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Vol. V, No. 40

TOM BROWN’S BANKING WEEKLY: 10/2/20

Financial Services Insights and Intelligence

FIRST WORD: Kudos to the CBA for its virtual conference.  For the last several years, the annual CBA Live, put on by the Consumer Bankers Association, has been one of my favorite conference events. I was prepared to join 1,700 others in San Diego this past March before that event was shut down. CBA Live has general sessions and then multiple tracks that cover operations, products, and regulations. The vast majority of attendees stick to one track, but I have enjoyed floating around and attending various tracks. This week, the CBA pulled off holding its conference 100% virtually. Logistically, there were hardly any glitches, which was amazing given the event’s complexity. There were 2,400 virtual attendees, 130 hours of programming, and 323 speakers. Wow! And as I have come to expect, the content was outstanding. Here are my takeaways from the presentations I heard:

The digital-banking discussion was the star of the show. Consumer behavior and attitudes have significantly changed since the advent of the pandemic, which has forced some banks to adopt digital tools and practices faster than they were originally anticipating. I have talked about the adoption of digital signatures in the past, and while many banks procrastinated for years, they’ve quickly adopted digital signatures in the pandemic. Various statistics were cited in presentations, such as a 33% increase in mobile payments and a 27% increase in mobile deposits. A couple presentations I heard cited a recent BAI study which reported that half of bank customers say they are using digital products more often since the pandemic, and 87% of them are planning to continue this increased usage after the pandemic. Some customers have not and will not change their banking habits, but I think the BAI is right when they write that we have reached a tipping point and have moved from the “early majority” curve and into the “late majority” phase of technology adoption. I am told that the most well-attended session was the combined session of the digital and the deposits tracks, which I attended, as well.

More scrutiny on branch networks.  At first, bankers were too busy dealing with closed branches, working from home, and the PPP program to give any attention to what the changing consumer behavior means for the longer-term size and shape of their retail distribution networks. I sense that has changed in the last two months because the disruption has lasted longer, the change in consumer behavior is sticking, and because it’s now 2021 budget time and there is little room for marginal expenses. I have complained for years at the slow pace of branch closures by the larger banks, but I believe the industry has reached the point of accelerated closures.

Most banks are planning for a difficult revenue environment for at least the next six months, with little loan growth, margin pressure, and pockets of fee income weakness, notably in overdraft and ATM fees.

Some recognition that banks have entered a war on consumer nuisance fees, and that the fees are about to be slowly competed away. Huntington has already announced its “safety zone” of no NSF charges for overdrafts of $50 or less if the customer has direct deposit. One presenter suggested a product for $10 per month that would permit one overdraft below a certain dollar level. There are a lot of consumer fees, and I think bankers need to consider which ones are most vulnerable to increased competition.

Compliance, fraud, and risk. As banks are forced to modify long-standing practices like limits on the amount of remote deposits, fraud attempts have gone up, forcing the various units of the bank to work with each other on new practices.

A radical reduction in operating cost structure is required for many banks with less than $100 billion in assets. The industry has entered an era where the usual cost-cutting activities will not be sufficient. Meanwhile, the Fed has said interest rates are staying near zero for many years. A handful of companies are attacking the cost problem by moving to a new core processing system. Others are going all in on moving to the cloud and adopting APIs from fintech providers like nCino, Blend, and Numerated. Further, Numerated said this week that clients that adopt its commercial loan processing system do two-and-a-half times  the client load as they did before adoption.

Kudos to CBA President Richard Hunt, the CBA staff, and all the bankers on the various committees which make up each track, for so successfully running such a large and complex conference virtually. With so many dramatic and unprecedented changes taking place in the banking industry, the CBA’s role and this event have never been more valuable.

AN EAGER BUYER: OK this is getting ridiculous. A group of SPAC sponsors is putting together a SPAC that will only invest in SPACs.

OUT OF HAND?: While I’m on the topic: oof:

BETTER: Happy earnings season! Might more than the typical number of positive surprises be in store? Maybe! Earnings Scout’s Nick Raich tells CNBC.com that of the twelve companies that have already reported their numbers—including AutoZone, Darden, FedEx, Lennar, and Nike—all have topped expectations. Further, post-report, eleven of the twelve companies have seen consensus fourth-quarter numbers rise “by the greatest amount we have measured in a decade,” Raich says.

SYSTEMIC FORECAST ERROR: Explain to me again why anyone should ever take an interest rate forecast by the CBO seriously:

To be fair to the CBO, for the past ten years, basically no one else has gotten their rate forecasts right, either.

OUT THE DOOR: Say, Goldman Sachs’s move into consumer banking seems to be going swimmingly. From Bloomberg, on Monday:

 ROOM STILL TO RUN: While its recent weakness could indeed be evidence to the contrary, the stock market might not be running out of gas, after all. Money manager Ken Fisher points out that since 1928, following the 34 occasions that stocks rose for five straight months, as they did from July through August, they continued to generate positive returns over the subsequent six, twelve, and eighteen months fully 80% of the time.

CAUTIOUS COMPANY RE-HIRING: More evidence that companies need to get their workers back in the office. On Indeed, job postings for the highest-paying jobs have recovered the least, likely because companies don’t want to add high-priced people without being able to easily onboard and integrate them into the organization. You can’t do that when everyone’s working from home.

BACK AT IT: Boy, they sure didn’t need much in the way of convincing. With the stock market off by just 7% from its peak, corporate insiders have started buying again.

THE RESPONSE OF COMPANIES TO COVID: This isn’t so great. A survey by IBM of 3,800 C-Suite executives shows that there’s a huge gap between how companies think they’re doing in helping employees cope with the pandemic and how their actual employees think the companies are doing.

TOO EAGER: An early sign that speculation has begun to creep into the IPO market? I say yes! The first-day return on deals is now higher than it’s been in years:

NOT ALWAYS DISCOUNTED: I’ve always assumed that the stock market is so efficient and far-sighted that it tends to not react sharply to near-term political events. But if I’m understanding this chart—which covers presidential elections from 1900 through 2016—that might not necessarily be so.

BEST TAGLINES: I agreed with most of Bank Innovation’s list of the 31 best taglines in financial services. Most were solid, such as “What would you like the power to do?,” from Bank of America, and “This is banking, a Fifth Third better.” A few really have stood the test of time, notably, “American Express: don’t leave home without it”. But Citibank ‘s “Welcome what’s next” really doesn’t hold a candle to the old “The Citi never sleeps.” And you’ll surely remember what must be the greatest financial services tagline of all time: John Housman gravely intoning to prospective Smith Barney customers: “We make money the old fashioned way. . . We earn it!”

FOWL WORDS: In the UK last month, two African grey parrots were removed from a safari park in Lincolnshire and put in quarantine after park staff members realized they had taught each other to swear.

MAIN STREET WINS: Now this is my kind of divergence. Leuthold Group’s Jim Paulsen notes that when Main Street is booming—which, if you look at recent numbers such as consumer confidence and home sales, it seems to be—at a time (like now) of deep investor pessimism, good things tend to happen. “Since 1988, and when consumer confidence has been above average while investor confidence is below, you’ve had 20% annualized returns in the S&P 500,” he said on CNBC on Wednesday. “So, I think it’s going to prove to be another good quarter.” Sounds good to me.

DOWNBEAT: To underscore the above, the latest survey by the American Association of Individual Investors is decidedly overweighted with  bears:

ABSOLVED:  It’s about time! The federal government will start forgiving PPP loans within a week, the New York Post reports. P.S. I also really like the proposal, which Steve Mnuchin says he supports, that any loan for less than $150,000 be forgiven automatically.

GRAYER AND LOWER: Say, maybe interest rates really will stay low for longer than most people expect. I usually don’t put much stock in oddball correlations, but if Ed Yardeni, who’s basically made a career out of coming up with meaningfully predictive metrics that aren’t exactly intuitive, says that the aging of the work force is putting downward pressure on rates, that’s good enough for me.

WRONG DIRECTION: Ugh. More companies are starting to provide earnings guidance again.

I mean what, exactly, is the point? Companies that give guidance aren’t doing anyone any favors, since  a) No one, not even mighty corporate executives, can accurately say what the future holds, which—as investors have found again and again—makes guidance useless, b) Guidance serves as an entirely artificial near-term bogey (and distraction) that can at times tempt managements to make bad decisions, and c) It’s of exactly zero use to actual investors like me, as opposed to sell-side analysts, who can be counted on to always be clamoring for it. Anyway, companies really should just stop.

SURGING: OK, I admit it. Maybe things are starting to get out of hand:

SO HOMEY: Oh great, just what the country needs. In California, a startup called Mighty Buildings has developed a 3-D printer that churns out . . . home offices.

EVEN-HANDED: If you’ve ever wondered whether the people who respond to opinion polls might not always think through the questions they’re asked, you could be on to something. From Gallup’s home page, on Monday:

Same site, the next day.

OK!

BUMPS AHEAD: Welcome to October! Mark Hulbert reminds that while the month isn’t nearly as bad for stocks as is commonly supposed, it is, by far, the most volatile:

NICE TIMING: While I’m on the topic of what time of year it is, financial blogger Eddy Elfenbein notes that since 2000, the Dow Jones Industrials have returned just 0.91%, annualized, over the first three quarters of the year, but during the fourth quarter—which began yesterday, remember—they’ve returned 17.83%.

HIGHLY CORRELATED: Well this should surprise exactly no one: the stricter a given country’s Covid lockdown, the slower its economic growth has been:

CONSUMER SPENDING: Things are sort of recovering, anyway. Data from Bank of America shows that overall consumer spending is down only marginally from a year ago, but that—and this won’t surprise you—spending at restaurants is still in deep decline.

RECORD PRICE-TO-TBV VALUATIONS, BUT NOT FOR THE BANKS: This can’t go on forever, right? While the S&P 500’s overall price to tangible book is nearing levels not seen since the dot-com bubble, bank stocks are still trading at just 100% of tangible book, which is less than a third of what they were trading at the earlier bubble’s peak.

SHARE REPURCHASES ARE DOWN: Well, this is different. While corporate buybacks have been a main force behind stocks’ rise in recent years, companies have largely sat out the market rally that began in March.

BUY RATINGS HANDED OUT LIKE PARTICIPATION TROPHIES: Sell-side research sure does add value! If it’s a stock and it trades on a public exchange, there’s a really good chance that the analysts who cover it will absolutely love it:

Such discerning judgment! By the way, what ever happened to Eliot Spitzer’s 2003 deal that forced broker/dealers to keep their equity research departments and investment banking departments separate?

GROWTH STOCKS CONTINUING TO BEAT VALUE STOCKS: The outperformance of growth stocks relative to value stocks (financials, energy, industrials and materials) is now at an extreme. A reversal of this trend will likely be driven by stronger economic growth and a steeper yield curve.

GOOD CHEMISTRY: More evidence that the economy is set to keep expanding: the American Chemistry Council’s Chemical Activity Barometer, said to be a leading indicator for industrial production broadly, rose by 1.6% in September on a three-month moving average basis, following a 2.7% gain in August.

“With five consecutive months of gains, the September CAB reading is consistent with recovery in the U.S. economy,” said the group’s chief economist.

LESSONS LEARNED FROM PC GAMING COMPANIES: Maybe banking companies can learn from the battles going on in the PC gaming industry. Since 2013, the PlayStation 4 has sold more than 100 million units, while its primary competitor, the Xbox One, has sold fewer than 50 million. Industry consultant Ben Thompson attributes PlayStation’s success to three factors.

  • Product positioning. PlayStation treated its console as a niche gaming console and invested significantly in exclusive game titles. Xbox was positioned to “take over the living room.” Sometimes the specialist is more appealing to the customer.
  • PlayStation’s big bet was on titles, while Xbox bundled in its motion-sensor Kenect camera, which raised the Xbox price.
  • Digital rights management. When a game is downloaded, it is locked to the console. Xbox tried applying the same policy to its physical game disks, which proved to be an unpopular move with consumers.

The divisions within a banking company over specialists versus generalists are increasingly posing management challenges, such as the balance between simplicity and robustness on landing pages.

THE BIG IMPACT OF CHANGING AMAZON PRIME DAY: Some retail analysts have suggested there will be some significant ramifications of Amazon’s decision to hold its re-scheduled (from July) Prime Day on October 13 and 14. For one, this will effectively move the entire holiday shopping season up a month. One estimate is that Prime Day will pull 10% of November’s Black Friday and Cyber Monday sales forward a month. That would be around $26 billion in spending globally, and $6 billion in the U.S. Overall, the success of the holiday season will likely depend on whether there is further consumer stimulus, the level of new infections, and progress on a vaccine.

STRESS TEST BALONEY:  When is a stress test not really a stress test?  When it is being administered by our bureaucrats at the Fed.  According to the Fed, a good stress test is supposed to be “an analysis conducted under hypothetical scenarios designed to determine whether a bank has enough capital to withstand a negative economic shock and still have the lending capacity to handle its borrowers’ needs.” But if the regulator administering the test needs to revise its assumptions within months of evaluating the stress test results, then the regulator is incompetent, in my opinion. Actual operating results since the pandemic began are already so different from those used by banks in their models that the Fed should at least recognize the limitations of this exercise in the current environment. As an investor, I am in favor of the Fed conducting annual stress tests. But let bank boards make their own capital decisions within the established annual parameters throughout the year. The Fed needs to accept that the issues from the most recent recession have created earnings problems, but will not create balance sheet problems.

NEXT WEEK: On Monday, we’ll get the ISM Services Index for September. The consensus looks for 56.3 vs 56.9 in August.

THE LAST WORD:  Amy and I were on a walk last week and she asked me if I had made a planned phone call to a friend of ours. I had not, I said. She proceeded to say a few times in a row, “You are not a good communicator. You write well, but you don’t communicate enough verbally.”  I reminded her that on average, a man uses 8,000 words a day, while the average woman uses 20,000 and, like in so many things, I considered her above average in that regard. That line only stirred the hornets’ nest, so we continued the discussion for most of the walk. The next few days I worked hard to communicate with her, and knew I had been successful when she blurted out on Tuesday night, “Stop taking, stop communicating.” On Wednesday night, Amy was on the bed reading at about 9:30 p.m., and I decided to do something I never do: Facetime the four kids, sitting next to Amy. I started with the youngest, Piper, whom we found in a hotel room with two other Clemson freshmen because they are in quarantine. (She feels fine.) I think Piper has been treating it as a weeklong slumber party. Next up was Colton, the sophomore at the University of Texas, who started telling us about his introductory accounting class. As a former accounting major, I gave him a 101 pop quiz, which he passed, and then tried a little old-man accounting humor by asking him which side the debits went on (the window) and which side the credits went on (the door). Neither he nor Amy understood, then he said good-bye and went off to a fraternity party. Next I called Doug, who answered from the couch downstairs, and told him what I was doing, communicating, and didn’t want him to feel left out.  Lastly was Tommy, the oldest, who was enjoying the sunset with his girlfriend, Devon, on a beach near L.A.  Four calls in less than 15 minutes and much fun. When I was done, I looked at Amy and said, “I think I have this communicating thing down.”

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Edited by Matt Stichnoth.

Copyright © 2020, Second Curve Capital LLC

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