Why Doesn't Wall Street Believe in Banks?

The banking industry is much stronger now than it was the last time the U.S. economy had a significant downturn. So why isn't that being reflected in the stock prices of publicly traded banks? 



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Questions? Comments? Email Jim Young at jyoung@precisionlender.com


Jim Young: Hi and welcome to The Purposeful Banker, the podcast brought to you by PrecisionLender. We discuss the big topics on the minds of today's best bankers. I'm Jim Young, Director of Content at PrecisionLender. I'm joined again by Dallas Wells, our EVP of Strategy. The title of today's podcast is Why Doesn't Wall Street Believe in Banks? And this is at least partially inspired by a recent Banking Exchange article titled US Banks Punished by Investors During Pandemic. So, Dallas, when the economic impact of the pandemic first began to set in, we initially talked on this podcast about how banks were positioned during that time upcoming economic downturn, as opposed to 2007-2008. So I'm wondering if first you can recap that comparison for our listeners.

Dallas Wells: Sure. And I think the quickest way to summarize that is that, that 07-08 downturn was really, for lack of a better way of putting it, caused by the banks. And so not necessarily anyone's direct behavior. But the issue started in the banking industry. It was a credit driven issue. That's why it was called the financial crisis. So it was a debt bubble. The banks just toppled over and they had these big gaping holes in their balance sheets and therefore in their P&L's, and as they pulled back, it caused the rest of the economy to suffer.

So, the banks were really weak as the rest of the economy then started to slow down and we went into a classic recession and you had wounded banks as we entered that. This time around, the banks were rock solid coming off a decade plus of really, really solid returns, a good healthy credit environment and all of the regulatory reforms from the financial crisis, which were really painful to get through, but they did leave the industry in a really strong position.

Now you do have a recession that has set in, we'll see the length and extent of it. But there clearly is a recession brought about by the pandemic and all the shutdown of the economy, but the banks were really healthy coming into it. So they weren't already wounded, really high capital levels, really healthy loan books, pretty solid credit practices across the industry.

So, coming in, in really good shape and not just able to withstand the storm, but actually able to step in and help a lot in the early days and be really flexible in this environment for a lot of their borrowers. It's really night and day difference from those two crises and the industry's position coming into them.

Jim Young: Okay. All right. So given that banks are much healthier now and given that the S&P at least has largely rebounded from the early days of the pandemic. And I know that you can make an argument that Apple and a couple of them are really the thing that's dragging it up, but still, it seems striking to me that banks really are not being given a vote of confidence here by investors. Why do you think that is?

Dallas Wells: You touched on it a little, but there is a big disconnect between the equity markets and the actual underlying economic metrics. And it's because this pandemic and all the societal fallout from it has had really different impacts on different industries, different companies. So over the last few years, the markets have become pretty tech-centric. So, the top four or five tech companies in the world have just become an outsized portion of all those equity market indices.

There has been a big bull recovery in the markets, but hasn't had a lot of breadth to it. So you've got Amazon and Apple and Facebook, et cetera, at all time highs and as they go, so the market goes. But you have a lot of other companies, not just banks, but a lot of other companies that are not doing as well.

They're down 20%-30% from the pre-COVID highs of January and February. So there's not this like, everybody's leaving the banks behind in terms of equity prices. So that's part of it, is that this is a very tech driven equity rally, and that the banks look like the rest of the economy. And the banking industry is an extremely cyclical industry, maybe the most cyclical business that there is, just by its nature.

When the economy is weak, I think investors get leery of how bad is this going to be for the banks. And that leads to another issue of two or three things that get added to that uncertainty. It's always a little hard to tell how the banks are handling it because there's kind of a lag in, a borrower gets a little wobbly and then they get slightly past due, and then they get really past due. And then it actually hits the bank's books as a charged-off loan. And somewhere in there, the bank will start to set aside some money for those things that they see going bad, but there's definitely a delay to it.

So, on top of that, we had lots of government intervention this time. So, the giant CARES Act, PPP loans for business borrowers, direct payments to consumers. You also have the banks being encouraged to institute forbearance programs. So lots of loans just got pushed pause on them. So no payment's due. We don't really know how many of those deals are bad yet, the banks themselves don't know. And so I think there's a lot of wait and see from investors.

Throw some CECL into that, where you had banks starting to do CECL method for their loan loss reserves in the first quarter. So, you had banks using new methods. So that's another thing that investors aren't quite sure what to make of that. And then you have near zero interest rates. So, on top of all the credit issues, you've got record low net interest margins and really no relief in sight. So, I think that's why you see a lot of investors just saying, "There's lots of momentum in the market in some other places, there's other places to get return. So we'll just wait and see on the banks until we know how ugly it is." So the fundamentals in the markets are disconnected in lots of places here.

Jim Young: Yeah. And maybe that answers my next question, which is, shouldn't all these arguments for why banks seem to be a bit shaky investment be applied to basically other stocks? You know what I mean? In other words, if banks sneeze, shouldn't it be the rest of the economy catching a cold? I mean like the reason that their credit stuff doesn't look great is because other companies are struggling right now.

Dallas Wells: Yeah. And there's lots of pundits scratching their heads over that like, "Why on Earth should Tesla be up several multiples over its market cap from just a few months ago?" This certainly doesn't seem like a better environment in which to sell high-end electric cars. But I think there'll clearly be some winners and losers from all of this. And I think that's partially what some investors are making bets in and banks have just fallen on the wrong side of that.

But I think that absolutely that logic could be applied to a lot of those. And that's a little bit what we talked about earlier of the breadth of this market rally is pretty weak actually. There are a few outliers, there's the Teslas and Amazons and others who have had these massive rallies. Some of them justified, some of them, I don't know, maybe not, we'll see. But there's lots of other companies that are struggling as investors wait to see what's their business actually look like on the other side of this. And just as important, how long does it take us to get to the other side. Do we ever get to another side? Or are some things fundamentally changed? Things like business travel and the hotel industry and restaurants and you're talking about some kind of existential questions about some of those.

Jim Young: Yeah, yeah. One of Carl's favorite things to talk about and he usually directs us at the banking industry. He talks about fighting the last war. I.e. applying lessons from the last thing that happened to something that's happening now, that's fundamentally different. And in this case, I'm wondering if, is there any element of that, applying lessons from the financial crisis, to something else it's really a black swan sort of event.

And one thing going through this, it was Kroll Bond Rating Agency, they did a report on this and they conducted their own stress tests on this. And they used losses of the degree experienced during the global financial crisis, reading that directly off their report. And it showed investors expect banks to be hit hard, but the industry is way more robust than those beliefs imply. And I'm wondering to what extent this is just, like I said, the case of, is there any evidence, I guess maybe, that people are applying prior lessons that shouldn't be really applied in this instance?

Dallas Wells: I think they absolutely are applying some of those old lessons. And I think that's especially true because we don't have any idea of how else to do this one. So all the banks are all running their own credit models and they're using trends from prior recessions and trying to plug those in there. And this recession doesn't look like anything we've seen before. It really is truly different.

Every recession has a little bit of a different flavor to it and it centers in different industries. But they at least rhyme. This one's been truly an anomaly. So when the banks' own internal models, where they have a full view of what's actually going on, can't capture all that. I don't think investors have any hope of, like an outside agency trying to do these stress tests. All they can do is take loss rates from last time and plug them in. But those are not the places where the... Residential real estate, banks had massive losses in those last time. That doesn't seem to be a problem this time, even mortgage delinquency rates are actually not that bad. Lots of forbearance still, lots of things that are still a little bit uncertain, but largely unscathed.

So applying those sorts of things to a bank balance sheets, and yeah, they look okay, we're still waiting to see where the losses will show up. So what the banks are trying to do is trying to incorporate more forward-looking things, seeing some interesting things happen of, as deals get done, some of them are asking for borrowers to have their independent accounting firm basically do a certification of this is viable, ongoing business. And we're doing some forward-looking projections based on trends from the last 60 days.

They're trying to take COVID operations and say, "Can they survive at this kind of a run rate for the foreseeable future?" And that's a really unusual way for... Banks have always relied a little bit on proforma projections to make decisions, but they largely have to throw away the old historical information and everything is proforma. And they're trying to incorporate some kind of outside independent reviews of that. And it's just new motions that I think the investors will have to catch up with also to see like, "Is there really risk or are we okay?"

Jim Young: All right. I want to pivot this a little bit too. And this is sort of the fun of when your bank is publicly traded or really the fun of any time you're trying to run a publicly traded company in which you've got sort of the way you'd like to run things and the long-term strategy you'd like to adhere to. And then what investors want you to do and the influence that they can have on that.

And it just struck me. I just saw a recent article and it was one of those call reports. The bank's CEO was talking to investors and really giving a hard sell about, "Man, we're going to be able to cut a lot of, we've got big goals." And it just sounded so disconcerting. "We got big goals on cutting expenses."

And this is tricky ground, I admit. Because, look, full transparency here, sometimes those expenses for banks are software purchases. So, we come at this not from a totally unbiased angle, but still I want to get your take on the concern that, in this coming quarter and maybe coming quarters or however long this lasts, that there's more of an attempt to satisfy Wall Street that might not actually be the best long-term strategy for the bank.

Dallas Wells: Yeah. And this environment is especially susceptible to that issue. So the classic playbook is when recession comes and there are losses and declining revenue, you cut expenses and Wall Street generally responds pretty darn well to that. So you can do some, you start with the easy cuts and they eventually get more painful, but you just cut until you get to the other side. And honestly, a lot of banks come out on the other side in better shape. They're leaner, they're kind of in fighting shape, then ready to jump into growing again, as they get healthy and as the economy gets healthy.

Especially after a 10-, 12-year run, banks have, they generally still operate pretty efficiently, even though there's been a decade of good times, but there is some fat that can be trimmed. That's always inevitably true. So, I don't want to make a blanket statement that cuts are bad. But I think it's where you see it as, in this environment, now banks are saying, well, even those that were better prepared than others are saying, "We got caught a little flat-footed where we still required signatures on some things and to see people in person to do certain kinds of transactions. And when that became not possible, there was some investment that had to be sped up."

So you're having to cut expenses on one hand, but also make some, in some cases, pretty big investments on the other hand to really be able to properly serve your customers. And I think where you see that split direction, Bank Director does a tech survey every year, the results that just came out, I'm sure we'll talk about it at some point.

But one of the questions they were talking about is, what are the top priorities? And the top two were make the bank more efficient and improve the customer experience. And sometimes those things line up and sometimes they don't. So I think this is a real struggle that executives have to figure out how to balance those two, of how do we invest for the future. And in some cases, how do we pull some of that future investment forward? Because we got to do it right now, sooner than we thought we would. But also I have to overall cut some expenses.

I think that's where you'll see more branch closures, not just because of the real estate expense, but because of the staff that it takes to run those. I think you'll see some reduction in office expenses, you'll see the usual things happening. But I think the tech investments won't actually get cut this time around. I don't think they can. But this is, I think that's part of why you're seeing bank share prices stay down the way they have is a lot of banks haven't yet come out and said, "We're just going to cut and we're going to cut our way to profitability."

A lot of them have just said, "Yeah, earnings are going to take a hit for a while. Because we have to be prepared for the recession and we also have to make some investments to make sure we can serve our customers properly." So I think they're doing a pretty good job of taking the long-term view and Wall Street doesn't love it yet. We'll see who blinks first.

Jim Young: Yeah. And I guess that was sort of my final question is, and you've experienced a little bit of this when PrecisionLender was a smaller private company with the board. But the board plays a big role in this. And I guess that would be my thought is that it would seem to me, it would be critical is to have a board that sort of can be patient with you and understand that, "Hey, I know you're doing it the right way. I know Wall Street doesn't view it that way, but I think they'll come around to it. And I'm behind you on that sort of thing." Versus, "Hey, I own a large chunk of stock in this bank and you are costing me money right now."

Yeah. And I think you'll see banks pointing to their peer group a lot trying to say, "I know Wall Street doesn't love this, but they don't love any of the banks. And so, we're doing what we can with it and it'll come back around." Look, this is why it's easy to look good when times are good. It's the rising tide lifts all boats kind of thing.

So lots of management teams have been looking pretty good. Shares were going up, earnings were going up, balance sheets were strong. This is where you actually test the metal of those management teams. And there will be some winners and losers here. And so what I think you'll see is you'll see how much confidence do the boards really have in their management team and how much leeway do they give them.

If you're Jamie Dimon at JPMorgan, I'm guessing he can do what he thinks is right from a long-term standpoint. He's not going to lose his job over a couple of bad quarters and the share price being down for six months. There's been lots of turnover at Wells Fargo. They may just have a shorter lease just because of the different dynamics and what's been happening besides us.

Those are the big names that applies all the way down to the smaller ones as well is, do you have a track record of surviving these things and if you were here through the last crisis, then you can say, "Look, we navigated it. We made long-term decisions. Everybody made out really well because of it, be patient." I think a lot of banks will lean on that credibility that they've built over the last decade or so of weathering a storm and getting stronger through it. They will have to get the patience that they need to make it through what will inevitably be a pretty rough time for the industry.

Jim Young: Yeah, absolutely. All right. I feel like I almost should close off here with that standard stock disclaimer about past results, future performance and that sort of thing. But, trust me, if you've been using this podcast to do your investment ...

Dallas Wells: ... Yeah. I wouldn't recommend that.

Jim Young: Yeah. All right. But that will do it for this week's show. Dallas, thanks again for coming on.

Dallas Wells: You bet. Thank you, Jim.

Jim Young: And thanks so much for listening. And now for a few friendly reminders, listen to more podcast or check out more of our content, visit the resource page, PrecisionLender.com or just head over to the homepage to learn more about the company behind the content. If you like what you've been hearing, make sure to subscribe to the feed in Apple Podcasts, Google Play, or Stitcher. We love to get ratings and feedback on any of those platforms. Until next time. This is Jim Young with Dallas Wells. You've been listening to Purposeful Banker


About the Author

Jim Young

Jim Young, Director of Content at PrecisionLender, is an award-winning writer with experience in a range of positions in media and marketing, from reporter to website editor to content marketer. Throughout his career Jim has focused on the story – how to find it, how to understand it, and how best to share it with others. At PrecisionLender, he manages the many ways in which the company shares its philosophy on banking and the power of relationships. Jim graduated Phi Beta Kappa from Duke University and holds a masters degree in journalism from Columbia University.

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