A year of money in motion
There is no industry or sector that has not been overshadowed by an era of macro-economic volatility, geopolitical disruption, and transformative innovation. However, for Financial Institutions, these heightened pivot points are converging to create unique challenges, opportunities and directions for growth.
In their opening keynote to this year’s Global Financial Institutions Conference, Dave McKay, President and Chief Executive Officer of the Royal Bank of Canada, and Derek Neldner, Chief Executive Officer of RBC Capital Markets, reflected on how the key events of 2023 – inflationary pressures, monetary policy, interest rates, and an unexpected regional banking crises – have dominated the financial landscape.
Against this macro backdrop, money is in motion in new ways. Funds rotated out of the traditional banking system into higher yielding products. Then as market conditions improved, funds rotated back into bank depository accounts as well as equities, fixed income, and securities.
While the 2024 economic outlook still remains uncertain, there’s room for optimism as financial flows continue to shift and adapt. Despite the possibility of regional divergence in interest rates worldwide over the next 6-12 months, the US economy is expected to follow a glide path towards a soft landing, with lower unemployment rates, healthier GDP growth, and a manageable credit outlook also providing macroeconomic tailwinds across the industry.
Credit quality remained a key focus point for bank stock investors at our conference.
Despite the higher-for-longer rate environment drawing attention, credit quality remains strong. Banks managing credit exposure without any material earnings reduction may receive higher valuations. Conversely, banks with rising credit costs and reduced dividends or depreciated tangible book value may face market penalties. We anticipate credit quality will normalize in 2024, resembling the 1994–1995 period more than 1990 or 2008–2009.
Net interest margins (NIMs) and net interest income (NII) were also key topics. After a turbulent 2023 due to the Federal Reserve’s rate hikes and a banking crisis, optimism grew for stable NIMs and NII in 2024. Management teams expect easing deposit and funding costs and the potential for upcoming Federal Reserve rate cuts to drive margin stability in the next one to two quarters.
Generative AI leads the way
Any doubts about the role of Generative AI in driving the trajectories of financial institutions are vanishing quickly. However, as Ryan McInerney, Chief Executive Officer of Visa, asserted in a fireside chat with RBC’s Dave McKay, the power of AI needs to be managed with a surefooted understanding of its transformative potential.
The Visa CEO believes that Generative AI is set to usher in several key impacts across the industry. It will dramatically enhance workforce productivity, transform commerce by personalizing shopping experiences, and level the playing field for smaller merchants as they compete with larger counterparts who have better access to various commerce tools.
Additionally, Visa is developing its own foundational Large Language Model (LLM) using the world’s largest global payments dataset. This initiative aims to reduce fraud and create innovative scoring algorithms for account-to-account payments.
Separately, McInerney also noted that regulators, central banks and governments are now encouraging the adoption of digital payments, prompting Visa to invest meaningfully in its government engagement capabilities, which allows the company’s product and engineering teams to better create solutions that fit into their respective broader digital payments strategy.
Alternatives take center stage
In a panel to predict the future of altnerative asset managers, Michael Rees, Co-President and Head of GP Strategic Capital of Blue Owl Capital, John Toomey, Co-CEO of HarbourVest Partners, and Mike McCabe, Head of Strategy of StepStone Group, shared insights into growth opportunities around alternative investment strategies, expansion into wealth management channels, and the changes being seen in the industry in terms of solutions and products.
Each panelist highlighted the significant evolution of the sector, from its roots in leveraged buyouts to today where alternative investment products and strategies have broadened to include private credit, infrastructure, and real estate.
All three believe there could be further substantial growth in the sector, highlighting an unrealized opportunity beyond institutional investors in retail and high-net-worth channels, which represent a relatively underpenetrated $70trn market. However, our panelists caution that any strategy for expanding into wealth management channels will require intensive human capital compared to the traditional distribution model of selling to institutional investors.
Interestingly, each panelist expects consolidation in the industry but flag that M&A between traditional asset management firms and alternative investment firms could face challenges in terms of cultural fit and operational hurdles, noting that they would expect to see such transactions infrequently.
Property and Casualty insurance pricing
Overall, there was constructive commentary on P&C pricing, with all signs pointing to positive trends staying intact over the next several quarters. While P&C insurance pricing could be in the later stages of the cycle, momentum isn’t over just yet.
Constructive commentary at the conference suggests that pricing trends should stay favorable at least for the near term. One of the key messages continues to be that rate increases are outpacing loss cost inflation in most lines and that isn’t expected to change anytime soon.
With no signs that pricing is about to weaken considerably anytime soon, our view is that trends could diverge by lines impacted by severity/inflation (property, commercial auto, umbrella) with rate increases in those lines remaining comparatively stronger than others.
Unlocking opportunities in Private Credit
Finally, in a panel to discuss the future of Business Development Companies (BDCs), Kort Schnabel, Co-President of Ares Capital Corp, Jonathan Bock, Co-CEO of Blackstone Secured Lending Fund, Craig Packer, CEO of Blue Owl Capital Corp, and Josh Easterly, Chairman and CEO of Sixth Street Specialty Lending Fund (TSLX), presented their thoughts on the ‘institutionalization’ of the sector.
All three panelists discussed the evolution of the BDC industry over the past twenty years or so, noting how the BDC model has proven to be very resilient, with only modest leverage, and predictable liabilities.
Overall, panelists emphasized their BDCs are underwriting very high-quality companies, often very large-scale companies, backed by quality PE sponsors, and that defensive, non-cyclical sector selection is key for mitigating risk within their portfolios.
While some investors may focus on competitive activity from new entrants into the space, given a very favorable macro backdrop, panelists highlighted there are roughly 1,400 private credit managers today; virtually all are smaller-scale and likely unable to compete meaningfully on larger scale transactions.
Interestingly, panelists’ comments indicated it would be more difficult to start up a new BDC today compared to a few years back, especially one at scale.
