From Tom Brown’s Banking Weekly, 10/13/23

FIRST WORD: Thoughts from my meeting this week with Jamie Dimon.  After every meeting I’ve had with JPMorgan Chase CEO Jamie Dimon, I’ve hurried to find some place to go over my notes to determine what were the most important points he made, and I did that again after I met with him this week. There was one overwhelming takeaway for me: Dimon’s thought framework has been remarkably consistent over the more than 30 years I have known him. The individual circumstances are always changing, but the context in which he evaluates current events doesn’t change.

The press loves to focus on his specific comments, such as when he says he’s preparing for a hurricane, rather than his main point, which is to always have a plan, but be prepared for alternative scenarios as well. We spent most of our time discussing the proposed capital changes, with his views being very consistent with his views about bank capital standards over the years.

Bank regulation and capital standards. To really understand Dimon’s views on the regulators’ proposed Basel III end game capital standards, you need to understand his view of the entire bank regulatory system. For years, he has written in his annual shareholder letters about that system being the result of a series of actions taken, often after a problem or crisis, which has ended up creating a regulatory system with no clear goal. Who can ever forget this graphic of the U.S. banking regulatory structure Dimon included in his 2011 letter to shareholders?

Dimon would just like to sit down with the regulators and ask them what they are trying to accomplish, because he believes some of the specifics of the current capital regulations and some proposed ones run contrary to their true objectives. Here are some examples he gave:

• What is the overall point of bank regulation? Do regulators want a system designed to prevent any bank from failing? If so, Dimon believes they can create one, but they’d need to completely overhaul the current regulatory system. Dimon doesn’t believe a no-bank-failure system would be consistent with the country’s entrepreneur-driven economy. (He talks extensively about the bank regulatory system in his 2022 letter to shareholders.) The latest proposed capital changes are largely a knee-jerk reaction to the bank failures in the spring. The regulators didn’t ask for any input from industry leaders before issuing their proposal, which calls for essentially a 20% increase in the capital required at banks with over $100 billion in assets.
• Use actual data in setting capital requirements. Should bank regulators use actual data in determining the optimal capital level? Of course! So why then in its regulatory proposal do the regulators write, “Current capital requirements in the United States are toward the low end of the range of optimal capital levels described in the existing literature.” The Bank Policy Institute takes issue with this when they write that while “this statement is frequently repeated, it is false.” BPI goes on to show the CET1 ratio for U.S banks is currently 12.8% compared to “recent academic papers’ estimates of a range from 6.0% to 14.5%, with a midpoint of 10.3%.” The U.S. banks are not at the “low end” of capital ratios around the world, as the regulators wrongly assert, but are above the mid-point level. We should expect bank regulators to use actual data for their decision-making, but they have not.

Dimon has been saying for years the banking industry is overcapitalized, and the BPI agrees. The group estimates that U.S. banks have loss-absorbing capital and debt of an incredible $2.7 trillion! When I mentioned to Dimon that JPMorgan has enough capital to absorb all the stress-test losses of the top 30 banks in the country, he reminded me that those are worst-case loss estimates for all 30 banks, which would be incredibly unlikely to ever happen. Bottom line: no one except politicians and their appointees, devoid of facts, thinks the U.S. banking system needs more capital, but the regulators just proposed a 20% increase.

• Stress testing remains flawed. Do the regulators want a testing system that evaluates how the large banks would do in stressed economic environments, or do they just want a testing system that spits out a number and a pass/fail grade? Ever since the Fed mandated its annual stress test for large banks, Dimon has discussed why he thinks the system is flawed. Obviously, given his practice of preparing for the most likely outcome and understanding the worst case, he has a problem with the test using only one set of economic assumptions. He also has frequently complained, as has everyone else, about the lack of transparency of the tests. Dimon points out that the Fed’s stress test model would have predicted that JPMorgan would lose a significant amount of money when Lehman failed, but the company made money during that period. The Fed model also would have predicted the company would lose money during the first 20 days of the pandemic when there weren’t any government-assistance plans in place, but JPMorgan made money. Perhaps if the Fed was transparent with JPMorgan about their model, it might adjust it so it would be better at predicting outcomes. Dimon says this flawed stress testing system has resulted in 100-basis-point swings in the company’s capital requirement, creating needless uncertainty about required capital levels.
• Residential mortgages. Do bank regulators not want banks to hold residential mortgage loans on their balance sheets? The proposed capital standards would significantly raise the capital required for residential mortgage loans kept on a bank’s balance sheet. The BPI estimates the required capital will double. In addition, the BPI pointed out “the loss rates presumed in the proposed rule exceed even those experienced during the Global Financial Crisis.” Finally, since the increased capital requirement would be credit-risk-based, it would raise the capital required for mortgage loans made to lower-income individuals. This would raise their mortgage rate and hurt affordability. Dimon doesn’t think making housing less affordable for minorities and other low-income households is what regulators are intending, but it would be the result.
• Mortgage origination business. Do the regulators want to eliminate the banks from the mortgage origination business? The new standards would require an additional capital charge based on operational risk, which itself would be based on revenues. This would be quite punitive to banks that originate and sell conforming mortgages, since the sale creates revenues. Banks have already seen their share of the mortgage origination business cut in half; it’s as if regulators simply want banks out of the mortgage origination business entirely.
• U.S. banks as part of international bank capital standards. Do the regulators want U.S. banks to operate under the same capital standards as their foreign competitors? The proposed standards do just the opposite, by requiring U.S. banks to have even more capital than their foreign competitors. The whole point of the multi-decade development of Basel capital standards was to place all the world’s major banks under the same capital standards, thereby leveling the playfield. This inconsistency frustrates Dimon.

The end state of the banking industry’s structure. I told Dimon that at our annual CEO Retreat held last week, retired Truist CEO Kelly King said he believes the U.S. banking industry will eventually consist of ten banks with over $1 trillion in assets and 2,000 banks with less than $100 billion in assets. There will be no middle ground with respect to asset size. Dimon flat out rejected the premise. He said the banking industry has been and will continue to be dynamic, with banks of all sizes having problems and shrinking while others will have better opportunities and will expand via organic growth and acquisitions. In addition, he sees a continuation of de novo banks entering the market, as well as neo-banks such as PayPal, Chime, and Varo. For as long as I have known Dimon, he has said the U.S. will always have a strong community bank component to its banking system because of community banks’ ability to provide closer personal relationships with customers.

The economic outlook. The media loves to quote Dimon’s view on the economy which for the last 18 months has varied somewhat. Some people have found this confusing, but I have found it totally consistent with the broader context of the point he is trying to make. In June of 2022 at the Bernstein investor conference, he warned investors that the U.S. economy might be about to enter an economic “hurricane.” Over the past 18 months he has been quoted several times to the effect that the economy is still doing fine. A couple weeks ago in an interview on CNN, he warned investors to perhaps prepare for 7% interest rates. But his economic views haven’t vacillated in the past 18 months; the company’s base case scenario is largely unchanged. It sees the economy slowing, perhaps by enough to slip into a mild recession.

The framework of his economic views follows the old military philosophy: plan for the most likely course of action but understand the implications of the most dangerous course. He believes that the economy was distorted for years by massive monetary and fiscal policy easing, which are now being reined in. The economy is in unprecedented economic territory, and he advises everyone to do more scenario planning involving extreme economic scenarios.  Dimon doesn’t necessarily expect 7% interest rates, but he knows what would happen to the company’s financials if that scenario played out without any management actions. JPMorgan does 100 stress tests a week; Dimon’s advice to bankers is do more stress testing in order to be prepared for the unexpected.

Branch expansion. I asked Dimon which of the three of the large investments the company is making (in domestic branch expansion, the UK digital bank, and fintech investments) will provide the best return. He said the expected returns are not just different, but the degree of confidence varies widely. However, he was highly confident that the branch network transformation will provide an outstanding return because the company already has five years of experience with the expansion. Dimon pointed out that the branches create new business for all areas of the bank and not just retail deposits.

UK digital bank development. Dimon described this as a “skunk works” project with an uncertain investment return; however, he was even more optimistic about the building of the digital bank than the last time we spoke. He said he never would have gone in with a plan to build a physical branch retail strategy in the UK because it would have been too expensive and taken too long, but with a digital bank JPMorgan can go in branch-light and plug in existing JPMorgan capabilities. For example, he cited the addition of JPMorgan asset management services into its Nutmeg investment management subsidiary. Dimon said he believes the company will eventually use the de novo digital bank strategy to enter another country.

First Republic acquisition. Dimon repeated what he had said on the company’s last conference call that Silicon Valley and First Republic had truly customer-centric business models. JPMorgan acquired First Republic, which utilized a single point of contact model for its customers. When First Republic came to Manhattan in 2001, we moved Second Curve Capital’s operating account to the bank to see if the service was as good as was touted. In addition, I opened a checking account, and eventually First Republic originated two mortgages for me. Whenever the firm wanted to do something, or if I wanted to do something personally, we went through Ruth Aronowitz and her team at First Republic. The service level has been outstanding and timely. That is what Dimon admires. I asked him if such a customer-centric approach could operate in the larger, more control-oriented JPMorgan, and he said it could. When the meeting was over, I asked our CFO to check to see if Aronowitz and her team stayed at JPMorgan. He was surprised to learn they left for Citizens Financial a month ago. We will have to wait and see just how well JPMorgan can absorb First Republic, and will learn much more about where all the Silicon Valley and First Republic bankers are landing on the upcoming earnings calls.

Lighter observations from the meeting.

Retirement. I asked Dimon if I should just write down “five years” as the answer to the question about when he will retire. I was joking because for the last few years that has been his stock answer when anyone asks.  This time he looked at me with a little smile and said, “I no longer comment on my retirement.” Still smiling, he added, “but I can tell you the board talks about it at every meeting.” I don’t know if it will be another five years, but I do know the company has a great bench. However, no one will be happy when he does retire. I figure he must stay at least through 2025, when the company’s spectacular new headquarters building will be complete.

Pulling a “Brady.” I asked if he ever thought about pulling a “Brady”? He thought I was referring to former Treasury secretary Nick Brady, but I actually meant Tom Brady. I said he could retire for a couple months then come back as the CEO of Citigroup and take the bank from being a mediocre to a high performer. “I am not going to run any other bank.” My dream was crushed.

His family. As our meeting ended and Dimon headed for lunch, I asked about his family and he said, “They are great. How is your family . . .  never mind, I read about them every week.”  I left laughing.