Are big banks value traps ?

[Viking]

“...big banks may be the department store equivalent of the financial industry.”

 

Spekulatius, thanks for posing the question as it has been rattling around in my mind as well.

 

The banks in Europe look to be value traps. In my mind this is driven primarily by their economy and the ECB response/policies (negative interest rates).  A secondary reason is their inability to achieve greater scale as there is no appetite or synergies with cross-border mergers.

 

I really like the US big banks. The industry is undergoing dramatic change and I think these are benefitting the very big banks as scale seems to be very important.  My primary concern with the US big banks is trying to understand if negative interest rates are coming to the US.  If the US, in response to economic weakness and potential deflation, resorts to European style monetary policy (negative interest rates) then this will be negative for earnings for the big US banks. This could play out over many years and result in poor earnings growth and flat stock price (value trap). You are already seeing slowing earnings (as NIM falls); the big banks are relying more and more on share buy backs to show growth in earnings per share. And times are very good for the big US banks right now... what happens when times are not good (lower NIM and higher credit costs)?

[Spekulatius]

Pretty timely interview with Mike Mayo regarding banks and technology:

https://finance.yahoo.com/video/wells-fargos-mike-mayo-banking-152840836.html

 

Sounds like he is reasonably optimistic on banks.

[Viking]

Pretty timely interview with Mike Mayo regarding banks and technology:

https://finance.yahoo.com/video/wells-fargos-mike-mayo-banking-152840836.html

 

Sounds like he is reasonably optimistic on banks.

 

Great video. I liked his comment that, yes, revenue growth was slowing but as long as expense growth was lower the big banks would continue to post solid earnings. And it was their massive investmemts in technology that would allow them to continue to bring down expenses.

 

I think he said 200,000 jobs to come out of the financial industry in the next 10 years (right timeframe)? Expect bank expense ratios to continue falling for many years.

[JEast]

From about 1986 thru to 1992, US banks in general had a tough time with the S&L crisis where over 1,000 banks were closed and that also included a nice recession in ’90-‘91.  Near the end of this terrible period, you could buy banks for 60-80% of TBV and all paying a healthy dividend.  Then, coming out of that period the banks had a long runway for 10 years only culminating at the end of the dot-com era.  Then low interest rate gave them another run until the ’07 crisis.  It took nearly six years to clean up the mess the first time and appears that it has taken about 8 years to clean up the mess second time.  What’s different now versus the ’86-’92 period?  A lot. 

• 
  • There were roughly 12,000 banks in the US in 1992 and today their are less than 4,900 due to consolidation and Dodd/Frank pushing smaller banks out, and
  • Now, the top 10 banks capture the vast majority of all US deposits.
  • The regulatory capture has also made the largest banks even in a more advantageous position with the ‘stickiness’ of IT, such as,
  • Winner takes all effects with digital and ongoing with Fintech R&D (e.g. what small bank can afford to spend $500m a year on cybersecurity).
  • IFSR9 implications are pro-cyclical (booking loan losses up front) so the downturn when it comes will be less worrisome not to mention the overcapitalization of most banks now. 
  • Also, Buffett gave a big thumb up to banking with his BAC conversion in ’17 and Dimon says it is just the sixth inning in early ‘19.
  

There used to be a metric in the cellphone industry that each customer was worth $1,200 (if memory serves) for the life of a customer, usually less than 5-years.  For a bank, what is the customer life?  If you open a checking account and keep it for two-years, you are a probably with that bank for 30+ years! Even with all the baggage of bad press, etc… WFC opened up over 500k new checking accounts in the first six-months of 2019, and other big banks were positive too.  What are those customers worth?

 

Big banks may not perform for innings 6-9, but they do not appear to be value traps as they are adding value by capturing more of the pie.  We just need to figure out how much pie there will be in five years.

 

[wabuffo]

If you open a checking account and keep it for two-years, you are a probably with that bank for 30+ years! Even with all the baggage of bad press, etc… WFC opened up over 500k new checking accounts in the first six-months of 2019, and other big banks were positive too.  What are those customers worth?

 

I think even more than deposits, the big banks dominate credit card usage.  The most important asset for a bank is the front-of-wallet credit card.  It has most of the spend and the least amount of losses.  The second and third cards in the wallet are statistical losers - they only get used when no 1 card is maxed out and therefore have a higher loss rate. 

 

In addition to being super-profitable for the banks, the front-of-wallet credit card tends to be very sticky and usually ties the user to other bank services.  If you look at what is happening in the loyalty business with airline frequent flyer miles and what airlines/banks are paying to repatriate them you can tell just how important to the big banks credit cards are (the banks often pay upfront large payments to continue to tie their credit cards to the airline loyalty program).

 

Having said that - I think deposits continue to grow 3-4% per year for the US banking industry with continued consolidation allowing the big 3 banks (WFC, BAC, JPM) to grow deposits even faster.  Its why Buffett loves the big three banks as investments - they have a big tailwind.

 

wabuffo

 

 

[scorpioncapital]

I have a feeling brokerage firms are at intersection of payment services and banking. In fact if banks ever go negative in rates brokerage firms may offer lower borrow costs and higher interest rates. If this is so I think brokerage firms may be able to substitute a vast amount of function of the bank at the consumer level.

[TwoCitiesCapital]

I have a feeling brokerage firms are at intersection of payment services and banking. In fact if banks ever go negative in rates brokerage firms may offer lower borrow costs and higher interest rates. If this is so I think brokerage firms may be able to substitute a vast amount of function of the bank at the consumer level.

 

I disagree. Brokerages can certainly collect deposits - but they've shown an unwillingness to pay decent returns on it by moving from money markets to bank deposit sweeps as the default options.

 

In other words, brokerages have obviously expressed a preference to move deposits held BACK to banks in exchange for fees for those banks.

 

Further, there is limited lending brokerages can engage in outside of securities Based lending. Mortgages/personal loans/auto loans/etc for those who don't have the cash/securities to cover those expenses would be non-existent.

 

Banks still win here and brokerages are demonstrating that by sending current deposits straight back to banks.

[John Hjorth]

Natural Park Service - Gates of the Arctic - Muskox: Circle Defense.

[John Hjorth]

Mastercard [June 25th 2015: Press Releases - Mastercard and P27 Nordic Payments Platform to build a world first real-time payments system across the region.

 

Now exactly that press release made me relate to what has been posted here on CoBF by Spekulatius earlier. [No link here, but i'll dig it up, if needed]. In short : Wake up, [not as a an investor, more like as a citizen] or you're destined to fall behind.

 

There are no cheques bouncing around here in Denmark, now for years. Simply because the whole chequing account system was put into run-off YE2016 [if IRC, with a 3 months run-off period.]. Pretty much the most cost intensive and the most cumbersome system - ever - to carry cash from A to B.

[Spekulatius]

I think one takeaway from this is that technological prowess matter more so in the past for banks. In the US, I consider BAC and JPM the leader followed by WFC. WFC really was the best bank in terms of how they managed their branches, but I think this is now much less and advantage than it has been in the last. A lot of regional and small banks are going to be in trouble.

 

A lot of the larger credit unions are doing well. I am member with a few and many have grown their balance sheet organically by ~10% annually since the Great Recession. They have certainly taken market share, probably from smaller banks. Credit unions tend to have very few, but larger branches, which plays well into going online and doing just doing the transactions requiring consulting in the branches.

[JEast]

The big banks reported this week and nearly all exceeded expectations and reported that the consumer is strong with exceptional credit. 

 

The big banks indicated they will continue to gather more deposits (market share) in a low rate environment and appears to be true as BAC opened up 700k (net) checking accounts so far this year.

[wabuffo]

The big banks indicated they will continue to gather more deposits (market share) in a low rate environment

 

It also appears that the big banks (led by Jamie Dimon) used the September repo melt-down to get the bank regulators to loosen up on what the preferred collateral for meeting the new Liquidity Coverage Ratio regs will be allowed.  They will be freer to use the cash they have on deposit at the Fed in order to provide liquidity to repo markets (and who knows where else). 

 

Bank regulators were leaning on the banks to use reserves only (and not other zero-credit risk assets like Treasuries) to meet the LCR stress test regulations.  While both cash on deposit at the Fed (reserves) and Treasuries are zero credit risk, regulators worried that in a crisis, Treasuries had some price risk - ie, a stressed bank would not be able to sell them at 100-cents on the dollar.  Cash on deposit at the Fed has no price risk - its cash!.  That's why once reserves dropped to a certain lower level from the Fed's Quantitative Tightening, the banks could only sit on their hands and watch while repo rates spiked to almost 10% in mid-Sept.  They believed that the regulators wanted this cash to stay at the Fed.

 

An article in Reuters today says that bank regulators are loosening up and permitting Treasuries (in addition to reserves) in meeting LCR.  This frees up the big banks to deploy more of their cash excess reserves.  This is probably positive for big bank earnings.  They will continue to see rising deposits and it looks like they will be allowed to hold a lower percentage of their assets as cash deposited at the Fed earning a low return.

 

https://www.reuters.com/article/us-usa-banks-rates-exclusive/exclusive-wall-street-banks-see-green-light-from-fed-on-reserves-sources-idUSKBN1WW2T6

 

wabuffo

[cameronfen]

So I think I argued in the WFC thread a while ago that big banks are at risk of losing their moat because there is so much fintech that is basically modularizing everything that big banks do.  For example if you want a loan you can now go to Quicken, or Lending Tree.  If you want to buy stocks, discount broker (or even a safe place to deposit money).  You want to perform an electronic payment transaction you can now work around banks with things like Paypal, venmo, Alipay.  If you want deposits, there are challenger banks going all electronic that have no branches willing to give you higher interest deposits and lower interest loans.  I think I made a big point on challenger banks. 

 

I wanted to point out that it looks like challenger banks and other fintech looking to disrupt how banks do business are running into more difficulty overcoming the regulation that big banks use as moats.  For example, see here:

 

https://www.ft.com/content/77ef93ec-e100-11e9-9743-db5a370481bc

 

Goldman Sach's Marcus is also having trouble:

 

https://www.pymnts.com/earnings/2019/red-ink-marks-marcus-and-goldmans-risky-consumer-bet/

 

As is Facebook's Libra which is well known. 

 

Anyway, my point is that my position on this whole thing has evolved as I got more information (as well as discussions on the WFC thread).  I think modularization is still a thing, and it will take big banks like ten years to have an as efficient cost structure as these challenger banks (as they have to close down branches and build up an entirely online deposit base) and other non-bank entities.  But thus far, it seems like the big bank moats are holding up and preventing even the low-cost producers from taking significant share.  I still wouldn't be long WFC though, as a lot of other big banks are further along in closing branches than WFC and will have a cost advantage for the foreseeable feature. 

[plato1976]

It will take decades to disrupt the current bank business model;

so a bank like BAC still has time to grow through share buy back, and then begin to issue fat div when the valuation is high;

I think they have enough time to generate shareholder value before the business model goes obsolete

 

Also, we cannot exclude the possibility that the transition is so slow that those big banks adapt to the new world successfully

 

So I think I argued in the WFC thread a while ago that big banks are at risk of losing their moat because there is so much fintech that is basically modularizing everything that big banks do.  For example if you want a loan you can now go to Quicken, or Lending Tree.  If you want to buy stocks, discount broker (or even a safe place to deposit money).  You want to perform an electronic payment transaction you can now work around banks with things like Paypal, venmo, Alipay.  If you want deposits, there are challenger banks going all electronic that have no branches willing to give you higher interest deposits and lower interest loans.  I think I made a big point on challenger banks. 

 

I wanted to point out that it looks like challenger banks and other fintech looking to disrupt how banks do business are running into more difficulty overcoming the regulation that big banks use as moats.  For example, see here:

 

https://www.ft.com/content/77ef93ec-e100-11e9-9743-db5a370481bc

 

Goldman Sach's Marcus is also having trouble:

 

https://www.pymnts.com/earnings/2019/red-ink-marks-marcus-and-goldmans-risky-consumer-bet/

 

As is Facebook's Libra which is well known. 

 

Anyway, my point is that my position on this whole thing has evolved as I got more information (as well as discussions on the WFC thread).  I think modularization is still a thing, and it will take big banks like ten years to have an as efficient cost structure as these challenger banks (as they have to close down branches and build up an entirely online deposit base) and other non-bank entities.  But thus far, it seems like the big bank moats are holding up and preventing even the low-cost producers from taking significant share.  I still wouldn't be long WFC though, as a lot of other big banks are further along in closing branches than WFC and will have a cost advantage for the foreseeable feature.

[cameronfen]

It will take decades to disrupt the current bank business model;

so a bank like BAC still has time to grow through share buy back, and then begin to issue fat div when the valuation is high;

I think they have enough time to generate shareholder value before the business model goes obsolete

 

Also, we cannot exclude the possibility that the transition is so slow that those big banks adapt to the new world successfully

 

So I think I argued in the WFC thread a while ago that big banks are at risk of losing their moat because there is so much fintech that is basically modularizing everything that big banks do.  For example if you want a loan you can now go to Quicken, or Lending Tree.  If you want to buy stocks, discount broker (or even a safe place to deposit money).  You want to perform an electronic payment transaction you can now work around banks with things like Paypal, venmo, Alipay.  If you want deposits, there are challenger banks going all electronic that have no branches willing to give you higher interest deposits and lower interest loans.  I think I made a big point on challenger banks. 

 

I wanted to point out that it looks like challenger banks and other fintech looking to disrupt how banks do business are running into more difficulty overcoming the regulation that big banks use as moats.  For example, see here:

 

https://www.ft.com/content/77ef93ec-e100-11e9-9743-db5a370481bc

 

Goldman Sach's Marcus is also having trouble:

 

https://www.pymnts.com/earnings/2019/red-ink-marks-marcus-and-goldmans-risky-consumer-bet/

 

As is Facebook's Libra which is well known. 

 

Anyway, my point is that my position on this whole thing has evolved as I got more information (as well as discussions on the WFC thread).  I think modularization is still a thing, and it will take big banks like ten years to have an as efficient cost structure as these challenger banks (as they have to close down branches and build up an entirely online deposit base) and other non-bank entities.  But thus far, it seems like the big bank moats are holding up and preventing even the low-cost producers from taking significant share.  I still wouldn't be long WFC though, as a lot of other big banks are further along in closing branches than WFC and will have a cost advantage for the foreseeable feature.

 

Yes that is generally the conclusion I was trying to convey.  Its a threat to the moat, but likely the big banks will be okay especially BAC that is ahead of the curve on branch closings.  I think the problem is WFC which has the most branches per $deposit by a decent margin compared to the other banks which means even if they close at the same rate as other banks they are likely to be the high cost provider in what is generally a commodity business where the main advantage is cost (through historically economies of scale but branchesless bank is a different advantage).  My 2 cents.  I don't really invest in banks so weigh my opinions however you want. 

[sleepydragon]

So I think I argued in the WFC thread a while ago that big banks are at risk of losing their moat because there is so much fintech that is basically modularizing everything that big banks do.  For example if you want a loan you can now go to Quicken, or Lending Tree.  If you want to buy stocks, discount broker (or even a safe place to deposit money).  You want to perform an electronic payment transaction you can now work around banks with things like Paypal, venmo, Alipay.  If you want deposits, there are challenger banks going all electronic that have no branches willing to give you higher interest deposits and lower interest loans.  I think I made a big point on challenger banks. 

 

I wanted to point out that it looks like challenger banks and other fintech looking to disrupt how banks do business are running into more difficulty overcoming the regulation that big banks use as moats.  For example, see here:

 

https://www.ft.com/content/77ef93ec-e100-11e9-9743-db5a370481bc

 

Goldman Sach's Marcus is also having trouble:

 

https://www.pymnts.com/earnings/2019/red-ink-marks-marcus-and-goldmans-risky-consumer-bet/

 

As is Facebook's Libra which is well known. 

 

Anyway, my point is that my position on this whole thing has evolved as I got more information (as well as discussions on the WFC thread).  I think modularization is still a thing, and it will take big banks like ten years to have an as efficient cost structure as these challenger banks (as they have to close down branches and build up an entirely online deposit base) and other non-bank entities.  But thus far, it seems like the big bank moats are holding up and preventing even the low-cost producers from taking significant share.  I still wouldn't be long WFC though, as a lot of other big banks are further along in closing branches than WFC and will have a cost advantage for the foreseeable feature.

 

To me, all these thoughts about what future will looks like are speculations.  It’s same as speculating Tesla or beyond burger will take over the world. What matters now is banks are generating huge amount of cash, well managed, and valuation is cheap. It’s a good investment.

 

[wabuffo]

The current US monetary system is a closed loop system between the Federal Reserve and the Chartered banks.  This closed loop involves banks transacting amongst themselves in reserve funds which are deposit accounts at the Fed and are used for clearing all bank payment transactions vital to US commerce.  Your deposits at a bank get a guarantee by the US Treasury and in return the banks accept the rules and regulations of the US Treasury via the 12 Federal Reserve banks. 

 

The federally chartered banks are agents of the US Treasury and the Federal Reserve and are the most important transmission mechanism of monetary policy.  This system will never be disrupted unless the US Treasury allows it to be disrupted.  Which it will never do. 

 

If any technological changes happen to money, payments, etc - this will be the same group of institutions managing it in a closed loop system.

 

The big banks are here to stay and will only get bigger, IMO. 

 

wabuffo

[Spekulatius]

I don’t think it’s quite as simple. Look for example at mortgage origination. WFC  had a huge part of the market - ~27%. I think right now they have 10-11%. Focused players ate their lunch. I think asset management will go down the same route. Why hold assets at JPM, Merrilledge (BAC), JPM, when Fidelity, Schwab etc offer zero commissions and more interest on cash and a better platform. I personally just moved my assets from WFC to Fidelity and I don’t think I am the only one. Payment is another one, where Visa, Mastercard and other tech savvy players take. It’s and pieces from the banks.

Mortgage market shares for mortgage origination (PFSI long thesis):

https://www.valueinvestorsclub.com/idea/PENNYMAC_FINANCIAL_SERVICES/6907838692

 

The advantage of the big banks is that they can win share from smaller players, who have are much less tech savvy. I do agree it will be a slow bleed, but I think the banks will lose large parts of ancillary business over time.

 

I do think the process is slow enough that it does not negate an investment thesis is the large bank stocks, especially given the current low valuations.

 

<typing corrected>

[wabuffo]

I don’t think it’s quite as simple. Look for example at mortgage origination.

Sure.  Mortgage origination is a large and complex market. 

 

Extending credit can be done by anyone - I can give you an IOU and you just extended credit to me.  Loan creation!  ;D  If my credit rating is superb, you can even sell that IOU piece of paper (chit) to someone else at 100-cents on the dollar.  Even better - Money creation!  ;D  You are now a bank!  8)  Only problem is that this chit is not 100% guaranteed by the US Treasury - so not a bank! :-[  Probably not going to get 100-cents on the dollar - so real banks win!

 

But take a look at your example of PennyMac.  Who funds their origination and loan purchases with wholesale financing?:

We maintain multiple master repurchase agreements and mortgage loan participation and sale agreements with money center banks to fund newly originated prime mortgage loans purchased from correspondent sellers. The total unpaid principal balance (“UPB”) outstanding under the facilities in existence as of December 31, 2018 was $1.5 billion.

The banks may not want to take every credit risk out there - but they are happy to fund those who do for a price.

 

The big banks have huge funding advantages and while they may not play in every part of the financial services business, their central role in deposit gathering and payment clearing as well as their integration with the transmission of interest rates to the broader economy makes them pretty bullet-proof.  Does that make them great investments relative to every other stock, I'm agnostic about that.  But they are not "melting ice cubes".  I'm pretty sure about that.

 

wabuffo

[cameronfen]

I don’t think it’s quite as simple. Look for example at mortgage origination.

Sure.  Mortgage origination is a large and complex market. 

 

Extending credit can be done by anyone - I can give you an IOU and you just extended credit to me.  Loan creation!  ;D  If my credit rating is superb, you can even sell that IOU piece of paper (chit) to someone else at 100-cents on the dollar.  Even better - Money creation!  ;D  You are now a bank!  8)  Only problem is that this chit is not 100% guaranteed by the US Treasury - so not a bank! :-[  Probably not going to get 100-cents on the dollar - so real banks win!

 

But take a look at your example of PennyMac.  Who funds their origination and loan purchases with wholesale financing?:

We maintain multiple master repurchase agreements and mortgage loan participation and sale agreements with money center banks to fund newly originated prime mortgage loans purchased from correspondent sellers. The total unpaid principal balance (“UPB”) outstanding under the facilities in existence as of December 31, 2018 was $1.5 billion.

The banks may not want to take every credit risk out there - but they are happy to fund those who do for a price.

 

The big banks have huge funding advantages and while they may not play in every part of the financial services business, their central role in deposit gathering and payment clearing as well as their integration with the transmission of interest rates to the broader economy makes them pretty bullet-proof.  Does that make them great investments relative to every other stock, I'm agnostic about that.  But they are not "melting ice cubes".  I'm pretty sure about that.

 

wabuffo

 

If you look at branchless banks, it is obvious that big banks with branches are at a severe cost disadvantage and that shows in Roe/RoA numbers dispite having much smaller scale. But one big problem with modularization is that matters less and less. If I can originate a loan and sell the securitized loan on the public market, it doesnt matter if I have lowest cost of funds.  All that matters is there is someone in the market that has low cost of funds. 

[KJP]

I don’t think it’s quite as simple. Look for example at mortgage origination.

Sure.  Mortgage origination is a large and complex market. 

 

Extending credit can be done by anyone - I can give you an IOU and you just extended credit to me.  Loan creation!  ;D  If my credit rating is superb, you can even sell that IOU piece of paper (chit) to someone else at 100-cents on the dollar.  Even better - Money creation!  ;D  You are now a bank!  8)  Only problem is that this chit is not 100% guaranteed by the US Treasury - so not a bank! :-[  Probably not going to get 100-cents on the dollar - so real banks win!

 

But take a look at your example of PennyMac.  Who funds their origination and loan purchases with wholesale financing?:

We maintain multiple master repurchase agreements and mortgage loan participation and sale agreements with money center banks to fund newly originated prime mortgage loans purchased from correspondent sellers. The total unpaid principal balance (“UPB”) outstanding under the facilities in existence as of December 31, 2018 was $1.5 billion.

The banks may not want to take every credit risk out there - but they are happy to fund those who do for a price.

 

The big banks have huge funding advantages and while they may not play in every part of the financial services business, their central role in deposit gathering and payment clearing as well as their integration with the transmission of interest rates to the broader economy makes them pretty bullet-proof.  Does that make them great investments relative to every other stock, I'm agnostic about that.  But they are not "melting ice cubes".  I'm pretty sure about that.

 

wabuffo

 

If you look at branchless banks, it is obvious that big banks with branches are at a severe cost disadvantage and that shows in Roe/RoA numbers dispite having much smaller scale. But one big problem with modularization is that matters less and less. If I can originate a loan and sell the securitized loan on the public market, it doesnt matter if I have lowest cost of funds.  All that matters is there is someone in the market that has low cost of funds.

 

Aren't there two different activities going on here?  Activity 1 is the identifying borrowers and underwriting loans ("origination") and Activity 2 is earning an investment return by owning the loan ("providing capital").  So long as there is a pool of capital available to purchase loans originated by third parties and the transaction costs of doing that are relatively low, the two activities can be separated.  Once separated, Activity 2 becomes supplying a commodity -- money. The greater the supply of capital, the less profitable that activity is likely to be. 

 

Cost of funds certainly matters for the profitability of Activity 2, just as costs of production matter to the profitability of a seller of commodities. I agree that you have to look at the true cost of funds (including the cost to gather), rather than just interest paid on your funds.

 

 

[wabuffo]

Aren't there two different activities going on here? 

 

I think Activity 1 is a commodity.  But specifically related to Activity 2:

 

1) Where does a non-bank (e.g. PennyMac) get the money to originate loans?  - the non-bank needs to find it.  In their case a warehouse line from JPM, BAC, WFC, etc.

2) Where does a bank (JPM, BAC, WFC) get the money to originate loans? - the bank just creates it.  In their case, loans create new deposits out of thin air, literally.

 

Who do you think has the real advantage for Activity 2?

 

wabuffo

[JEast]

Since 2010, there have been 100+ challenger banks and fintech start-ups in the UK.  The results to date are not very encouraging as most have closed their doors or still trying to launch officially.  The ones that have opened only scratched the mostly cash only and less than $1,000 dollar accounts (e.g. basically non-accretive accounts that change after the next best deal comes along). The poster child of challenger banks is/was Metro Bank, but that now seems to have imploded on aggressive marketing to attract the wrong customers. In conjunction with UK government support for challenger banks along with attempting to punish/destroy the top 5 banks all the while the top 5 just got bigger over these years since 2010!

 

Why hold assets at JPM, Merrilledge (BAC), JPM, when Fidelity, Schwab etc offer zero commissions and more interest on cash and a better platform.

I guess that question is answered by where one looks.  JPM (You Invest) and BAC (Merrill Edge) have offered zero commissions with research for sometime but just don't advertise it. Were these folks gaining share and reason Fidelity/Schwab had to react??

[KJP]

Aren't there two different activities going on here? 

 

I think Activity 1 is a commodity.  But specifically related to Activity 2:

 

1) Where does a non-bank (e.g. PennyMac) get the money to originate loans?  - the non-bank needs to find it.  In their case a warehouse line from JPM, BAC, WFC, etc.

2) Where does a bank (JPM, BAC, WFC) get the money to originate loans? - the bank just creates it.  In their case, loans create new deposits out of thin air, literally.

 

Who do you think has the real advantage for Activity 2?

 

wabuffo

 

If Activity 1 is a commodity, then the only potential advantage is lowest cost, with the costs being the SG&A associated with identifying borrowers and underwriting their loans, the capital cost of temporarily warehousing loans prior to selling them on and any transaction costs in doing so.  In my mind, a huge funding advantage for money center banks over other capital providers doesn't necessarily mean third parties can't have lower origination costs, which are largely SG&A, rather than capital costs.  If money-center banks have a clear lower cost for origination activity, why do third-party originators exist?  Are they really only flex capacity that picks up marginal business during good times and collapses during bad times when access to third-party capital dries up? 

 

Regarding Activity 2, I agree that non-bank originators are dependent on third-party capital, both temporary (warehouse lines) and permanent (whoever ultimately holds the loan on their books).  That is why I don't think they are even really involved in Activity 2.  Instead, their business model is dependent upon the existence of someone else willing to engage in Activity 2.  Because Activity 2 is the provision of money, I think whoever has the lowest cost of money would have the biggest advantage in Activity 2, just as the person who operates the lowest cost coal mine typically has the biggest advantage in market for supplying coal.  Your view, I take it, is that money-center banks have the lowest costs because of their ability to gather deposits at low cost. 

 

Another poster has opined that branchless banks can gather deposits at even lower costs, and thus represent a long-term threat to money-center banks.  In other words, that poster is challenging your statement that money-center banks have "huge funding advantages."  I don't know if that's true or not. 

 

 

[wabuffo]

Another poster has opined that branchless banks can gather deposits at even lower costs

 

I don't think you understand what I am saying.  I believe you have the causation backwards for the banks.  You seem to be assuming that banks must (1) gather deposits, before (2) creating loans. 

 

That is not how the current monetary system works.  The order is (1) banks create a loan, which (2) creates a deposit. Sure a few deposits switch from one bank to another but on the whole its not a big factor.  This is because banks are federally chartered by the US Treasury and the Federal Reserve.  They don't need to gather deposits - for the most part they create them.  Branch operations are not an input cost for deposits when you are talking banks.

 

The only thing that limits their deposit (and credit creation) is regulations and capital.  It isn't even reserves (never was).  There is no relation between credit creation/deposits and reserves.  Anyone who quotes you the old chestnut of the banks "gather $10 of deposits, loan out $9 and must keep $1 of reserves" from the textbooks is wrong and you should immediately stop listening to them.

 

Non-banks can't do that.  They actually have to find money since they can't create it like the big banks can.

 

Didn't mean to turn this into a macroeconomics and monetary theory thread.  But there's a lot of misunderstanding of how banks work.

 

wabuffo