WFC - Wells Fargo

[Dalal.Holdings]

Things to think about:

- The IOUs a bank can issue is limited by the capital they have.

- Bank profits are an opinion, whether it is a fact won't be known until the next recession.

- When a recession occurs, the default rate among the Kanodias is not proportional to the higher interest rate on the loans. It can be 100%.

 

Example:

- Suppose Axos issues CDs for 3%.

- WFC can offer mortgages for 3.25% if you move money into their brokerage accounts and put 20% down with enough income.

- Axos has to find the Kanodias of the world, because normal mortgages where the payments are 45% of income are taken up by BAC and WFC.

- Axos has to compete with GS and everyone else in offering better terms to Kanodia. Even if Kanodia is paying 3% more on his mortgage now, he is guaranteed to walk away as soon as the next recession appears.

 

I asked WFC for a construction loan in the past for an investment. They said they don't make such loans (even if you buy the land with cash yourself.) LTV doesn't matter - they won't make even a 30% LTV for a construction project.

 

So axos has a weighted average interest on liabilities of 1.5% which is nowhere close to 3%.

 

Axos can also offer mortgages at 3.25% and would still have a profit margin of 20% which is where WFC is now currently with a weighted average ir on loans yielding 4.79%.  You are right though thats bc the libilities are higher yielding its more leveraged to a decrease in asset yield. 

 

As far as loan quality, this is a fair point.  However, Axos bank has a higher equity tier 1 capital ratio than WFC at somewhere around 12.5 versus 11.7.  Addtitionally LTV for Axos is 55% which is likely below WFC even though I couldn't find an exact value (but I found a table with LTV buckets). If Axos offered loans comperable to the average WFC loan yielding 4.79% at 3.25% I think most customers would choose Axos giving them lots of choice to pick the best customers.  Keep in mind while there is some moat in banking its basically a commodity business.  Depositers flock to the highest interest rates and borrowers flock to the lowest.  In commodity businesses the low cost producer ultimately wins.  So even though Axos is writing riskier loans, it seems likely that Axos could write pretty safe loans and still earn their cost of capital. 

 

Just to illustrate: when calculating imagined profits on an interest rate, I multiply the imagined ir on loans and subtract that amount from the actual loan return.  Multiply that by 2/3 (taxes) and subtract that from current net income to get adjusted net income then calculate net profit margin in the same way (by dividing by adjusted revenue now).

 

This is a good conversation to be having to really drill down as to what the moats are in this business.

 

You seem to be ignoring a crucial aspect of banking: loan origination. Someone has to be there to initially write the paper (many discounted the merits of this process leading up to the mortgage crash of '08). Often, that's at a branch. To underwrite a mortgage, you need staff including a loan officer to analyze the risks involved with loaning the money (the asset side of the business). There may be those out there who think AI or some great technology can estimate risks and underwrite loans better than a real person, but that has yet to be proven. The process of getting a mortgage loan is so regulated that one cannot do it easily over the phone/online (regulatory moat for older banks).

 

Once you add the loan underwriting/risk management and regulatory costs that internet banks would need to replicate this, the margins for internet banks gets smaller.

 

And then not only do you need the underwriters, but you need someone to bear the costs of having ATMs and maintaining them (loading with cash, emptying, real estate, etc). Right now, it's the old school banks doing it and your online banks paying for the small fees. In your future where all banking is with online-only banks (because branched banks are inferior), the cost of ATMs will also chip away at what seem like amazing margins right now (because the big banks are bearing the majority of the costs of running ATMs right now).

 

You seem to be looking too hard at the income statement and focusing on margins there when in fact, with banking, the focus should be on the balance sheet and return on asset/equity figures (and account for risks and leverage). That's why NIM matters here more than margins on the income statement do for a non-financial business.

 

These banks might be offering great rates for depositors, but their rates for borrowers don't seem that competitive--and that's because the cost of funding (deposits) is higher--again, NIM matters. This might explain why a lot of these banks seem to be writing risky loans--because they have no alternative to cover their cost of funding. So they may have the advantage on the liabilities side, but not the asset side.

 

Furthermore, due to their lack of moat, the liabilities side of online banks could disappear rapidly due to non-sticky deposits which would prove devastating. After all, banks fundamentally borrow short and lend long: the online banks have not been really tested in this regard and there could be widespread failure ("internet bank runs") in this space should such a test come. Sticky deposits are a MUST in this business and the old school banks have demonstrated stickiness, the online players do not and are untested.

 

Finally, if your thesis is true, there is little to stop the the big banks from rapidly moving to online-only business models on their own. After all, they already provide online banking services to hundreds of millions of people and have the back end and front end of the technology deployed and running relatively seamlessly: this situation isn't equivalent to a Blockbuster vs Netflix situation--the old banks' online game is already very strong and proven with hundreds of millions of active daily users. All that's left is to close branches which can be done rapidly if need be.

[racemize]

Adding to the branch discussion, I think there's a good reason JPM is adding them--Dimon isn't stupid and he's talked about per branch profitability.  They seem to continue to be useful in the present time.  Certainly, bad branches are bad, but bad branches do not equal all branches.

[cameronfen]

I will say this is the most reasonable response imo from the other side.  What other people seem not to understand is you literally can't argue about cost structure.  But I will respond:

 

1.  Tieing deals together can be done by anyone.  I think WFC and WB like to talk about this, but just from gut instinct i can't believe it moves the needle (for example do you really think tying deals is even resposible for 500m in earnings?).  At least it doesn't pass the smell test for me. 

 

2.  Internet banks have been around for a while and they have taken share from traditional banks:  Banking is not a business where fast growth is good.  You need to maintain asset quality so you can only grow at a very slow rate.  Also people are sticky for banks.  It's not so easy peeling away customers but people are slowly leaving as branchless banking becomes the obviously better choice for consumers.  That being said branchless banks are a thing and the cats out of the bag.  They have a cost structure advantage and will continue to do so for now until eternity, slowly taking share.  also most branchless banks were no name firms that people didn't trust.  With bigger names getting in taking share will accelerate. 

 

3.  As regards to Dimon opening up branches, I could say the same thing about GS opening up Marcus.  The GS management team is arguebly better than the JPM one and they decide to go with the strategy.  I think the real answer is like someone said "someone with a hammer..." GS has no branches and JPM does.  They see different nails and have different hammers. 

 

edit: I'd like to add the assault on deposits is only one dimension of the disruption big banks are facing.  You have more effective competitors on the wealth management side. You have emerging competition on the loan issuance side, credit cards....  Banks are risking distruption not just from branchless banks but basically from the vast majority of the fintech space against virtually every aspect of their business (except maybe IB).

 

It just isn't as simple as math -- that is what everyone is trying to argue . Not having branches is a very easily replicated cost structure advantage. All can add 2+2 and see that branches cost money.

 

If branchless banking is so obvious and the math is so shockingly easy, why isn't even going that way? Why doesn't every bank just close its branches? For a total no-brainer, why isn't every bank copying these internet bank? Might there be a reason?

 

A well run, well located bank branch both makes money and reduces overall costs and risk. The actual "cost" of running a branchless model is the cost of A. Having to often buy loans at wholesale prices, as well as taking on risk of representation by the seller (i.e., you didn't do the underwriting yourself), B. The cost and risk involved with quickly moving deposits (fast money). C. Reputational/trust issues (as shown by many here).

 

The big banks also have mindshare. When I drive around town, I see B of A, Wells Fargo, a few local banks, Chase. When I drive around a town in another state I see... B of A, Wells Fargo, Chase, a few local banks...

 

This drives banking relationships - and the banks know it.

 

There is also the tie between personal and commercial banking. (These discussion about internet banks typically revolve around consumer savings accounts -- that's one piece of a much greater overall pie.)

 

If I run a $10 million manufacturer and I need somewhere to put my business' checking account, and go to for a commercial loan as well as personal loans, do I go to Internet Bank X, or down the street, where my friend from high school is a loan officer and there's a branch I drive by every day? And once they've captured that, don't you think they make it easy and sensible for me to put my personal money there?

 

You had an aside that this "tying" is minimal -- I disagree. It might be a minority by number of people. But there's an 80/20 rule and, I'm sorry, a minority of people have a majority of the money and banking needs.

 

I don't mean to disparage the online-only model, it has a place and value for sure. The idea that everything's headed there is, I think, a mistake. Silicon Valley people really think everyone else is dumb and they're smart and that's that. Well, sometimes true, sometimes not.

 

All good discussion -- dissent makes markets.

 

Here I go again I guess... (not sacastic towards you just myself for getting sucked in again)

 

I just ran you through the numbers showing that branchless banking has lower cost structure than branch banking. If my analysis has a flaw (which it surely does but hopefully not a fatal one) please let me know.  Your defense that branch banking is profitable because banks do it doesn't hold water for the following reason: why didn't newspapers close all there paper routes and clone huff po when they had a chance?  Why didn't sears break all its leases and just sell its brands on Amazon?  Why didn't the large travel agencies buy priceline when it was a 100 million dollar business? 

 

The answer, at least partially, is inertia.  Compared to the opportunity cost of closing all your branches, its profitable to keep them open.  But if you had nothing and had to start all over, it's not.

It's not so easy to close down all your branches when that's how you get customers.  They are known for having branches and walk in service, its not so easy to discontinue that business no matter how inefficient it is and just get hundreds of billions in deposits from other sources.  I will say if incumbent banks are able to close down branches and transition to online model over time without alienating customers by moving too quick and without losing too much market share by moving too slow they could maintain their dominance.  IBM managed to do that, but its not easy. 

 

I will say it again.  Banking is a commodity business.  Your money is just as good as my money.  Incumbent banks had a moat because they were the low cost operator, due to things like economies of scale and too big to fail.  With branchless banks (and other fintech) this is no longer the case.  However, branchless banks (and other fintech) can not grow too quick unlike other industries despite their competitive advantage but they will slowly chip away at the deposit base. 

 

You mindshare argument is well received.  I just think over time people will prefer higher deposit rates and lower loan rates over mindshare. 

 

Again I'm not saying bank of the internet will get a SIFI designation anytime soon, and I'm not saying there isn't a place for branch banking, only the the economics favor big banks like WFC losing a lot of share to lower cost start ups over a long period of time. 

[Spekulatius]

The process of getting a mortgage loan is so regulated that one cannot do it easily over the phone/online (regulatory moat for older banks).

 

Actually, the process of obtaining a mortgage is highly standardized and can be done almost entirely remotely. I think it is done over a Fannie/Freddie platform, because with two different brokers I used, the process/online interface was virtually the same, except the skin was a bit different.

 

The only thing that can’t be done online is closing, because they still need papers to be signed. my last refinance was the easiest ever - took 2 weeks from initiating to closing (which was arranged at a local law office to sign the various papers).

[gary17]

As a small business owner I can tell you it’s not a commodity business

 

It’s a relationship based business.  I don’t often have time to shop around ... quality of service and efficiency trumps a few basis points I might save

[SHDL]

Finally, if your thesis is true, there is little to stop the the big banks from rapidly moving to online-only business models on their own.

 

This is the key point I would focus on.  It’s very difficult to be disrupted by a competitor who can only do X when you can do both X and Y.  The only way that can happen I think is through management incompetence (which you obviously have to watch out for). 

 

Branch counts have been trending down for years for the big US banks, by the way.  Chase has been opening new branches in certain regions over the last year or so, but that’s because they were prohibited from doing so by the government for years.  Wells Fargo has been a laggard in this regard for whatever reason, but they are now getting more aggressive about rationalizing their branch network and that should help their bottom line going forward. 

[Viking]

The big banks are morphing and have been doing so for years. Look athow many people BAC employed in 2009 and compare that to today. Branch count has been coming down quite aggressively, especially when you net out branches that are being openend in brand new markets. Wells Fargo is well behind in this trend and when the new CEO is announced expect aggressive branch reduction to be one of the first big decisions.

 

Consumers and businesses are very change resistant, especially when it comes to certain topics like banking. Yes, the indistry will morph. My guess is the big banks will continue to morph over time (as they have over the past 10 years).

 

My key takeaway is investors continue to underestimate how costs are going to fall for the big banks over time (as software allows them to shrink their branch count and reduce teller type jobs).

[cameronfen]

Things to think about:

- The IOUs a bank can issue is limited by the capital they have.

- Bank profits are an opinion, whether it is a fact won't be known until the next recession.

- When a recession occurs, the default rate among the Kanodias is not proportional to the higher interest rate on the loans. It can be 100%.

 

Example:

- Suppose Axos issues CDs for 3%.

- WFC can offer mortgages for 3.25% if you move money into their brokerage accounts and put 20% down with enough income.

- Axos has to find the Kanodias of the world, because normal mortgages where the payments are 45% of income are taken up by BAC and WFC.

- Axos has to compete with GS and everyone else in offering better terms to Kanodia. Even if Kanodia is paying 3% more on his mortgage now, he is guaranteed to walk away as soon as the next recession appears.

 

I asked WFC for a construction loan in the past for an investment. They said they don't make such loans (even if you buy the land with cash yourself.) LTV doesn't matter - they won't make even a 30% LTV for a construction project.

 

So axos has a weighted average interest on liabilities of 1.5% which is nowhere close to 3%.

 

Axos can also offer mortgages at 3.25% and would still have a profit margin of 20% which is where WFC is now currently with a weighted average ir on loans yielding 4.79%.  You are right though thats bc the libilities are higher yielding its more leveraged to a decrease in asset yield. 

 

As far as loan quality, this is a fair point.  However, Axos bank has a higher equity tier 1 capital ratio than WFC at somewhere around 12.5 versus 11.7.  Addtitionally LTV for Axos is 55% which is likely below WFC even though I couldn't find an exact value (but I found a table with LTV buckets). If Axos offered loans comperable to the average WFC loan yielding 4.79% at 3.25% I think most customers would choose Axos giving them lots of choice to pick the best customers.  Keep in mind while there is some moat in banking its basically a commodity business.  Depositers flock to the highest interest rates and borrowers flock to the lowest.  In commodity businesses the low cost producer ultimately wins.  So even though Axos is writing riskier loans, it seems likely that Axos could write pretty safe loans and still earn their cost of capital. 

 

Just to illustrate: when calculating imagined profits on an interest rate, I multiply the imagined ir on loans and subtract that amount from the actual loan return.  Multiply that by 2/3 (taxes) and subtract that from current net income to get adjusted net income then calculate net profit margin in the same way (by dividing by adjusted revenue now).

 

This is a good conversation to be having to really drill down as to what the moats are in this business.

 

You seem to be ignoring a crucial aspect of banking: loan origination. Someone has to be there to initially write the paper (many discounted the merits of this process leading up to the mortgage crash of '08). Often, that's at a branch. To underwrite a mortgage, you need staff including a loan officer to analyze the risks involved with loaning the money (the asset side of the business). There may be those out there who think AI or some great technology can estimate risks and underwrite loans better than a real person, but that has yet to be proven. The process of getting a mortgage loan is so regulated that one cannot do it easily over the phone/online (regulatory moat for older banks).

 

Once you add the loan underwriting/risk management and regulatory costs that internet banks would need to replicate this, the margins for internet banks gets smaller.

 

And then not only do you need the underwriters, but you need someone to bear the costs of having ATMs and maintaining them (loading with cash, emptying, real estate, etc). Right now, it's the old school banks doing it and your online banks paying for the small fees. In your future where all banking is with online-only banks (because branched banks are inferior), the cost of ATMs will also chip away at what seem like amazing margins right now (because the big banks are bearing the majority of the costs of running ATMs right now).

 

You seem to be looking too hard at the income statement and focusing on margins there when in fact, with banking, the focus should be on the balance sheet and return on asset/equity figures (and account for risks and leverage). That's why NIM matters here more than margins on the income statement do for a non-financial business.

 

These banks might be offering great rates for depositors, but their rates for borrowers don't seem that competitive--and that's because the cost of funding (deposits) is higher--again, NIM matters. This might explain why a lot of these banks seem to be writing risky loans--because they have no alternative to cover their cost of funding. So they may have the advantage on the liabilities side, but not the asset side.

 

Furthermore, due to their lack of moat, the liabilities side of online banks could disappear rapidly due to non-sticky deposits which would prove devastating. After all, banks fundamentally borrow short and lend long: the online banks have not been really tested in this regard and there could be widespread failure ("internet bank runs") in this space should such a test come. Sticky deposits are a MUST in this business and the old school banks have demonstrated stickiness, the online players do not and are untested.

 

Finally, if your thesis is true, there is little to stop the the big banks from rapidly moving to online-only business models on their own. After all, they already provide online banking services to hundreds of millions of people and have the back end and front end of the technology deployed and running relatively seamlessly: this situation isn't equivalent to a Blockbuster vs Netflix situation--the old banks' online game is already very strong and proven with hundreds of millions of active daily users. All that's left is to close branches which can be done rapidly if need be.

 

1.  re Loan Origination:  So I do think branchless banks are a threat, but I was clear the threat was coming from all sides.  You guys choose to pounce on branchless banks, so I responded.  Loan origination could be a bigger threat.  The second largest loan originator is Quicken Loans with $81 billion in originations a year.  No branches, few loan officers, all computer code (and the perfect proof of concept that you don't need lots of loan officiers and risk management personal to originate loans).  Higher risk than WFC, certainly, but they survived and thrived after the great recession and have a way better cost structure than loan origination from banks.  4 of top 8 loan originators are non-bank originators.  They are rapidly taking market share.  They have a higher cost of capital, but you sell these things off to people that have lower costs of capital like insurance companies or branchless banks and you have a recipe for an industry that can continue to take share from banks.  This competition seems to me to be a more immediate threat than branchless banking, but I don't know much about it.   

 

2.  Asset costs for branchless banks.  See 1. and also note that branchless banks have lower deposit gathering costs than branch banks.  I showed the favorable economics of branchless banks on the deposit side showing Axos net profit margin would be equivenlent to wfc even if they charged 3.25% weighted average yield compared to 4.79% for wfc. 

 

3.  Balance sheet.  The reason I don't discuss NIM and balance sheet is because the advantage for branchless banks comes from opex.  If you assume the same yield from loans and the same net income margin and same equity ratio then RoE is mechanically the same.  Thus when I say net income margin is higher, I'm implicitly saying RoE and RoA is higher.  Looking it up, Axos roe 15.2% to Wfc roe 10.7% (note Axos Tier 1 equity is higher than WFC). Axos RoA 1.67% Wfc RoA 1.14%.  Even if you control for asset quality via lowering interest rates  on Axos loans Axos RoA would be higher (via my net income margin argument). 

 

4.  Non sticky deposits.  True.  But this is true for all banks especially start up banks.  They are less tried and true by definition. This doesn't mean the business model at scale will not work and doesn't mean some banks won't reach scale.  Further more: banking is a commodity business.  If you charge higher deposit interst rates depositers will likely stay with you.  If you charge lower loan rates borrowers will stay with you.  I find a hard time believing Axos customers will leave Axos for another bank even though Axos has higher interest rates.  Also FDIC. 

 

5. Atm fees.  Branchless banks already pay the fees from withdrawing your money from an atm.  Those fees are enough to cover the running of an atm which is relatively costless. 

 

6. Copy branchless business model.  I discussed this with my other comment with coc.  They still have as many branches as they did 10 15 years ago sometimes more.  They still have to run those branches even if they have online customers.  Thats a cost even if everyone is banking online.  If the migrate to an online model they could maintain dominance but easier said than done.  If you close all 2500 of your branches you lose hundreds of billions in deposits easy.  You won't recover that right away by being an online bank.  However if you don't close 2500 branches you still have to pay for employees and rent which makes your cost structure uncompetitive.  Pick your poison.

See my other answer for a proper response. 

[cameronfen]

Finally, if your thesis is true, there is little to stop the the big banks from rapidly moving to online-only business models on their own.

 

This is the key point I would focus on.  It’s very difficult to be disrupted by a competitor who can only do X when you can do both X and Y.  The only way that can happen I think is through management incompetence (which you obviously have to watch out for). 

 

Branch counts have been trending down for years for the big US banks, by the way.  Chase has been opening new branches in certain regions over the last year or so, but that’s because they were prohibited from doing so by the government for years.  Wells Fargo has been a laggard in this regard for whatever reason, but they are now getting more aggressive about rationalizing their branch network and that should help their bottom line going forward.

 

Yes this and vikings point is the big question.  The transition is not easy to manage.  Like I said sears knew what it had to do.  So did the newspapers.  Neither was able to manage it sucessfully.  IBM also did and suceeded in the transistion (although now its got new problems).  Transition is not as easy as just closing some branches. 

 

Also note JPM had a Marcus like program called Finn before they closed it down.  The reason stated was because it was canabalizing businesses.  So its not so easy for CEOs that will make decisions that will help the company 20 years down the road but cost you quarterly profits now.  Even for CEOs like Dimon. 

 

Vikings point about higher margins as banks shift to internet was interesting I hadn't thought about that but that makes sense. 

[Dalal.Holdings]

Finally, if your thesis is true, there is little to stop the the big banks from rapidly moving to online-only business models on their own.

 

This is the key point I would focus on.  It’s very difficult to be disrupted by a competitor who can only do X when you can do both X and Y.  The only way that can happen I think is through management incompetence (which you obviously have to watch out for). 

 

Branch counts have been trending down for years for the big US banks, by the way.  Chase has been opening new branches in certain regions over the last year or so, but that’s because they were prohibited from doing so by the government for years.  Wells Fargo has been a laggard in this regard for whatever reason, but they are now getting more aggressive about rationalizing their branch network and that should help their bottom line going forward.

 

Yes this and vikings point is the big question.  The transition is not easy to manage.  Like I said sears knew what it had to do.  So did the newspapers.  Neither was able to manage it sucessfully.  IBM also did and suceeded in the transistion (although now its got new problems).  Transition is not as easy as just closing some branches. 

 

Also note JPM had a Marcus like program called Finn before they closed it down.  The reason stated was because it was canabalizing businesses.  So its not so easy for CEOs that will make decisions that will help the company 20 years down the road but cost you quarterly profits now.  Even for CEOs like Dimon. 

 

Vikings point about higher margins as banks shift to internet was interesting I hadn't thought about that but that makes sense.

 

The transition (if there is one) will be a lot easier than it was for Sears and Newspapers. If what you say is true--that customers don't care about branches--then closing branches won't hurt their business (people won't automatically move their accounts if Wells happens to close a branch in their town). For Sears and the Newspapers that failed, their online business was tiny and they were dependent on their legacy business (brick and mortar stores and physical newspapers) to generate revenue.

 

Old banks are not like Blockbuster or Sears: they already have a strong online presence with great UI and apps that have been proven over likely billions and billions of online transactions/accounts/etc. If you are correct, then they only need to close branches and closing or neglecting branches will not hurt them directly like closing or neglecting stores hurt Sears and its reputation. Blockbuster had pretty much no online customers as well so all it had was the legacy brick and mortar stores. Old banks can let their branches rot away if consumers truly do not care about them and they will still keep most accounts while their operating costs fall as you say.

[cameronfen]

Finally, if your thesis is true, there is little to stop the the big banks from rapidly moving to online-only business models on their own.

 

This is the key point I would focus on.  It’s very difficult to be disrupted by a competitor who can only do X when you can do both X and Y.  The only way that can happen I think is through management incompetence (which you obviously have to watch out for). 

 

Branch counts have been trending down for years for the big US banks, by the way.  Chase has been opening new branches in certain regions over the last year or so, but that’s because they were prohibited from doing so by the government for years.  Wells Fargo has been a laggard in this regard for whatever reason, but they are now getting more aggressive about rationalizing their branch network and that should help their bottom line going forward.

 

Yes this and vikings point is the big question.  The transition is not easy to manage.  Like I said sears knew what it had to do.  So did the newspapers.  Neither was able to manage it sucessfully.  IBM also did and suceeded in the transistion (although now its got new problems).  Transition is not as easy as just closing some branches. 

 

Also note JPM had a Marcus like program called Finn before they closed it down.  The reason stated was because it was canabalizing businesses.  So its not so easy for CEOs that will make decisions that will help the company 20 years down the road but cost you quarterly profits now.  Even for CEOs like Dimon. 

 

Vikings point about higher margins as banks shift to internet was interesting I hadn't thought about that but that makes sense.

 

The transition (if there is one) will be a lot easier than it was for Sears and Newspapers. If what you say is true--that customers don't care about branches--then closing branches won't hurt their business (people won't close their accounts if Wells closes a branch in their town). For Sears and the Newspapers that failed, their online business was tiny and they were dependent on their legacy business (brick and mortar stores and physical newspapers) to generate revenue.

 

Old banks are not like Blockbuster or Sears: they already have a strong online presence with great UI and apps that have been proven over likely billions and billions of online transactions/accounts/etc. If you are correct, then they only need to close branches and closing or neglecting branches will not hurt them directly like closing or neglecting stores hurt Sears. They can let their branches rot away if consumers truly do not care about them and they still keep most accounts while their operating costs fall as you say.

 

Yeah I'm not sure.  I mean closing branches will hurt them because they will lose deposits, but long run it will help them as they are better able to compete.  Newspapers might be a better comp.  Some survived, but some weren't able to normalize their org structure to resemble like a buzzfeed or whatever, and they have to pain now or pain later dynamic (and everyone knew what to do).  I don't think these banks will fail, but just like newspapers some could lose non-trivial amounts of value for stockholders.  Those that do these things (and WFC is slow to the game probably because they had the best branch business of all the banks), probably will earn higher profits at least temporarily (until everyone basically becomes online first) and may be good bets.  I don't know if you can tell who's going to figure it out though.  I don't invest in banks anyways even something like a branchless bank because ROE aren't that great and they have no moat, other than being a current low cost operator in a business with low barriers to entry and commodity business (but again a current secular advantage over incumbent banks).  As a small investor if you want to invest in banks, maybe you just do the Stilwell approach and buy undervalued banks wait for an acquisition and just plan for a day when that no longer works (if you believe what I'm saying). 

[Spekulatius]

I don't have a strong view as to where interest rates will go, but if one expects the US to follow Europe, banks are gonna be much "cheaper" on a price/book basis (since they're much worse businesses). Europe is swimming in banks that have a hard time to earn a double digit return on equity and thus trades at a sizeable discount to book value since NIM is getting compressed by negative rates. What happens if rates turn negative in the US?

 

Lower interest rates are a significant risk and one that gives me a bit pause. I think the level of interest rates and competition are the main reason why US banks do that much better than European counterparts. If interest rates go negative like they went in Europe US banking profits will get severely reduced. Other  reasons for higher prints are somewhat less competition in the US and perhaps a more gullible consumer (especially with respect to Credit cards).

[Guest eatliftinvestgolf]

Yeah I'm not sure.  I mean closing branches will hurt them because they will lose deposits, but long run it will help them as they are better able to compete.  Newspapers might be a better comp.  Some survived, but some weren't able to normalize their org structure to resemble like a buzzfeed or whatever, and they have to pain now or pain later dynamic (and everyone knew what to do).  I don't think these banks will fail, but just like newspapers some could lose non-trivial amounts of value for stockholders.  Those that do these things (and WFC is slow to the game probably because they had the best branch business of all the banks), probably will earn higher profits at least temporarily (until everyone basically becomes online first) and may be good bets.  I don't know if you can tell who's going to figure it out though. I don't invest in banks anyways even something like a branchless bank because ROE aren't that great and they have no moat, other than being a current low cost operator in a business with low barriers to entry and commodity business (but again a current secular advantage over incumbent banks).  As a small investor if you want to invest in banks, maybe you just do the Stilwell approach and buy undervalued banks wait for an acquisition and just plan for a day when that no longer works (if you believe what I'm saying).

 

Wow the bolded part really says it all.

[Viking]

Yeah I'm not sure.  I mean closing branches will hurt them because they will lose deposits, but long run it will help them as they are better able to compete.  Newspapers might be a better comp.  Some survived, but some weren't able to normalize their org structure to resemble like a buzzfeed or whatever, and they have to pain now or pain later dynamic (and everyone knew what to do).  I don't think these banks will fail, but just like newspapers some could lose non-trivial amounts of value for stockholders.  Those that do these things (and WFC is slow to the game probably because they had the best branch business of all the banks), probably will earn higher profits at least temporarily (until everyone basically becomes online first) and may be good bets.  I don't know if you can tell who's going to figure it out though. I don't invest in banks anyways even something like a branchless bank because ROE aren't that great and they have no moat, other than being a current low cost operator in a business with low barriers to entry and commodity business (but again a current secular advantage over incumbent banks).  As a small investor if you want to invest in banks, maybe you just do the Stilwell approach and buy undervalued banks wait for an acquisition and just plan for a day when that no longer works (if you believe what I'm saying).

 

Wow the bolded part really says it all.

 

Looking at Canada, investing in banks was an absolute brilliant move for investors over the past 20 years. What will the next 20 years hold? Not sure. However, my guess is the big US banks will continue to morph and find a way to deliver adequate returns to their investors. The US is looking more like the olgopoly we have here in Canada; similar to a regulated utility. The internet is the best thing that could have happened to them. Yes, top line growth will be challenging. However, costs will continue to fall and operating leverage should remain positive.

[RuleNumberOne]

Denmark has negative mortgage rates and booming house prices. Governments and central bankers in Europe are far more crooked than the US. Throughout Europe you have rock-bottom interest rates and booming house prices. Debauchery of the currency is a mild description. How long can this go on?

 

https://www.globalpropertyguide.com/Europe/Denmark/Price-History

 

"Denmark´s negative interest rates continue to work their dangerous magic on both the housing and mortgage markets.

 

The price index of owner-occupied flats in Denmark rose by 7.88% (7.25% when adjusted for inflation) during the year to February 2018, an acceleration from last year´s growth of 6.87% (5.81% when adjusted for inflation), according to Statistics Denmark."

 

I don't have a strong view as to where interest rates will go, but if one expects the US to follow Europe, banks are gonna be much "cheaper" on a price/book basis (since they're much worse businesses). Europe is swimming in banks that have a hard time to earn a double digit return on equity and thus trades at a sizeable discount to book value since NIM is getting compressed by negative rates. What happens if rates turn negative in the US?

 

Lower interest rates are a significant risk and one that gives me a bit pause. I think the level of interest rates and competition are the main reason why US banks do that much better than European counterparts. If interest rates go negative like they went in Europe US banking profits will get severely reduced. Other  reasons for higher prints are somewhat less competition in the US and perhaps a more gullible consumer (especially with respect to Credit cards).

[Guest eatliftinvestgolf]

Yeah I'm not sure.  I mean closing branches will hurt them because they will lose deposits, but long run it will help them as they are better able to compete.  Newspapers might be a better comp.  Some survived, but some weren't able to normalize their org structure to resemble like a buzzfeed or whatever, and they have to pain now or pain later dynamic (and everyone knew what to do).  I don't think these banks will fail, but just like newspapers some could lose non-trivial amounts of value for stockholders.  Those that do these things (and WFC is slow to the game probably because they had the best branch business of all the banks), probably will earn higher profits at least temporarily (until everyone basically becomes online first) and may be good bets.  I don't know if you can tell who's going to figure it out though. I don't invest in banks anyways even something like a branchless bank because ROE aren't that great and they have no moat, other than being a current low cost operator in a business with low barriers to entry and commodity business (but again a current secular advantage over incumbent banks).  As a small investor if you want to invest in banks, maybe you just do the Stilwell approach and buy undervalued banks wait for an acquisition and just plan for a day when that no longer works (if you believe what I'm saying).

 

Wow the bolded part really says it all.

 

Looking at Canada, investing in banks was an absolute brilliant move for investors over the past 20 years. What will the next 20 years hold? Not sure. However, my guess is the big US banks will continue to morph and find a way to deliver adequate returns to their investors. The US is looking more like the olgopoly we have here in Canada; similar to a regulated utility. The internet is the best thing that could have happened to them. Yes, top line growth will be challenging. However, costs will continue to fall and operating leverage should remain positive.

 

I completely agree. 

 

The last few pages of comments, I felt like the conversation did not adequately address:

- the benefits of scale with respect to spreading the costs of technology over the deposit base

- the usefulness of bank branches as customer acquisition tools, from both a signage and psychological standpoint

- the difficulty of launching a new bank in the US and the minimum size required to be profitable relative to compliance costs

- the oligopoly-like nature of US banking with respect to pricing / ongoing ability to reprice their deposits if they needed to do so to retain customers

- the potential for under-provisioning to overstate the true earnings power of a business in a portion of the full business cycle

- the 'survival odds' benefits of a more conservative balance that do not show up in an income statement

- the repeated adoption of technology without threat to the business model (cashless payment, ATM, now mobile banking)

- the vital role of trust in banking to avoid destructive, surprise events

- the reasons why Finn were shut down were not accurately described

- the relative level of balance sheet risk being taken to earn a given level of ROA

 

And for the record, Axos is a horrible example:

- not that large as a company

- decent chunk of growth related to acquisitions

- has New York Times articles written about its under-provisioning against loans (not choosing to dig into these articles, but seems like a red flag about management from a basic google search)

- the company had to recently change its name, carries little trusted brand value

- the press release regarding the name change points out that the company now operates in 'a variety of channels and strategic partnerships' - not just internet D2C

 

And finally, not even sure the claims that were made regarding internet only challengers taking share was accurate.  Have big banks lost deposit market share? I don't think so.

[cameronfen]

Yeah I'm not sure.  I mean closing branches will hurt them because they will lose deposits, but long run it will help them as they are better able to compete.  Newspapers might be a better comp.  Some survived, but some weren't able to normalize their org structure to resemble like a buzzfeed or whatever, and they have to pain now or pain later dynamic (and everyone knew what to do).  I don't think these banks will fail, but just like newspapers some could lose non-trivial amounts of value for stockholders.  Those that do these things (and WFC is slow to the game probably because they had the best branch business of all the banks), probably will earn higher profits at least temporarily (until everyone basically becomes online first) and may be good bets.  I don't know if you can tell who's going to figure it out though. I don't invest in banks anyways even something like a branchless bank because ROE aren't that great and they have no moat, other than being a current low cost operator in a business with low barriers to entry and commodity business (but again a current secular advantage over incumbent banks).  As a small investor if you want to invest in banks, maybe you just do the Stilwell approach and buy undervalued banks wait for an acquisition and just plan for a day when that no longer works (if you believe what I'm saying).

 

Wow the bolded part really says it all.

 

Looking at Canada, investing in banks was an absolute brilliant move for investors over the past 20 years. What will the next 20 years hold? Not sure. However, my guess is the big US banks will continue to morph and find a way to deliver adequate returns to their investors. The US is looking more like the olgopoly we have here in Canada; similar to a regulated utility. The internet is the best thing that could have happened to them. Yes, top line growth will be challenging. However, costs will continue to fall and operating leverage should remain positive.

 

I completely agree. 

 

The last few pages of comments, I felt like the conversation did not adequately address:

- the benefits of scale with respect to spreading the costs of technology over the deposit base

- the usefulness of bank branches as customer acquisition tools, from both a signage and psychological standpoint

- the difficulty of launching a new bank in the US and the minimum size required to be profitable relative to compliance costs

- the oligopoly-like nature of US banking with respect to pricing / ongoing ability to reprice their deposits if they needed to do so to retain customers

- the potential for under-provisioning to overstate the true earnings power of a business in a portion of the full business cycle

- the 'survival odds' benefits of a more conservative balance that do not show up in an income statement

- the repeated adoption of technology without threat to the business model (cashless payment, ATM, now mobile banking)

- the vital role of trust in banking to avoid destructive, surprise events

- the reasons why Finn were shut down were not accurately described

- the relative level of balance sheet risk being taken to earn a given level of ROA

 

And for the record, Axos is a horrible example:

- not that large as a company

- decent chunk of growth related to acquisitions

- has New York Times articles written about its under-provisioning against loans (not choosing to dig into these articles, but seems like a red flag about management from a basic google search)

- the company had to recently change its name, carries little trusted brand value

- the press release regarding the name change points out that the company now operates in 'a variety of channels and strategic partnerships' - not just internet D2C

 

And finally, not even sure the claims that were made regarding internet only challengers taking share was accurate.  Have big banks lost deposit market share? I don't think so.

 

Ok here goes again:

 

1. To get this point out of the way: The reason I use Axos is that it is a pure play on branchless banking.  I am aware of its issues and risks.  Here is a list of branchless banks: http://emiboston.com/bank-deposit-growth-trends/ .  None of them are pureplay banks and so understanding the cost advantage is more difficult.  Incidentally, this also shows branchless banks taking share.  I by no means am suggesting Axos will take share nor is an exemplar in the field, only it illustrates the cost advantage branchless banks have on the liability side which all the banks listed in the link possess, but is much more difficult to suss out on their 10-Ks.  See here for something more recent: https://www.jdpower.com/business/press-releases/jd-power-2017-us-direct-banking-satisfaction-study  See below too were I discuss this again. 

 

Real 1.  Scale: True.  Large banks like WFC have economics of scale.  What does that say about branchless banks since they are already more profitable from a cost perspective than WFC? 

2.  Signage: Covered.  True it is an advantage but again banking is a commodity business to a large extent.  Lending you money is still money whoever it comes from.  Less so but still very similar with deposits.  What matters is the price. 

3.  Difficult entry:  There are 4900 banks in the US.  Regulatory and scale is tough but a lot of people start banks.  Branchless banking makes things much easier.  Still, regulations is a point well taken. 

4.  oligopoly:  Kodak was a monopoly too.  The problem with innovation is that changes.  Whether banks are oligoloplies no one has disputed my numbers saying that branchless banks are more efficient profit generators.  You can reprice deposits all you want if someone has a lower cost structure than you they can offer higher rates (albeit internet banks aren't as highly regarded but that is changing (see the jd power article))

5.  under provisioning:  I don't know the great recession didn't make banks look like they were under provisioning but neither of us knows if that is true. 

6.  Survival odds:  True but I showed that Axos could write loans at 3.25% interest rate and have the same profit margins as WFC.  Axos is being aggressive because management is stupid not because it can't afford to be conservative. 

7.  Repeated resilience in face of tech:  Sure I'll give you that one to some extent.  But again none of these threats were as existential as the entire fintech industry aiming to disrupt every aspect of a bank (except I-banking.)

8.  Trust:  Four letters: FDIC

9.  Finn:  Ok sure JPM didn't say it was cannibalizing business, he only said they already had an app in Chase that did the same thing as Finn.  I was reading between the lines and at least to me seems like a reasonable extrapolation. 

10.  Balance sheet risk: Axos has a higher T1 equity ratio than WFC and still earns much higher ROAs.  Even if you assumed it was writing loans at 4.79% interest which is WFC weighted average interest rate, it would still have a higher ROA than WFC. 

 

Axos: Yes it is not a great example.  Unfortunately, it is the biggest pure-play branchless bank to my knowledge.  Lots of branchless "banks" are bigger, but they do other things as well like act as brokerages, or insurance companies and have large credit card loans.  Thus its easier to do the math on its balance sheet and income statement, then playing around with Schwab and taking out the brokerage business assets as well assets/liabilites and earnings.  Note that most of the big banks became big by acquisition too.  That's really the only way you can grow quickly and safely as a bank.  The vast majority of Axos if not the whole thing is internet and branchless banking.  source: https://smartasset.com/checking-account/bank-of-internet-banking-review I guess I should have used Ally.  But again its heavily skewed to car loans which make it not really comparable to a big bank. 

 

11. Taking share: From 2005-2017 branchless banks went from 1% deposit share to 6% deposit share.  That's slow growth but in the banking world growing too quick organically is a recipe for disaster and so that's why growth is slow.  This also benefits incumbents I will admit as they can react with more time to threats. 

 

I feel like I'm starting to get annoying but as long as people keep on being critical, I feel like I should defend myself. 

 

edis: Just clarifying and spell check

[Viking]

Another important factor will be how the new (and old) banks perform in the next down cycle. Given all the significant regulatory changes the past 10 years i am not sure anybody has a clear grasp of what is going to happen to the banking system.

[vinod1]

cameronfen,

 

Good points!

 

I have more than a fifth of the portfolio in bank stocks so I am clearly biased. It is great to see someone make a good case on the opposite side.

 

I do think Internet is fundamentally transforming businesses and it is incumbent upon every investor to seriously assess how it is impacting each of the businesses they invest in. So spent a lot of time thinking about this issue and studying disruption theory from Christensen, Ben Thompson's modifications to it, and many case studies.

 

At a very basic level all innovations (that serve as basis for disruption) can be categorized as either

 

1. Sustaining - that is, they can be copied by incumbents

2. Disruptive - ignored by incumbents for various reasons. There are three sub cases here for why they do this. Would not go into detail on each as it is too tedious.

 

The way I see it, branchless is one subset of many changes and it is not even the most important one. Many of these changes all are which can be copied by the incumbents. So they are not disruptive. Many banks get it. They know how fatal it can be to ignore these changes and many are partnering with startups, trying out different things, reworking their operations, spending massive amounts on technology, etc. to keep up.

 

They have formidable advantages against newer players, given the regulatory constraints and it looks to me that they would not only survive but do reasonable well. To take branchless as an example, banks would keep optimizing the branch network to right size as customers needs change. It might mean zero branches in 2030 or branch within some other store or a much smaller number of branches or some combination.

 

To really bring disruption you need (a) to reduce some major pain point for consumers (b) reduce costs significantly, or © be able to do something differently that is beneficial to consumers.

 

Not seeing many major pain points that are crying for solutions. No major cost reductions. Note that credit unions have paid higher rates and even lower loan costs but consumers still ended up with the major banks. So a slightly higher rate on deposits is not going to be a truly disruptive event.

 

Need to keep watching but that is where things stand today from my perspective.

 

Thanks

 

Vinod

 

 

[cameronfen]

cameronfen,

 

Good points!

 

I have more than a fifth of the portfolio in bank stocks so I am clearly biased. It is great to see someone make a good case on the opposite side.

 

I do think Internet is fundamentally transforming businesses and it is incumbent upon every investor to seriously assess how it is impacting each of the businesses they invest in. So spent a lot of time thinking about this issue and studying disruption theory from Christensen, Ben Thompson's modifications to it, and many case studies.

 

At a very basic level all innovations (that serve as basis for disruption) can be categorized as either

 

1. Sustaining - that is, they can be copied by incumbents

2. Disruptive - ignored by incumbents for various reasons. There are three sub cases here for why they do this. Would not go into detail on each as it is too tedious.

 

The way I see it, branchless is one subset of many changes and it is not even the most important one. Many of these changes all are which can be copied by the incumbents. So they are not disruptive. Many banks get it. They know how fatal it can be to ignore these changes and many are partnering with startups, trying out different things, reworking their operations, spending massive amounts on technology, etc. to keep up.

 

They have formidable advantages against newer players, given the regulatory constraints and it looks to me that they would not only survive but do reasonable well. To take branchless as an example, banks would keep optimizing the branch network to right size as customers needs change. It might mean zero branches in 2030 or branch within some other store or a much smaller number of branches or some combination.

 

To really bring disruption you need (a) to reduce some major pain point for consumers (b) reduce costs significantly, or © be able to do something differently that is beneficial to consumers.

 

Not seeing many major pain points that are crying for solutions. No major cost reductions. Note that credit unions have paid higher rates and even lower loan costs but consumers still ended up with the major banks. So a slightly higher rate on deposits is not going to be a truly disruptive event.

 

Need to keep watching but that is where things stand today from my perspective.

 

Thanks

 

Vinod

 

Ya I'm also somewhat coming over to the view that they can adapt.  But the question is if you can close branches faster then the challenger banks grow deposit and credit TPV share.  WFC is least well position and if BoA in 15 years gets to the point where it has a fraction of the branches but the same deposit base, any big bank that still has a current cost structure is in trouble.  Its a slow moving crash as deposit share is eroding slowly but branch closures are slow too. 

[RuleNumberOne]

WFC, BAC have an earnings yield of 11%.

 

Isn't it strange that "investors" are buying negative yielding Danish mortgages, 2% yielding Greece 10-Y, 1% yielding Austria 100-Y, negative yielding European government debt of many countries.

 

They are even buying billions in WeWork debt! WeWork's losses are greater than its revenue - e.g. revenue = 1.8 billion, losses = 1.9 billion.

 

But WFC and BAC just announced they will yield 14% of their market cap to investors within one year.

 

Yet "investors" come up with every kind of excuse to not buy WFC, BAC. These are not Buffett's kind of investors. Buffett wrote in the 1970s about this sort of craziness. Who are these "investors" buying up all this debt at these stupid terms?

[Gamecock-YT]

pension and sovereign wealth funds...

[Rasputin]

Historical data from Q1 2011 to Q1 2019 for BAC consumer banking number of branches, average total deposits

 

Q1 2011 Number of branches : 5805

 

Q1 2019 Number of branches : 4353

 

 

Q1 2011 Average total deposits : $466.239 Billions

 

Q1 2019 Average total deposits : $696.939 Billions

 

After WFC gets past its regulatory issues, they will have similar number of branches and average deposits trend as BAC's.

 

 

What happens if US interest environment continue its downward trend to follow Europe or Japan? 

 

BAC's NIM may trend down toward 1.5%, while WFC's NIM may trend down toward 1.8%.  If this happens instantaneously in 2020,ceteris parisbus, BAC's eps will be around $1.25, while WFC's eps will be around $1.4.  By following BAC's example past 8 years, past regulatory issues (remediation, fines, settlements, penalties), WFC's annual operating expenses will be roughly $5 B lower vs 2019, boosting WFC's eps to $2.29.  If this scenario happens over time while they are able to reduce shares outstanding, eps will be higher.  Further cost reductions are very likely through out the industry which I haven't taken into account.

 

20 times eps for these 100% distributable eps generated by these safe diversified large banks should be reasonable valuation in a negative 10 yr treasury rate environment. 

 

https://www.wsj.com/articles/bank-stocks-havent-priced-in-enough-bad-news-11562583780

 

https://www.wsj.com/articles/u-s-banks-rush-in-as-european-banks-stumble-11562591312?tesla=y&mod=article_inline

 

 

[sleepydragon]

When I was in high school, I worked at a restaurant. Each day at the end of the day, the boss would give me a bag full of cash and I would walk to a bank to deposit the money. It’s usually a few thousand dollars. I would go to a special window and the teller is always very warm and extra friendly.

I guess that’s one example of that branches will not go away?

 

[WayWardCloud]

When I was in high school, I worked at a restaurant. Each day at the end of the day, the boss would give me a bag full of cash and I would walk to a bank to deposit the money. It’s usually a few thousand dollars. I would go to a special window and the teller is always very warm and extra friendly.

I guess that’s one example of that branches will not go away?

 

I have a big jar of coins at home in which I empty the change out of my pockets. Every two years or so the jar gets full and I go to the Bank of America branch down the street. The teller is neither warm nor friendly, they are on the other side of a protective glass window and I can never hear what they say. I'm tall so I have to awkwardly bend the whole time so my ear is near the level of the microphone thingy. It feels like I'm mildly bothering them, like I'm at the DMV except the wait is 10 minutes instead of 5 hours. The branch is huge for no reason: there are about 15 windows but only 2-4 are ever in use, plus 4-5 office space with glass walls to receive clients, 1 or 2 are actually in use, very high ceilings, a long line of customers waiting patiently on their feet, often elderly or young parents dealing with restless children, nobody to greet them, orient them, no coffee, no bathroom, no area for the children to play, even strikingly hardly any seats. They put all my coins in a transparent bag and ship it to some mysterious remote coin counting center. It takes 2 to 3 (!) months but eventually I get the amount credited to my account (I have to trust the number is correct). They don't even tell me it's been credited, I just eventually find out some day when I check my balance. I also have to assume that's what it is because the description on the line item is some technical mambo jumbo of letters and numbers which I'm sure makes sense to THEM but not to me, the customer...

 

The punch line of the story is this: The last time I walked in holding my little jar they told me they don't do that anymore (handling money, a bank...). So I googled it, went to a nearby CVS and used their coin counting machine. There was no line, it took only a couple minutes and I got my money immediately. Since I was already there I bought sunscreen and insect repellent  ;)