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Vol. VII, No. 21


Financial Services Insights and Intelligence

FIRST WORD: My talk with Bank of America’s Brian Moynihan. I have known Brian Moynihan for about 25 years, going back to his days in various roles at Fleet Financial. You will remember he became CEO of Bank of America in January, 2010, when the company had significant and wide-ranging problems. The transformation from the troubled company then to an industry leader today is amazing. I’ve said many times that his decision to step up the company’s technology spending while losing money was one of the bravest decisions I have seen in banking, and, boy, has it paid off. We spoke by phone this week. Some highlights:

Davos. Moynihan attended the World Economic Forum last week, as he usually does. He goes primarily to be part of the discussion of the most important issues that the world needs to address, such as poverty, climate change, and food shortages. He said this year there wasn’t as much discussion on such issues because of the war in Ukraine. He reminded me that there is no ocean separating what is going on in Ukraine from other European countries, as we have in the U.S. He also pointed out that the economic consequences of the war are greater for the European countries that buy energy from Russia. Overall, Moynihan thought the media reports he saw about the tone of the meetings was more negative than he experienced.

Return to the office.  As of this week, all Bank of America employees are invited back to their office building to work. It is not mandatory. The company is still surveying employees and studying its options before coming up with a new permanent plan. It’s trying to balance providing flexibility for employees based on job and location with the benefits that accrue from employees working together. In addition, Moynihan wants the plan to be “fair” for everyone. Finally, he doesn’t want to keep announcing a new “final” plan.

The state of the U.S. economy.  Moynihan pays close attention to external and internal data about the economy. The coincident measures all show things are still robust. The public employment data have seldom been better. He said consumer spending in May on Bank of America credit and debit cards was up 9% to 10% from last May, and it’s not just inflation-driven, since transactions are up 7% to 8%. Memorial Day spending was up 30% from the 2019 level. The company has seen a spending mix shift in recent months from goods to travel and entertainment. Moynihan also looks at the cash levels of Bank of America’s retail banking customers. Those customers who were running a balance of between $1,000 and $2,000 pre-pandemic have seen their average balance increase to $7,000 from $1,400, while those who were running a balance of between $2,000 and $5,000 have seen their average balance increase to $13,000 from $3,500. Finally, Moynihan mentioned consumer delinquencies which are at an unprecedented low level and have yet to even start “normalizing.”

Net interest income growth outlook. On its first-quarter earnings call, Moynihan discussed the company’s net interest income growth in the quarter and then predicted that net interest income would increase at least $650 million in the second quarter from the first, and then move higher in the second half of the year. He also said he expected the company’s expenses to stay roughly flat throughout the year. On our call this week, he reiterated those forecasts with confidence. This will result in the company having both revenue and net income momentum for the remainder of the year.

Digital transformation and the success in retail banking.  Moynihan can’t hide, nor should he, his pride in what the company has accomplished since he became CEO, but I think he is most proud of the company’s digital transformation, and how this has led to great success in retail banking. Moynihan knows too well what a misguided, poorly executing retail bank BofA had become, because he was put in charge of retail banking just a few months before he became CEO. All he had time to do was identify the problems, but that experience certainly helped his decision-making after he became CEO. For example, he identified that the company’s main measure of success was how many retail checking accounts it opened. The problem was that the accounts were low-balance, secondary accounts, and because of the company’s poor add-on products and terrible customer service, it closed more checking accounts than it opened for several years before Moynihan took over. He changed the focus to providing a continuously improving customer experience, as part of an attempt to open and maintain a customer’s primary checking account. He told me several years ago that the company was going to take so much cost out of managing checking accounts that the percentage of its unprofitable checking accounts would fall from a third to almost zero. I was highly skeptical, but that has happened. Perhaps no single statistic better shows the company’s progress in retail banking than the 228,000 net new checking accounts the company added in the first quarter, and at significantly higher balances, indicating a primary checking account. A huge positive for the company. Other noticeable signs of success: for the first time, in the first quarter, over 50% of the company’s sales were done digitally, and for the first time, the number of consumer payments made by Zelle, 140 million, exceeded the number of consumer payments by check, 120 million. It costs the bank one-tenth as much to process a Zelle transaction as it does to process a check.

Physical distribution network changes. In this digital transformation, everything about the physical distribution network has needed to change. The number of branches in the existing footprint needed to be reduced, many of the remaining branches needed to be remodeled, ATMs needed to be increased and upgraded, and the talent level of those working in the branches needed to be upgraded. Bank of America has made tremendous progress in all those areas, but the work is far from over. The company’s branch total has been reduced from over 6,000 to around 4,000. The company is in the midst of a multi-year plan to refresh existing branches, with 800 completed over the last year. It has upgraded the functionality of its ATMs and now has a network of 16,000. Finally, Moynihan announced a few years ago that, to improve the talent in the branches, that it needed to attract new employees who want to, and financially can, make the branch associate position a career job. Using MIT data, the company set out to raise its minimum wage for employees by 2025, such that a person working at that wage in that geography would earn more than the poverty level for a family of four. Company-wide, this would result in a $25-per-hour minimum wage by 2025, from $10 per hour a few years ago. The company has made several increases already, including one recently that pushes the company’s minimum wage to $22 per hour. The new approach to entry-level employees has drastically cut the attrition rate at the entry level from 20% before the pandemic to 12%. Moynihan believes this program is a key reason for higher employee engagement and satisfaction, and that a more experienced and stable frontline workforce leads to a better customer experience, which he feels is why the customer satisfaction scores are at a record high.

Geographic expansion.  Five years ago, Moynihan announced the company was going to take its high tech/high touch retail banking model into new markets. As JPMorgan does, when Bank of America moves into a “new” market, it actually already has a significant presence there, with its credit-card business and commercial bankers. Bank of America has now moved into nine new metro areas, with 150 branches and has gathered $20 billion in deposits. The company has a top-ten market share position in seven of these markets. Moynihan said they plan to move into an additional seven metro markets. When the bank moves into a new market, it wants to make sure it has a critical mass, and it particularly likes to locate a branch near a large college campus. Moynihan told me that the company’s share of new account openings from those aged 18 to 25 is disproportionately larger than the share of that demographic group in the U.S.

BNPL? I told Moynihan I was surprised at JPMorgan’s announcement last week that it is entering the buy now, pay later space, since I think it is a young product in the U.S. that could result in at least reputational damage if other BNPL lenders are overly aggressive, which I expect they will be. He did not agree or disagree with my statement, but did say Bank of America’s credit card can adequately serve those needs. Don’t expect Bank of America to enter the BNPL space any time soon.

Biggest challenge? Moynihan said cyber security is the biggest challenge, but it has been that way his entire time as CEO, despite the fact that the company will spend over ten times as much on cyber security this year than when he took over. The next biggest challenge is the economy because, while it is incredibly strong now, with a solid foundation, the Fed is set to slow the economy in an attempt to reduce the rate of inflation. The key is to stay vigilant and agile.

Complacency? To end the discussion, I told Moynihan that I never thought ten years ago I would be asking him today if he is worried about complacency, but the company has been performing at a high level, with a strong net interest income outlook. He didn’t hesitate, and said he is worried about it and that he had been a little late for our call because the senior management team had just completed an exercise to help prevent such complacency. Moynihan didn’t recite Jim Collins’ five stages of decline (hubris from success, undisciplined pursuit of more, denial of risk, grasping for salvation, and capitulation to irrelevance), but they are always on his mind because you will never hear him talk about the company’s strategy without hearing him say “responsible growth.” Moynihan believes that to prevent hubris, he needs to bring in opinion and information to his senior management team from outside the company that make them feel uncomfortable. He could have quoted Collins:

Comfort is not the objective in a visionary company. Indeed, visionary companies install powerful mechanisms to create discomfort—to obliterate complacency—and thereby stimulate change and improvement before the external world demands it.

Moynihan has led Bank of America into a long-term position of strength and, with accelerating near-term earnings momentum to help it handle whatever economic environment awaits. A great banking transformation indeed.

LOOKING WOBBLY: Happy June! Or maybe not. LPL Financial notes that during midterm election years like the one we’re in now, this month is just awful for the stock market.

BRAND REPUTATION SURVEY: The worm certainly does turn from time to time. The latest Harris Brand Reputation Survey shows that the industry whose reputation has seen the biggest improvement over the past year is financial services, while the one that’s seen the biggest decline is technology.

THE WRONG WAY: But of course. As stock prices have fallen, hedge funds have been selling rather than buying.

Genius. Pure genius.

CALLED OUT: Well it’s about time:

As the ESG industry faces attacks from a growing chorus of detractors, insiders are also starting to air their doubts around aspects of the investing form.

James Whittington, head of responsible investment at Dimensional Fund Advisors with about $660 billion of assets under management, said the industry is struggling both in terms of real-world impact and returns.

Any “promise that you can outperform the market by your insight and evaluating ESG risks probably isn’t going to stack up,” he said in an interview. What’s more, Whittington said his team found “no compelling evidence” that investors targeting environmental, social and governance goals are altering companies’ cost of capital or achieving change through stewardship.

Whittington’s comments add to an increasingly incendiary debate that’s hitting ESG from all sides. . . . [Emphasis added.]

Funny how skepticism about ESG is spiking just as tech stocks—which tend to dominate ESG portfolios, remember—have hit the skids.

EXPENSIVE: Good lord. The global corporate withdrawal from Russia following its invasion of Ukraine has cost shareholders a ton of money:

WEAN YOUR INVESTORS OFF EARNINGS GUIDANCE: Explain to me again the benefits of providing quarterly earnings guidance? Here’s what happened to Snap, Inc. last week when it announced it would miss the reduced guidance it offered on its earnings call in April. I suspect shareholders would have been better off if the company had just stayed mum the whole time.

I continue to believe that the whole practice of giving guidance is just a sop to sell-side analysts, who seem to prefer a high degree of hand-holding with regards to their quarterly earnings models.

EVER LOWER: Ugh. Americans’ feelings about the economy just keep getting worse and worse. The Gallup Economic Confidence Index is approaching the lows it hit in the midst of the financial crisis.

PAIN FROM THE PUMP: And given what gas prices have been doing lately, consumers’ moods aren’t apt to brighten any time soon:

INTEREST ON THE FEDERAL DEBT: Here’s a budding problem I’m not hearing enough discussion of. Even holding interest rates constant, the CBO now estimates that interest on the national debt will surpass $1 trillion, or 3.3% of GDP,  by 2030, double the current percentage. But interest rates won’t be held constant; they’ll almost certainly rise. So at some point, servicing the debt will become a material burden for the economy. Sooner or later, someone will have to take the federal debt and deficits seriously, but if past is prologue, it will take a crisis.

TOO HIGH: An early sign of a crack in the housing market? Maybe! The number of sellers cutting price is on the rise.

NO LONGER: Add $16 billion First Financial Bancorp of Cincinnati to the list of banks that say they are phasing out NSF fees.

QT AND THE FED’S CHALLENGE: The Fed’s plan to run off its MBS holdings from its balance sheet might not be as straightforward as it seems at first glance. As interest rates rise, the securities’ expected paydowns—which is the Fed’s preferred way of disposing of the bonds—could slow by a lot, and so to stay with its $35-billion-a-month QT target, the Fed might have to actually sell its securities, perhaps at a meaningful loss. News that the Fed is losing lots of money in the bond market isn’t apt to sit well with Fed skeptics, both in and out of Congress. So, as I say, it could be a problem.

GONE AT LAST: A sad moment for those of us of a certain age. In Lake George, N.Y. last month, the last surviving Howard Johnson’s restaurant closed its doors for good.

TOO MUCH: I’ll admit, he’s going a little far, I’d say.

But only a little! In any event, once interest rates do start to rise in earnest, it’ll be interesting to see the marks PE investors come up with for their portfolio companies.

A VERITEX UPDATE: Veritex is a $10.5 billion, Dallas-based banking company run by founder Malcolm Holland. He was away during my trip to Dallas last month, but I was able to receive an update from CFO Terry Earley. I have known Earley for over 25 years, and have found him to have a high degree of curiosity. I caught him after a weekend where he had done some interesting analysis.  Here are some highlights.

Strong loan growth continues. After declining by around $100 million in January from year end, loans at Veritex grew over the remaining two months of the quarter. This has continued in the second quarter. Earley was curious to see how much of this growth was originated by the producers the company has added since last April, and he found they contributed 32% of the growth. That’s impressive, since it usually takes even proven producers a while to ramp up production at a new employer.

Corporate structure. Veritex is clearly a business-focused bank that consists of a community bank with generalist bankers. The community bank accounts for about 25% of total loans and has grown its loan portfolio in the high-single-digit range. It also generates more deposits than it does loans. The bank’s other commercial lending consists of a series of vertical specialties such as commercial real estate lending.  Part of Veritex’s success is its focus on what it does well and maintaining the discipline to not be lulled into areas where it has no expertise, such as energy lending.

Talent.  The company has been very active over the last 15 months in hiring new talent and in encouraging the underperformers to leave. Earley’s review showed 20 new producers have been added over this period and another 27 have been added as replacements. It has become so hard for the company to hire additional producers that Veritex has started an internal banker-development program.

InterLink acquisition still pending. In March, Veritex announced the acquisition of InterLink, an eight-employee high tech deposit-spreading business with eight clients involving $9 billion in deposits. The acquisition is awaiting FDIC approval. While the deposits will have high betas, they are considered core, and will be lower-cost than wholesale funds. Veritex often has funding challenges because its loan portfolio has tended to grow at twice the rate of its deposits. This acquisition would eliminate funding as an issue for awhile, but the company is not pulling back from its internal deposit-growth plans. Earley said they are more optimistic about additional revenue-generating opportunities than they were when the deal was announced.

Acquisitions? Before the InterLink agreement, Veritex looked at acquiring two or three banks in West Texas that had excess core deposits, but the company thought there was less execution risk with InterLink, and it provides triple the level of deposits. The company has also had serious discussions to acquire a large out-of-state bank, but concluded that its growth opportunities were better in Texas.

What is the end game? Holland has created a very attractive franchise, so at the age of 62 he has some attractive strategic options. He can stay independent and acquire smaller banking companies, he could try to engineer a merger of equals, or he could choose to sell Veritex to any number of interested buyers. Earley assured me the company spends a lot of time on succession planning, but it could be tough to avoid an attractive offer when bank stock valuations become more rational.

The investment partnership I manage owns Veritex, and it looks to me that the company is operating in a sweet spot currently with respect to growth, profitability, and funding, assuming the InterLink acquisition goes through. It should be a very enjoyable ride.

PREPARED FOR A DOWNTURN: I am agnostic on the question of whether or not the economy is on the verge of a technical recession. Whether it is or not, though, consumers and corporations are better prepared for it than they were prior to past recessions.

FRONT-RUNNING THE RECESSION: On the question of whether a recession is looming, by the way, the stock market seems to have already made up its mind:

FRACTIONAL RESIDENTIAL REAL ESTATE OWNERSHIP. Here is an idea created in the wake of the great post-pandemic asset inflation: fractional residential real-state ownership. Investors can own a percentage of a property with no right to occupy it at any point. A handful of companies are in the business. One is Arrived, backed by Jeff Bezos, which just raised $25 million. The company lets people buy shares in single-family rentals for as little as $100. Other companies, such as Fintor Fractional and Pacaso, provide similar investment opportunities. I will not be investing in these vehicles.

TROUBLE AHEAD: Well this wasn’t exactly a confidence-booster, I have to admit:

OOPS: This wasn’t either, for that matter:

DOOM AND GLOOM ON STEROIDS: Then again, I find this to be more than a little bullish:


The world’s financial elite gathered in Davos, Switzerland, at the World Economic Forum this week, and a darkening global economic outlook was the number one talking point.

While some foresaw regional pockets of recession in countries or continents particularly exposed to the Russia-Ukraine war and global supply chain problems—with Europe a particular concern—others painted a far bleaker global picture.

Inflation has soared worldwide, with food and energy costs skyrocketing as the war and supply chain bottlenecks bite, along with the residual effects of the Covid-19 pandemic. This has forced central banks to start tightening monetary policy against a backdrop of slowing economic activity. [Emphasis added.]

It’s as if nothing’s going right at the moment, with no hope of no near-term improvement in sight. Terrific!  A better backdrop for the stock market I can’t imagine.

INSURANCE PREMIUMS BACK ON THE RISE: Auto insurance premiums have begun to rise, to offset higher inflation and an increase in severity.

SEN. SHERROD BROWN: I’m not sure what Ohio Sen. Sherrod Brown was thinking this week when he sent a two-and-a-half page letter to Wells Fargo CEO Charlie Scharf telling him to “once and for all” fix the company’s compliance problems. Given the spotlight that Scharf and Wells are under (and assuming he knows Scharf as well as I do), Brown already understands that Scharf is doing everything he can, as expeditiously as he can, to get things fixed. Meanwhile, Brown’s letter surely angered Wells’ regulators. As I say, I don’t see the point.

LAGGING BY A LOT: Stephen Roach makes what should be the obvious point that, compared to what Paul Volcker had to do to get inflation under control in the 1980’s, Jerome Powell’s Fed is way, way behind the curve.

Powell’s problem is all the more evident when viewed through the inflation-adjusted lens of real interest rates. Over the 51 months of his leadership of the Fed (through April 2022), the real federal funds rate has averaged -1.95% (with a stress on the minus sign). This extraordinary monetary accommodation is unmatched in modern times. . . .

Under Volcker, by comparison, the real federal funds rate averaged 4.4% for eight years (with a stress on the positive sign). Moreover, notwithstanding the Powell Fed’s newfound determination to move swiftly to counter what it belatedly views as a serious inflation problem, I suspect that the federal funds rate will remain below the U.S. inflation rate well into 2023. . . . [Emphasis added.]

I mean, what’s Powell waiting for? He spent months denying that inflation was even a problem, and now his efforts to get it under control are half-hearted, at best. Crazy.

WEAK: As if to underscore how lame Powell’s approach has been, here’s the fed funds futures market’s expectation for rate hikes in coming months, compared to prior cycles of Fed tightening.

NEXT WEEK: On Friday, the Labor Department will release the May Consumer Price Index. The consensus looks for a month-on-month change of +0.7% vs +0.3% in April.

THE LAST WORD: Last summer, the head of the women’s golf committee for St. David’s Golf Club here asked Amy and her friend Carol Higgins to be in charge of the 2022 women’s member/guest golf tournament. It is a prestigious job with its share of downside if not handled well. This year’s event is especially important, since St. David’s is celebrating its 125th anniversary. In my opinion, the committee’s co-chairmen choice was brilliant, since if there are two people to put in charge of an event that ends with a fun party, Amy and Carol are ideal choices. There is little risk of disappointment from the event, but this is somewhat offset by its well-above-average budgetary risk. Amy and Carol have been planning the event since they received the assignment, and tournament-related packages started arriving at our home three months ago. The first boxes to arrive were the gold and white flower vases, which will be filled with fresh flowers and be the centerpieces on the dinner tables. Next were the goodie bags and 125th-anniversary decals to be placed on them.  No goodie bag would be complete without the tissue paper to line the bag and gold ribbon to tie the handles together. Then the goodies started showing up, including water bottles with the 125th-anniversary logo, small notebooks with the logo, bags of candy with the logo, and I am sure I am missing something. All the items were stored in our dining and living room. Last weekend, Amy created an assembly line on the dining room table to assemble the 75 bags, and put the flowers in the vases on the ping-pong table in the basement on Tuesday night. On Monday night, Amy got nervous after she checked the weather forecast: thunderstorms likely for Thursday afternoon.

Bad weather led to the 2019 member/guest being cut in half, which resulted in an excessively long cocktail hour. The women’s member/guest had never established a rain date in the past, but after that experience, the women demanded and got a backup date. Amy fretted, but the food had been ordered by the club and the flowers purchased, so she assembled the vases Tuesday night knowing that a decision whether to hold the event or move it to the rain date would be made by the club around 1:00 p.m. on Wednesday. Amy’s biggest fear was that they would start to play and then be called off the course, as happened in 2019.  Around 1:00 on Wednesday, the club postponed the event. Amy was both upset that it was moved and relieved she didn’t have to make the call. But she was nervous that there might not be any storms, and all the women would blame her for cancelling the event. That concern was eliminated around 4:00 on Wednesday when she received a text with a picture showing a Piper 2-passenger plane that had made an emergency landing on the 15th hole, resulting in significant damage and preventing the use of holes 11 through 16. No one was hurt, and Amy felt resolved of any guilt for the event’s postponement. Stay tuned for the event’s makeup date: June 23. By the way, not one drop of rain fell during the time the event would have been held.

Copyright © 2022, Second Curve Capital LLC

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