The banking sector: Optimism in a post-crisis environment

If any industry is indelibly associated with the depths of the global financial crisis, it’s the banking industry. Dating back to the earliest tremors of market instability, banks (big and small) were guilty of leaving their fingerprints at the scene of a historic market disruption. The ensuing backlash has been long lived, subjecting banks to a host of regulatory changes, oversight requirements, and the inevitable ups and downs of public opinion.

But the world is different today. Banks are adjusting their internal controls and repositioning their businesses to accommodate a new, post-crisis environment. They are diversifying revenue sources, improving capital reserves, tamping down credit risk, and pursuing strategic consolidation opportunities. In a nutshell, we believe banks are working constructively toward stabilization. They are moving beyond their bouts of remediation into a period of renewal, clarity, and growth. Along the way, they are taking advantage of positive environmental factors (see table below).

Table: On the road to recovery

A landscape of supportive conditions

A continued economic recovery means more scope for loan issuance, which is a consistently profitable line of business.
By most indications, regulatory pressure will turn out to be weaker than anticipated.
Investment banking, which is a traditionally profitable segment within major banks, will be active as it accommodates a healthy volume of merger and acquisition activity.
The industry’s dividend yields may be attractive to investors who are seeking yield in places other than traditional fixed income assets.
An anticipated rise in interest rates could prove supportive of profitability by boosting net interest margins.

A bias toward flexibility?

Many U.S. banks (especially larger-cap firms) are embracing flexibility as they steer their way through a post-crisis recovery. They have shed unprofitable assets and business lines while accumulating enough capital to pursue shareholder-friendly activities like share buybacks and dividend distributions. At the same time, they’ve switched from a defensive orientation to a proactive search for revenue growth (and, where possible, cost reduction). In short, they have embraced a new, more flexible way of doing things, focusing on transparency, risk management, and strategic growth.

Perhaps the biggest display of flexibility has been in the realm of regulation. Instead of strong-arming and resisting the post-crisis groundswell of legislation, many banks have taken a proactive and cooperative approach. Consider, for instance, that some large banks have confirmed their optimism about meeting newly heightened capital requirements. In a certain sense, these developments suggest that banks are acclimating rather gracefully to regulatory pressure, a signal that we view as extremely positive and indicative of an industry on the mend.

Two possible tailwinds: Mergers and acquisitions, and a steeper yield curve

The pace of mergers and acquisitions in 2015 is likely to play an important role as banks — particularly those with busy investment banking divisions — continue managing their way toward better health. M&A transactions, which enjoyed a brisk pace in 2014, are likely to maintain a solid pace through 2015. A couple of reasons why:

  • In a relentlessly cost-conscious environment, companies are relying on acquisitions to create new sources of revenue, instead of pursuing organic growth.
  • Relatively strong balance sheets mean that more firms are in positions to acquire new businesses.

To be sure, overall deal volume has been facilitated by generic forces as well, including (1) the availability of historically inexpensive debt, and (2) elevated share prices (which generally enhance the likelihood that prospective deals will actually close successfully).

Since the earliest iterations of finacial markets, investors have tried — and largely failed — to predict changes in interest rates. But we think it makes sense to expect a steeper yield curve in the quarters ahead as the U.S. Federal Reserve looks to end an era of loose monetary policy. At this writing, the Fed appears to be on course to begin raising short-term rates later this year or in early 2016, and we expect long-term Treasury yields to rise as well.

As rates climb, banks could likely see a lift in net interest margins (measured as the spread between the interest paid on deposits and the interest earned on loans). This humble but important source of income, which has been soft in recent years, could be poised to make a larger contribution when interest rates begin ticking upward (see chart below).

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Net interest margins across U.S. banks remain under pressure in what has been a prolonged environment of low interest rates.

A long-suppressed source of income: Ready for a revival?

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A long-suppressed source of income: Ready for a revival?

Net interest margins across U.S. banks remain under pressure in what has been a prolonged environment of low interest rates. Given widespread expectations of monetary tightening by the end of 2015, interest margins will likely begin making stronger contributions to bank performance.

Data: Federal Financial Institutions Examination Council, via Federal Reserve Bank of St. Louis. Quarterly observations.

Outlook and expectations

During the coming months, outcomes within the banking industry will depend on factors such as economic growth, the timing of rate hikes, and continued management of regulatory costs. On the whole, we expect to see such factors trend favorably, setting the stage for stronger bank profitability.

This is not to say that we don’t expect challenges. To maximize competitiveness, we believe bank executives will have to rely on agility, innovation, and collaboration. They will have to accommodate a tighter regulatory environment, which could mean stricter internal controls and additional compliance staff. This will not come easily at all firms, especially smaller banks, but we believe the regulatory overhang should be less onerous than is currently expected. (We also note that bank balance sheets already appear strong enough to meet most regulatory requirements that are likely to come along.)

While we think it makes sense to consider an increased allocation to the financial services sector, we don’t think investments should be made blindly, without regard to the underlying quality of the firms themselves. Here are a few company-level attributes that we believe are worth emphasizing:

  • a disciplined approach to controlling costs
  • diversified revenue streams
  • good credit quality within investment and loan portfolios
  • a range of product lines that are well priced and highly tailored to their target customers.

A closing word on risk

As outlined in this commentary, our view on banks is constructive; but we are also aware that investments in the banking industry are not without risks. Balance sheet deterioration, for instance, is always something that we are cautious about. Our list of areas to monitor also includes revenue growth, cost containment, sufficient loan growth, and unforeseen credit problems.

The views expressed represent the Manager's assessment of the market environment as of October 2015 and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice. Views are subject to change without notice and may not reflect the Manager's views.

Carefully consider the Funds' investment objectives, risk factors, charges, and expenses before investing. This and other information can be found in the Funds' prospectuses and summary prospectuses, which may be obtained by visiting or calling 877 693-3546. Investors should read the prospectus and the summary prospectus carefully before investing.


Investing involves risk, including the possible loss of principal.

Past performance does not guarantee future results.

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