Bank Investing

A Practitioner's Field Guide

Suhail Chandy, Weison Ding

• Publisher: Wiley
• Year: 2021
• ISBN:
  9781119729808
• Edition: 1
• Topic: Business
• Subtopic: Valuation
• Index: Business

Bank Investing: A Practitioner's Field Guide offers you the essential toolkit to become a successful bank investor. It packages practical lessons, theoretical knowledge, and historical context, all into one compelling and hopefully entertaining book. The book includes conversations with investors and management teams. Investors include activists, financials specialists, credit investors, and multibillion-dollar asset managers. Management teams have a broad representation from the c-suite of a broad spectrum of participants ranging from a fintech to a bank with over $30bn in assets.

Banks are the oil that lubricates the economy. An understanding of how they operate is essential for analyzing any part of the economy since banks represent a large investing universe and control a sizeable portion of assets. With over 800 public tickers representing over $3 trillion market cap, banks are larger than several other industry groups. Banks are the largest financial intermediaries in the U.S., controlling $15 trillion in financial assets. Their relative size can amplify effects. For example, a small regulatory or environmental change can cascade and ripple through financial markets and have a major impact on the economy.

As fintechs gain in prominence, a fundamental grasp of topics related to banking will help enhance understanding of fintech.

Bank investing can be a fruitful pursuit:

• The most successful investor of our times, Warren Buffett, has had a sizeable investment in banks over time (close to a third of his portfolio weight used to be in banks).
• Banks allow you to make macro-economic bets since they are highly levered to business cycles.
• Bank investing allows you to scale your knowledge, as they have relatively homogenized business models...
• ...at the same time, banks are diverse enough to drive meaningful dispersion in price performance. This divergence of performance can be taken advantage of by an astute and prepared securities analyst.
• Banks are good vehicles to make specific investment plays on geographic regions, demographic trends (suburban to urban migration, aging), industries (agriculture, tech, energy), news flow (trade/tariffs, weather), real estate subsectors (NYC office, bay area apartments), and investing themes such as ESG, cryptocurrency, and venture capital.
• Finally, fintech disruption is creating an investing opportunity to play the digital divide between banks that embrace technology successfully and those that get left behind.

CHAPTER 1
Introduction

“The judicious operations of banking enable him to convert this dead stock into active and productive stock; into materials to work upon, into tools to work with, and into provision and subsistence to work for; into stock which produces something both to himself and to his country.”

– The Wealth of Nations Book II: Of the Nature, Accumulation, and Employment of Stock, Adam Smith

WHY A BOOK ON BANK INVESTING?

We believe that bank investing can be a fruitful pursuit. As authors of a book on the topic we have a vested interest, but we ask the reader to consider the following:

1. The most successful investor of our times, Warren Buffett, has had a sizeable investment in banks over time (close to a third of his portfolio weight used to be in banks). This is based on the minority investments in publicly listed entities, and we do not include Berkshire's operating subsidiaries.
2. Banks allow you to make macroeconomic bets since they are highly levered to business cycles.
3. Bank investing allows you to scale your knowledge, as they have relatively homogenized business models.
4. At the same time, banks are diverse enough to drive meaningful dispersion in price performance. This divergence of performance can be taken advantage of by an astute and prepared security analyst.
5. Banks are great vehicles to make specific investment plays on geographic regions, demographic trends (suburban to urban migration, aging), industries (agriculture, tech, energy), news flow (trade/tariffs, weather), real estate subsectors (NYC office, bay area apartments), and investing themes such as ESG, cryptocurrency, and venture capital.
6. The largest asset on a bank's balance sheet is its loan book. This is not directly analyzable; one cannot walk up to a bank and ask permission to view the loan book. There are limited instances when a small bank is getting re-capitalized that its loan book may be made available in a selective sample manner, but those are very limited instances.
   This information asymmetry makes it tougher but also in some instances rewards the diligent and dogged analyst. This relative opacity makes banks very different from an allied sector such as REITs. The real estate assets of a REIT are tangible and can be toured and independently assessed. There is a large CRE market where real estate assets trade, and one can use that to value the assets of REITs. We highly recommend an excellent book on the topic of REITs by our good friend Stephanie Krewson-Kelly and her co-author R. Brad Thomas. That book is The Intelligent REIT Investor: How to Build Wealth with Real Estate Investment.
7. Fintech disruption is real, but to understand this phenomenon one needs to understand the sector being disrupted. It is not a coincidence that some of the biggest fintech names have applied for and obtained a bank charter. That is a validation that a charter can provide benefits exceeding the regulatory cost. Finally, we believe that fintech disruption is creating an investing opportunity to play the digital divide between banks that embrace technology successfully and those that get left behind. Banks have to start viewing themselves as fintechs with the ability to accept deposits.

FINTECH ONSLAUGHT

The fintech onslaught is just getting started. There is no denying that fintech is disrupting the banking business. The challengers and “potential” challengers range in size from minnows being dreamt up in dorm rooms to giants such as Amazon. A study by the consulting firm Bain and Company in 2018 postulated that Amazon's banking services, if launched, could grow to more than 70 million US consumer relationships over a five-year period. See the link below: https://www.bain.com/insights/bankings-amazon-moment/

This would be the same size as Wells Fargo, founded in 1852, which is the fourth largest bank in the country. We are not privy to the plans of Amazon, but we are not surprised by the hypothetical growth trajectory of a potential challenger who has significant heft and has consumed entire industries. While not surprising, it is unsettling that someone takes 168 years to become the fourth largest bank and then find themselves rivaled by a digital upstart who took five years to get to the same size.

The relentless fintech onslaught has seen skyrocketing valuation, a burgeoning number of players, increasing interest in the concept, and a barrage of news flow all reinforcing each other.

EXHIBIT 1.1 Interest over Time for Search Term Fintech

Source: Google Trends

Fintech unicorns, of which there are 58, have an aggregate valuation of $213.5B according to CB Insights. Nearly every transaction one would traditionally do with a bank can now be done through a fintech using a mobile app on your smartphone. The fintechs include SoFi, Earnest (owned by Navient), Chime, Varo, Money Lion, Stash, Square, Kabbage, OnDeck, Affirm, Klarna, Greensky, Afterpay, and a long list of vendors covering residential mortgage loans, student loans, online checking and savings, SMB loans, point-of-sale financing, and more. The list is endless, and there is a virtual tapestry of fintech logos that cover a variety of areas.

Interest in fintech has grown immensely as can be seen in Exhibit 1.1, a chart of Google trends on the search term fintech over the last 10 years.

AN OPPORTUNITY TO LEVEL THE PLAYING FIELD

While innovation is exciting, it is important to not get caught up in the fintech narrative and lose sight that ultimately banking at its core is about accepting deposits, making loans profitably, acquiring customers efficiently, and engaging with customers meaningfully to increase the cross-sell of products. It is also important to remember that several new age fintech lenders have not been fully cycle tested.

Branchless banks are not a new concept. Telebank, a division of TeleBanc Financial of Arlington, VA, was founded in 1990 and operated with a branchless strategy initially using the telephone network. Security First Network Bank (SFNB), founded in 1995, was a pure internet bank.

While branchless banking is at least 30 years old, the new age of the challenger banks is fueled by powerful smartphones, a mobile app ecosystem, and a bunch of critical technologies and APIs that allow the orchestration of bank transactions and activities in a seamless manner.

Banks, especially regional and community banks, have a lot to worry about given this relentless onslaught from nimble start-ups and the level of tech spending at the large banks. The largest seven banks in the country are collectively spending upwards of $45B on technology. Smaller banks will not be able to match that level of spending. However, in this David versus Goliath struggle, all is not lost for David.

It is accurate and intuitive that smaller banks simply do not have the resources (both talent and budget) to compete with the large banks. However, if they partner with the right technology vendors, for efficient digital acquisition of customers, frictionless services provided via mobile and online, and reassuring levels of cyber security, David will more than match Goliath.

In order to compete successfully banks, large and small, have to reimagine themselves as a fintech with a bank charter.

While they can't match the large banks in spending billions on technology a year, there is no one stopping small banks from architecting a vision for their digital...