Solid Industry Fundamentals & Continued Consolidation

Key Takeaways

» Banks outperformed in 2025, led by large-caps, while the smaller regional banks lagged.

» Fintech competition continues to intensify, driving increased consolidation across the industry. » Bank M&A accelerated sharply in 2025, and we expect that momentum to carry into 2026.

» We see some of the best opportunities in larger banks, where scale supports continued investment and efficiency, with added upside from selective M&A.

» Fintech adoption should continue, and AI is expected to become more tangible as a potential source of cost savings and revenue opportunities; macro and credit remain risks to watch.

Would you please summarize Financials sector performance in 2025 in light of a year dominated by technology and AI-led market leadership?

Large-cap banks as measured by the KBW Bank Index outperformed the overall S&P 500® Index. The KBW Bank Index rose 32.6% and the S&P 500 increased 17.9% in 2025, on a total return basis, as the yield curve steepened (i.e., the difference between long-term rates and short-term rates increased), and investment banking, asset management, and trading-related business activity exceeded expectations. Large banks experienced improving earnings and a strong operating environment along with strong credit conditions and solid loan growth. 

Smaller bank performance was impacted favorably by merger and acquisition (M&A) activity but was curtailed by lingering concerns about long-term competitiveness. Specifically, the KBW Regional Banking Index posted a total return of 6.5% in 2025.

How are banks responding to competition from Fintech companies, and what does this signal for the industry going into 2026?

Smaller banks have felt the impact of rapid fintech growth and adoption. We believe this intensifying competition will continue to drive consolidation across the industry.

M&A activity accelerated throughout 2025, making it the strongest year for bank dealmaking since 2021. There were 184 deals totaling $49.5 billion in 2025, up from 133 deals worth $17.0 billion in 2024. We expect this momentum to carry into 2026, supported by pentup demand to complete transactions under a faster regulatory process. Deal pricing is rising as well, an added benefit for shareholders of target companies.

In the future, we see fewer banks, with larger banks continuing to take market share in the most profitable product subsectors. In fact, 20 years ago, there were approximately 9,000 FDIC-insured banks; today there are less than half that (4,379 as of 9/30/25).

What assumptions does the market appear to be making about Financials today?

We expect larger banks to generate significant profits to invest in their businesses to remain competitive. As competition intensifies, smaller banks will likely need to scale up, sell, or risk falling behind. While Fintech is an increasing competitive pressure, banks’ embedded deposit franchises should erode only gradually. Overall, there does not appear to be a disconnect between market prices and fundamentals, and we expect earnings to rise again in 2026.

Where are you finding the best opportunities?

Industry fundamentals have remained solid over the past few years. We view today’s interest-rate backdrop and yield-curve steepness as constructive, providing a supportive foundation for Financials. Importantly, many management teams appear focused on growth opportunities and are generally taking a conservative approach to lending.

In this environment, we continue to see the best opportunities in larger banks, where scale and profitability support ongoing investment, efficiency initiatives, and stronger competitive positioning. We also see potential upside from selective M&A opportunities, as consolidation remains a viable path to improve returns and strengthen franchises.

Valuations remain compelling as well. Banks continue to look attractive relative to both book value and earnings, with the KBW Nasdaq Bank Index trading around 12.9x estimated 2026 earnings per share versus roughly 22.3x for the S&P 500.

Would you please provide your 2026 outlook for Financials?

We expect another year of earnings growth in 2026, supported by resilient fundamentals and disciplined balance-sheet management. We also anticipate continued M&A activity as banks look to improve scale, expand capabilities, and respond to intensifying competition, particularly among smaller and mid-sized institutions.

Fintech adoption should continue. Banks are increasingly integrating digital products and services, whether through partnerships, in-house development, or targeted acquisitions. At the same time, we expect 2026 to bring greater clarity around AI costs and revenue opportunities. Management teams are moving beyond experimentation and beginning to define where AI can meaningfully reduce costs, improve efficiency, strengthen risk controls, and unlock new revenue opportunities.

On the regulatory front, we anticipate relatively limited hurdles compared to prior cycles, which should help support deal activity and strategic flexibility.

The biggest risks remain macro-driven. Key variables to watch include shifts in interest rates, changes in the yield curve, and the direction of employment and economic growth. Credit quality is another critical area, since investors will continue to scrutinize any signs of deterioration across consumer and commercial portfolios.