Looking For Trouble with Anton Schutz

All right, it’s February, and Plugged In is up and rolling in our Scottsdale studios.

I’m your host, Al Dominick. Normally, I’m joined in the studio by my man Steve Williams. He’s out on the road, so I found an incredible replacement, at least for today.

This is Anton Schutz. Anton, welcome to the show.

Always a pleasure, Al.

It’s always a pleasure.

Anton is an avid sportsman, a connoisseur of wine, and someone who founded Mendon Venture Partners, a venture capital investment firm focused on the intersection of financial institutions and technology companies.

He brought a few wine selections for us to talk about later on, but he’s also doing some pretty cool stuff with Mendon.

It’s really cool because it’s a fund where the investors are banks and the investments are for banks. It completes this virtuous circle of finding a great investment, making a bank better, a bank using it, revenue going up, and the company getting more valuable.

It really is virtuous in terms of its function.

Banks are also part of the due diligence. When we find something interesting, we’ll bring it to a bank and ask, “Can you use this? What do you think?”

It’s really critical that it’s functional.

One of the reasons we put Plugged In on the map was to help executives who are thinking about what’s coming up and how they can prepare themselves for the next six to nine months.

Anton is someone who is so well-versed in the financial industry. He’s been doing things for and with banks for a long time, so his perspective is one that we want to draw on.

Coming on the heels of Bank Director’s Acquire or Be Acquired conference and Janney’s investor event, we were able to hang out at both of those.

I want to talk to you a little bit about some of the key takeaways. We’ll do that by framing the conversation, like we always do on Plugged In, with some great references to some very cool tracks.

The first musical reference I’m going to use is “Owner of a Lonely Heart,” because “you always live your life never thinking of the future.”

Yes.

Right? Yes is the name of the band.

So you love this.

Yes, indeed, it is the name of the band.

I was thinking about using this because Tom Michaud, the CEO of Keefe, Bruyette & Woods, opened Acquire or Be Acquired, as he always does, talking about how his firm is starting to model a softer landing, not a soft landing.

I’m curious, as we think about this desire to hop into a quick recession, how do you think about this given all you see across the industry?

You can’t find the losses right now.

You talk to every bank and ask, “What do you see? What are you afraid of?”

They can’t see the losses on the credit side.

I don’t think the credit, at least from a new perspective other than the subprime space, which most of the banks have avoided, is where we’re seeing cracks. They learned their lesson from 2007 and 2008.

I think employment being so strong has certainly created some stability.

I think onshoring has created a lot of activity in the manufacturing space.

Quite frankly, I think the end of the COVID benefits, potentially things like Medicaid, can bring people back to the workforce.

I think that actually could reaccelerate the economy as people come back in, but hold down wage pressure.

Well, we can certainly cross our fingers.

A great strategy I like to use is just hoping for the best.

So, if that’s Yes’ “Owner of a Lonely Heart,” let me pivot over to a 1992 classic by Screaming Trees. This is “Nearly Lost You.”

You’re going to have to go onto our Spotify playlist to listen to this one, but I think “Nearly Lost You” lines up with some of the M&A conversations taking place right now.

We’re in a quiet period, and this is an industry marked by consolidation.

If we pull back and look at the last 20 years, we went from 15,000-plus institutions to under 5,000 at the moment.

When we talk M&A, nobody’s really that optimistic for the near term.

How do you make sense of what the year might look like?

You have a sort of latent desire to have M&A for lots of reasons.

People have underinvested in technology. You have people who don’t have the right deposit structure. You have people who don’t have the right plan, period.

By the way, you always have CEOs who age out and get to a point where they ask, “All right, who’s my successor? Let me move on and find a partner.”

Then there’s that need to spend and cut costs.

If you want to invest in technology, sometimes it’s better to partner with somebody, cut costs, and use those savings to invest.

There are lots of drivers here, but you’ve got a couple of things working against it right now.

Part of it is the price of securities. AOCI is a really big monster under the bed, and it’s a monster.

Marking that portfolio and taking on that interest-rate risk is one thing. Taking on another bank’s credit risk is another.

We talked about credit. Nobody sees it yet, but everybody’s afraid of somebody else’s credit. That’s a detriment to M&A.

On the larger-bank side, I think the regulators really are taking their cue from Washington, D.C., and they’re slow-rolling deals.

People are afraid because it takes a long time to complete a deal.

When you announce a deal, your workforce sits there and waits, and there’s a lot of disruption.

It would be nice to know with some certainty that a deal will get approved or have a certain timeframe in which it gets approved.

I think smaller deals have a much better chance of closing on a quicker basis. Again, it always does depend on the regulator, but clearly that’s a tough environment.

I do think in the back half of the year, and perhaps later, when there’s a little more clarity on what interest-rate policies are and what credit quality is looking like, M&A will pick up.

You’re basically bottlenecking M&A that was going at 4% to 6% a year over the last few years and freezing it cold.

I think there’s definitely that latent desire to do it.

Growth through acquisition was the primary catalyst for many institutions. They’re going to find other opportunities to pursue size and scale.

You talk about regulatory concerns and compliance challenges. These are familiar to most listeners.

When it comes to M&A, it strikes me that a lot of people are parroting the old adage, “Banks aren’t bought. They’re sold.”

I wish I had a dollar for each time I heard that this week.

I said it earlier today.

I’d be a rich man because it seems to be one of the lines of the week.

So let’s think about growth.

If it’s not going to be through a bank-on-bank deal, it’s probably going to be looking at some organic expansion opportunities, which is where Mendon Venture Partners comes into play.

If we roll back the clock and go to our good friend Patty B., as in Pat Benatar...

Oh, I knew what you meant.

“Love Is a Battlefield.”

For the last few years, fintechs and banks have been trying to dance with each other in some creative ways.

Last year, with the massive pullback in fintech valuations, there was almost indiscriminate carnage across the industry.

I think there’s an opportunity for banks and fintechs to look at each other a little differently and realize love doesn’t have to be that battlefield. It might actually be a really healthy thing.

Talk a little bit about the types of tech companies that get you excited when you think about their potential to help expand a bank’s franchise value.

Sure.

I’m actually going to step back and talk about the word “fintech.”

It’s come to represent companies that originate loans and fund on the wholesale market.

You think about companies like Afterpay, Affirm, Upstart, and SoFi.

SoFi got a bank charter. They’re one of the few.

But from a funding perspective, that word “fintech” kind of means not a bank and not having funding advantages.

It also suggests that their credit has a better mousetrap.

The data is vast, but it’s still limited. It’s not typically gathered during stress periods, and we’re seeing some real problems right now in that space.

The valuations are lower for a reason. The funding doesn’t exist as well.

Some of those companies I just mentioned may very well end up as divisions of much bigger banks that have the ability to diversify that type of business as well as fund it.

In terms of what we’ve looked at, we’ve not gone for the shiny object.

We’ve not gone for the “build a better mousetrap” in lending from a credit perspective to mass-market consumers.

What we have done is gone for things that make companies operationally better.

We’ve invested in things like wealth technology.

We’ve invested in things that allow consumers to communicate with their bankers through video and AI, choose who they speak with, and actually get relationship managers online.

There have been some really neat cost-saving things.

Fraud prevention is certainly very important. The bad actors have created a lot of trouble.

Big data is a big catchphrase, but there are so many applications in the banking industry, both offensive and defensive.

There is a wealth of opportunity out there for banks to improve efficiency and improve their battle plans going forward.

You’re talking catchphrases, and it lets me pivot to Talking Heads and one of my favorite songs, “This Must Be the Place.”

For so many catchphrases in the tech world, it starts with “digital” and ends with “transformation.”

At least here at Cornerstone, we see a lot of initiatives that are really more digital in nature than they are truly transformative.

That was one of the big takeaways from Acquire or Be Acquired.

Help me understand this ChatGPT moment that we’re in, where AI and some of the more advanced technologies pique your interest and should at least excite the transformative nature of bankers.

Well, as long as we’re not “Burning Down the House.”

It’s really important for banks to understand that this AI is real.

In many ways, there’s still a lot of human interaction that’s going to need to happen. It’s still in its early stages.

I do think efficiency ratios are going to come down.

I think the number of employees at banks is going to come down because a lot of the guts of a bank, from an operational perspective, are driven by technology.

A lot of those processes are driven by technology and people together.

If AI takes the place of people, it’ll certainly help improve efficiency ratios.

I think on the people front, that’s one of those areas for 2023 that I get excited about.

When I think of certain efficiencies that can be created, that allows you to reduce certain expenses and redirect them in different directions.

If you have a team that’s got an appetite for change and has the leadership support to give cover to their growth, all of a sudden you’re going to build some redundancies into your organization that may not have existed a few years ago.

I think that’s where technology can be a catalyst for the type of change that you’re looking for, as long as you don’t forget that technology is just a tool and a means to an end.

Yeah.

We’ve seen things like branch-based technology. We’ve seen the ITMs. We’ve seen all sorts of things that make it easier for a customer in a branch to do things.

But in the regulatory environment we’re in, shutting a branch is pretty difficult.

So what do you do with the employees in the branch who have to be there and are not busy?

There are technological tools to actually have them be available to their customers or other customers through tools like Agent IQ, where they can literally plug in, be the relationship manager, and help solve problems for people across the whole system.

I think there’s a way to repurpose the employees in that branch to help the entire organization.

I think this ties into the whole concept of earnings, efficiency, and agility, and how all three really are interdependent.

If you can help your team become a little bit smarter about where they’re using their time and what they’re focused on in terms of potential outcomes, that’s a real win.

Exactly.

We’ve been a few places in the last few weeks. We’ve had a chance to talk to some really cool folks.

I’m going to use Fleetwood Mac, because everyone loves Fleetwood Mac, and the great song “Everywhere” as a way to bring it into the takeaways from the last week.

I was thinking it’s deposits, deposits, deposits.

I’m sure you’re going to bang the table and say the same thing.

Were there any themes or trends that you took away from either the Janney event or the Acquire or Be Acquired conference that, if you weren’t out in the desert, you probably need to pay attention to?

I talked about it earlier: credit quality.

You’re just looking for the trouble. You’re looking for the mistake.

I think the fact that nonbank lenders have such a share of lending is important.

I think Tom Michaud put it very well from KBW in terms of the slides he put out.

There’s such a market share of unregulated lending.

I think the law of unintended consequences is real here.

Things like Dodd-Frank and the actions regulators have taken have driven a lot of lending outside the banking space, and there are really some dangerous practices out there.

If we do get into a deeper recession, it’s not the banks doing it.

It’s not the products that were around in 2007 and 2008. It’s not those lending practices.

The banks are scratching their heads, asking, “Where are the lending problems?”

They’re not necessarily inside the banking industry.

However, some of those lenders that have been doing dangerous things do borrow money from banks.

There is some potential systemic risk, particularly to the bigger banks that lend to some of those players.

I was struck by how many people were really focusing their comments on the small- to midsize-business sector.

In the past, when we’ve talked technology, it’s been more consumer- and retail-oriented.

This year, there seemed to be a very clear drive to say, “We have a segment that we know well.”

Whether it’s through the PPP rollout from a few years ago, where we started to earn trust, or where we are today, we have opportunities to serve in a way that is going to be memorable, repeatable, and profitable.

That’s not a bad thing for a capitalistic society like ours.

Profits are what drive a lot of these management teams.

If you really think about it, the customers appreciated what banks did in times of crisis.

They were there for their customers. They worked midnight shifts getting PPP loans approved.

I think the service quality of the smaller banks is really critical to their success, and that exists today.

The bigger banks are working on a lot of bigger-type situations.

I will tell you, the regulators have their eyes on the big banks.

They’re going to have to raise more capital. They’re going to be under a lot of scrutiny.

We’ll see about the CFPB. We’ll see what the Supreme Court does.

Clearly, they went after the credit card companies this week, and we’ll see how that continues to move down the pike.

The old Chinese proverb, “May you live in interesting times,” continues to apply to our industry.

I’m going to take us home with a little Foghat and “Slow Ride.”

If you’re able to watch a snippet of this, Anton is an incredible wine collector and knows that I’m something of a cork dork myself.

He’s got some bottles here.

I just want him to describe this one with an American flag.

This is from Pride Mountain Vineyards, and I think anyone should hear this because it’s a great story about a company that really cares about the country.

They really do care about the country.

They first had that bottle made right after the aftermath of 9/11 for Windows on the World.

They had fundraisers for the families of their employees who lost their lives, and they actually had the top bottle at their auction.

They said, “Wow, we’re onto something.”

So they made a bunch of these bottles for auction and donated them to lots of charities trying to help people.

Finally, they decided, “Wait a second. These are pretty popular bottles. Maybe we ought to think about actually selling some of these.”

Their attorney said, “There’s no way you’re going to get permission to put an American flag on a bottle. You are not legally allowed to put an American flag on containers of alcohol of any sort.”

So they called their trade association and said, “Can you please go to the Bureau of Alcohol, Tobacco and Firearms and get us an approval?”

Their representative said, “No, they’re never going to approve this.”

They said, “Listen, we pay you a lot of money. Please go do it.”

So they walked across the street, and clearly the person over there had to be in a patriotic mood. They stamped the application and approved it.

That is one of the neatest bottles.

By the way, the wine in there is really terrific.

They’re on top of Spring Mountain.

They had a tragedy themselves where, during some of the California fires, their whole bottling room and everything burned to the ground.

They’ve reconstructed it. They’ve come back, and they make some great wine.

Well, there’s some good juice sitting right here.

We’re going to juice it up here on Plugged In whenever we can with some unexpected comments like this.

Let me send my thanks to everyone who’s listening and watching, and to Anton for joining us.

This wine is tempting me.

Again, Cornerstone appreciates getting Plugged In whenever and wherever we can.

I’m Al Dominick. We’ll catch up with you again as soon as we possibly can.

Thanks.