Inside Financial Services
Vol. V, No. 19
TOM BROWN’S BANKING WEEKLY: 5/8/20
Financial Services Insights and Intelligence
FIRST WORD: Notes from D.A. Davidson’s 22nd annual financial institutions conference. I’ve spent the past two days virtually attending D.A. Davidson’s annual financial services conference. It’s been a very worthwhile use of my time. I submitted a list of ten banking companies I wanted to meet with, and D.A. Davidson gave me a schedule with dial-in numbers and passcodes. Eight of the calls were just me and the management team, while the other two included another investor. Normally, I’d just set these calls up myself, but this turned out to be a highly efficient process. First, I will share some general thoughts about topics that arose in most of the calls, and then add some highlights that apply to individual banks. General thoughts:
The PPP program. People like me were wrong about how long it would take for the second round of PPP funding to be used up; it lasted longer than I expected, because banks received applications for loans that were less than half, in dollar terms, than what they received in the first round. The consensus from the bankers was that larger companies with more sophisticated finance functions were ready to go immediately. Some banks reported that in round two, some businesses applied for less than they were qualified for because they knew that payroll had been reduced and they wanted to ensure the amount granted would be forgiven. The majority of bankers thought that most of the loans would qualify for forgiveness, but only one attempted to provide its borrowers with a worksheet to help them figure it out. Frankly, everyone expects more details and many believe there will be further changes to the program before they can more accurately determine which loans will be forgiven. When I asked one banker what percentage of his bank’s PPP loans he thought would be forgiven, he said, “I have no idea, but I can tell you that every one of the borrowers thinks its loan will be forgiven.”
Main Street Lending Facility. Talk about a muted reaction. There wasn’t one bank who was excited about this program, and many were unsure they will even participate, despite last week’s changes in the program. I heard many objections, starting with uncertainty given the lack of available details, pricing at Libor +3 not being sufficient, and concern about put-back risk from the government, should the borrower subsequently develop problems that the Treasury will say should have been determined in the underwriting process. It’s clear I was too optimistic about this program as currently constituted.
Uncertainty drives some young analysts nuts. At meetings like this, some participants only want the company managements to fill in their earnings spreadsheets. There is too much uncertainty now to do that, so the spreadsheet-focused freaks are incredibly frustrated. Take the influences on the margin. We know the fed funds rate came down sharply at the end of last quarter, which will put pressure on margins. But deposit levels are unusually and unsustainably high because of government stimulus checks and the funds from PPP loans. Also, there’s the issue of when and what percentage of PPP loans will be forgiven, which will affect the recognition of the fees associated into net interest income when it happens.
Some managements have real-time data and a finger on their business, and others don’t. This surprised me. All the banks have either credit- or debit-card businesses, or both, and I asked most what recent trends had been. Too many in my opinion could only tell me what the trend was last month. If I were sitting on top of such data, I’d make sure to see it on a daily basis to gauge the state of my local market’s economy.
I enjoyed asking everyone about the lessons learned so far. Everyone mentioned the need for physical branches and staffing. Personally, I don’t know what it means long-term when a bank shuts all its lobbies and does everything via drive-through or by appointment in the lobby. No question this will hasten the decline and redesign of physical branches. A few banks mentioned that the environment forced them to move to digital signature adoption, and said it should have happened long ago. Clearly, with the majority of bank employees at home, all the managements are evaluating what this means for their future office space needs. One bank mentioned that the WFH environment exposed the weakest employees, and that they will be released. A few were excited about the potential for video sales calls on commercial prospects in the future, and how this could increase productivity. Finally, a couple banks I talked with were pleased to discover they could do a bank conversion remotely.
Here are some individual bank takeaways.
Axos Financial. I have always liked this company’s unusual business model, but it has too many elements for me to understand without spending much more time.
Banc of California. CEO Jared Wolff, who was brought in last March to turn around the company, declared the turnaround to be complete, said that now is the time to grow, and said that the company has several unusual earnings levers to pull. He has done a great job since his arrival.
First Interstate BancSystem. What virus? When I asked CEO Kevin Riley what the toughest part to deal with was since the pandemic broke out, he said, “There hasn’t been a tough part, it’s pretty much business as usual.”
Great Western Bancorp. CEO Mark Borrecco just arrived two months ago, and a new chief credit officer is scheduled to start Monday. Prior management grew faster than its infrastructure and management could handle, kept overly large exposures on its balance sheet, and its ag book has problems. This is a long-term workout.
Hancock Whitney Corp. Energy loans have been a weight around this company’s neck for years. The exposure peaked at 14% of total and is now down to 4%, and headed lower. CEO John Hairston is clearly tired of talking about the portfolio and would like to focus on the company’s performance over the last five years, excluding the energy portfolio.
Hartland Financial. This is a great story that I didn’t know well before the meeting. Hartland is one of the few companies that has successfully grown through acquisition, by following a disciplined approach. A delightful meeting.
OceanFirst Financial. The environment has played into the bank’s hands of being a leader in digital adoption among banks its size ($10 billion). The bank has enjoyed a 40% increase in mobile deposits in the last 60 days.
ServisFirst Bancshares. This is one of the best banks in the country, run by one of the best bankers of all time, Tom Broughton. The business is simple to him; it’s all about the right people and disciplined execution of his strategy. I could talk with him all day.
TriState Capital Holdings. The company has a unique business model, which is providing strong growth in the current environment. However, the analysts covering the company are confused by the model, because it’s unlike any other bank they cover. Private banking (over half of total loans, with no losses) and Chartwell Capital are two of its three businesses, and they require little capital and no loss reserves.
These past two days were highly informative and reminded me again why I enjoy being a financial services analyst. There is so much variation among the companies as well as their strategy and execution.
BACK WITH A SPLASH: From the Associated Press, word of a notable milestone on the road to recovery:
PRINTING ON: This won’t come as much of a surprise, but growth in the money supply is surging:
Some of us remember a time when a chart like that would have had investors out in the street screaming and waving their arms, right?
DERELICTION: Larry Fink says BlackRock won’t vote its ETF shares for any director candidate it deems to be not sufficiently pro-ESG? How does that square with the company’s fiduciary duty to do everything it can to maximize value for investors? If BlackRock wants to pursue an ESG agenda—an entirely reasonable undertaking, in my view—it should develop an ESG-friendly ETF or fund and market it to potential investors.
NOT A CLUE: Here’s what you get when companies, as they have recently been doing en masse lately on account of the new economic uncertainty, stop providing earnings guidance.
I think I’ve seen random-number sets that are more tightly packed than that. This all might be bad for sell-side analysts, many of whom, when their quarterly numbers turn out to be wildly off base, will look (unfairly) like they don’t know what they’re talking about—but it will be great for long-term investors, who’ll have more chances to buy well-positioned, well-run companies on weakness after their quarterly reports “disappoint.” I kind of like that, to tell you the truth.
OUTSIDE THE BOX: And they say innovative thinking is dead:
BRIGHTENING?: Might the economy have already begun the process of bottoming? Maybe! The ever-optimistic Brian Wesbury of First Trust, on Monday:
[W]e already see some light at the end of the tunnel. During the week ending Saturday May 2, 939,790 passengers went through TSA checkpoints at airports. That’s up 26% from the prior week and up 40% from two weeks ago. The amount of motor gasoline supplied has grown three weeks in a row, and is up a total of 16%. Hotel occupancy and railcar traffic are both up from a month ago. These high-frequency data will give a clearer read on the pulse of the economy as we gradually reopen. [Emphasis added.]
Granted, Wesbury might be engaged in cherry-picking his data. Still, it’s my kind of cherry-picking.
HEADING UP: Along that same line, from Fundstrat, signs that the consumer is beginning to emerge from hibernation:
DIGITAL BANKING EXPLODING: The Covid-19 outbreak has caused banking customers to change their behavior in some pretty important ways, notably by pushing them to engage more with digital banking. In particular, roughly one-third of retail banking customers surveyed by J.D. Power say they’ve increased their use of mobile and on-line banking services. Similarly, just 46% say that once the outbreak is over, they plan to go back to “banking as usual.” All this is a great opportunity for banks to use their mobile and online banking products and services to provide real value to customers, wouldn’t you say?
MOVING UP: Say, even once the virus outbreak is over, this working-remotely thing might have legs. Here’s what $2.1 million will buy you in Palo Alto and in Columbus, Ohio:
Meanwhile, even investment bankers are learning to adapt. From the Wall Street Journal, on Wednesday:
Actually, not just adapt, but even thrive:
Many bankers are finding they can do their jobs without the cost of frequent flying or time wasted in airports thanks to videoconferencing and other technology that has become ubiquitous during the lockdowns resulting from coronavirus pandemic.
Before the lockdown, Vis Raghavan, chief executive for Europe, the Middle East and Africa at JPMorgan Chase & Co. would often rise at 4.30 a.m., head to London’s Heathrow Airport, fly to attend three meetings and return home at 10 p.m. Now he can arrange a video call from home for a meeting. [Emphasis added.]
Anyway, I’m having trouble seeing the downside.
MOVING AGAIN: People are starting to move around more as the country gradually opens up on a state-by-state basis—but the 10% of U.S. workers who use public transportation regularly say they have no desire to return to traveling that way.
WORSE THAN USELESS: That $50 billion loss that Berkshire Hathaway reported for its first quarter—the magnitude of which was largely attributable to an unrealized $54 billion decline in the value of the company’s securities portfolio—is a useful reminder that the people who write the nation’s accounting rules are a bunch of morons. Trust me, including unrealized gains and losses in GAAP earnings, which FASB now requires companies to do, does nothing to help me as an investor better understand a given company’s fundamental position. It’s just noise. Similarly, the new CECL loss-reserving rules will make banks’ loss-reserving practices even more pro-cyclical than they were under the old rules, and so, during slowdowns, will needlessly distort banks’ earnings more than ever. How is that helpful? Worst of all were the cussed mark-to-market rules that, until they were thankfully repealed in early 2009, nearly brought the entire financial system down during the recession twelve years ago. Seriously, the people who come up with these ideas are a menace, and ought to be put under adult supervision.
MISMATCH: Well this isn’t so great. While the S&P 500 is now down by just 11% since the start of the year, the 2021 dividend futures on the index are off by nearly three times that much.
A COMEBACK: Maybe made-up interest rates can have their uses, after all, particularly when there’s an economic crisis underway. From Bloomberg, on Wednesday:
So rather than continue with their years-long campaign to phase out Libor, Bloomberg reports, “U.S. policy makers last week changed tack and turned to Libor as the benchmark for their $600 billion Main Street Lending Program.” Why the change? It turns out that one of the problems with Libor’s planned replacement, the Secured Overnight Financing rate—which, unlike Libor, is based on actual interbank transactions—is its “susceptibility to periodic volatility.” I mean, who could have seen that coming?
PRETTY SOON: Let’s play ball! GoodJudgment.com—which says its systematic forecasting techniques have been shown to be demonstrably more accurate than a typical, finger-to-the-wind approach, and which appears to be run by some really smart people—says there’s nearly an 80% chance that Major League Baseball will next hold a regular season game sometime between June 1 and July 31 of this year.
UNUSUAL SUSPECT: In New Delhi this week, when police arrived to investigate an apparent ATM break-in, they saw on closed-circuit TV replay that the heist had been carried out by an overly curious rhesus monkey.
NOVEL APPROACH TO EDUCATION: In a rapidly changing economy like this one where few skills aren’t at risk of becoming obsolete, I like the idea of a “long-term education exchange” as a way for workers to upgrade their skills and learn new ones as a way to adapt. Incentives could even be created to reward people who continuously upskill. Perhaps four one-year degrees are better than one four year degree.
DON’T REMIND US: The costs of regulation introduced after the credit crunch, notably the Dodd-Frank law, really have been enormous. An analysis by researchers at Rice University put the increased compliance costs that Dodd-Frank imposed at $50 billion a year. Another study, done by researchers at George Mason, found that the number of new regulatory restrictions created by Dodd-Frank greatly exceeded the combined impact of every other Obama-era administrative law. Ouch!
NEW INVESTMENT VEHICLE: The Bessemer Emerging Cloud Index, which is made up of companies involved in and at the forefront of cloud computing, has risen by more than 500% since it was created in 2013, compared with just over 100% for the S&P 500. The index consists of 35 companies, including notable darlings such as Slack, Square, and PayPal. I like the concept, but all these companies are part of what I see as a tech valuation bubble.
BACK TO LIFE: I can’t vouch for the predictive accuracy of Bloomberg Economics’ new, real-time Recovery Tracker—it follows everything from new unemployment claims to the rig count—but if I’m reading this chart right, things seem to be getting appreciably better (or, at least less worse) pretty quickly, and on a pretty broad front:
SLOWING DOWN: Good news for mortgage lenders. The MBA reports that after skyrocketing in March, requests for mortgage forbearance have slowed significantly. Last week, forbearance requests fell for the third consecutive week, to 0.63% of servicing volume from 1.14%.
SUBPRIME CONSUMER LENDING: I was forced into understanding the subprime consumer lending business in the 1980s when Northwest Banccorp (aka Norwest, aka Wells Fargo) bought Dial Corp. I quickly learned that everything about subprime consumer lending is different from prime consumer lending, from originations, to account management, to collections. This week I had a follow-up conversation with Don Gayhardt, CEO of Curo Group, a deep-subprime lender. What many investors don’t understand about subprime borrowers is that they are incredibly rational with money because they’re constantly dealing with their own personal recessions while the rest of us are enjoying economic expansions. When this recession began, Gayhardt said Curo’s customers increased calls to the call centers, loan applications fell by 50%, line utilization on open-ended lines of credit went down, and delinquencies went up. This is rational consumer behavior. Curo’s behavior was also rational, as the company tightened its lending standards, to the point that its approval rate fell to 12% from 22%. The net result is lower new-loan volume in the midst of a recession. Curo is one of six subprime lenders that participates in a trade group that indexes origination loan volume. On March 15, the index was at 100; last week, it was 15.
Gayhardt had some interesting real-time credit metrics. The company has an information system that lets users drill down on one variable by product and by geography on a real-time basis. Curo’s 1-to-30 day delinquencies rose by 35 percentage points from March 15, until they peaked on April 12. Then by April 25, the year-on-year increase in the delinquency rate was 14 percentage points. As of last Friday, that same delinquency rate was slightly below the year-ago levels. That’s not what most investors would expect. (It’s important to note that Curo receives loan payments every two weeks from its borrowers.) Notably, the company’s cure rate out of the 1-to-30 day delinquency bucket is running around its normal level.
Experienced subprime lenders like Curo and CardWorks will weather this storm on credit quality and emerge smaller but with bags of cash to lend borrowers as the next expansion begins. The subprime consumer was rational entering the downturn and is behaving rationally so far in the downturn.
NEXT WEEK: On Tuesday, the National Federation of Independent Business will release its Small Business Optimism Index for April. The consensus expectation is 86.5 vs 96.4 in March.
THE LAST WORD: I am often accused by Amy and the kids of having OCD, since I’m constantly on everyone’s case to close drawers, turn off lights, and keep general living areas clean and orderly. In addition, my wife is constantly leaving doors to the outside open for various reasons, which can drive me nuts. That open-door practice came back to bite Amy this past week, though. First, there was the bird that entered the house and proceeded to relieve itself on a standing lamp. But that was nothing compared to what happened the next day. Soon after I left for the office, Amy started her day by making coffee and letting the cats out, then called a friend. Of course she left the door open so the cats could come back in when they wanted. When they did come back in, one had a present: a chipmunk in its mouth. Being such an animal lover, Amy quickly freed the chipmunk, but it didn’t run back outside, and instead ran under a speaker to keep away from the cats, who were hot in pursuit. Amy quickly figured out that to get the chipmunk out of the house, she had to put the cats in the basement. Then she built a jury-rigged maze, using cushions and furniture, that would guide the chipmunk to the door. After its construction was done she found a broom and went after the chipmunk. Amy says she screamed when it came out from under the speaker and, instead of following the maze, jumped over it and took off to the office at the other end of the house, with Amy in hot pursuit. She then locked herself in the office (which has a door to the outside) and went after him. This time, he climbed up the drapes and jumped over to the top of the credenza behind the desk. Amy was about to give him a sweep when he jumped down toward Amy and landed on on the desk. She let out another loud scream. Amy went after him again, but he kept running in circles around her. Eventually, the chipmunk stopped to rest (or perhaps laugh at Amy) and Amy, unleashing the best slapshot of her life, whisked the creature out the door. Not only was Amy exhausted, she was traumatized, as well. It worked out great for me, though, as I got a big laugh when she told me the story. Also, the doors have been closed tight ever since.
