New Essay: A Few Thoughts on Banks

[racemize]

Hi All, just wrapped up a new essay compiling my thoughts on banks at present prices.  I thought I'd post it here as a initial release in case there's any last-minute catches, before a "full" release tonight.

 

Special thanks to Viking and John for all the excellent posts--I wasn't really responding as I was incorporating my thoughts into this essay, so hopefully it adds some value to the BAC/JPM/C/WFC discussions that are ongoing.

 

Also, I'm very open to push back on this, as it is still a large composite position for me (BAC/JPM/C).

 

https://drive.google.com/file/d/1aNXxnWepesOuCWEffnytdAjFqx86Inu3/view?usp=sharing

[boilermaker75]

In your second table you have the price of BAC listed as $309.

 

Last line page 3 I think you left out a with, comfortable "with" that

 

And thanks for sharing!

[onyx1]

Well done Joel, thanks for sharing.

 

Dimon this morning offers further support to the golden age of banking thesis, and where the US stands in the credit cycle.

 

https://cnb.cx/2BNtNqu

[Liberty]

Thanks Joel!

[Artha158]

Thanks for sharing.

[CorpRaider]

Look forward to reading.  I haven't bought my BAC back. 

 

One reason is that I had occasion to see what a Merrill Lynch broker did to a retail account with a few hundred thousand bucks.  Churned it up, really badly....like one share of this, four shares of that with probably hundreds of micro positions. 

 

Pretty highly unethical/disturbing to me.  Once that person learns about vanguard and/or RIAs they are probably never again going to be in the market for any BofA product in my opinion. 

 

I also saw an advertisement from one of the banks for something they were calling a CD, which was basically a variable annuity.  Not sure if that is still alive.

 

Maybe I can go with JPM and avoid this type of retail "grifting" bidness?  Much prefer a rogue trader or two.

 

[stahleyp]

Corp,

 

are you sure that wasn't an SMA? I've seen that pretty often. They're charged an "advisory" fee but aren't charged commissions on trades?

[racemize]

In your second table you have the price of BAC listed as $309.

 

Last line page 3 I think you left out a with, comfortable "with" that

 

And thanks for sharing!

 

Actually, the error is with C/JPM/WFC--that was supposed to be market caps.  Good catch.

 

 

[racemize]

Look forward to reading.  I haven't bought my BAC back. 

 

One reason is that I had occasion to see what a Merrill Lynch broker did to a retail account with a few hundred thousand bucks.  Churned it up, really badly....like one share of this, four shares of that with probably hundreds of micro positions. 

 

Pretty highly unethical/disturbing to me.  Once that person learns about vanguard and/or RIAs they are probably never again going to be in the market for any BofA product in my opinion. 

 

I also saw an advertisement from one of the banks for something they were calling a CD, which was basically a variable annuity.  Not sure if that is still alive.

 

Maybe I can go with JPM and avoid this type of retail "grifting" bidness?  Much prefer a rogue trader or two.

 

Yeah, I can't say the thesis is that the banks are necessarily doing great things for customers or that shitty things aren't happening.  That being said, I think satisfaction scores have been going up over time.

[CorpRaider]

Corp,

 

are you sure that wasn't an SMA? I've seen that pretty often. They're charged an "advisory" fee but aren't charged commissions on trades?

 

Yeah, I'm not sure.  It was a reader e-mail question.  They didn't send statements or anything but were concerned about commissions that they would incur unwinding all these positions (leading me to infer they were paying $ per trade).  I also saw a similar situation posted on a more personal finance focused message board.

 

I just told them I'm not an investment advisor and to talk to vanguard or another RIA about moving their money over (and maybe a plaintiff's attorney who has handled some securities litigation/arbitrations, if they felt they were ripped off badly enough to feel like messing with it).

 

 

[stahleyp]

For what it's worth, I bet it was an SMA. Most clients think they're paying a commission even if they're not. Most of the large brokers have compliance departments to watch that stuff. That doesn't mean they're not churning but it doesn't happen all that often from my experience with the larger firms.

[Jurgis]

For what it's worth, I bet it was an SMA. Most clients think they're paying a commission even if they're not. Most of the large brokers have compliance departments to watch that stuff. That doesn't mean they're not churning but it doesn't happen all that often from my experience with the larger firms.

 

In IBKR SMAs client is paying the commissions for trades done by advisor. In Merrill Lynch, I don't know.

[stahleyp]

That's a good point. Actually that reminds me of some others too now. Ignore my other comments on this. I'll say that if the SMA advisor is the same as the platform provider (like if someone uses the Fidelity or Schwab RIA unit), no commissions are charged (but might be mistaken on that too!). My 21 month old won't sleep without me next to her over the past week so yeah...I'll blame it on a dead brain. :P

[Viking]

racemize, nice summary. Please feel free to incorporate anything I have written on the various topics that you find useful :-) I appreciate the opportunity to discuss and share ideas to the benefit of other board members.

 

Here are a couple of thoughts on your paper:

- C has stated they expect to return $60 billion over 3 CCAR cycles; the first cycle is almost over so they have a little over $40 billion to return to shareholders over the next 2 to hit their $60 billion total. Readers of your article may think that C has communicated there is $60 billion coming over the next 3 years.

 

- revenue: I think the most important driver of bank top line revenue growth is GDP. If US and global GDP growth is strong the big banks should see solid revenue growth. A second factor driving top line growth is rate increases by the Fed (this is also tied to GDP). If investors feel US GDP growth will be solid then US banks would make a good investment choice. A third factor are all the investments the various banks are making in their business. It is only in the last couple of years that C and BAC were able to really get focussed on driving growth as prior to this they had their hands full dealing with legacy issues.

- expenses: I think the most important driver of bank expense discipline is technology. It appears the banking industry as a whole will be a big beneficiary as technology continues to be implemented. This will allow the US banks to hold (in BAC’s case) or lower (moving forward in C’s case). A second driver of lower expenses may be the Trump administrations recent appointments to the various regulatory bodies and we should find out later this year how the regulatory environment will be streamlined which should lower expenses further.

- the net result of higher revenue combined with flat to falling expenses is the operating leverage that Moynihan has been talking about every conference call. I noticed that The C CEO is also starting to talk up operating leverage.

-lower taxes are also a very big deal for earnings growth in 2018. The banking sector benefitted much more than most other industries.

 

Regarding capital return you may want to add a paragraph on the dividend for each of the big banks and how much it has gone up the past three year and how much it will continue to go up in the next couple of years, especially for the banks like BAC and C that are well under the 30% payout ratio. High dividend payouts is a big deal. Significantly growing dividend payouts is an even bigger deal. My guess is the continued growth in dividends will be a big factor in the market over time loving the big banks once again.

 

Looking at share repurchases over a couple of years is also very powerful. C especially. C is reducing its outstanding shares by two hundred million every year or about 8% per year. Simply amazing. A 3 year chart showing how much the share count has been reduced is very powerful.

 

Regarding credit quality, I think Mike Mayo has commented repeatedly that the loan books of the big banks are higher quality than they have been in decades; this should help provide some comfort that in the next recession losses will be much better for the big banks than they were in 2008.

[Spekulatius]

What about thr risk of competition from online banks, since branches are less and less important. I don’t think I visit a bank branch more than once a year now. Online competition could crimp the margins over time, same than what is happening to retail. at least I think that most cost savings from digital transformation should be competed away.

 

Also, the online banking makes it easier to bank with credit unions, which have fewer branches. This is what I am doing. Then we have the risk of much higher credit losses when interest rates rise. I see reports that junk bonds are shakier than ever, does the same negligence bleed into bank loans.

 

I don’t think that banks have really moats. Maybe convenience is a moat, but once I have an app on my smartphone, how much more convenient can it get.

[Viking]

spekulatius, you discuss many things that I have been thinking about. My read is most people are actually very loyal to their financial institutions. Branding matters and is a big deal. Most people likely use different financial institutions for different products; however, once they set up all their accounts (direct deposit, paycheques, pay mortgage, pay bills, request cheques etc) they are very unwilling to take the time to do it all over again with another institution. They also likely have built personal relationships with people at their branch and will value these. They know where the ATM’s are located etc. And there is also a pretty steep learning curve for most people to learn and use all of the electronic functionality that is becoming available (smartphone, tablet and PC); passwords have been set up. Unless they are upset, most people will not want to start over with a new financial institution.

 

It is very time consuming to do the research, pick a new provider, complete all the paperwork to transfer accounts, etc. It might sound simple but my personal experience (making changes) is it is quite stressful and time consuming. I think most people go with the flow. Unless something happens where they get angry with their current provider my read is most people stay with what they know.

 

Apple is a great example of this. It has taken me and my family many, many years to learn the functionality of our iPhone, iPad, Mac, Apple TV. Other products are cheaper and have solid functionality. Doesn’t matter. For electronics once people learn an ecosystem and they are happy it takes a big reason to get them to switch. I think banks and their electronic offerings will be the same... it will make banking more sticky.

 

Here is my personal history and how long I have been with my 3 different financial institutions:

- primary chequing accounts - 20 years (Bank A)

- primary savings account - 20 years (Bank A)

- line of credit - 20 years (Bank A)

- credit card - 20 years (will be moving in the next year) (Bank B)

- mortgage - 8 years (Bank B)

- investment adviser - 20 years (although I did move from full serve to discount) (Bank C)

 

Scale is also becoming even more critical for banking. The 4 big US banks will be spending much, much more money and so should be able to build and provide the best digital experiences for users. This will be key for investors to monitor moving forward.

 

The only think that would cause me concern is if Amazon, Apple or even Google decided to enter banking in a big way (with a full suite of products). However, I don’t think it is imminent given the regulatory burden that it will put on their total business.

 

[racemize]

Thanks for all the comments, very appreciated.

 

With regard to the online issue, I actually think the big four have a large advantage.  They can spend a massive amount of capital on technology (and have been) that credit unions just won't be able to do.  I don't think any online bank can match their scale and/or the online bank would have to offer higher interest rates (which is what has happened previously).  I would hate to be a small bank and trying to create and maintain apps on devices with the corresponding backoffice stuff on a level that competes with JPM's spending on exactly the same feature set.  You can also see that when new features come out, it's always the big banks first (e.g., Apple Pay).

 

Moreover, the branches are still money makers for the banks--Dimon has talked about this, and that is why they are opening more of them.  Said another way, if it were such an advantage to close the branches, then BAC/C/JPM wouldn't be opening new ones now.  Certainly, they did close quite a few after the crisis, but I think that was a rationalization of the size and number per city.  Going forward, the branches provide a different service than before (less transactions, more advice/management), so the number/size/density will be different than it used to be.

 

I'm more concerned about the payment space after seeing what Tencent is doing.  I'm not sure if credit cards are going to be bank driven in China at all.  I also wonder if they can get disrupted out of the U.S./West, but I'm much less concerned about that over the next 5 years.

[CorpRaider]

Blockchain/distributed ledger is something to keep an eye on, but probably the big guys just end up employing the technology to reduce costs.

 

Was an interesting read, thanks.  Kind of like the usual hard transition from making an undervalued investment to trying to hang on for full upside.  Buffett's hold forever filter probably makes it a lot easier.

 

I do wonder how much bigger the big guys can get, they are kind of constrained by GDP and where they will go for growth.  Maybe outside U.S.?

 

Dimon comes off as such a stud in this piece (he is).    How stupid I am for not buying gobs of JPM when it was clear in/after the financial crisis they were the high ground. 

 

I wonder wow much longer Dimon hangs around?  Who is his heir apparent?  Staley at BCS?  I kind of like him but don't really like that bidness. 

 

I like the guy at CITI but they have gone bankrupt like three times in my investing life and I can't do it.

[John Hjorth]

To me, it's a wonderful write-up on the four large US banks, Joel,

 

Thank you very much for sharing that, too!

 

Somehow this essay is materially different to you former essays, so far. It is not as theoretical as your former essays, more practical oriented, and in a very compressed form [to me, not too compressed though] stating your stance on these banks. Like you, I also like the proposition the market is giving us right now on these investments, considering the risks involved.

 

To me, we get paid pretty dearly right now for assuming the risks involved.

 

To me personally, the most important thing, that you are mentioning in the essay is actually to try to understand the strengths right now of these four banks, where they are right now individually. Their true earnings power has been burried & disguised for so many years in all kinds of legacy issues, regulation and I don't even know what. I had to reread Mr. Dimons 2017 Shareholder Letter today to refresh it. It's well described there.

 

Looked at as a whole, they now posses an earnings power and thereto related abibilty to generate cash to the shareholders hovering almost in the USD 100 B area. That's actually a lot, compared to their market capitalization. Reported pre tax earnings [also before preferred dividends and minority interests] for 2017 are USD 115.147 B for them as a whole.

 

To phrase it another way: They now almost generate as much cash in one year that Berkshire holds on its balance sheet right now.

 

And then I start thinking about all the institutional capital there is allocated to these banks, after which I start to think about what those people managing this capital may actually be thinking right now about these banks, and then I get really confused!

[racemize]

I like the guy at CITI but they have gone bankrupt like three times in my investing life and I can't do it.

 

This lingers in my mind a lot--I was quite reluctant to start the position because of this, and I'll be quite happy to leave it (hopefully only a year or so to go)...

[racemize]

 

Somehow this essay is materially different to you former essays, so far. It is not as theoretical as your former essays, more practical oriented, and in a very compressed form [to me, not too compressed though] stating your stance on these banks. Like you, I also like the proposition the market is giving us right now on these investments, considering the risks involved.

 

 

Yes, this is quite different than normal--mostly I write essays when I think what I'm thinking about is worth writing down and sharing to other people, so in that sense, it made sense to write and share it.  On the other hand, this is very definitely an essay about a current situation, so I run the risk of being completely wrong!  Typically, I write essays where I know I'm mostly just stating facts, so there aren't statements that can go against me.  So, I'm somewhat nervous about it (Even here though, I hedged at the end by saying things could go wrong).

[John Hjorth]

Just posting some anecdotal stuff here related to these four banks, from a Scandinavian angle and perspective. I'm using Nordnet Bank AB, Danish branch - a beehive for Scandinavian DYI investors [sweden, Denmark Finland & Norway]. The bank runs an investment board for its customers, called Shareville.

 

Total NN active customers E2018Q1 : 698,500.

Total accounts NN E2018Q1 : 923,300.

 

Total accounts at NN connected to Shareville today: 193,474.

 

Total accounts today holding BAC : 187.

Total accounts today holding C : 110.

Total accounts today holding JPM : 130.

Total accounts today holding WFC : 469.

 

- - - o 0 o - - -

 

These four banks are overlooked in Scandinavia.

[stahleyp]

so I finally had time to read this one and I thought it was very solid. Thanks for sharing, Joel!

[Cigarbutt]

These four banks (BAC, C, JPM, WFC) are overlooked in Scandinavia.

 

So are Danes contrarians or simply too conservative?

https://finance.yahoo.com/news/richer-ever-danes-sitting-wealth-100000906.html

 

Racemize, your report was thoughtful and balanced.

Back in 2010, I thought deleveraging was an issue and was relevant for financial institutions.

Then people described beautiful deleveraging and then deleveraging, what deleveraging?

Is the topic of deleveraging still relevant for big US banks?

https://www.mckinsey.com/featured-insights/employment-and-growth/the-looming-deleveraging-challenge

[Spekulatius]

Just posting some anecdotal stuff here related to these four banks, from a Scandinavian angle and perspective. I'm using Nordnet Bank AB, Danish branch - a beehive for Scandinavian DYI investors [sweden, Denmark Finland & Norway]. The bank runs an investment board for its customers, called Shareville.

 

Total NN active customers E2018Q1 : 698,500.

Total accounts NN E2018Q1 : 923,300.

 

Total accounts at NN connected to Shareville today: 193,474.

 

Total accounts today holding BAC : 187.

Total accounts today holding C : 110.

Total accounts today holding JPM : 130.

Total accounts today holding WFC : 469.

 

- - - o 0 o - - -

 

These four banks are overlooked in Scandinavia.

 

That probably applies to all US stocks, except the tech stocks they onrnjust needs to own like Apple, Google and perhaps Facebook. Home bias is very real in investing.