Are big banks value traps ?

[benhacker]

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

 

+1

[reader]

 

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? 

 

 

AFAIK BAC doesn't want to originate mortgages to none BAC customers.

Money center banks paid tens of billions of dollars in fines and settlements. they simply have too deep of a pocket to make originating mortgages or student loans on a mass scale, lucrative. they know that there'll be a huge price to pay, and it's not priced into the origination margin because they're the designated fall guys.

So better not fight for market share and just provide a service to their customers.

In some cases keep the loans on BAC's books.

 

[Cigarbutt]

^Since 1984 when Continental Illinois was ‘saved’, the implicit support of government has increased steadily, in this closed loop environment, and, since the GFC, has moved into higher gear.

 

Since the GFC, the ‘deal’ between the big banks and their symbiotic public partners has been to improve capital ratios and to endure more intense regulatory scrutiny in exchange for even more concentration of assets (and matching liabilities) among the dominating players at the core of the center. Size has compensated for lower NIMs. Contrary to what Mr. Powell suggested in 2013 (speech) and what Mr. Dimon mentioned in 2016, TBTF has not been resolved. This growing implicit support associated with the TBTF label has meant lower funding costs and cost of capital, irrespective of the scale effect brought by size alone. This closed loop has become a self-feeding loop.

 

This competitive advantage for big banks is now entrenched and would only grow in a deleveraging environment, implying support for decent results in the new normal environment and a temporary floor on perceived value in downturns as the big becomes bigger. Not a value trap if you are enduring and can enjoy a backstop and if you agree that breaking up big banks has become next to impossible . This is not what creative destruction was meant to be but it is what it is.

[KJP]

 

I don't think you understand what I am saying.  I believe you have the causation backwards for the banks. 

 

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.

 

 

Yes, I did not understand what you were saying. Thanks for explaining your point further. 

 

I understand that a bank making a loan (a bank asset) creates a deposit (a bank liability) somewhere in the banking system. I also understand that banks makes loans first and independently manages its capital requirements later.

 

What I don't follow is why making a loan necessarily creates a deposit on the lending bank's balance sheet.  For example, if a bank loans me money to buy a house, it will have that loan on its balance sheet as an asset.  But the deposit will be on the balance sheet of the seller's bank, wouldn't it?  Or am I missing something.

 

 

 

 

[cameronfen]

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

 

Sure but how do deposits flow bank to a bank, through deposits gathered by the branch (or if you prefer the bank makes the loan through the branch). The point is even if you are saying branches are useless, which I don't think you are,  most of the big banks have large branch structures that they are paying to run.  If you are being more reasonable and argue that branches are the marketing tool for writing loans and taking deposits, this is where the bank structure runs into trouble.  Big banks have a cost disavantage to challeger banks (yes challengers are having trouble--we discussed this upthread--but they are here to stay, gaining significant share who knows), but they can't close all their branches at once because the type of customer they have are ones that use branches.  The only way they can cut costs is to slowly migrate people online while closing branches as they become less useful.  Thus challenger banks and big banks that did this early (ie BAC) will have this advantage for a long time. 

 

Edit: To claify even if its a closed loop, and deposits/loans are zero sum, banks have branches to take a bigger piece of the pie from other banks or whoever (local loan shark?) and use it as a marketing tool.

[Spekulatius]

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

 

The problem with abandoning mortgage origination (and servicing) is that banks are not customer facing any more and provide a commodity service to those that are. I am sure providing wholesale financing is profitable, but at that point, they lost part of their brand and data/knowledge about customers.

Brokerage (at zero commissions ) is a service banks provided to increase customer engagement and as a path to upsell wealth Management services etc. They were never good at it and if the Wells Fargo advisor GUI is an indicator for industry standards (that’s the only one I know), it was functional but bare bones. The zero commission trend for the brokerage become an issue with Robinhood and perhaps IBKR announcing lite with zero commissions. Now that you can have zero commission with all the main brokerages with much better service and GUI’s, I think the banks will be having a hard time keeping assets and hence lose another way to acquire and cross sell to customers.

 

It’s not going to kill them but things like this are slowly chipping away at their franchise.

[Cigarbutt]

I don't think you understand what I am saying.  I believe you have the causation backwards for the banks. 

 

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.

Yes, I did not understand what you were saying. Thanks for explaining your point further. 

 

I understand that a bank making a loan (a bank asset) creates a deposit (a bank liability) somewhere in the banking system. I also understand that banks makes loans first and independently manages its capital requirements later.

 

What I don't follow is why making a loan necessarily creates a deposit on the lending bank's balance sheet.  For example, if a bank loans me money to buy a house, it will have that loan on its balance sheet as an asset.  But the deposit will be on the balance sheet of the seller's bank, wouldn't it?  Or am I missing something.

Wabuffo has a better grasp and you would get a shorter and more illuminating answer form him but here's goes a too long attempt. The following may appear simplistic but I also find that the basics of the banking system are not well understood, perhaps at all levels of the hierarchy and sophistication.

 

First, it is a chicken and egg type of question to a certain degree and your example of bank A ending up with a leaving deposit created from the loan to bank B, given the circularity of the circulation within a relatively closed and steady-state fractional reserve loop, could be imagined to be matched by a scenario where a reciprocal and matching series of transactions from bank B to bank A occur, negating the money creation effect by allowing banks to do their basic mission: act as an intermediary for a profit.

 

But it is useful to apply the concept explained by wabuffo without the matching transactions because it fits better with the real world, it helps to understand what central banks are trying to do and because it underlines, conceptually, that money creation essentially happens when a loan is agreed upon at a bank (not the classic definition of banks looking for a use for their deposits).

 

So, bank A, seen in isolation, makes a loan, creates a deposit and then looks for reserves and capital. When this occurs and money is created, there a four accounting entries (all increase) for the bank and the client. As trees don't grow to the sky (unless you're a central bank), restraints have been put in place to keep this powerful process under (relative) control so that the bank, in substance, also is required two more accounting entry-equivalent 'liabilities': a reserve requirement related to the deposit and a capital requirement related to the loan. If the deposit liability remains at the bank, the requirement can be satisfied many ways including borrowing reserves in the Fed Funds Market (a hot topic these days). To meet the capital requirement, the bank can raise capital many ways (raise equity or equivalent and/or use retained earnings, some of it potentially coming from fees related to the loan made).

 

Linking with the non-bank lending part, to raise capital for liquidity purposes (deposit leaving to bank B), bank A has many options, many of which have to do with a regulatory moat nature, including using its loan asset as collateral, with a tiny haircut. Non-bank lenders have expanded in the mortgage market due to the big banks' reluctance with lower credit scores and have espoused technology related to the origination process, which has been equated to perceive them as fintech entrants but non-bank lenders rely, for funding, on the wholesale short-term market, do not have access to the Federal Reserve System or the FHLBS and rely on the big banks for much of the direct and indirect funding. See below, if interested, for the funding profile of various non-bank lenders according to size. I would say this is a relevant exercise because of the way we've come out of the GFC since business cycles have inevitably become more like credit cycles.

https://www2.deloitte.com/us/en/insights/industry/financial-services/cost-of-funding-survey-nonbank-online-lenders.html

 

A feature that needs to be incorporated in the non-bank lender analysis is that they operate, to some degree, in the 'shadow', have grown market share ++ in the lower credit scores space (will tend to show higher realized and perceived credit losses when applicable), will see higher losses while relying on funding whose cost will rise concurrently and in a context where big banks have built a regulatory safety net that is much less robust for non-bank lenders as it only percolated to the securitization space.

 

Non-bank lenders can be good investments (case by case and given certain holding periods) and the mortgage sector is in a better shape compared to the subprime epoch but it seems to me that non-bank lenders are the ones trapped in a situation where the big banks will relatively benefit from the asset-liability mismatch that is bound to happen over the whole cycle and that mismatch will be magnified by the regulatory closed loop that has developed. It seems to me that big banks will be there, with assistance, to pick up the pieces, including the technology related to the origination process and all the advantages that come with that.

[KJP]

I don't think you understand what I am saying.  I believe you have the causation backwards for the banks. 

 

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.

Yes, I did not understand what you were saying. Thanks for explaining your point further. 

 

I understand that a bank making a loan (a bank asset) creates a deposit (a bank liability) somewhere in the banking system. I also understand that banks makes loans first and independently manages its capital requirements later.

 

What I don't follow is why making a loan necessarily creates a deposit on the lending bank's balance sheet.  For example, if a bank loans me money to buy a house, it will have that loan on its balance sheet as an asset.  But the deposit will be on the balance sheet of the seller's bank, wouldn't it?  Or am I missing something.

Wabuffo has a better grasp and you would get a shorter and more illuminating answer form him but here's goes a too long attempt. The following may appear simplistic but I also find that the basics of the banking system are not well understood, perhaps at all levels of the hierarchy and sophistication.

 

First, it is a chicken and egg type of question to a certain degree and your example of bank A ending up with a leaving deposit created from the loan to bank B, given the circularity of the circulation within a relatively closed and steady-state fractional reserve loop, could be imagined to be matched by a scenario where a reciprocal and matching series of transactions from bank B to bank A occur, negating the money creation effect by allowing banks to do their basic mission: act as an intermediary for a profit.

 

But it is useful to apply the concept explained by wabuffo without the matching transactions because it fits better with the real world, it helps to understand what central banks are trying to do and because it underlines, conceptually, that money creation essentially happens when a loan is agreed upon at a bank (not the classic definition of banks looking for a use for their deposits).

 

So, bank A, seen in isolation, makes a loan, creates a deposit and then looks for reserves and capital. When this occurs and money is created, there a four accounting entries (all increase) for the bank and the client. As trees don't grow to the sky (unless you're a central bank), restraints have been put in place to keep this powerful process under (relative) control so that the bank, in substance, also is required two more accounting entry-equivalent 'liabilities': a reserve requirement related to the deposit and a capital requirement related to the loan. If the deposit liability remains at the bank, the requirement can be satisfied many ways including borrowing reserves in the Fed Funds Market (a hot topic these days). To meet the capital requirement, the bank can raise capital many ways (raise equity or equivalent and/or use retained earnings, some of it potentially coming from fees related to the loan made).

 

Linking with the non-bank lending part, to raise capital for liquidity purposes (deposit leaving to bank B), bank A has many options, many of which have to do with a regulatory moat nature, including using its loan asset as collateral, with a tiny haircut. Non-bank lenders have expanded in the mortgage market due to the big banks' reluctance with lower credit scores and have espoused technology related to the origination process, which has been equated to perceive them as fintech entrants but non-bank lenders rely, for funding, on the wholesale short-term market, do not have access to the Federal Reserve System or the FHLBS and rely on the big banks for much of the direct and indirect funding. See below, if interested, for the funding profile of various non-bank lenders according to size. I would say this is a relevant exercise because of the way we've come out of the GFC since business cycles have inevitably become more like credit cycles.

https://www2.deloitte.com/us/en/insights/industry/financial-services/cost-of-funding-survey-nonbank-online-lenders.html

 

A feature that needs to be incorporated in the non-bank lender analysis is that they operate, to some degree, in the 'shadow', have grown market share ++ in the lower credit scores space (will tend to show higher realized and perceived credit losses when applicable), will see higher losses while relying on funding whose cost will rise concurrently and in a context where big banks have built a regulatory safety net that is much less robust for non-bank lenders as it only percolated to the securitization space.

 

Non-bank lenders can be good investments (case by case and given certain holding periods) and the mortgage sector is in a better shape compared to the subprime epoch but it seems to me that non-bank lenders are the ones trapped in a situation where the big banks will relatively benefit from the asset-liability mismatch that is bound to happen over the whole cycle and that mismatch will be magnified by the regulatory closed loop that has developed. It seems to me that big banks will be there, with assistance, to pick up the pieces, including the technology related to the origination process and all the advantages that come with that.

 

Thanks to you and Wabuffo for posting your thoughts.  Does a bank ("Bank A") gain any benefit from attracting existing depositors to move their deposits (which you can assume are paid very little in interest) to Bank A from other banks?  I believe the branchless banking argument assumes that there is a significant benefit from having a large deposit base on which costs you very little to attract.  Is that correct?  If so, what is the benefit?

[wabuffo]

KJP - I think Cigarbutt is a better writer than I am so he probably explains things better than I can...

 

Here's how I think about banks (and non-banks) within our current monetary and credit creation system.  You need to think of the US monetary system as two closed-loops:

 

1) Bank Reserves:  as we discussed upthread this is a closed loop in which only the Federal Reserve and the federally-chartered banks play.  The currency here is reserves which are deposits at accounts at the Federal Reserve and can only be traded between the banks and the Fed. 

 

It has two purposes - the accounts are used to clear the bank payment system which is run by the Federal Reserve.  Reserves look stable but they fluctuate wildly intra-day as the US banking system processes billions (sometimes trillions) in bank payments between US banks on behalf of private sector commercial activity.  Its other purpose is that it acts as a policy lever for the Federal Reserve to manage short-term interest rates.  The way the Fed does this was through a "corridor" system before the GFC.  Today, the Fed manages interest rates through a "floor system" where it forces the banks to hold excess reserves at the Fed and pays them an interest rate on those reserves.  The amount of reserves are a policy variable that depends on the interest rate management mechanism being used by the Fed.  The size of the reserve isn't for the payment system volatility as banks like JPM used to manage their payments with just $2B in reserves at the Fed before the GFC and now they've had to hold as much as $500B in recently quarters.

 

2) Credit Creation:  again, as discussed banks and non-banks both create credit though as we've seen they do it differently.  The most important drivers of credit creation besides regulations and capital are: collateral and risk-appetite.  The one thing that doesn't regulate lending is the level of reserves.  This is what people misunderstand. 

 

All of these requirements fluctuate and lead to boom and bust.  Twas ever thus.  Collateral is the underappreciated aspect to our modern credit system.  Borrowing and lending is based on collateral.  Sometimes when risk appetite is low - what will be accepted as collateral is strict (eg. only risk-free Treasuries in an extreme case like the GFC).  At other times - even subprime mortgages are accepted with very little haircut.

 

I think the recent example of the overnight repo blow-up in mid-Sept shows the intersection between system 1 (reserves) and system 2 (credit creation) and how they can interact in unintended ways.  It was head-scratching that the big banks with trillions in excess reserves (cash on deposit at the Federal Reserve) couldn't/wouldn't take a few billion and lend it overnight at close to 10% in exchange for risk-free collateral (Treasuries).  I think this is why people get confused with reserves and lending.  I could go more into detail on this example if you're interested - but this post is already long and rambling.

 

As to deposits and branch economics - I remember when ATM's came out in the 1970s and 80s - everyone forecast that bank branches would be obsolete.  That was a major technological advance and yet branches are still ubiquitous.  I think its because branches serve an evolving and different purpose than deposit-gathering.  The banking industry employs more people now than it did in the 1970s despite less banks and more automation and technology.

 

wabuffo

[KJP]

KJP - I think Cigarbutt is a better writer than I am so he probably explains things better than I can...

 

Here's how I think about banks (and non-banks) within our current monetary and credit creation system.  You need to think of the US monetary system as two closed-loops:

 

1) Bank Reserves:  as we discussed upthread this is a closed loop in which only the Federal Reserve and the federally-chartered banks play.  The currency here is reserves which are deposits at accounts at the Federal Reserve and can only be traded between the banks and the Fed. 

 

It has two purposes - the accounts are used to clear the bank payment system which is run by the Federal Reserve.  Reserves look stable but they fluctuate wildly intra-day as the US banking system processes billions (sometimes trillions) in bank payments between US banks on behalf of private sector commercial activity.  Its other purpose is that it acts as a policy lever for the Federal Reserve to manage short-term interest rates.  The way the Fed does this was through a "corridor" system before the GFC.  Today, the Fed manages interest rates through a "floor system" where it forces the banks to hold excess reserves at the Fed and pays them an interest rate on those reserves.  The amount of reserves are a policy variable that depends on the interest rate management mechanism by the Fed.  It isn't for the payment system as banks like JPM used to manage their payments with just $2B in reserves at the Fed before the GFC and now they've held as much as $500B in reserves at the Fed recently.

 

2) Credit Creation:  again, as discussed banks and non-banks both create credit though as we've seen they do it differently.  The most important drivers of credit creation besides regulations and capital are: collateral and risk-appetite.  All of these requirements fluctuate and lead to boom and bust.  Twas ever thus.  Collateral is the underappreciated aspect to our modern credit system.  Borrowing and lending is based on collateral.  Sometimes when risk appetite is low - what will be accepted as collateral is strict (eg. only risk-free Treasuries in an extreme case like the GFC).  At other times - even subprime mortgages are accepted with very little haircut.

 

I think the recent example of the overnight repo blow-up in mid-Sept shows the intersection between system 1 (reserves) and system 2 (credit creation) and how they can interact in unintended ways.  It was head-scratching that the big banks with trillions in excess reserves (cash on deposit at the Federal Reserve) couldn't/wouldn't take a few billion and lend it overnight at close to 10% in exchange for risk-free collateral (Treasuries).  I think this is why people get confused with reserves and lending.  I could go more into detail on this example if you're interested - but this post is already long and rambling.

 

As to deposits and branch economics - I remember when ATM's came out in the 1970s and 80s - everyone forecast that bank branches would be obsolete.  That was a major technological advance and yet branches are still ubiquitous.  I think its because branches serve an evolving and different purpose than deposit-gathering.  The banking industry employs more people now than it did in the 1970s despite less banks and more automation and technology.

 

wabuffo

 

Thanks for the additional thoughts.  I understand the point about federally-chartered banks having an advantage over non-banks.  What I'm still unclear about is the benefit, if any, of a large deposit base.  I've always assumed (without much thought) that a bank's deposit base was cheap capital, and the larger its (cheap) deposit base, the better its NIM (and ultimately profitability) would be, holding the yield on its assets constant.  So, a large deposit franchise would be a significant advantage (i.e., lead to a more profitable bank than one that relied more on, for example, brokered CDs) that could be eroded by people taking their deposits elsewhere (e.g., federally-chartered branchless banks).

 

This potential risk might not be significant because (1) a large cheap deposit base isn't actually an advantage, or (2) depositors aren't likely to move to branchless banks, even assuming they can offer higher interest rates (I realize this is pushing back somewhat about the closed-loop point that moving deposits around isn't a big deal and will come out in the wash, but I ask that you indulge me).  I'd like to put (2) aside for a moment and just try to understand (1) -- is a cheap deposit base an advantage and, if so, why? 

[wabuffo]

This potential risk might not be significant because (1) a large cheap deposit base isn't actually an advantage, or (2) depositors aren't likely to move to branchless banks, even assuming they can offer higher interest rates.  I'd to put (2) aside for a moment and just try to understand (1) -- is a cheap deposit base an advantage and, if so, why? 

 

I only own one small bank (CASH) - but when I was investing in the banks I always thought that the four most important management levers were:

 

a) low-cost or zero cost deposits

b) high non-interest (or fee) income

c) low non-interest expense management (ie, overhead)

d) credit risk management - though being good at a), b), and c) helps in signing up the best borrowers from a low-credit-risk POV, because the well-managed bank can shave a few bps to attract the best borrowers vs its less well-run competitors (a little bit of a flywheel model for banking).

 

I always thought US Bancorp (USB) was exemplary in these four metrics.  Back when I was studying the banks more intently, I posted this post over at the Motley Fool's BRK board explaining what I thought were USB's competitive advantages.  (hopefully Parsad is ok with a link to another board - if not he can let me know and I will delete this post).

 

wabuffo

 

https://boards.fool.com/anybody-have-any-thoughtful-or-quantitative-27826750.aspx?sort=username

[CorpRaider]

Good stuff.  Why don't you invest in banks anymore...because they are value traps?  ;D

[wabuffo]

Why don't you invest in banks anymore...because they are value traps?

 

No - they are more like overly-regulated utilities now.  I think the problem is the Fed and its new toy, IOER (interest-on-excess-reserves).  The Fed wants to control BOTH interest rates and reserves INDEPENDENTLY.  Under its old, pre-GFC, methodology it could only control short-term interest rates and had to let the banks, in turn, determine the level of minimal reserves required to support the system.  The Fed had only one arrow and could only hit one target.  Now, they feel like they have two arrows.  Like good bureaucrats they want control and are forcing the banks to sit on trillions in reserves so that they can pay IOER in order to control short-term rates.

 

The result of this policy is that the big banks have to hold 10-16% of their total assets in cash (most of it on deposit at the Federal Reserve).  Because these reserves at the Fed are free of both credit and price risk, the regulators are leaning on the banks hard to use these assets as a way to meet their Liquidity Coverage Ratio (LCR) and HQLA (Hi-Quality Liquid Asset) requirements.  I'm not making a judgement that this is good or bad - in the 1950's and 60's most US banks held 10% of their assets in cash (though not at the Fed).  We've been here before.

 

This explains why Jamie Dimon sat on several hundred billion in cash at JPM in September during the mini-repo liquidity crash.  JPM's cash was yielding less than 2% when Dimon could've used some of it in the repo markets making 8-10% overnight with T-Bills being offered as collateral.

 

That's why I laugh when I hear some folks say that all those reserves will lead to a credit bubble.  If Jamie Dimon couldn't deploy JPM's excess cash when it was yielding less than 2%, into the repo markets and make a risk-free 8-10% overnight (with T-Bills were the collateral for an overnight loan), then he's not going to be using that cash to make CRE loans to WeWork landlords in Manhattan, LOL!

 

I own one small-cap bank that's interesting - but it's because it is a more idiosyncratic situation.

 

wabuffo

[sleepydragon]

Why don't you invest in banks anymore...because they are value traps?

 

No - they are more like overly-regulated utilities now.  I think the problem is the Fed and its new toy, IOER (interest-on-excess-reserves).  The Fed wants to control BOTH interest rates and reserves INDEPENDENTLY.  Under its old, pre-GFC, methodology it could only control short-term interest rates and had to let the banks, in turn, determine the level of minimal reserves required to support the system.  The Fed had only one arrow and could only hit one target.  Now, they feel like they have two arrows.  Like good bureaucrats they want control and are forcing the banks to sit on trillions in reserves so that they can pay IOER in order to control short-term rates.

 

The result of this policy is that the big banks have to hold 10-16% of their total assets in cash (most of it on deposit at the Federal Reserve).  Because these reserves at the Fed are free of both credit and price risk, the regulators are leaning on the banks hard to use these assets as a way to meet their Liquidity Coverage Ratio (LCR) and HQLA (Hi-Quality Liquid Asset) requirements.  I'm not making a judgement that this is good or bad - in the 1950's and 60's most US banks held 10% of their assets in cash (though not at the Fed).  We've been here before.

 

This explains why Jamie Dimon sat on several hundred billion in cash at JPM in September during the mini-repo liquidity crash.  JPM's cash was yielding less than 2% when Dimon could've used some of it in the repo markets making 8-10% overnight with T-Bills being offered as collateral.

 

That's why I laugh when I hear some folks say that all those reserves will lead to a credit bubble.  If Jamie Dimon couldn't deploy JPM's excess cash when it was yielding less than 2%, into the repo markets and make a risk-free 8-10% overnight (with T-Bills were the collateral for an overnight loan), then he's not going to be using that cash to make CRE loans to WeWork landlords in Manhattan, LOL!

 

I own one small-cap bank that's interesting - but it's because it is a more idiosyncratic situation.

 

wabuffo

 

But if Fed deregulate overtime, starting from reducing the reserve requirements, the banks will do well. Now seems the regulations are so tight it will only go one direction.

[Gregmal]

Further, largely because of regulation but other reasons as well, you're swimming against the tide here. When almost every company in a sector is cheap, Ive found you're most likely going to have to put up with underperformance because the cheapness is sector wide and unless you have a very specific, company related catalyst, you'll just move with the current. I mean C is cheap. So is BAC, WFC, etc, etc. In fact the only one that isn't really cheap is JPM, and thats arguably the one you'd want to own. Theres better alpha elsewhere.

[cameronfen]

Why don't you invest in banks anymore...because they are value traps?

 

No - they are more like overly-regulated utilities now.  I think the problem is the Fed and its new toy, IOER (interest-on-excess-reserves).  The Fed wants to control BOTH interest rates and reserves INDEPENDENTLY.  Under its old, pre-GFC, methodology it could only control short-term interest rates and had to let the banks, in turn, determine the level of minimal reserves required to support the system.  The Fed had only one arrow and could only hit one target.  Now, they feel like they have two arrows.  Like good bureaucrats they want control and are forcing the banks to sit on trillions in reserves so that they can pay IOER in order to control short-term rates.

 

The result of this policy is that the big banks have to hold 10-16% of their total assets in cash (most of it on deposit at the Federal Reserve).  Because these reserves at the Fed are free of both credit and price risk, the regulators are leaning on the banks hard to use these assets as a way to meet their Liquidity Coverage Ratio (LCR) and HQLA (Hi-Quality Liquid Asset) requirements.  I'm not making a judgement that this is good or bad - in the 1950's and 60's most US banks held 10% of their assets in cash (though not at the Fed).  We've been here before.

 

This explains why Jamie Dimon sat on several hundred billion in cash at JPM in September during the mini-repo liquidity crash.  JPM's cash was yielding less than 2% when Dimon could've used some of it in the repo markets making 8-10% overnight with T-Bills being offered as collateral.

 

That's why I laugh when I hear some folks say that all those reserves will lead to a credit bubble.  If Jamie Dimon couldn't deploy JPM's excess cash when it was yielding less than 2%, into the repo markets and make a risk-free 8-10% overnight (with T-Bills were the collateral for an overnight loan), then he's not going to be using that cash to make CRE loans to WeWork landlords in Manhattan, LOL!

 

I own one small-cap bank that's interesting - but it's because it is a more idiosyncratic situation.

 

wabuffo

 

Thanks for this post and the previous posts!  I learned a good deal. 

[wabuffo]

Thanks for this post and the previous posts!  I learned a good deal.

 

For further reading on this subject I would steer you to JPM's Q3 conference call:

Glenn Paul Schorr, Evercore ISI Institutional Equities, Research Division - Senior MD & Senior Research Analyst:

I'm curious your take on everything that went on in the repo markets during the quarter, and I would love it if you could put it in the context of maybe the fourth quarter of last year. If I remember correctly, you stepped in, in the fourth quarter, saw higher rates, threw money at it, made some more money, and it calmed the markets down. I'm curious what's different this quarter that, that did not happen? And curious if you think we need changes in the structure of the market to function better on a go-forward basis?

 

James Dimon, JPMorgan Chase & Co. - Chairman & CEO:

So if I remember correctly, you got to look at the concept of we have a checking account at the Fed with a certain amount of cash in it. Last year, we had more cash than we needed for regulatory requirements. So the repo rates went up, we went to the checking account which was paying IOER into repo.

 

Obviously makes sense, you make more money. But now the cash in the account, which is still huge. It's $120 billion in the morning, and it goes down to $60 billion during the course of the day and back to $120 billion at the end of the day. That cash, we believe, is required under resolution and recovery and liquidity stress testing. And therefore, we could not redeploy it into repo market, which we'd have been happy to do. And I think it's up to the regulators to decide they want to recalibrate the kind of liquidity they expect us to keep in that account.

 

And again, I look at this as technical. A lot of reasons why those balances dropped to where they were. I think a lot of banks are in the same position, by the way. But I think the real issue when you think about it, is does that mean that we ever have bad markets? Because that kind of hitting a red line in that checking account, you're also going to hit a red line in LCR, like HQLA, which cannot be redeployed either. So to me, that will be the issue when the time comes.  And it's not about JPMorgan. JPMorgan decline -- in any event, it's about how do regulators want to manage the system and who they want to intermediate when the time comes.

 

Doesn't it sound to you like Mr. James Dimon is chafing a bit under the Fed's interest rate and regulatory regime?  He wouldn't have purposely held back liquidity by "working to rule" in order to force the Fed's hand?  I thought that his last statement: "it's about how do regulators want to manage the system and who they want to intermediate when the time comes." was verrrrrrrrrrry interesting!

 

Oh lookie here - some new news since the September repo market debacle.

 

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

"Wall Street banks believe they are getting a green light from supervisors to hold more Treasury debt and less cash after last month’s volatility in overnight lending markets, three industry sources told Reuters.  In private conversations with senior bankers, supervisors have attempted to make banks more comfortable with using excess reserves to lend in repo markets rather than hold onto more cash, sources familiar with the discussions said."

 

wabuffo

[Cigarbutt]

@wabuffo

The comments from 2009 are appreciated. The banks I liked the most then were also USB and WFC. M&T was also up there. In retrospect, I wish I had liked USB for longer. I differ on the hyper-regulated outcome (more below) in the long run but isn't it emblematically ironic that the Fed injected a huge amount of reserves to support their theoretical transmission mechanism framework to the real world while simultaneously forcing the banks to keep the excess reserves on their balance sheet and parked at the Fed for a stipend? Quite recently, the FDIC chair (who listens to these people in good times?) quietly mentioned that the systemically regulated banks had done well (risk-wise) but that the much of the risk had been transferred and still existed somewhere. "Where did it go?" she said and wondered (from the regulatory risk management point of view):"Have we done more damage than good?" These questions are always answered retrospectively.

 

@KJP

Your question about the cost of brick and mortar units and the relevant deposit funding aspect is very relevant. Forgetting the chicken or egg question about money creation for a minute and looking at what happened to the loan to deposit ratios over time, overall, at the big banks, growth in deposits has followed growth in loans. Funding from deposits has relative advantages and apart from the four levers of the Holy Grail, banks want a diverse source of low cost funds and diversification as well as FDIC backstop are useful. In the loan and deposit growth however, there has been some decoupling. For the loans, shadow banks (non-bank, online alternatives etc) have gained market share in certain segments. For deposits, the same has happened to some extent but (the last time I looked) US online banks' share of total deposits has increased only from about 2 to 6% over the last 15 years or so. What is interesting is that, traditionally, the growth of deposits has been closely related to the number of physical branches for the largest banks. This link has broken since the GFC, with banks (especially the largest 5 banks decreasing the number of physical outlets by about 15%) while growing deposits by more than 250%, suggesting that they are adapting fairly well to the online threat. Because of the way banking services are bundled, physical branches should be seen as profit centers and not as cost centers and it seems that a restructuring of their physical footprint is not incompatible with significant growth of the deposits. It seems to me that they also could develop online options themselves if the threat becomes significant for some services. So, you have to make up your mind if the physical branches aspect will turn out like Sears (could not adapt), the music industry (unbundling) or something else. I offer the opinion that the big banks will behave more like the pharmaceutical industry in the 70's and 80's. They will continue to offer regulatory collaboration (capture to a large degree) while offering a non-discretionary product, play the game which may involve holding more capital than considered necessary and deal with the occasional entrants by squeezing them or buying them, building an enduring moat.

[Spekulatius]

This link has broken since the GFC, with banks (especially the largest 5 banks decreasing the number of physical outlets by about 15%) while growing deposits by more than 250%,

 

Isn’t the growth in deposits for the larger banks mostly from acquisitions (during the GFC) and not organically? The organic deposit growth doesn’t look all that impressive to me.

[wabuffo]

The organic deposit growth doesn’t look all that impressive to me.

 

Spek - you are very hard to please  8)

 

The big mergers took place in 2008-2009 (WFC/Wachovia, JPM/Bear/Wamu, BAC/Countrywide/Merrill).  If we start the meter for total deposits of the big 3 banks (WFC, BAC, JPM) at year-end 2010 vs latest Q (6/30/19) -- this is all organic growth.

 

WFC went from  $ 847B at y-e 2010 to $1.346T at Q2, 2019.  +59%

BAC went from $1.038T at y-e 2010 to $1.441T at Q2, 2019.  +39%

JPM went from  $1.020T at y-e 2010 to $1.606T at Q2, 2019    +58%

 

IMHO, deposits in the banking sector grow largely due to two major factors:

1) net credit creation

2) federal spending in excess of taxation

 

Both of these factors create net, new deposits in the US banking sector.  Deposits continue to grow, though they have moderated in the last 18 months or so.  The big banks continue to take deposit share from the small banks, though even the small banks are growing deposits (just not as fast).

 

wabuffo

[Cigarbutt]

This link has broken since the GFC, with banks (especially the largest 5 banks decreasing the number of physical outlets by about 15%) while growing deposits by more than 250%,

 

Isn’t the growth in deposits for the larger banks mostly from acquisitions (during the GFC) and not organically? The organic deposit growth doesn’t look all that impressive to me.

If you want more "color" (probably more than you asked for).  :)

 

Like usual, you are correct and if you decompose into periods since the GFC, the early upheaval period was accompanied by a relative bump in deposits for the big boys as the FDIC margin (and patience) was wearing thin. However, deposit growth has been relatively steady overall

https://fred.stlouisfed.org/series/DPSACBW027SBOG

and increasingly (slightly) divergent versus the decreasing number of physical branches, especially for the big five.

 

The following shows some details related to the recent deposit growth, the competitive dynamics and how (big) banks have many internal levers to keep customers happy:

https://www.spglobal.com/marketintelligence/en/news-insights/trending/ALnK3nDipmnnl4bEkVQ96g2

 

So, to the question: Is the deposit growth rate impressive? I would say it depends on the perspective. If you believe wabuffo and think that the recent rise in deposits has been correlated (caused by?) rising liabilities then the answer may reside in the ability to answer the following questions: 1-Deleveraging, what deleveraging? and 2-Where are we in the cycle?

 

For question #1, the following gives an interesting perspective:

https://fred.stlouisfed.org/series/DDOI02USA156NWDB

The positive slope followed by a flat line is called a success by central bankers but I have doubts.

 

For question #2, if you are agnostic about exactly timing the cycles and/or if you can opportunistically build-up your position as a privileged insider and deep pocketed investor when the sun don't shine, you can still consider the option of focusing on the US "market leaders" and the "resilients". From a globalist and marketing-oriented report recently released and relayed by Bloomberg with sensationalist titles.

https://www.mckinsey.com/industries/financial-services/our-insights/global-banking-annual-review-2019-the-last-pit-stop-time-for-bold-late-cycle-moves

 

 

 

 

 

[CorpRaider]

Didn't WFC just post like a +2% growth in deposits?  With no CEO and being a supposed national pariah? 

[JEast]

Another challenger bank bites the dust, but the multitudes still keep trying.  Maybe a few will eventually take hold in 10years time as the big FAANG types seem more focused with making 'content' for streaming these days.

 

https://www.fintechfutures.com/2019/10/us-challenger-bank-denizen-shuts-down/

 

[John Hjorth]

Didn't WFC just post like a +2% growth in deposits?  With no CEO and being a supposed national pariah?

 

CorpRaider,

 

Please read here.

[RuleNumberOne]

All the Dems have said they want to restore the corporate tax rate to 35%. Bank EPS takes a big hit right there.