Transcript
Coming up on a very special episode of Cornerstone Advisors’ Plugged In.
I’m Al Dominick, joined by the incomparable Steve Williams.
Yeah, and we’ve got a powerhouse guest today. I’m talking about the man, the myth, the CEO of Keefe, Bruyette & Woods.
That’s right. We’re talking about the business of banking and leadership with Tom Michaud.
Tom, what’s happening?
Al, good morning. Thank you for the very kind introduction and for keeping expectations really low for me.
Tempering expectations, because here’s a guy that I’ve known for quite some time.
I’ve had the great fortune of being able to introduce him on stage at various places, but this is only the first time in Plugged In history we’ve been able to welcome a guest back.
So Tom’s making history by being our first two-time guest on this bank-leadership-focused series.
Steve, can we give him just a little round of applause for being so bold?
Snaps for the sorority girls.
All right. We’ll snap it out with Tom throughout this episode.
Two-time guest. Quite the accolade.
When Tom joined us the first time, a tradition was born on Plugged In.
We’ve remained super keen on bringing you insights from standout executives in the banking space, but we decided this Cornerstone twist that Tom was party to in the beginning has to continue.
We’ve been diving into some classic tunes that really echo the rhythm of our conversation.
So I know Tom’s excited to see what music we’ve pulled for him this time.
Is that a fair assumption?
I will admit it. I’m a Yankee fan, and I spent many decades knowing which reliever was coming into the game by the music.
So I look forward to seeing what music is going to be played.
Tom’s always teasing me.
That’s why I carry my Red Sox hat close by.
We’re not pulling any “Enter Sandman” by Metallica, as great as Mariano Rivera was.
We are going to limit the Yankee stuff we’re doing.
No Dropkick Murphys, because the Red Sox aren’t coming to this conversation.
We really are getting into the business of banking.
The way I thought we could get up and rolling is to remind Tom that the song that really started this whole thing off came from U2 and their album Achtung Baby.
There’s a song that asks the age-old question, “Is it getting better, or do you feel the same?”
We thought we’d merge industry insights with lyrics like these to get Tom’s perspective on things.
You and I have been to various events over the first few months of the year.
I was just down in Boca at your Winter Financial Services Conference.
What are some of the bigger themes or takeaways that fell into your notebook that you’d be willing to share with us?
Well, my first takeaway, and yes, we had our biggest Regional Bank Conference ever last week.
We had close to a thousand attendees, and it was our 31st annual.
The first takeaway was that demand from investors was high.
We had great turnout from the institutional investor community, and some of the biggest long-only owners of bank stocks in the country were there.
So I think that was the first takeaway.
Interest is really high in this group.
I think that’s for a couple of reasons.
Number one, don’t forget the stocks had a 35% rally from the end of October to year-end.
That got everyone’s attention.
I also think there’s a view that we’re at a turning point on a variety of fronts.
One of the turning points is a really good one.
We think revenues are going to start growing again by the end of the year.
We’re going to have a little bit of exit velocity as we come out of 2024.
That really speaks to the heat probably coming off competition for deposits, and banks starting to get some net-interest-income growth going again.
So I think that’s one shift investors were interested in hearing more about.
I think the other shift, though, is there’s a sense that we’re in the earlier stages of a credit cycle.
Now, this credit cycle, in our opinion, is a normalization of credit costs.
Al, you may have heard me say in the past, the surprise when credit costs go up shouldn’t be that they’ve gone up.
The surprise should be how long they’ve been zero.
No bank can run its bank and underwrite to zero risk.
It just doesn’t happen.
We’ve got 25 basis points of provisions in our models for this year.
That probably is still below the over-the-cycle average.
So it could go higher from there.
I think investors want to get a feel for what’s happening, especially in the area of commercial real estate.
Yeah.
I want to ask you real quick on that.
Are investors digging into the numbers?
You hear a sound bite where someone says there’s a trillion dollars of value loss in CRE, and there’s this big office in San Francisco or Manhattan.
But if you dig into a lot of the regional bank numbers, there’s this percentage of office at a 50% loan-to-appraisal ratio, with guarantees and cross-collateral.
Are investors digging into that to demystify some of this risk?
What I try to speak about is that there is not one brush for the whole painting of the industry.
I personally believe that there are three banking industries.
There are the top 25 banks.
There are the midsize banks.
Then there are the 97% of banks in America that are below $10 billion in assets.
So there are really three different industries, and they all kind of do different things.
The same thing applies with commercial real estate.
Wells Fargo has over 10% reserves against its urban large-office buildings.
That’s completely different than what an Indiana regional bank is going to do.
Their median loan size is going to be a lot smaller.
The chances of there being a personal guarantee are going to be a lot higher.
The chances of that building having tenants that include medical, legal, or local businesses are higher.
That’s not to say there won’t be losses.
Another way to look at it is you have to look at the 2020 and 2021 originations, when interest rates were near zero.
You have to look at what kind of growth happened there.
You have to stress-test those portfolios for current rates.
That’s just a math conversation.
There will be challenges in those markets, but I just don’t think the final outcome will be the same as what you read about in these big cities.
And don’t forget the influence of nonbanks.
We think at least half of that credit you just mentioned is owned by nonbanks.
It’s inside CLOs and CMOs, insurance companies, and private credit.
Banks aren’t the only owners of those mortgages.
Thank you.
Yes.
That’s a great question.
I keep hearing it brought up in public settings and private ones.
The whole CRE concentration risk, people take the broad brush to it.
I like Tom’s response because I’ve been hearing different bank CEOs that are publicly traded say, “Hey, let’s not confuse where we are with where this market narrative has been drawn.”
I had one great CFO last Friday say, “I had to explain to my investors how many of our offices don’t have more than two floors.”
These are suburban medical offices.
They’re solid.
The average loan might be two or three million dollars on these things.
I was with a Montana bank CEO recently, with a group of folks, and we were talking about business.
I asked him, “Can you tell us a little bit about your rent-controlled mortgage portfolio?”
He said, “Oh, you mean the one with zero dollars in it?”
I said, “Yes, that one.”
Well, we won’t guess the name of that executive, but I’m sure we could throw a few darts and see.
Tom, you acknowledged that we’re going to pull some music out.
There’s a song with the lyric, “Every single one’s got a story to tell. Everyone knows about it.”
It’s sung by Jack White.
This is “Seven Nation Army” by The White Stripes.
I had to pull this one up because everyone’s got a story to tell.
Like you just acknowledged, Tom, it depends on whether you’re an individual or looking at the industry.
But one of the stories I think we should talk about is how scale is working while consolidation has been on pause the last few years.
I pulled this directly from a slide I saw you present.
I thought you put that up before Capital One announced its acquisition of Discover.
Can we unpack this key point with some current perspective?
Absolutely.
Also, I have to tell you something.
I said to my firm, take a close look at the investor deck that Capital One presented.
As somebody who makes those for a living, I know how many versions of that deck there must have been before they had the final round.
I can tell you a lot of really thoughtful individuals looked at every word in that deck.
So when you look at it, there are not a lot of accidental comments, in my opinion.
I looked at the first page for investors, where they said the reasons why they did the deal.
Bullet point number one was scale.
Bullet point number two was to build a competitor for the largest banks.
That’s exactly what I’ve been thinking and saying.
Scale has been working, and we need more competitors for the big four.
If there is no consolidation, we will be sitting here saying these are the four big banks we’re going to have.
They will probably grow faster than the rest of the market and become even bigger as a percentage of the industry in a couple of years.
The nonbanks will be bigger too.
I had a chance to read the speech Acting Comptroller Hsu gave when he came out with his new M&A regulation proposal.
It was interesting because he did get to a theme that I think is important.
We have to stop talking about the industry we don’t want.
At some point, which I think is now, we need to talk about the industry we do want.
What do we want banks to do?
What do we want the industry to look like?
Rather than dismantling it activity by activity, one at a time, let’s talk about what we do want them to do.
He introduced that topic in that speech.
But in that speech, he never once mentioned nonbanks.
Remember, banks have been losing market share to nonbanks really ever since Dodd-Frank came into play.
That’s been de-risking the banking industry, and the activity has been going somewhere else.
I believe there are going to be very big ramifications if this continues to play out.
We will get to a point where small business will be yelling that they don’t have proper access to credit.
You could have midsize banks not in a position to service them like they have in the past.
That’s one example.
With regard to the Discover-Capital One deal, which we’re not an adviser on, so I’m free to speak about it, yes, they are doing it for scale, as well as to build a competitor for the big four.
Then there’s another piece to it, which is the nonbank piece.
Discover has one of the four networks that matter.
The two dominant ones are Mastercard and Visa.
Then you’ve got American Express, which is very important.
Then you’ve got the fourth-place finisher, which is Discover.
Imagine if Apple bought that.
That could be split out and sold to Apple.
There’s this argument about, “We don’t need bigger banks.”
Would it be better if Apple bought it?
If Apple bought it, then this whole thing could be turned in a different, nonregulated direction.
The outcome could certainly be anything.
I can’t determine exactly what the outcome would be.
My own opinion is the banks are regulated.
They have supervision.
Better to have this activity in a regulated environment and allow competition rather than draw the wall so high and not allow consolidation, so it is forced to go outside of the umbrella.
So, in my opinion, it’s good that a bank has bought that.
I agree with you.
If we take all the risk out of the system where no exams take place, because when you move all things into the shadow-banking industry, yes, there’s governance, but there’s not the good old regulatory exam.
That’s a big part of how we keep an eye on things.
I don’t think policymakers get that.
When they think they’re de-risking, they’re really just moving it.
I’ll add my two cents.
I think the important element there is the charge for a bank versus a nonbank is different.
I hope no one thinks I’m saying anything negative about nonbanks.
They’re very good organizations.
They’ve driven a lot of value.
Their market caps are very big.
Many of them are very well run.
That being said, they exist to be fiduciaries for their investors.
If they believe that underwriting credit is a bad idea for their investors, they will cease immediately.
If you’re a bank, you have a different charge to your community.
You have insured deposits.
You have a bank charter.
I think you have a little bit more engagement with your stakeholders to be there in good times and in bad.
It’s a different feel, especially with the fact that you tend to have physical locations in your community.
I think that’s the difference.
If we get to a moment where nonbank underwriters think it’s a bad idea to make loans, we’ll then hear a scream from small business, where half of the jobs in America are, that we’ve got a credit crunch.
It’ll be because the industry changed because of the steps being taken now.
That was really long.
I’m sorry, Steve, but I had to get that off my chest.
That was.
Michaud, you’re exceeding your answer time by about 50%.
Sorry.
I think this is going to come into policy in the next administration as well.
What do we do about this?
I appreciate the answer.
If you really want to ramp up that machine to get more off my chest, FTX was an unfortunate and spectacular bankruptcy last year.
Unfortunately, that CEO has gone to jail for fraud.
There’s been no legislation or changes around the activities that led to that.
Some of those activities have been illegal in the securities industry in the United States since the 1930s.
Meanwhile, we’ve had an avalanche of bank proposals.
It just tells you how the banking industry is the magnet for this type of regulation, and it’s just not a level playing field.
I think I would even argue that the banks would be comfortable with a level playing field.
If you want to see what an unlevel playing field looks like, just look at the mortgage market.
Since the passage of the laws in 2008, banks, which used to dominate mortgages in America, today only make one out of every five.
Twenty percent.
Nonbanks make 80% of the mortgages in America.
That’s due to regulation, not because banks don’t want to do it.
As you two are talking, I’m jotting a few notes down.
Steve and I have heard different folks almost lament the fact that we could be seeing not just four, but maybe 10 mega-banks, and the erosion of the regional and community bank space that we know and love.
So we’re really trying to figure out how to help people stay relevant and competitive in this really precarious time that we’re all going through.
I’ll transition to our next song because we’ve got to keep things light and moving.
The lyrics go, “Is a word that only leaves you guessing, guessing about a thing you really ought to know.”
That, of course, Steve, is who?
I’m stumped.
Good. I finally stumped you after all this time.
It’s Led Zeppelin’s “Over the Hills and Far Away.”
Oh, I love that song.
I know you do.
That’s why I had to say it in such a terrible voice.
If we’re going to transition to that track, let’s explore the continued fallout from New York Community Bank and Flagstar.
Really, what’s happened, and why should we take note so that we can learn from some of the challenges that created the recent misfortune?
Sure.
My opinion is that I started in the industry in 1986 as a credit analyst.
KBW at the time owned a division called BankWatch.
That was during some of the Texas energy banking-crisis period.
It was a great experience for me because I learned a lot of the core principles around risk in banks.
When you look at what’s happened at New York Community or the three banks that failed last year, there are a couple of common principles that I think are worth observing.
One is concentration.
When I learned at Silicon Valley that their top 10 deposit relationships had $13 billion of deposits at the bank, I was shocked.
That’s just not something you normally get as information.
It came out in the after-failure report.
That’s shocking.
Also, when you look at the size of some of the loans that New York Community was making, of course the impact is going to be significant.
When you look at the concentration of exposure by geography, by credit size, or by asset class, I feel like it dramatically changes the risk profile.
There’s something I’ve been saying a lot that I’ve got to make sure I’m cautious about, which is, “Well, this is very idiosyncratic.”
“That’s just New York Community.”
“That was just First Republic.”
“They relied too much on held-to-maturity accounting and fixed-rate mortgages.”
But when you say it enough times, it’s not as idiosyncratic.
I did get a chance to talk to one bank in the New York City area at our conference last week.
They told me that their entire commercial office portfolio could be written off with profits in about three months.
They could write off 100% of those loans.
It’s a diversified portfolio that could never bite that bank on the bottom line because it’s diversified.
So I think there are a couple of core tenets.
When I think about regulation, I’m a little surprised that this didn’t come up earlier with the regulators.
We don’t need more rules.
We kind of need to just look at the principles.
Have core deposits.
Bank profitability matters.
Don’t be overconcentrated.
Don’t pay up for hot money.
Be well capitalized.
These are basics.
So I think it’s good to stay with the banks that are a little bit more traditional.
I would also say something I said last year.
While we had three spectacular, unfortunate bank failures, let us not forget that there were 4,750 that didn’t fail.
Right.
I also think, Tom, when we look at Citizens and New York Community, they were very opportunistic last year as Signature and SVB went down.
To me, I like when people are opportunistic and say, “I think I see value,” and go for it.
I worry sometimes now that people see if you bite off more than you can chew, you might have more blowback than you would have in different times.
I think people are saying, “We’ve got to only bite off what we can do in this environment right now and reduce some of that volatility risk.”
Yeah, 100%.
I should have thrown another principle out there, which is fast growth.
Remember, Silicon Valley grew 85% in one year organically.
That is stressful.
In hindsight, it was a lot.
They might have pulled it off if they hadn’t used held-to-maturity accounting on the bonds, which they probably thought was the most conservative thing they could do at the time.
In hindsight, you can unpack how they got to the decision.
But nonetheless, managing growth matters.
Most banks don’t grow like that.
Maybe, remember, most banks grow about GDP growth and then some.
As your resident DJ, as you two are talking, this is not a song I was going to use, but it’s like Tom Petty.
“Felt so good, like anything was possible.”
As you two are talking, we should just have “Runnin’ Down a Dream” playing behind us.
Let me ask you this, though.
As you two are talking, I’m curious.
Banks endure not just because they have excellent customer experiences, but because of smart balance-sheet management.
Again, this is a theme that continues to come up in public conversations.
Tom, you’ve already started to talk about some of the common mistakes banks make.
But if you’re sitting as a board member today, are there things that you should be paying a little bit more attention to than maybe you thought you would at the end of last year?
Well, first of all, I think the banking business can still be a very good business.
I often think about what it takes to be successful.
If a bank consistently grows earnings per share 8% a year for the next decade, they probably win.
They probably feel like winners.
It doesn’t have to be Herculean.
Whatever you do, you’ve just got to do it consistently.
Also, size alone isn’t a determinant.
I said scale matters.
That’s on the median.
But size alone isn’t a singular determinant of success.
Credit Suisse essentially just failed.
It was a global SIFI.
Citigroup, no offense offered here, hasn’t earned a double-digit return on tangible common equity on an operating basis in quite some time.
There are several trillion dollars in assets there.
So just being big alone isn’t a determinant.
There are really good small banks.
You can be a small bank.
I think of Scott Dueser’s bank, which is not one of the biggest banks in the country, but maybe one of the most consistent in terms of profitability.
He’s driven enormous shareholder value.
So I think it’s quality over quantity.
But you also need to remember that if you’re a banker, you are still an entrepreneur and a businessman.
You need to be adaptive, and you need to look for opportunities.
I personally believe there are opportunities to beat the big banks.
The big banks are very good at many of the things they do.
Remember, you’re talking to someone who started at a firm with 75 people when I started at KBW.
I’m happy to be David and not Goliath because I think there are great opportunities.
So scale is important.
Statistically, it shows it works.
But it’s not insurance that you’re going to be successful.
You need to operate a sound bank.
But I also wouldn’t get so conservative that you can’t grow and invest.
By the way, if I were running a bank today, I would run it like I owned 100% of it myself.
I would not take the bait of quarterly earnings.
I would build a great company over a long period of time.
Investors will sniff that out and reward you.
Yeah.
Run the company like you own 100% of it.
Don’t be scared to do so.
I give that all the time.
Our Gonzo Award winner, Dave Findlay at Lake City Bank, is someone who just has that discipline time in, time out.
To answer your question, Al, I’d say at the board level I’m looking for a RAROC culture.
I want smart people arguing all day long about risk-adjusted returns across the entire balance sheet.
I want the arguments to take place.
That’s the only way to get the truth.
The other thing, though, to your point, is I want to be risk-averse there or have a moderate risk appetite.
I don’t want to blow it with my balance sheet.
But I want to take some risk on marketing and customer experience.
I want to spend some money in technology.
I’ve always been saying we’ve got to take our two risk appetites and separate them.
That entrepreneurial appetite around new business versus my RAROC discipline on risk-adjusted returns.
There’s a list of core principles.
I think also, too, be a talent magnet.
I think the talent magnets will win.
The banks where everybody wants to work.
I look for that.
Also, the most accretive, best acquisition I’ve ever seen anybody do is organic growth, one client at a time.
That’s the best acquisition.
That’s what we try to do.
Have a really good service that is growing on its own organically.
Then, a conversation I had at the conference, something that I’ve been encouraging bank managements to think about, is in a moment where the market is more focused on exit velocity out of 2024.
I don’t want to say that current earnings don’t matter, but exit velocity does.
I would clear the deck of some balance-sheet capacity that’s being used by non-core clients.
I think the winners on the back end of this post-COVID moment are going to be the banks that have capacity to grow organically and serve their best clients.
Those are the ones that are going to win.
I look at what Synovus did.
They sold a bunch of assets in medical-office buildings that were performing, but they didn’t come with a lot of other business or deposits.
They sold them to create capacity to go after their core C&I business.
That’s a fantastic trade.
I’m watching Comerica, which of course is navigating $100 billion, but at the same time exiting mortgage warehouse, which is not a high-value business, so they can focus on their core clients.
At the end of the day, they’ll be better rewarded for having done that.
That’s running the bank like you own 100% of it yourself.
Right.
And never cross $10 billion or $100 billion with those diluted assets.
Right.
Don’t use up your time to make a crossing from a regulatory standpoint.
And when you go to cross, we recently wrote a report we call our Chutes and Ladders report.
Al, I know both of you have seen the slide we’ve used from that.
It talks about how scale works until you hit a big regulatory threshold, and then it doesn’t.
You’ve got to rebuild.
Unfortunately, that’s the world we’re operating in.
It’s disappointing because the subject of crossing $100 billion, when you’re a board of an $80 billion bank, you talk about it all the time.
Don’t think that it starts at $100.
You better be well underway by the time you’re 80.
Right.
You mentioned Synovus.
I just saw Kevin Blair and his CFO a day ago.
When I listen to them talk about their business, it reminds me that quality never goes out of style.
As you guys are talking about it, I also think the concept of building franchise value is something that will never go out of style.
As we think about how the business of banking continues to move and shift, Steve’s talked about being opportunistic.
Tom’s talked about being, I’ll call it, hyper-efficient, being a magnet for talent, and really keeping that entrepreneurial spirit alive and well.
That’s something that is so critical for everyone in the financial space to get their arms around.
Figure out how you can add to your business’s future because it’s not going to just happen if you sit and talk about it.
You’ve got to roll up your sleeves and get after it.
It’s part of the reason we have this Plugged In series, just to inspire when and where we can.
I promised we were going to talk some songs.
I’ve got to give my wife Amy some credit.
Both Tom and Steve know Amy.
She knew we were doing this podcast today.
I’ve been on the road almost nonstop.
She said, “You’ve got to work in Journey’s ‘Lights,’ because, ‘So you think you’re lonely? Well, my friend, I’m lonely too.’”
So I got home.
I got home to D.C.
I’m going to see my family and friends tonight.
I hope you guys are able to do the same thing.
I really want to thank Tom.
I want to thank Steve.
And I want to thank all the listeners for getting Plugged In yet again with Cornerstone Advisors.
Our two-time guest, Tom Michaud, is going to take us out with hopefully a nice pause of note.
Right, Tom?
Exactly.
I do think that the troubles of the COVID crisis are more in the rearview mirror.
I think while there’s been a lot of pressure from nonbanks, that pressure feels to me like it’s peaking.
I still think there are a lot of great opportunities.
I said if you grew earnings per share 8% a year for a decade, you win.
It doesn’t have to be much harder than that.
Thank you for having me on.
I love talking about these topics, and I look forward to seeing everybody soon.
Thank you, Tom.
Appreciate it.
Guys, thank you.
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