Stirring the Pot with Tom Brown

Welcome to a very special podcast series from Cornerstone Advisors.

Just as MTV went Unplugged in the ’90s, we decided to reverse course here, go a little GonzoBanker style, plug it up and turn up the volume on opinions and ideas specific to the financial sector.

I’m checking in from our D.C. studios while my co-host, Steve Williams, holds it down in Cornerstone’s Scottsdale, Arizona headquarters.

Now we’re joined by someone who is known for having an opinion or two or three.

That’s right. This is Tom Brown.

We are lucky to have the man, the myth, the legend of Second Curve Capital and BankStocks.com, one of the most popular newsletters in the industry.

Al, he has a history of speaking the truth. I remember watching him on 60 Minutes. I remember a little prodding of Ken Lewis and Hugh McColl over the years.

But recently, we saw him getting along just fine with Brian Moynihan at BofA these days, so maybe he’s softened. We don’t know. We’re going to find out.

Tom, great to have you, buddy.

Nice to be with you guys.

We want to ask you a few questions about what’s going on out there.

What’s keeping you busy at this moment? What are you working on that’s interesting?

I probably have a CEO discussion every day, and the discussion always starts with the economy as it is today and the economy looking forward.

It’s amazing. I don’t remember a time when the two have been so different.

The economy that most midsize regional banks are experiencing is pretty good.

Interesting.

Well, let’s kick it off, Al.

Yeah, we’ve got to drum up this conversation because we know Tom has some opinions.

As we do for each of our Plugged In episodes, Steve and I put on our headphones and developed a five-track playlist for this conversation.

Tom, we have everyone from Queen to Alice Cooper to Cyndi Lauper as inspiration.

You don’t have to worry. We’re not going to try to serenade you with each artist’s song.

But I hope I can get a laugh out of you when I say we drew some early inspiration from Miley Cyrus and her hit song “Wrecking Ball” to get this thing going.

So I’m going to dare you to channel your inner Miley, come in hot, and talk about all these reductions in force that you’re seeing in the fintech world.

Talk about these layoffs. Twitter, Meta, everyone seems to be doing it.

Folks invested big time a few years ago. They seem to be pulling back.

What are you seeing in terms of talent across the financial sector today?

You have the fintechs that are still privately held, and they were operating with a different model.

The model was, “Let’s try to do a land grab as fast as we can. We’re going to get all this capital from venture capitalists, and we’re just going to spend and not worry about making a profit.”

Well, that game changed earlier this year.

Now the VCs are telling them, “You’ve got to develop a pathway to profitability.”

For many of them, that means they have to reduce their expansion efforts or reduce their headcount.

In terms of the publicly traded tech companies, it’s about time they got their day of reckoning.

They had a bull market for the last seven years relative to the rest of the market.

In Twitter’s case, you’ve got a very specific change of direction by a new CEO and new owner.

In Meta’s case, you’ve got a very high-profile failure, which was a big bet on the metaverse.

But the rest of the tech companies, I think, are just going through a typical downsizing before a recession.

It’s interesting.

We were together in Chicago, and we were listening to Nigel Morris. Steve and I were trading some notes.

What really stood out from some of his remarks around the fintech space was what’s taking place.

In 2021, the narrative was, “Don’t worry about financing deficits. The cash will be there for you.”

We know that’s not the case anymore.

We also kind of learned that a lot of lending businesses just masqueraded as SaaS businesses for their valuations.

When you’re talking about public fintech stocks, I think it’s important to note they’re down anywhere from 75% to 80% of their value.

“Indiscriminate carnage,” I think, were the words Nigel used.

When I think of what’s changed, fintech founders in particular today are thinking about, “How do I preserve capital? How do I get leaner faster? How do I pull back on my marketing spend? How do I get to cash flow positive?”

That reduction in force can be anywhere from 50% to 60% of an organization, which is shocking when you think about what that does for culture.

Steve, you’ve heard me talk about culture. Do you have a song that might tie into this?

Well, I picture culture, and I picture a Clemson football game on a Saturday afternoon.

“Buddy, you’re a boy, make a big noise, playing in the street, gonna be a big man someday.”

Tom, we recently got to see Jim Clements from Clemson talk at your CEO conference.

He talked about culture, culture, culture.

What are you seeing there?

You’re not just a finance guy. You like to look at the operating model. You like to look at other things.

What are you seeing in terms of culture and how that’s impacting the banking industry right now?

I’m a big believer in culture.

Every company has a culture, whether they want to have one or not.

For instance, I just got off the phone with H. Jay Hillenbrand, who runs Stock Yards Bank.

They’ve done a great job of keeping a very distinct community bank culture.

That’s one of the things I find very hard.

As you grow in size and go from $1 billion to $5 billion to $10 billion, once you get over $10 billion, keeping that community bank culture really takes a lot of effort.

You have to think small.

That’s one of the things Sam Walton always said.

“How do you run a company the size of Walmart?”

He would always say, “I don’t know. I know how to run a store.”

That’s the community bank mentality.

If you’re operating a community bank model, then you’ve got to work hard to keep that community bank mentality and culture.

I remember you having Jim Herbert from First Republic talk about some of the relationship manager retention numbers that he had compared to the rest of the industry.

When you’re looking at a stock, you’re actually underwriting culture as well, aren’t you?

Trying to.

It’s hard from afar, particularly when you’re dealing with senior people.

That’s why I do like to do things like visit call centers or talk to the security people in the headquarters building.

You’d be amazed at the stories they can tell you.

You’ve done some mystery shopping too over the years.

I don’t know if you’re doing it like you once did, but maybe you could give the CliffNotes version of what you found as you walked the mean streets of Philly and New York.

Yeah.

We do it with products too.

If you looked at my wallet, you’d say, “What are you doing with all those credit cards?”

But I like to see how companies manage credit cards.

Fifteen years ago, I defaulted on one to test out their collection practices.

It took years before they finally sold it to a firm that was smart enough to figure out how to collect it.

With branch activity, in recent years we compare how long it takes to open an account in the branch compared to doing it online.

I’m still amazed that it takes longer to open up an account physically with a customer rep than I can do on a cell phone.

There’s a lot of catch-up.

Folks are saying, “Do I invest in all that branch technology, or do I just shutter some of the branches and get a lighter, branch-light footprint?”

I’m hearing a lot of that in budget meetings these days.

Yeah.

But Steve, what I find interesting as you say that is people talk about going branch-light, but if you look at where the dollars are going, they’re still putting a lot into the physical locations that they have.

When you consider, you and I talk about, “What would you do with a million or a million and a half dollars?”

That’s one of those conversations at a board level that becomes really interesting.

When you think about the expense and how you’re trying to pull back on certain things, you and I have touched on why every basis point matters.

But thinking about your branch network and what you can reconcile so that you can reduce certain expenses and redirect them into new initiatives, I think that is one of those themes that is not going to lose its luster going into 2023.

I’m curious, Tom, as you’ve talked to people like JB Straubel at Ally, who talks about being insight-driven and not just data-rich.

He has a model that is very light in physical footprint, really digitally sophisticated.

It takes a lot of effort to make something look effortless.

You’ve got to have a perspective on this conundrum.

It’s real interesting right now.

In fact, I just looked at some charts in my office.

If you take the banks that don’t have any physical network and have gone completely branchless, their cost of funds is at the market rate.

Then you take a look at banks like First Republic, which are heavy into high-net-worth people with huge accounts, and they’re pretty close to being at market rates.

Then you look at the traditional banks, whether it be Bank of America, KeyCorp or Huntington, and their deposit betas are less than 10% right now.

There’s a huge dichotomy in the industry.

You better have the asset yields to be able to afford those market rates on deposits.

Companies like Capital One or Ally are in asset classes that enable them to still enjoy healthy margins.

That’s why I like that metric Moynihan uses at BofA about the direct cost, both cost of funds plus direct operating cost.

It gives you that trade-off between, “Am I creating some stickiness in deposit beta?” versus “Am I low cost, but I have to pay market?”

I think that’s a great point.

The problem on the outside is we can’t calculate that number very easily, so it’s not an easy, transparent number.

Got to get some Cornerstone benchmarkers in there to help you do that.

You’re shameless, Steve.

Sorry.

You two nice guys are going to recognize that we take our cues for this next track from a Valley of the Sun resident.

Steve alluded to your banking weekly newsletter, which really has become a must-read for many across the U.S.

I don’t know which one you put this in, but basically you noted that in the first six months of the year, corporate earnings held up pretty well, even as the economy clearly slowed.

But then I made a note. You said, “Don’t feel too reassured. The pattern of previous recessions is that earnings don’t start to fall in earnest until a recession is well underway.”

If you were Alice Cooper and had just listened to “No More Mr. Nice Guy,” can you explain what your thinking was when you wrote that?

Sure.

If you look back over the last 15 years, what you’ll see is that for the S&P 500 companies there’s a consensus earnings estimate driven by the estimates on each of the 500 companies.

From the beginning of the year to the end of the year, the average decline is 5%.

In recessions, the decline accelerates beyond that curve.

It takes about three months into the recession.

Interestingly, there have been two exceptions to that.

One was in 2018, when corporations got tax refunds.

One was in 2021, of course, the economic recovery year.

This year, the pattern was a little different because for the first six months earnings went up by 5%.

In the last four months, they’ve come down by 5%.

I think they’ll drift a little lower by year-end, but the real decline in corporate earnings will take place next year.

Tom, if we were going to look at the earnings season and what’s ahead, the potential for recession, and then go to investing, I’m thinking about Australian-born Bon Scott and AC/DC.

“No stop signs, speed limit, nobody’s gonna slow me down.”

Are we on the highway to hell?

Here’s what’s interesting about the highway to hell.

You like to invest when there’s hair around a deal, when there’s a franchise that may have been hurt and now it’s undervalued.

Looking out there, when people are afraid of that highway, what are you guys looking at right now?

Where do you see there is still a reckoning to come, and where do you see value starting to creep in?

I think value has crept in.

From a macro standpoint, what is frustrating is the volatility.

But volatility increases at the end of a bear market.

There are several measures we have of volatility, but they would suggest that six months from now, maybe three months from now, the market is going to move out of a bear market and into a bull market.

One of those measures, which I just came across, is that we’ve set a record this year with the number of weeks that the market is either up or down by 1% on a Friday, or whatever the last day of that trading week is.

We went to a five-day trading pattern in 1952, and there’s never been another year where we’ve had more of that volatility on a Friday.

There are still eight weeks left in the year, so we’ll see what happens.

But if you look at the average market, the average stock in the S&P 500 trades at about 17 times next year’s earnings.

The average bank is trading at 10.

That is an unusually wide discount to the market.

I think bank earnings will hold up much better next year than corporate earnings will.

So I think it could be a good year for bank stocks.

I think it’s interesting with bank stocks that it’s not about finding a bank stock that’s going to trade at 25 times earnings.

It’s about all these really nicely run, conservative banks when they’re at six to nine times, just getting back to 11 to 13.

What that appreciation looks like, with a dividend, is always the game to me.

That’s really interesting.

Steve, you’re talking about these troublemakers.

I think troublemakers, yeah.

The regional and community banks, the commercial banks, entrepreneurial, trying to be magnets for talent out there across the country.

They’re facing a lot of evolution, but they still confound the experts and find ways to create value.

Hey Tom, this last track, I’m going to give you a few names and see if you can place the artist.

Harry Truman. Doris Day. Red China. Johnny Ray.

Ring a bell?

No.

Oh God.

That’s “We Didn’t Start the Fire” by Billy Joel.

We’re going to talk to your wife about your music collection.

We’re going to draft off “We Didn’t Start the Fire,” because that’s a song I bet a bunch of investors in the fintech space might take some comfort in hearing as things get sideways with them.

Steve and I have talked at length with our fintech team, but I’ve also talked to Tom over the years about this intersection of banking and technology and where things get interesting.

Most of those conversations really came back to themes around insight, experiences and connections.

I want to frame this concept of connectivity that’s taking place right now based on something our head of research, Ron Shevlin, just posted on Forbes.

He talks about connectivity as being a primary factor in determining who will win the financial data aggregation battle.

That sounds nerdy, but when you think of data aggregation, that’s a big thing.

That’s where MX is making a big push. It’s where Plaid has been sitting.

You’ve seen the movement of people and talent.

It strikes us that technology continues to transform the business of banking.

Whether it’s open banking, embedded finance, embedded fintech, banking as a service, these are big themes that have gotten a lot of attention.

What gets you most jazzed up these days at that intersection of banking and technology?

Maybe I’ll take a step back and say that 15 or 20 years ago, technology was about products.

You can really go back to the ’80s, when online banking was introduced, and that was a new product.

Then you can fast-forward to the deployment of ATMs.

Then you had call centers.

It was all about products, using technology to offer better customer service.

I would say around 15 years ago, maybe 2010, the light started to shine differently.

I usually get called in to speak to boards when that light shines.

Now we’re still on this long journey of adjusting our companies to deal with the digital revolution.

I like embedded finance, though, and companies that can benefit from that.

We are large owners of some of the banking-as-a-service providers.

One thing Nigel Morris talked about at your CEO meeting was the rise of a super fintech.

I’m wondering, with these valuations and the rationalization going on, will we see M&A activity among fintechs in 2023?

Do you think so?

In 2000, after the tech bubble burst, as an investor I was able to pick up a company like LendingTree that came public at 120 and buy it at three.

I think there will be some opportunities for public investors to pick up some of these fintechs.

You know how much I love the business model of nCino.

When nCino came public, it was at an outrageous valuation.

I wasn’t afraid to tell Pierre, the CEO, that I loved the company, but I didn’t like the valuation.

I don’t want to root against him and his company’s valuation, but I’m certainly paying attention to that.

There may be a time when public investors can pick up some of these companies.

If I can do it, then I think there will be opportunities for some of the banks to see that opportunity as well and pick up some broken fintechs.

We’re seeing a lot of résumés hit the street.

I think for banks too, it’s a great opportunity to be thinking about the transformational talent that knows how to connect the fintech world to the traditional banking world.

I think we’re going to see more of that activity just because some of those people are not in a growth mode anymore.

They’re on the street looking for work, and some of them will integrate back into banking, but hopefully change it.

That’s what makes Nigel Morris and Hans Morris so interesting.

They have the banking experience, and now they’re fintech investors.

I think they see the world from both sides better than most.

Al, I know we’re out of time, but you had one last kind of bonus question for Tom that we can’t leave without asking.

It’s not even a bonus question.

This is just a bonus track.

It’s “Girls Just Want to Have Fun” by Cyndi Lauper, and that’s for your wife, Amy.

We have to give her some props as one of the highlights of your newsletter.

Actually, I will take a moment, Steve.

If we turned the tables on you, Tom, and said, “Hey, Amy, we’re going to let you write a closing paragraph on Tom, as opposed to Tom writing one on Amy,” what do you think she would come up with?

She’d come up with a big snore and just say, “He’s one boring guy.”

But I like being with him.

Well then, let’s close by thanking Amy Brown for letting Tom Brown from Second Curve get Plugged In with us today.

He’s Steve Williams. I’m Al Dominick.

We’ll be back to turn up the mics on the business of banking again real soon.

Thanks so much, Tom. Great discussion.

Good to be with you.