Are big banks value traps ?

[wabuffo]

Spek - I like to dig beyond the NIM margins.  Banks have different business models that entail other sources of income (and expense). 

 

One of the banks I like is USB (though I don't own it).  They have built a significant non-lending related business that compliments their core lending operations. It involves selling other services to its banking customers (eg, wealth mgmt) as well as adding ancillary services that depend on connectivity to ATMs/VISA & MC interchange systems that only a bank can provide (payment systems, open-loop prepaid debit card services). The result is the generation of significant levels of fee income that don't depend on direct lending. When that non-interest income is added to a culture of very strong cost controls, it creates some competitive advantages.

 

You can see these advantages in the numbers. I will ignore provisions for credit losses and just look at pre-provision, pre-tax income (PPPT).  I will also ignore a big bank like JPM that has a large investment bank attached since its non-interest income is volatile.  Here's the numbers for the Q2, 2020.

 

 

I've also attached a snapshot of Meta Financial (my favorite small bank and only bank stock that I hold).  I think it is a bank to watch as it shifts its business model and really leverages its market-leading strength in open-loop prepaid debit cards.  Of course, one quarter's results probably isn't a deep enough analysis and this should be looked at over time.

 

wabuffo

 

 

[Viking]

So BAC has a market cap of $207 billion. It has something like $35 billion in excess capital; likely $20 billion it does not need?

 

- In Q3 it earned $5 billion.

- Expects net interest income has hit low point. Flat to up slightly in Q4 and flat to up slightly in 2021

- expects expenses in Q4 of $13.7 billion. $3-$400 million due to covid which should come out in 2021 (mostly back half).

- expect delinquencies to push to mid 2021; consumer is doing better than models predict.

- dividend yield is almost 3% and dividend is safe

 

Business has been remarkably resilient in 2020. Very different than what happened in 2008-2012.

 

Stock looks cheap at under $24. But where does economy and earnings and capital return go from here?

[hyten1]

this market is getting out of hand, the market cap of TSLA ~= BAC + C + WFC +GM ?!?!

 

the combine net income of these companies is more than DOUBLE tsla's sales

[DooDiligence]

this market is getting out of hand, the market cap of TSLA ~= BAC + C + WFC +GM ?!?!

 

the combine net income of these companies is more than DOUBLE tsla's sales

 

I like my chances with this dislocation.

[John Hjorth]

this market is getting out of hand, the market cap of TSLA ~= BAC + C + WFC +GM ?!?!

 

the combine net income of these companies is more than DOUBLE tsla's sales

 

I like my chances with this dislocation.

 

Hyten & Jeff,

 

Yeah, the whole market proposition appear [humm-hooo!] twisted right now. No real connection between earnings and expected earnings vs. price in so many sectors.

 

Banks in general appear cheap on metrics, also certain kind of real estate. To me, the issue at hand for banks is that they have - in general - absolutely no clue about how much money they will loose related to pandemic business restrictions. [simply, just "caught with their trousers down" & "don't know" - but "will learn along the way".]

[RadMan24]

Spek - I like to dig beyond the NIM margins.  Banks have different business models that entail other sources of income (and expense). 

 

One of the banks I like is USB (though I don't own it).  They have built a significant non-lending related business that compliments their core lending operations. It involves selling other services to its banking customers (eg, wealth mgmt) as well as adding ancillary services that depend on connectivity to ATMs/VISA & MC interchange systems that only a bank can provide (payment systems, open-loop prepaid debit card services). The result is the generation of significant levels of fee income that don't depend on direct lending. When that non-interest income is added to a culture of very strong cost controls, it creates some competitive advantages.

 

You can see these advantages in the numbers. I will ignore provisions for credit losses and just look at pre-provision, pre-tax income (PPPT).  I will also ignore a big bank like JPM that has a large investment bank attached since its non-interest income is volatile.  Here's the numbers for the Q2, 2020.

 

 

I've also attached a snapshot of Meta Financial (my favorite small bank and only bank stock that I hold).  I think it is a bank to watch as it shifts its business model and really leverages its market-leading strength in open-loop prepaid debit cards.  Of course, one quarter's results probably isn't a deep enough analysis and this should be looked at over time.

 

wabuffo

 

Truth be told, based on simply those numbers, the bank's valuations between themselves don't appear out of whack.

[Cigarbutt]

Banks have to be evaluated one by one and some may have developed some kind of edge in the non-interest income category but there are a few trends to consider for banks.

The NIM at banks has gone down:

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

Large banks (total assets more than 50B) typically maintained lower NIMs and their NIMs has decreased even more than the smaller banks since the GFC. The primary reason for this is that their funding costs (deposits) has not been brought down as much because of the zero lower bound.

 

However, this has been more than mitigated by a significant rise in loans/deposits:

 

http://www.yardeni.com/pub/tc_20201012_11.png

 

So, interest income has grown since the GFC but this phenomenon has been driven by consistently high public debt issues with the Fed pushing for regulatory rules to force the banks to hold more capital and to park cash from its asset swap operations at the Fed in the form of excess reserves.

 

Non-interest income grew significantly in the 1980s and 1990s (% of operating revenue from 20 to 40%) but the % of operating revenue has come down since the GFC. When dissecting the composition of non-interest income which overall has a lower share of revenue, various service charges have gone up and securitization fees are down.

 

The net result so far since the GFC (before Covid) has meant an inability to reach the same historical ROE levels, which is felt to be OK by some because interest rates are low.

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

 

A good outcome for banks however requires that interest rates go up and that the term curve becomes steep (not steep by today's definition of the 30-yr at 1.49%!). It's hard to imagine a path leading to higher interest rates without some kind of buying opportunity. In the meantime, banks can always try to mitigate the low returns with higher fees but the real economy also needs higher real rates.

 

Increasingly, the Fed has been buying a larger share of the government debt issued (at least very clear recently) and has been forcing banks to hold 'safe' government debt securities on their balance sheet. i think the Fed has become the marginal buyer and this is a big negative for banks (large and small) in terms of profitability and returns.

 

 

[John Hjorth]

As always, thank you for your post, Cigarbutt,

 

However I have to ask : What's your your scope in your last post? [global, "american" [<- north & south], European or whatever].

[Cigarbutt]

I have to ask : What's your your scope in your last post? [global, "american" [<- north & south], European or whatever].

Disclosure: i've held banks before and, in fact, in 1996-7, investing in CIBC (one of the large oligopolistic banks in Canada) resulted in my first double over a few short months. In retrospect, i eventually realized i didn't know what i was doing and that everybody is a genius in a bull market. Unfortunately, this means that in 2044, it could be realized that the post referred to above is utterly irrelevant.

 

The post was triggered by the items listed below and concerns mainly the US although similar dynamics apply in countries equipped with a modern day central bank. In fact, one could argue that the ECB countries and especially Japan are leading the way (declining NIMs, ROEs etc) into the quicksand and the US seems to say "i can stop anytime". i wonder if negative rates are on the way and some people suggest that, after a very short term boost, negative rates would tend to cause what European and Japanese banks, in general, are experiencing.

https://www.frbsf.org/economic-research/publications/economic-letter/2020/september/commercial-banks-under-persistent-negative-rates/

 

items:

-a few 10-Ks

-this thread

-this, read this AM:

http://blog.yardeni.com/2020/10/dont-fight-t-fed.html

-this book, written some time ago, before Citigroup became a shadow of its former self

https://www.amazon.com/Citibank-1812-1970-Harold-van-Cleveland/dp/0674131762

[ValuePadawan]

I have to ask : What's your your scope in your last post? [global, "american" [<- north & south], European or whatever].

Disclosure: i've held banks before and, in fact, in 1996-7, investing in CIBC (one of the large oligopolistic banks in Canada) resulted in my first double over a few short months. In retrospect, i eventually realized i didn't know what i was doing and that everybody is a genius in a bull market. Unfortunately, this means that in 2044, it could be realized that the post referred to above is utterly irrelevant.

 

The post was triggered by the items listed below and concerns mainly the US although similar dynamics apply in countries equipped with a modern day central bank. In fact, one could argue that the ECB countries and especially Japan are leading the way (declining NIMs, ROEs etc) into the quicksand and the US seems to say "i can stop anytime". i wonder if negative rates are on the way and some people suggest that, after a very short term boost, negative rates would tend to cause what European and Japanese banks, in general, are experiencing.

https://www.frbsf.org/economic-research/publications/economic-letter/2020/september/commercial-banks-under-persistent-negative-rates/

 

items:

-a few 10-Ks

-this thread

-this, read this AM:

http://blog.yardeni.com/2020/10/dont-fight-t-fed.html

-this book, written some time ago, before Citigroup became a shadow of its former self

https://www.amazon.com/Citibank-1812-1970-Harold-van-Cleveland/dp/0674131762

 

The way I've been trying to think about how the profitability of the US and Canadian banks will fare in a zero or even negative rate environment is to look at some of the Nordic countries and other European countries with banking oligopolies. They have been dealing with zero and negative rates the last few years and have remained profitable throughout. Lower rates hurt profitability until the structure of an oligopolistic market kicks in and the big players compete less on price.

[Spekulatius]

I have to ask : What's your your scope in your last post? [global, "american" [<- north & south], European or whatever].

Disclosure: i've held banks before and, in fact, in 1996-7, investing in CIBC (one of the large oligopolistic banks in Canada) resulted in my first double over a few short months. In retrospect, i eventually realized i didn't know what i was doing and that everybody is a genius in a bull market. Unfortunately, this means that in 2044, it could be realized that the post referred to above is utterly irrelevant.

 

The post was triggered by the items listed below and concerns mainly the US although similar dynamics apply in countries equipped with a modern day central bank. In fact, one could argue that the ECB countries and especially Japan are leading the way (declining NIMs, ROEs etc) into the quicksand and the US seems to say "i can stop anytime". i wonder if negative rates are on the way and some people suggest that, after a very short term boost, negative rates would tend to cause what European and Japanese banks, in general, are experiencing.

https://www.frbsf.org/economic-research/publications/economic-letter/2020/september/commercial-banks-under-persistent-negative-rates/

 

items:

-a few 10-Ks

-this thread

-this, read this AM:

http://blog.yardeni.com/2020/10/dont-fight-t-fed.html

-this book, written some time ago, before Citigroup became a shadow of its former self

https://www.amazon.com/Citibank-1812-1970-Harold-van-Cleveland/dp/0674131762

 

The way I've been trying to think about how the profitability of the US and Canadian banks will fare in a zero or even negative rate environment is to look at some of the Nordic countries and other European countries with banking oligopolies. They have been dealing with zero and negative rates the last few years and have remained profitable throughout. Lower rates hurt profitability until the structure of an oligopolistic market kicks in and the big players compete less on price.

 

How encouraging is the example of Scandinavian banks really? I it is correct that those banks are profitable, but Nordea trades at 0.85x book, Danske trades at 0.45x book, SVenska trades around book.

 

Better than some European peers, but not great either. From the looks of it, they run way higher leverage than HS banks too, which is another issue (probably structurally enabled through regulatory constraints ).

 

Besides, the US market is way less of an oligopoly than Canada and Scandinavia. Inthink the Bank to look at are the UK banks like Lloyd once the UK comes past Brexit and the COVID-19 issues.

[DooDiligence]

-- At least four banks have warned investors in shareholder filings about PPP regulatory and legal risk. Bank of America, for example, said in a July filing that its participation in government stimulus programs “could result in reputational harm and government actions and proceedings, and has resulted in, and may continue to result in, litigation, including class actions.” --

 

-- An October congressional report said that several lenders, including JPMorgan, PNC Financial Services Group Inc and Truist Financial Corp, processed larger PPP loans for wealthy customers at two to four times the speed of smaller loans for the neediest small businesses. --

 

-- A recent U.S. House committee analysis found tens of thousands of PPP loans could be subject to fraud, waste, or abuse, including more than $1 billion in multiple loans to the same company, a violation of program rules.

 

“Regulatory scrutiny of banks is always in hindsight,” Stevens said. “It’s going to come.” --

 

www.reuters.com/article/us-health-coronavirus-ppp-banks-focus/u-s-banks-sweat-regulatory-exposure-from-pandemic-loans-idUSKBN2761G4?utm_source=reddit.com

 

---

 

Banks just can't win for losing.

[Cigarbutt]

...

The way I've been trying to think about how the profitability of the US and Canadian banks will fare in a zero or even negative rate environment is to look at some of the Nordic countries and other European countries with banking oligopolies. They have been dealing with zero and negative rates the last few years and have remained profitable throughout. Lower rates hurt profitability until the structure of an oligopolistic market kicks in and the big players compete less on price.

Don't hesitate to develop ideas in this space as there may be regional opportunities due to specific factors and low bank equity valuations are bound to meet favorable economic prospects at some point.

A word about bank 'fees':

https://www.bankrate.com/banking/checking/checking-account-survey/

In order to maintain a sustainable moat over various fintechs and related, it would be better for banks to focus attention and profitability where their expertise resides: making money with maturity transformation. Absence of central interventions may (eventually) help.

 

i think the experience in Europe overall has confirmed that negative rates for ordinary retail deposit accounts won't work so the magic of low interest rates (the magic being higher valuations and capital gains in the securities trading department and unsustainable inflation in assets without inflation on main street) may eventually run out even if some regional banks may benefit from unusual relative advantages. The low-rate environment may have sparked some risky reaching-for-yield on the loan side and even if these behaviors have been subdued, the real estate price levels in Ireland and the Nordic countries imply that a return to more 'normal' valuation levels may mean higher (much higher?) credit losses at some point. There are many drivers for real estate price but interest rates have been, especially recently, a fundamental driver; the situation being similar in Canada with its oligopolistic banks. Bank profitability, at this point, requires to assume that low interest rates will persist despite the negative impact on the main driver for returns: the net interest income.

 

Each country is different (Anglo-Saxon model etc) and the currency exchange rate may even be a factor to consider. For example, the Irish and Nordic banks have historically relied on wholesale funding and have benefitted (contrary to large US banks that rely more on retail deposits) from unsustainably low funding costs that have matched the ECB 'policy' rates. The process has been recently been compounded by the longer-term ECB zero cost funding tied to additional lending. This process, from a humble perspective, reminds me of the following (two-minute mark, watch for thirty seconds):

As DooDiligence alludes to above, 'forcing' banks to loan money may give rise to unintended consequences.

https://www.bofbulletin.fi/en/charts/chart/the-unsecured-overnight-interbank-eonia-rate-has-tracked-the-ecb-s-deposit-facility-rate-since-the-crisis/

https://www.bofbulletin.fi/en/charts/chart/interest-rate-cuts-are-transmitted-to-bank-retail-deposit-and-lending-rates-through-money-market-rates/

 

The following "Macro Theme" is interesting although it wonders about alternatives too timidly.

https://e-markets.nordea.com/api/research/attachment/102051

 

With ultra-low and sub-zero rates, the bank business model has been turned upside down but it's fair to assume IMO that the outlook will eventually (somehow) become sustainable, again.

 

[mattee2264]

 

I've heard one bullish argument that the recession won't be as damaging as recessions usually are for banks because of the unprecedented government support and the fact banks are much better capitalized than they usually are going into a recession.

What do people make of this?

 

And yeah European banks are much cheaper. See below:

https://www.ft.com/content/27d54524-bde1-11e9-b350-db00d509634e

[TwoCitiesCapital]

 

I've heard one bullish argument that the recession won't be as damaging as recessions usually are for banks because of the unprecedented government support and the fact banks are much better capitalized than they usually are going into a recession.

What do people make of this?

 

And yeah European banks are much cheaper. See below:

https://www.ft.com/content/27d54524-bde1-11e9-b350-db00d509634e

 

I agree that this probably won't be an existential crisis for banks like 2008 was. My concern with US banks is that they're still not priced for an environment of low rates/flat yield curves.

 

While inflation is a possibility, I think it's a few years away with rates range bound And volatile inn between. European banks have been priced for deaths for years and have slowly adapted to 0 rates. US banks have not.

 

This entire time I've owned European banks waiting for them to catch-up to the US, but the possibility of the US catching down to Europe is becoming more likely.

[scorpioncapital]

short of a side business like fintech, most banks are simply a bet on rising rates for purpose of capital appreciation.

 

banking is being asked (made) to pay for the sins of society and by the graces of government as part of the contract of having made all this money for decades. they are politicized. especially big Banks in oligopoly country. i can see an argument for a small nimble community bank in the usa with good management and maybe a dividend. not that they have much of an advantage. but they may have some.

 

big Banks depend on people borrowing and no options. i feel that all the herding and lockdowns serve to prevent people and capital from flowing where it wants , out of countries it no longer likes. but capital is more mobile than people this year. this behavior can chip away at oligopolies, at least in so much as countries do not look favourable for investment and banking. they must then offer higher rates to attract it.

 

looking at insurance companies which are also trading below book value. not sure which is better , a bank or insured below book value. insurer has less regulation and more ability to invest in equities and corporate bonds. however a bank has 10:1 leverage. who wins in a race between 3x leveraged at 3% net Investment income and 10x leveraged at 1.5%? I'd say the bank still wins. however if rates go up, the insurer may still produce near zero cost of float while the bank may be forced to pay a higher interest rate on all 10x leveraged deposits. that could tip the scale to insurers if inflation takes off.