it's a similar story in that part of the crypto story is regulatory arbitrage as it gets brought into the more formal economy. That will come with some regulation, therefore, they're less advantaged once you have to put regulation on top of it. I agree with Lee that the banks are flexible so the banks will adjust. The truth is it just incrementally increases competition in the banking system and they'll put more pressure on fees. We've seen the same trends over the last 20 years, fees slowly ticking down, bank fees coming down, and that will continue on a go-forward basis. Within a Canadian context, a lot of the innovation, a lot of the fee pressure, all that stuff, it generally lags the U.S. because we're more in close economy. I think that will also follow, those same trends will occur in Canada as well just will occur as a lag.

[00:30:04] Pamela Ritchie: Really, really interesting. Let's ask you, Lee, a little bit about positioning, what you like. You do go around the world a bit. I know insurance has been a focus in the past. Give us some broad strokes on the position that you have it in the fund right now.

[00:30:19] Lee Sotos: I think one thing to highlight is it is a financials fund and not just a bank fund. As we've discussed in the past, one of the things we've tried to do is to have some balance as far as interest rates go. As I've mentioned, if 10-year traders can't get it right then we're pretty much sure we can. We have a number of names that benefit if interest rates stay higher for longer, we also have a number of names that would benefit in a lower interest rate environment.

[00:30:57] Pamela Ritchie: So your rate's agnostic to an extent.

[00:30:58] Lee Sotos: Yes, it's actually one of the least contributing factors to performance within the fund. If rates do come back down we would expect a lot of our capital markets names to do well. There's also other areas that would do well. We have some private equity as well as private credit funds would do well, or private equity firms and private credit firms. I think the important thing to think of is, again, it's not just a bank funding. You can get interest income out of very different sources. Some of our most asset-sensitive names are actually investment platforms, not the banks but the investment platform. One of the things we've done is looked at all the fundamental factors that drive the portfolio and we try to really accentuate the different factors themselves as opposed to we need a bank because we need more interest income. Well, we can get that lots of different places. When you look at it we still are pretty rates agnostic.

[00:32:26] I think we've talked in the past we still favour growth areas like Asia. We still favour themes like wealth management and trading platforms. When we look at Europe, we have been underweight European banks but overweight European insurance. Probably the biggest shift we've made, which is not a huge shift, is we've shifted a little bit of our U.S. exposure from the larger banks to the regional banks just because they've, as Thomas had mentioned, they've lagged so much. We've moved a little bit more there but outside of that, not a lot of changes.

[00:33:15] Pamela Ritchie: That's fascinating. We just have a few seconds here but just sort of a quick case for the Canadian banks at this stage. Maybe it's just a neutral discussion but what do you think the banks have ahead in Canada?

[00:33:26] Thomas Goldthorpe: We're in an interesting period for the banks with both positives and negatives. The positives are very much credit remains at above normalized levels, they'll, ultimately, return to normalized levels. When that occurs that gives you some access to earnings growth so you should see above normalized earnings growth in the coming years. You also have this regulatory angle which instead of having to hoard capital every year now you don't need to do that. That will lead to higher share buybacks. Just in general, the banks are well run, they're better capital allocators than they have been on a historic basis.

[00:34:04] On the flip side, a lot of this has already being priced in given that we're at peak valuation multiples. There's still non-zero economic risk in the Canadian economy. Base case remains that we muddle through, it'll be fine, but there's still risk out there, whether it's tariffs, whether it's the housing market, whether it's other stuff going on. Unemployment continues to go up, there's other stuff to keep an eye on. At this point there may not be a clear ... because there's times when there's big macro directional trades to be made and there's time when you can focus on stock picking, this is more of a time for stock picking. Generally, as a group, we've done a good job of really staying on top of all the banks, not just the ones that have done well, really understanding the core drivers of those banks and really trying to take advantage of disconnects  because you do get these, especially in this market. In this market every two months you have a different thematic. This is a tariff winner, this is a tariff loser, this is the U.S., we want Canada, we want housing, we want consumer, whatever, and you get these really big disconnects on valuation. The banks are notoriously mean-reverting so there is a lot of contrarian opportunities to be had by--

[00:35:22] Pamela Ritchie: It's been interesting [crosstalk] that way.

[00:35:24] Thomas Goldthorpe: --finding real disconnects. The great thing with us is we don't have to worry about what's going to happen next month or what's going to happen in earnings, it's too early in the schematic, or momentum, or they're going to shut me down, we can take that longer term view and...

[00:35:45] Pamela Ritchie: That's perfect. We'll have to leave it there. Thomas and Lee, thank you. I hope you have a great weekend ahead, and thank you for spending your Friday with us to talk about the global financial picture. I feel like we all learned something. Thank you for joining us on Fidelity Connects. Here is what is coming up next week. Director of Global Macro on Monday, Jurrien Timmer, will be back to dive into his latest macro themes, what he's been researching. He'll share all of that with you to kick off our week.

[00:36:07] Then on Tuesday, Director of Research at Fidelity Digital Assets, Chris Kuiper, he's joining us for a timely discussion on the digital asset landscape including Bitcoin's institutional and government adoption. We'll be digging into all of that.

[00:36:21] On Wednesday, Étienne Joncas-Bouchard, he's Director of ETFs in Alternative Strategy. He joins us to discuss trends shaping up the ETF space, how investors, ultimately, can benefit from taking a look at the Fidelity All-in-One ETFs as well. Tuesday and Wednesday shows, those will be available with live French audio interpretation. Thank you for joining us. Have a good weekend ahead. I'm Pamela Ritchie.