Author Topic: Are big banks value traps ?  (Read 12818 times)

wabuffo

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Re: Are big banks value traps ?
« Reply #60 on: October 21, 2019, 08:45:59 AM »
This potential risk might not be significant because (1) a large cheap deposit base isn't actually an advantage, or (2) depositors aren't likely to move to branchless banks, even assuming they can offer higher interest rates.  I'd to put (2) aside for a moment and just try to understand (1) -- is a cheap deposit base an advantage and, if so, why? 

I only own one small bank (CASH) - but when I was investing in the banks I always thought that the four most important management levers were:

a) low-cost or zero cost deposits
b) high non-interest (or fee) income
c) low non-interest expense management (ie, overhead)
d) credit risk management - though being good at a), b), and c) helps in signing up the best borrowers from a low-credit-risk POV, because the well-managed bank can shave a few bps to attract the best borrowers vs its less well-run competitors (a little bit of a flywheel model for banking).

I always thought US Bancorp (USB) was exemplary in these four metrics.  Back when I was studying the banks more intently, I posted this post over at the Motley Fool's BRK board explaining what I thought were USB's competitive advantages.  (hopefully Parsad is ok with a link to another board - if not he can let me know and I will delete this post).

wabuffo

https://boards.fool.com/anybody-have-any-thoughtful-or-quantitative-27826750.aspx?sort=username
« Last Edit: October 21, 2019, 08:52:16 AM by wabuffo »


CorpRaider

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Re: Are big banks value traps ?
« Reply #61 on: October 21, 2019, 11:34:04 AM »
Good stuff.  Why don't you invest in banks anymore...because they are value traps?   ;D

wabuffo

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Re: Are big banks value traps ?
« Reply #62 on: October 21, 2019, 12:25:40 PM »
Why don't you invest in banks anymore...because they are value traps?

No - they are more like overly-regulated utilities now.  I think the problem is the Fed and its new toy, IOER (interest-on-excess-reserves).  The Fed wants to control BOTH interest rates and reserves INDEPENDENTLY.  Under its old, pre-GFC, methodology it could only control short-term interest rates and had to let the banks, in turn, determine the level of minimal reserves required to support the system.  The Fed had only one arrow and could only hit one target.  Now, they feel like they have two arrows.  Like good bureaucrats they want control and are forcing the banks to sit on trillions in reserves so that they can pay IOER in order to control short-term rates.

The result of this policy is that the big banks have to hold 10-16% of their total assets in cash (most of it on deposit at the Federal Reserve).  Because these reserves at the Fed are free of both credit and price risk, the regulators are leaning on the banks hard to use these assets as a way to meet their Liquidity Coverage Ratio (LCR) and HQLA (Hi-Quality Liquid Asset) requirements.  I'm not making a judgement that this is good or bad - in the 1950's and 60's most US banks held 10% of their assets in cash (though not at the Fed).  We've been here before.

This explains why Jamie Dimon sat on several hundred billion in cash at JPM in September during the mini-repo liquidity crash.  JPM's cash was yielding less than 2% when Dimon could've used some of it in the repo markets making 8-10% overnight with T-Bills being offered as collateral.

That's why I laugh when I hear some folks say that all those reserves will lead to a credit bubble.  If Jamie Dimon couldn't deploy JPM's excess cash when it was yielding less than 2%, into the repo markets and make a risk-free 8-10% overnight (with T-Bills were the collateral for an overnight loan), then he's not going to be using that cash to make CRE loans to WeWork landlords in Manhattan, LOL!

I own one small-cap bank that's interesting - but it's because it is a more idiosyncratic situation.

wabuffo
« Last Edit: October 21, 2019, 12:31:50 PM by wabuffo »

sleepydragon

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Re: Are big banks value traps ?
« Reply #63 on: October 21, 2019, 12:52:54 PM »
Why don't you invest in banks anymore...because they are value traps?

No - they are more like overly-regulated utilities now.  I think the problem is the Fed and its new toy, IOER (interest-on-excess-reserves).  The Fed wants to control BOTH interest rates and reserves INDEPENDENTLY.  Under its old, pre-GFC, methodology it could only control short-term interest rates and had to let the banks, in turn, determine the level of minimal reserves required to support the system.  The Fed had only one arrow and could only hit one target.  Now, they feel like they have two arrows.  Like good bureaucrats they want control and are forcing the banks to sit on trillions in reserves so that they can pay IOER in order to control short-term rates.

The result of this policy is that the big banks have to hold 10-16% of their total assets in cash (most of it on deposit at the Federal Reserve).  Because these reserves at the Fed are free of both credit and price risk, the regulators are leaning on the banks hard to use these assets as a way to meet their Liquidity Coverage Ratio (LCR) and HQLA (Hi-Quality Liquid Asset) requirements.  I'm not making a judgement that this is good or bad - in the 1950's and 60's most US banks held 10% of their assets in cash (though not at the Fed).  We've been here before.

This explains why Jamie Dimon sat on several hundred billion in cash at JPM in September during the mini-repo liquidity crash.  JPM's cash was yielding less than 2% when Dimon could've used some of it in the repo markets making 8-10% overnight with T-Bills being offered as collateral.

That's why I laugh when I hear some folks say that all those reserves will lead to a credit bubble.  If Jamie Dimon couldn't deploy JPM's excess cash when it was yielding less than 2%, into the repo markets and make a risk-free 8-10% overnight (with T-Bills were the collateral for an overnight loan), then he's not going to be using that cash to make CRE loans to WeWork landlords in Manhattan, LOL!

I own one small-cap bank that's interesting - but it's because it is a more idiosyncratic situation.

wabuffo

But if Fed deregulate overtime, starting from reducing the reserve requirements, the banks will do well. Now seems the regulations are so tight it will only go one direction.

Gregmal

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Re: Are big banks value traps ?
« Reply #64 on: October 21, 2019, 01:00:57 PM »
Further, largely because of regulation but other reasons as well, you're swimming against the tide here. When almost every company in a sector is cheap, Ive found you're most likely going to have to put up with underperformance because the cheapness is sector wide and unless you have a very specific, company related catalyst, you'll just move with the current. I mean C is cheap. So is BAC, WFC, etc, etc. In fact the only one that isn't really cheap is JPM, and thats arguably the one you'd want to own. Theres better alpha elsewhere.

cameronfen

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Re: Are big banks value traps ?
« Reply #65 on: October 21, 2019, 01:13:03 PM »
Why don't you invest in banks anymore...because they are value traps?

No - they are more like overly-regulated utilities now.  I think the problem is the Fed and its new toy, IOER (interest-on-excess-reserves).  The Fed wants to control BOTH interest rates and reserves INDEPENDENTLY.  Under its old, pre-GFC, methodology it could only control short-term interest rates and had to let the banks, in turn, determine the level of minimal reserves required to support the system.  The Fed had only one arrow and could only hit one target.  Now, they feel like they have two arrows.  Like good bureaucrats they want control and are forcing the banks to sit on trillions in reserves so that they can pay IOER in order to control short-term rates.

The result of this policy is that the big banks have to hold 10-16% of their total assets in cash (most of it on deposit at the Federal Reserve).  Because these reserves at the Fed are free of both credit and price risk, the regulators are leaning on the banks hard to use these assets as a way to meet their Liquidity Coverage Ratio (LCR) and HQLA (Hi-Quality Liquid Asset) requirements.  I'm not making a judgement that this is good or bad - in the 1950's and 60's most US banks held 10% of their assets in cash (though not at the Fed).  We've been here before.

This explains why Jamie Dimon sat on several hundred billion in cash at JPM in September during the mini-repo liquidity crash.  JPM's cash was yielding less than 2% when Dimon could've used some of it in the repo markets making 8-10% overnight with T-Bills being offered as collateral.

That's why I laugh when I hear some folks say that all those reserves will lead to a credit bubble.  If Jamie Dimon couldn't deploy JPM's excess cash when it was yielding less than 2%, into the repo markets and make a risk-free 8-10% overnight (with T-Bills were the collateral for an overnight loan), then he's not going to be using that cash to make CRE loans to WeWork landlords in Manhattan, LOL!

I own one small-cap bank that's interesting - but it's because it is a more idiosyncratic situation.

wabuffo

Thanks for this post and the previous posts!  I learned a good deal. 

wabuffo

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Re: Are big banks value traps ?
« Reply #66 on: October 21, 2019, 01:29:37 PM »
Thanks for this post and the previous posts!  I learned a good deal.

For further reading on this subject I would steer you to JPM's Q3 conference call:
Quote
Glenn Paul Schorr, Evercore ISI Institutional Equities, Research Division - Senior MD & Senior Research Analyst:
I'm curious your take on everything that went on in the repo markets during the quarter, and I would love it if you could put it in the context of maybe the fourth quarter of last year. If I remember correctly, you stepped in, in the fourth quarter, saw higher rates, threw money at it, made some more money, and it calmed the markets down. I'm curious what's different this quarter that, that did not happen? And curious if you think we need changes in the structure of the market to function better on a go-forward basis?
 
James Dimon, JPMorgan Chase & Co. - Chairman & CEO:
So if I remember correctly, you got to look at the concept of we have a checking account at the Fed with a certain amount of cash in it. Last year, we had more cash than we needed for regulatory requirements. So the repo rates went up, we went to the checking account which was paying IOER into repo.
 
Obviously makes sense, you make more money. But now the cash in the account, which is still huge. It's $120 billion in the morning, and it goes down to $60 billion during the course of the day and back to $120 billion at the end of the day. That cash, we believe, is required under resolution and recovery and liquidity stress testing. And therefore, we could not redeploy it into repo market, which we'd have been happy to do. And I think it's up to the regulators to decide they want to recalibrate the kind of liquidity they expect us to keep in that account.
 
And again, I look at this as technical. A lot of reasons why those balances dropped to where they were. I think a lot of banks are in the same position, by the way. But I think the real issue when you think about it, is does that mean that we ever have bad markets? Because that kind of hitting a red line in that checking account, you're also going to hit a red line in LCR, like HQLA, which cannot be redeployed either. So to me, that will be the issue when the time comes.  And it's not about JPMorgan. JPMorgan decline -- in any event, it's about how do regulators want to manage the system and who they want to intermediate when the time comes.

Doesn't it sound to you like Mr. James Dimon is chafing a bit under the Fed's interest rate and regulatory regime?  He wouldn't have purposely held back liquidity by "working to rule" in order to force the Fed's hand?  I thought that his last statement: "it's about how do regulators want to manage the system and who they want to intermediate when the time comes." was verrrrrrrrrrry interesting!

Oh lookie here - some new news since the September repo market debacle.
 
https://www.reuters.com/article/us-usa-banks-rates-exclusive/exclusive-wall-street-banks-see-green-light-from-fed-on-reserves-sources-idUSKBN1WW2T6
Quote
"Wall Street banks believe they are getting a green light from supervisors to hold more Treasury debt and less cash after last monthís volatility in overnight lending markets, three industry sources told Reuters.  In private conversations with senior bankers, supervisors have attempted to make banks more comfortable with using excess reserves to lend in repo markets rather than hold onto more cash, sources familiar with the discussions said."

wabuffo

Cigarbutt

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Re: Are big banks value traps ?
« Reply #67 on: October 21, 2019, 01:50:01 PM »
@wabuffo
The comments from 2009 are appreciated. The banks I liked the most then were also USB and WFC. M&T was also up there. In retrospect, I wish I had liked USB for longer. I differ on the hyper-regulated outcome (more below) in the long run but isn't it emblematically ironic that the Fed injected a huge amount of reserves to support their theoretical transmission mechanism framework to the real world while simultaneously forcing the banks to keep the excess reserves on their balance sheet and parked at the Fed for a stipend? Quite recently, the FDIC chair (who listens to these people in good times?) quietly mentioned that the systemically regulated banks had done well (risk-wise) but that the much of the risk had been transferred and still existed somewhere. "Where did it go?" she said and wondered (from the regulatory risk management point of view):"Have we done more damage than good?" These questions are always answered retrospectively.

@KJP
Your question about the cost of brick and mortar units and the relevant deposit funding aspect is very relevant. Forgetting the chicken or egg question about money creation for a minute and looking at what happened to the loan to deposit ratios over time, overall, at the big banks, growth in deposits has followed growth in loans. Funding from deposits has relative advantages and apart from the four levers of the Holy Grail, banks want a diverse source of low cost funds and diversification as well as FDIC backstop are useful. In the loan and deposit growth however, there has been some decoupling. For the loans, shadow banks (non-bank, online alternatives etc) have gained market share in certain segments. For deposits, the same has happened to some extent but (the last time I looked) US online banks' share of total deposits has increased only from about 2 to 6% over the last 15 years or so. What is interesting is that, traditionally, the growth of deposits has been closely related to the number of physical branches for the largest banks. This link has broken since the GFC, with banks (especially the largest 5 banks decreasing the number of physical outlets by about 15%) while growing deposits by more than 250%, suggesting that they are adapting fairly well to the online threat. Because of the way banking services are bundled, physical branches should be seen as profit centers and not as cost centers and it seems that a restructuring of their physical footprint is not incompatible with significant growth of the deposits. It seems to me that they also could develop online options themselves if the threat becomes significant for some services. So, you have to make up your mind if the physical branches aspect will turn out like Sears (could not adapt), the music industry (unbundling) or something else. I offer the opinion that the big banks will behave more like the pharmaceutical industry in the 70's and 80's. They will continue to offer regulatory collaboration (capture to a large degree) while offering a non-discretionary product, play the game which may involve holding more capital than considered necessary and deal with the occasional entrants by squeezing them or buying them, building an enduring moat.

Spekulatius

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Re: Are big banks value traps ?
« Reply #68 on: October 21, 2019, 03:42:47 PM »
Quote
This link has broken since the GFC, with banks (especially the largest 5 banks decreasing the number of physical outlets by about 15%) while growing deposits by more than 250%,

Isnít the growth in deposits for the larger banks mostly from acquisitions (during the GFC) and not organically? The organic deposit growth doesnít look all that impressive to me.
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wabuffo

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Re: Are big banks value traps ?
« Reply #69 on: October 21, 2019, 05:54:51 PM »
The organic deposit growth doesnít look all that impressive to me.

Spek - you are very hard to please  8)

The big mergers took place in 2008-2009 (WFC/Wachovia, JPM/Bear/Wamu, BAC/Countrywide/Merrill).  If we start the meter for total deposits of the big 3 banks (WFC, BAC, JPM) at year-end 2010 vs latest Q (6/30/19) -- this is all organic growth.

WFC went from  $ 847B at y-e 2010 to $1.346T at Q2, 2019.   +59%
BAC went from $1.038T at y-e 2010 to $1.441T at Q2, 2019.   +39%
JPM went from  $1.020T at y-e 2010 to $1.606T at Q2, 2019    +58%

IMHO, deposits in the banking sector grow largely due to two major factors:
1) net credit creation
2) federal spending in excess of taxation

Both of these factors create net, new deposits in the US banking sector.  Deposits continue to grow, though they have moderated in the last 18 months or so.  The big banks continue to take deposit share from the small banks, though even the small banks are growing deposits (just not as fast).

wabuffo
« Last Edit: October 21, 2019, 05:57:37 PM by wabuffo »