FidelityConnects: Inside the Vault: North American banks and financials today

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<b>Subtitles are AI Generated</b>

 

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Hello, and welcome to Fidelity Connects.

 

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I'm Lauren Gardy, Vice President of Strategic Partnerships.

 

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The big six Canadian banks posted robust first quarter results

 

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marking the first time all have exceeded earnings estimates.

 

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In total the banks reported approximately $19 billion in

 

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profit, an increase in about $14 billion in the first quarter of

 

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last year. But delinquency data shows that more consumers are

 

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struggling to pay off their debts.

 

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At the same time early AI volatility is creating sharper dispersion

 

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across financials worldwide leading our next guests towards risk

 

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preservation and selective opportunities in areas like insurance,

 

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North American banks, and Japan.

 

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What does this ultimately mean for investors right now?

 

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Joining me to break it all down is Global Financial Services fund portfolio

 

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manager, Lee Sotos, and equity research analyst, Thomas Goldthorpe.

 

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Welcome, Lee and Thomas, thank you so much for joining us today.

 

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Lee, why don't we start our conversation over with you?

 

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What a week this has been, so much volatility, geopolitically in the Middle

 

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East, tariff uncertainty, back and forth inflation prints, how are

 

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you breaking this all down really and does this look like a expectation

 

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change for growth in 2026 or just noise that the market is digesting.

 

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I think that's a good place to start because over

 

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the last number of months I think if you look at

 

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the industry we've had a number of different

 

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observations or concerns kind

 

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of come up, whether it is tariffs, as you mentioned,

 

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worries about private credit, worries about AI's

 

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impact on different sectors, and most

 

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recently war with Iran.

 

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I think what we're looking at right now is

 

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more kind of a consolidation phase where

 

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the banks and insurance companies that we look at

 

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have performed quite well through 2025.

 

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I think we're at this point where things have traded off a little bit but at

 

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the same token I don't think investors quite know

 

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sort of what to make about the situation in Iran yet.

 

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When we see days of high volatility I think

 

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investors have a tendency to always look at the tail risk

 

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so you get a lot of sort of stagflation

 

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narrative that people will jump to and then it

 

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sort of clears out the next day and things settle down a little bit.

 

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The space has done quite well and has been pretty resilient,

 

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if you think about it.

 

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Over the last three months most geographies

 

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and most subsectors are still up.

 

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We've seen a bit of a trade-off in some of the subsectors over this past

 

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month but overall valuations

 

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haven't changed that much.

 

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When we kind of look forward I think the bigger

 

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question is sort of how long the Iran

 

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situation plays out and that will kind of

 

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inform decision making going forward.

 

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That's a good reminder for our audience.

 

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Looking back over history in your tenure and careers at Fidelity is there a

 

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time in the past where we've lived through something similar or a story that

 

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sticks out to you that really you would leave with our listeners on the line in

 

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terms of advice for looking through the noise and what's more important to look

 

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at from a portfolio perspective.

 

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I think for myself I still look at this more

 

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akin to a 1999, 2000,

 

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2001 where there

 

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was a lot of hype about the internet and how that was

 

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going to impact things.

 

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You see a lot of that as far as AI or

 

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artificial intelligence and its impact on different industries.

 

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There's a lot of capital going into different parts

 

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of AI.

 

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Right now there's a lot of concerns about it

 

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but at the same token the world found a

 

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way to adapt and I think we're

 

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looking at most of our industries and

 

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viewing AI as basically an

 

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enhancer and enabler.

 

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I would probably put it more akin to that.

 

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Thomas.

 

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I would generally agree with that. I think in these situations of high

 

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uncertainty, high volatility, you want to look at

 

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different scenarios and try to see, oaky, what are

 

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upside, what are downside, kind of really understand the risks, and

 

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make sure you're in positions where you get positive asymmetry

 

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returns, and really understand kind of the downside.

 

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At the same time, to Lee's point, I think a lot of this technological

 

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innovation, a lot these geopolitical events impact companies

 

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differently and oftentimes the

 

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first reaction by the markets, not the correct reaction, oftentimes

 

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the whole sector trades down in parallel, where

 

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in actuality there's real winners and losers.

 

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Whether it's the AI, whether it's the Iran War, whether it's

 

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some other stuff coming out, I think the key is

 

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there is actually a lot of opportunity to pick stocks

 

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and a lot of opportunity to not

 

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necessarily get too caught up in the consensus narrative because

 

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oftentimes in these situations where there's max uncertainty, everything sells,

 

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and then if you give it six months, one year, two years,

 

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the reality of the situation plays out on the true fundamental

 

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impact and you often get rewarded for having

 

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a differentiated view.

 

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A great thing with Fidelity, and I'm sure Lee can attest to this as well,

 

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is we have a structure in place where you can take these longer

 

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term views. We don't have to worry about what my next 12

 

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hours of performance is gonna be or my next month of performance is gonna be,

 

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I can take that one to two year view.

 

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What generally happens in these situations is on

 

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a one to two year basis you go into a

 

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position expecting it's gonna take that long to resolve but the market's

 

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generally smart, they figure it out, they often get that return in only

 

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a couple of months.

 

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Yes, it's a good reminder for our audience so thank you for sharing that.

 

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Another theme we haven't touched on yet would be policy divergence, looking on

 

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a global scale. For the past decade or so, seemingly, a lot of main countries

 

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have moved their rates in similar direction.

 

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Now we're seeing divergence amongst US, Japan, ECB.

 

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How does this play into your portfolio allocation specifically when you're

 

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looking at, say, financial institutions that have a global presence?

 

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I think for the global portfolio, and

 

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I've mentioned this in past conversations, we

 

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really try to take the

 

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portfolio and make it as rate agnostic as we can.

 

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We don't feel like we have necessarily an edge in

 

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predicting global rates.

 

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When you look at the portfolio it's very well balanced between those

 

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names that would benefit from cuts in interest rates or

 

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those names that would benefit from higher for longer.

 

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When we go into sort of our quarterly risk meetings

 

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one of the smallest factors impacting the portfolio is actually global

 

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interest rates. We try not to really make an explicit

 

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call, although we may have some tilts from geography to geography

 

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but not necessarily at a portfolio level.

 

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That's great. Let's focus in on the US for a minute, curious

 

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best guess what your expectation of US rate cuts in the future would be and if

 

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they're somewhat limited based on sticky inflation and strong consumer

 

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data that we continue to see.

 

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I think there are definitely puts and takes on where

 

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the rate cut path will take.

 

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The forward curve is still predicting rate cuts and I think that's a reasonable

 

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outcome but timing around geopolitical events will

 

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definitely have some impact on that.

 

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Let's pivot to global deregulation as well.

 

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This was a really big theme through 2025.

 

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I believe we're still seeing this play out through 2026.

 

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Looking at US financials specifically where do you see areas of deregulation

 

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being, say, the biggest beneficiaries and maybe the more least impacted sectors

 

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or areas within your coverage through this year.

 

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First off, I think the thematic around deregulation

 

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is powerful for the banks.

 

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Background is we had the global financial crisis, everyone identified

 

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the banks as being evil

 

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and creating a lot of the systematic risk that we saw in the

 

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world. Then for roughly 15 years after

 

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2009 the regulators year after year punish

 

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the banks, whether with higher capital, more control, more qualitative

 

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controls, more, more, more regulation, de-risking

 

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the balance sheets. Ut was viewed as, okay, banks are a problem,

 

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they need more regulation, they need more control.

 

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Then we had this kind of complete 180 shift

 

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in the regulatory view starting kind of

 

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late '24, early '25 in that there's

 

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this growing consensus, not just in the US but in Canada and

 

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Europe and a lot of areas in the world that we

 

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just went through a decade of kind of low growth, low stagnant growth.

 

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There's this increasingly amount of debt in

 

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society, productivity being really poor, something needs

 

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to change. One idea that's come up is let's get

 

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growth higher, let's focus on productivity, let's focus on

 

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economic growth.

 

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And one solution that came from that was, hey, let's actually

 

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deregulate the banks, the banks are now our friend, and

 

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going from a world of, okay, every year we're going to make it harder for you

 

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to lend, every year we are going to make it less profitable for you to

 

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lend, we're going to keep going deeper and deeper in your organization, putting

 

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more and more controls on what you can and can't do to, okay,

 

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we actually want banks to lend more, we

 

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want banks help fuel this potential

 

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economic recovery.

 

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In a Canadian context that comes through an idea, okay, want to build these big

 

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national infrastructure projects so the banks

 

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could be a solution to provide the financing required to finance

 

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these multi-billion dollar projects.

 

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That is a big transition from

 

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every year your kind of returns would go down a

 

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bit or you would have to post more capital.

 

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There's all this restriction and it would just get a little bit worse every

 

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year. Now we're in a world where at

 

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absolute worst it's not getting worse and it's actually getting better

 

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in cases.

 

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So seeing some signs that potential capital could go lower,

 

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potential various liquidity rules, various non-financial

 

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restrictions could be loosened.

 

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All those things are generally a positive driver on

 

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both bank earnings but also on bank returns.

 

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Even just the perception around the banks that you don't have to worry

 

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about, okay, what's the next thing that's coming.

 

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That's the other thing. It's coming and then it's like, okay, what's next?

 

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Is there gonna be a special tax on banks, is there gonna be even more

 

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restrictions on growth, in their next round of

 

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audits are they going to find even more bad stuff?

 

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Now it's more, okay, what's the good thing that is going to come, It

 

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does very much change both the financial but also kind of the

 

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sentiment around the space as well.

 

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Very fascinating. I'm curious how this translates into investment themes within

 

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the portfolio. Is this a good case for investment banks specifically if there's

 

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more M&A activity happening?

 

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Also curious, regional banks, if that changes your view on how you're viewing

 

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smaller banks in the US.

 

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I think the US in general is probably

 

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out in front most as far as deregulation.

 

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When you look at the various measures, as Thomas

 

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had mentioned, you've got Basel

 

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III endgame or new capital rules coming out, those should be released

 

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for comment sometime in March.

 

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Now the Fed is talking about liquidity rules

 

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and allowing banks to

 

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use prepositioned collateral at

 

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the discount window and utilize that as liquidity

 

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where historically they have not been able to.

 

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You've also seen the guardrails or

 

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the stepping off points of 100 billion for

 

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certain regulations being moved up to 150 billion.

 

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The next step is moving the next category up to

 

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370 billion.

 

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You actually have certain things that benefit

 

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different parts. The capital rules are definitely more favourable

 

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for, say, the investment banks or the large

 

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G-SIBs like a JP Morgan or a Bank of America.

 

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Some of the other rules, there's also new mortgage rules coming out

 

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that would lessen capital for mortgages.

 

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Those would benefit probably more via regional banks that are more

 

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interested in getting back into mortgage.

 

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M&A is certainly a topic.

 

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We've seen M&A, different deals

 

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that have already been done have been approved much

 

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quicker than they have versus the last 15 or

 

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20 years.

 

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I think the US banking industry in

 

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particular really needs consolidation.

 

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There's still 3,000 banks out there and right now

 

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I think there is a window in which consolidation can actually happen.

 

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Hello, investors. We'll be back to the show in just a moment.

 

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DialoguesFidelity podcasts available on Apple, Spotify, YouTube, or wherever

 

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else you get your podcasts. Now back to today's show.

 

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Three thousand is a big difference from what we have here in Canada, for sure.

 

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Both of you cover global, especially Lee, let's zoom out from the US a little

 

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bit. Considering all these themes we've talked about, policy divergence, global

 

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deregulation, US dominance, how are you considering valuations

 

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being a little bit higher in the US and North America versus those in

 

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international markets, and are you focused on any geographies outside of North

 

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America specifically?

 

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I think valuations in Europe have largely caught up

 

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to the US, particularly if you look at price-to-tangible book

 

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which we do tend to look at in the banking sector.

 

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Insurance is

 

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fairly comparable as well.

 

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I don't think the valuation discrepancies are

 

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quite as large as they have been in past.

 

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When we

 

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kind of are looking at the portfolio now we do have a

 

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tilt towards North America and

 

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part of that right now is advantageous just because of

 

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kind of the energy security where

 

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we look at Europe or we look at portions of Asia and

 

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net energy importers.

 

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Right now we sort of see a little more insulation within kind

 

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of North America, whether it's insurance or

 

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banks or whatever.

 

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There is a bit of a tilt to the portfolio towards that right now

 

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but we also like Asia for certain growth

 

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dynamics and we do believe that

 

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what is going on in the Middle East is transitory

 

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so we've positioned the portfolio

 

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relatively heavily in Japan which is also going

 

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through its own deregulatory phase trying to become more sort

 

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of shareholder friendly, other

 

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areas like Singapore which is heavy in wealth management.

 

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We're finding opportunities on a global basis with

 

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right now maybe a slight tilt towards North America.

 

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Just on that point I would add that in these times of elevated

 

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uncertainty, elevated volatility, opportunities

 

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do present themselves between these markets.

 

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Being able to watch these different markets, a lot of the participants are just

 

[00:18:56.135]

focused on one market, but being able to see, okay, this market, this market,

 

[00:19:00.105]

this market, this market, seeing different kinds of dislocations, especially in

 

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these times of high uncertainty you can have pretty outsized

 

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relative moves that don't necessarily reflect the long term

 

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intrinsic value or relative intrinsic value of these companies so

 

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it does present opportunities to be flexible and take advantage of

 

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being an active manager.

 

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And very helpful, I'm sure, that you're able to rely on Fidelity's global bench

 

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and actually being in these countries as well.

 

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Yes, without a doubt. Having sort of the global analyst

 

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profile that we do gives us

 

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not only the ability to understand different

 

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markets better just with their input but also

 

[00:19:45.184]

not just buy national champions.

 

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We can buy and invest in different

 

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companies that our analysts find more interesting than just

 

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sort of buying the biggest bank in each country.

 

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Find countries that have gone through similar type transitions

 

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and being able to study how those transitions impact the financial institutions

 

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before other markets are also going through it.

 

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You can kind of see the analogies, you can see the patterns, and kind of take

 

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advantage of that learning. We, obviously, have the big note system seeing,

 

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say, hey, this regulation happened or they got hit by this or

 

[00:20:25.757]

such and such happened, let's go back, let's do our research.

 

[00:20:30.262]

You have these on the ground experts as well through the specialized analyst

 

[00:20:34.333]

team, all that plays into helping

 

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to find the best opportunity.

 

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Yeah, tremendous expertise that you all have access to.

 

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Let's spend some time focusing in on AI.

 

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Now, there's a lot of investor debate about CapEx versus ROI, what we're

 

[00:20:50.182]

seeing with companies implementing it.

 

[00:20:52.584]

Curious what you've seen within financial services, if there's specific regions

 

[00:20:56.421]

or areas within financial markets where you've seen AI really add value or

 

[00:21:00.525]

have a use case.

 

[00:21:02.094]

I think within the Canadian context what you've

 

[00:21:06.365]

seen is AI is used to kind of increase productivity

 

[00:21:11.036]

but a lot of the productivity increases are a lot of the mundane tasks

 

[00:21:15.407]

that people need to do.

 

[00:21:17.442]

You see a lot in private wealth that now you can have AI

 

[00:21:21.747]

just take notes of the calls that are being done.

 

[00:21:25.684]

They help populate your CRM

 

[00:21:29.688]

software and stuff. A lot of it is

 

[00:21:34.393]

not necessarily rocket science but a lot the data entry.

 

[00:21:38.096]

You receive data on mortgage applications, you can just auto enter it into the

 

[00:21:41.900]

computer as opposed to having someone manually having to do it.

 

[00:21:45.237]

It's a lot of stuff like that.

 

[00:21:47.506]

It has had a visible increase in productivity.

 

[00:21:54.446]

Now I think the banks are taking a twofold approach on it. On one hand

 

[00:22:00.319]

it clearly has slowed down hiring, not necessarily laying off people per se

 

[00:22:04.523]

but it's more they're managing the

 

[00:22:08.560]

employment count through attrition.

 

[00:22:10.862]

The other hand is now your front office staff

 

[00:22:15.067]

is more productive so they can go and do more selling and spend more time with

 

[00:22:18.904]

their customers.

 

[00:22:21.440]

That's been like the two dynamics.

 

[00:22:23.942]

More on the programming side, productivity of

 

[00:22:27.879]

programmers has gone up 20, 30% so, again, you have

 

[00:22:31.850]

to hire less developers but also you can accelerate the pace

 

[00:22:35.854]

of innovation of your product. What we've seen so far

 

[00:22:39.891]

is a lot of

 

[00:22:44.496]

the productivity gains both the customer wins, they get a better product that's

 

[00:22:47.432]

updated quicker but also

 

[00:22:51.603]

your cost increase has gone down.

 

[00:22:53.705]

You get to increase, generally, profitability but also your

 

[00:22:57.676]

customers are also happy because they're getting a better product.

 

[00:23:00.479]

Yes, it's a win-win.

 

[00:23:02.414]

Lee, are you seeing any trends outside of Canada?

 

[00:23:04.349]

Would Canada be ahead of the curve or is this common across a few countries?

 

[00:23:08.286]

I would say from my experience looking on a

 

[00:23:12.357]

global basis Canada and the US are probably

 

[00:23:17.262]

ahead of the curve.

 

[00:23:21.099]

You look at a bank like a JP Morgan

 

[00:23:25.270]

or a Bank of America or Wells Fargo, they're investing very heavily

 

[00:23:29.508]

in AI tools.

 

[00:23:33.745]

You're also seeing it kind of within the investment

 

[00:23:37.816]

banks as well. Morgan Stanley is using it now

 

[00:23:42.120]

for wealth management.

 

[00:23:48.427]

Thomas and I were joking that there's a lot of

 

[00:23:52.397]

use cases out there but right now they're still kind of ethereal.

 

[00:23:57.669]

You're listening to banks and a lot of it is productivity enhancing

 

[00:24:02.541]

but you are starting to see some areas where

 

[00:24:06.578]

it's becoming more customer facing and maybe moving

 

[00:24:11.383]

more towards revenue generation or idea generation.

 

[00:24:16.288]

Outside of the US and Canada, a little bit in

 

[00:24:20.258]

Asia but there's only a couple banks that I would say are

 

[00:24:24.429]

kind of leaders, maybe DBS in Singapore.

 

[00:24:30.836]

Generally, you're seeing a little bit less in Europe.

 

[00:24:34.573]

I think some of that has to do with the fact that

 

[00:24:38.543]

you have fairly self-contained countries with

 

[00:24:42.714]

maybe one or two champions that have kind of their own competitive moats

 

[00:24:47.285]

that don't feel kind of maybe the need to

 

[00:24:51.256]

lead but can be kind of the fast followers

 

[00:24:55.627]

and buy the technology and adapt it sort of

 

[00:25:00.165]

behind everyone else.

 

[00:25:02.067]

There are still banks in Europe that are at the forefront

 

[00:25:06.271]

but maybe not quite as much as we're seeing in North America.

 

[00:25:10.609]

Interesting. Well, it'll be a good space to keep an eye on. I'm sure next time

 

[00:25:12.777]

we have you on the call we'll have a new update on that as well.

 

[00:25:16.147]

I wanted to touch on crypto before we wrap up.

 

[00:25:18.216]

Obviously, we're seeing different regulatory restrictions on cryptocurrency but

 

[00:25:21.953]

it's still an emerging asset class, if you will.

 

[00:25:24.789]

How do you see it playing into mainstream financial markets?

 

[00:25:29.961]

Do you want to start?

 

[00:25:31.530]

Sure.

 

[00:25:36.668]

I think there's two things. One, the banks have done a lot of work

 

[00:25:40.639]

on it and I think they're prepared for

 

[00:25:46.044]

innovation as it comes.

 

[00:25:49.414]

I think right now as we sit here today there's a lot of

 

[00:25:53.418]

interesting things that can be done with crypto.

 

[00:25:57.389]

There's a lot of innovation that will come on the back of the new technology

 

[00:26:01.793]

but there's also a lot of debate around the regulatory side of it.

 

[00:26:06.631]

A lot of the 1.0 applications are really just circumventing the

 

[00:26:10.569]

existing regulatory system and I don't think that's really what the regulators

 

[00:26:14.573]

want.

 

[00:26:16.675]

At the same time there's clear efficiencies in certain areas like cross-border

 

[00:26:21.012]

FX, trade settlement, stuff like that where

 

[00:26:25.250]

there is a real use case there.

 

[00:26:28.987]

The way I would think about it is it's probably ultimately

 

[00:26:32.924]

going to be productivity enhancing for the banks, and the banks will adjust,

 

[00:26:38.163]

more so than a true disruptor

 

[00:26:42.100]

that is gonna kill all the banks or some more

 

[00:26:46.071]

dramatic stuff you hear about because ultimately I think the regulators will

 

[00:26:50.442]

put regulation around crypto so it won't

 

[00:26:54.613]

be as maybe transformative for new entrants as

 

[00:26:59.484]

it may initially look when you first consider it.

 

[00:27:02.087]

I would agree. I think when we talk about crypto we're really talking

 

[00:27:06.157]

about stablecoins.

 

[00:27:09.628]

Stablecoins within the US framework right

 

[00:27:13.898]

now, you had the Genius Act, the Clarity Act, and those are

 

[00:27:17.936]

being held up by sort of

 

[00:27:22.407]

will stablecoins be able to to pay rewards

 

[00:27:26.611]

or some form of interest  which I

 

[00:27:31.783]

think the banks are obviously against.

 

[00:27:34.552]

The banks already have a competing product.

 

[00:27:37.656]

You've got tokenized deposits which would essentially

 

[00:27:41.826]

do the same thing.

 

[00:27:44.829]

I think Thomas has a good point

 

[00:27:48.900]

in that a lot of cross-border solutions could

 

[00:27:52.937]

come into being through stablecoins

 

[00:27:57.275]

but the regulation of stablecoins still needs to be figured

 

[00:28:01.246]

out at this point.

 

[00:28:03.014]

Niche applications for now.

 

[00:28:05.417]

Before we wrap up, looking at current positioning in the portfolio and really,

 

[00:28:08.687]

I guess, leaving our listeners with final thoughts on Canadian financials.

 

[00:28:11.756]

We started the conversation by pointing out how profitability of the banks has

 

[00:28:14.893]

increased but so have delinquency rates so I'm curious how the two of you are

 

[00:28:18.730]

looking at this space.

 

[00:28:20.532]

I think in Canada, as you

 

[00:28:24.569]

said, there's competing factors.

 

[00:28:27.105]

On the more positive side, reported reasonable earnings and

 

[00:28:31.509]

should have a reasonable earnings setup going forward on credit normalization,

 

[00:28:36.881]

this deregulation theme, and the ultimate benefits of

 

[00:28:40.885]

some of the policies that the Prime Minister is putting in effect.

 

[00:28:45.757]

At the same time, those have to be balanced by effectively

 

[00:28:50.161]

peak valuations.

 

[00:28:52.363]

Credit, as you noted, is more kind of stabilizing, housing prices are

 

[00:28:56.501]

still coming down.

 

[00:29:00.905]

Carney is saying a lot of the right stuff, and I think he's trying to do a lot

 

[00:29:04.843]

of the right things, but when you actually look on the ground, how many new

 

[00:29:08.346]

projects have really been announced

 

[00:29:12.617]

since he's become prime minister, how many have been approved, how

 

[00:29:16.821]

many shovels are in the ground? It's just the timing of when that could come

 

[00:29:20.291]

and the handoff from kind of this muted growth environment we're in today to

 

[00:29:24.529]

kind of potentially an acceleration.

 

[00:29:27.632]

I think in that way, there's both positives and negatives to

 

[00:29:31.636]

be weighed. If you kind of look outside the banks there's obviously been a lot

 

[00:29:35.073]

of volatility in the remaining financials.

 

[00:29:39.944]

Again, that presents opportunity to trade

 

[00:29:44.048]

these different themes off against each

 

[00:29:47.986]

other. It's very much everything

 

[00:29:52.223]

is sold off so there's times where you can find

 

[00:29:56.728]

real dislocations here.

 

[00:29:59.297]

For our model where we cover these companies no matter what

 

[00:30:06.638]

these kinds of volatility has generally been a good thing.

 

[00:30:09.107]

Yes, volatility can create opportunity.

 

[00:30:11.843]

Looks like we're at time but thank you both very much, Lee and Thomas, for

 

[00:30:14.846]

joining us today. Appreciate your insights, as always.

 

[00:30:17.816]

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