Hello, and welcome to another episode of the Odd Lots Podcast. I'm Joe Wisenthal and.
I'm Tracy Alloway.
Tracy, it's been about, I guess three months or so since the s V blow up, and I don't know people, it sort of seems like a thing of the past.
Now.
I'm trying to remember when I went on vacation, but I guess it was March. So yeah, yeah, I guess three months. Can I ask before we start this conversation, are we going to call it a crisis or not? Because that seems to be a new terminology debate.
Well, yeah, it's a good question. I'm team anti crisis. But also, I remember you were on vacation and I remember You're like, oh, got a missing a financial crisis, and I was like, no, no, it's not a crisis.
Enjoy your vacation. It's not worth like.
It was still the most interesting thing to have happened to banks in me, it was very interesting. All right, Well, let's let's agree to call it drama. Drama drama that works, that works for everyone.
It was drama. I think that's right.
And you know, after that, we you know, there were all these questions like why do we have thousands?
Why do we have banks at all?
But we did? We hit like an episode, So why do we have private banks?
Oh that's true?
Yeah we did.
Yeah, why do we have private banks? Especially if the depositors can almost always be guaranteed to be bailed out?
Yes?
So it did raise some existential questions for banks, and one of them was the deposit insurance question that you just mentioned. But the other one was the nature or the breadth of the US banking system altogether. And this is something that I think comes up after almost every about banking drama slash crisis. You saw in the savings and loan crisis. Certainly after two thousand and eight, there was a lot of discussion about what should banks be doing.
Do we need this many banks? Or are we comfortable maybe with merging some of them, consolidating them into megabanks. And now fast forward to twenty twenty three, a lot of that consolidation is happening again, and we are seeing some of these same questions raised.
Right, And I guess there's like this sort of two ways of talking about consolidation. One is like, could we see the giant banks just sort of like buy everyone else? And then we sort of have like a Canada style banking system where there's like eight banks whatever, or could it be like from the depositor perspective where they're just like, why wouldn't I just put my money at JP Morgan, the ultimate too big to fail bank? And then I sleep at night and you know, and just why not?
Right?
And they have a good website and it works and all that stuff, and so there's just like it feels like there's all these forces put a lot of stress on the thousands and thousands of smaller community and regional banks out there.
Yeah, And at the same time, you know, this idea of small local banks is kind of embedded in American psyche. I feel like, certainly, going back to It's a wonderful life, everyone casts this notion of a cozy community bank where everyone kind of knows each other and so they put some value on that. But that's not the only way to have a banking system. You could have a Canada style banking system, as you just pointed out. So all these big existential questions at the moment.
And to me, a bank is just an app at this point, no, for real, Like I have a bank that does not have like physical branches that I go into.
They might have.
You don't have intense personal feelings for your bank?
No, No, I have like it's like the app works, it doesn't crash. It's like, great, there's my bank. Anyway, So what is the future of banks and what is happening and will we have when they have a Canada style banking system. I think even though things have quieted down, it's sort of a good time. Actually, it's like take stock of what's happening.
It is always a good time to talk about the meaning of banks in America.
Well, I'm very excited today we have the perfect guests, someone who works directly in this space and has for a long time. We're going to be speaking with Scott Hildenbrand, chief balance sheet strategist and head of financial Strategies at Piper Sandler. Scott, thank you so much for coming in.
Hey, good morning, Joe and Tracy. Thanks for inviting me in. I'm thrilled.
What do we actually just start with? Like, what is a chief balance sheet strategist and head of financial strategies at Piper Sandler Time.
I wish I had a nickel for every time I've gotten that question. Joe, but no, so a chief balance sheet strategist really is. I spend every day, all day, predominantly on the road, working with the community banks all throughout the country. So if you think about it, there's about a thousand community banks that come through our group. I have a team of thirty five of us, and we spend every day all day looking at bank balance sheets from an interest rate, risk perspective, a liquidity perspective,
a capital perspective, an investor perspective, regulatory perspective. So think of sort of the top fifty banks and then everybody else. I sort of work with everyone else and think through on all of those issues that are certainly front and center. As you to just chat a little bit about perfect guest.
So next question, how busy have you been over the past three months?
You know, Tracy, it's interesting. It's the first time I think my family and friends know what I do for a liv. It has been incredibly busy, to the point where I can't even go play golf with friends without the word Silicon Valley, hedging, uninsured, all those types of terms popping up. And I do a fair amount of public speaking and a lot of people want to hear about what's going on, what are others doing and thinking
about post the drama? And I love the way you all described it, the drama around the Silicon Valley, etc.
Would you say, do agree was not a crisis?
I do, but I think it was also. What's a lot easier for me to say that now versus when Tracy was on vacation and when it was happening that Sunday in March, when it felt pretty quickly like it was getting out of control. But I think, as you said, Joe, I think over the last three months we have seen some stabilization. I think everybody's calmed down a little bit, but there's still a lot to unpack and a lot of challenges coming.
So why don't we do a little bit of looking in the rear view mirror first and then we can move on to what we've been seeing currently. But what happened in March, how would you characterize the drama that we saw or.
I think what ultimately happened. And again, being an asset liability NERD that I am. All I have done for twenty three years is modeled balance sheets. So I take assets, I take the liabilities, I take changes in rates, and we try to determine the impact what happens to those balance sheets. One of the things that we were taught very early on, and almost everyone who's listening, who's ever modeled an interest rate risk for a bank, will tell you that the deposit side of the world is the
ultimate hedge against higher rates. Right. And so if you had told me, Joe or Tracy five years ago you had me on here and you said, you know what, there's a bank that's all they're going to do is buy treasuries and all of their deposits are in checking accounts, and by the way, they're going to fail. I would have laughed at I would have laughed at both of you. I wouldn't have come back. I don't know, you all are crazy. So literally in March, Tracy'd answer your question,
I think everything was flipped upside down. What we had all learned was the fact that operating accounts and checking accounts are great until they're not. And what we've learned also is that while it's been a slow bleed Joe and you were sort of talking about this, we finally all now really that there's really no contractual liabilities or deposits on a bank balance sheet anymore. People can move money a lot faster. Bank balance sheets are more athletic
and nimble. You couple that with really what happened if you think about it too, is you think about from an M and A perspective. There was no M and A during twenty twenty and COVID for those couple of months. Yet every single bank in the country did one. They didn't realize it. They got no assets. An enormous amount of deposits were dumped into the industry. They didn't ask for it, major growth on a deposit front, interest rates at zero, and no lending anywhere. So you think about
how balloons those balance sheets got. It's not like banks woke up overnight and all of a sudden became fantastically better at gathering deposits. So those balance sheets looked a lot different. And then fast forward, we were a little late to the inflation game. You go up five hundred
basis points in a very short period of time. You have Twitter and the social media role here, and all of a sudden, everybody got spooked and dollars started running out, not like the WAMU days or not once what's a wonderful life it was three hours and forty two billion dollars.
That's what happened.
Yeah, this is kind of the dark side of the app. Yeah, yeah, it's just the flightiness of deposits. You can pull everything out with the click of a button.
Now, I know, like for our listeners, and I've had to explain what is it about just for sort of like banking asset liability in the industry like one on one, probably even pre one on one. Why is it the deposits are interest rate hedge?
Sure so in theory over the years, historically most of us all have checking accounts, We've got savings accounts, and predominantly, if you think about it, banks make money not because of the asset side the lending, it's because they don't pay at market rates on the deposit side. Right, checking accounts, nobody really cares what you're making on your checking account. As long as the app works, you move your money around,
you're good. I think what what ultimately happened is for years and years you'll hear the term beta and it's not from an investor perspective. It's in the bank world. Everybody likes to try to project every time the FED moves how much a bank have to move their deposit rates to keep money in and forever it's kind of been this thirty to fifty percent, and I've never really subscribed to it. And that's a separate topic, but typically
that's what we've seen historically. But unfortunately, what it doesn't measure is the fact that not only is it a rate that we have to pay, but dollars can move so much faster based on the technology. And I'd argue the demographics here's the bigger issue. If you think about it from an asset liability perspective, I can't model the
demographic breakdown well enough. Yet you think about my father's generation versus you know, my future grandchildren's generations, and you think about how they view a bank sort of the way you all were describing it today. There's a loyalty trust matrix, and you think about the loyalty. A lot of loyalty in my father's generation and very little trust. He gets a two thousand dollars check, he is going to a branch, he is going to make sure that money is in. He gets his lollipop, he says hi,
and he leaves. Then you think about the generations beneath below. There's a ton of trust. They'll move money around on they don't even know the name of the bank they're banking app. They'll move it so quickly, but there's very little loyalty. And there in lies the difference and why we're struggling with how to determine how to manage and hedge a balance sheet from a deposit perspective.
Maybe the banking app should figure out a way to deliver lollipops.
That's right.
Can I ask another step back question, which is you know I was a banking correspondent soon after the two thousand and eight financial crisis, and I remember the big hope of banks back then was interest rates are going to rise and will finally be able to make money off of lending. What happened to that portion of it?
That's the best question I've gotten around this topic over the last ninety or one hundred days, Tracy, And I'll tell you why. For if I had a nickel for every bank that told me in January of twenty twenty two, so not too long ago, that they couldn't wait for rates to rise. We were prepared for rates to rise, Scott. We're going to look so good it's coming finally. I mean I for honestly, I've been doing this twenty three years.
I could have taken the first twenty years off. Everybody told me rates were going higher, they never moved right. It was very low interest rate environment for twenty years. Finally we see interest rates hied tracy and it took about, I don't know, nine months until everybody called me and said we need help pedging against higher rates. And I'm like, well,
wait a minute. But ultimately, what we didn't realize, right, what we didn't facet in is the fact that, yes, when the FED hikes interest rates, and it's why you saw twenty twenty two. In the first six months, we saw great margin expansion for banks, which was phenomenal. The asset side was resetting higher, and nobody was paying up for deposits because it wasn't based on the FED. It's based on supply and demand. And we had so much supply of deposits after COVID that it took a while
for anyone had to have to pay. Then all of a sudden, we had to pay. As things started to catch up, Treasury rates got a lot higher. But here's the bigger problem. Everybody was looking at their balance sheet as if it would stay the same in terms of product mix, in terms of size, and ultimately what happened is everybody said, well, wait a minute, I can move
money all over the place. Not only two different banks, but banks were competing against treasury rates, right, So all of a sudden, people moved their money around a lot faster. So we always say it's not changes in rates that caused it, It was the way and how athletic bank balance youse are today versus where they used to be, and it moves a lot faster, tracy, and that's where people got caught.
Just a follow up based on that, But how much of the concerns that banks tend to have are shaped by things in a stress test? So I'm thinking back, worst case scenario of the banking stress test for a long time was a recession and rates going very very low. It didn't really have much as far as I can remember, Like, there wasn't that much modeling based on rates going really really high. So does that tend to shape bank behavior? Like? Is that the scenario that they end up worrying about?
This was the double whammy? You're right if you think about you know, if you pulled one hundred CEOs throughout the country and it was two years ago, even four years ago, ten years ago, and you say, what's the worst scenario, they tell you, well, rates down to zero probably means recession. We've got credit price problems, etc. That's
going to be a really tough environment for us. Where I think we didn't focus enough on is really understanding the impact that both technologies social media and the demographic changes around the deposit front from a liquidity perspective in a higher rate environment. This wasn't a we got to slow the economy down from because it's booming organically. This was, Hey, we're gonna throw way more money into your industry than you asked for, and then we're gonna suck it out
in record pace. And by the way, we're gonna do it over a nine month period, and hopefully you're prepared to handle that.
I want to talk more about the demographics and really get these sort of like long term structural changes. But before we do, I just want to sort of like ask one more question about this sort of like post SVB environment. Like KRI the Regional bank ETF is actually still lower than it was on March thirteenth, like they've stopped spiraling. But the valuations you mentioned, I guess like deposits have been stable. But can you talk about like there has clearly been this huge repricing of the sector
that has not bounced back since then. I mean it's flat, like there's not everything else is really what about this moment, either sort of perceptually or business wise, like, really has changed how people view the viability the business prospects of these banks.
Right, there's well, as you know, and both M and A and invaluation unknown as a problem. Right, And so you've got a few unknowns, Joe, You've got you've got regulatory issues coming further stress more capital what is it going to be? That's obviously whatever it is, we all know it's gonna hurt earnings, right, So you've had it correct. Yes,
it'll trickle down, there'll be some impacts. And then you know you also have and I talked to a lot of investors to your point, Joe, you know, almost half the banks in the country trading below their tangible book value. It's almost weird for me to say that. And we
really haven't seen any credit losses yet. The problem is almost every investor I talk to, whether it's unknown around what we just talked about, the regulatory environment, or quite frankly unknown around interest rates, or the final one, you know, is unknown around credit. And I haven't met an investor that's excited about the incredit environment which we're headed into. And I think the real problem is we're sort of
stuck in this nobody knows mode. I'd rather us, you know, let's take some hits here, Let's have some credit concerns and start to deal with them. We're kind of waiting and waiting for the hurricane, but it hasn't come, and it might not be a major hurricane, it might be small. We just don't know, and so from evaluation perspective, it's tough for anyone to invest in anything from that perspective.
And just real quickly the deposits have settled down.
Correct.
Okay, So Joe mentioned that KBW Regional Bank Index. Can you talk a little bit more about the differentiation that we've seen between the big banks, so the JP Morgan's of the world, which seem to have been massive beneficiaries of these liquidity issues, the regionals and then the really small community banks, Because I think a lot of the community banks ended up getting lumped up in the regional category. But actually they seem to do okay.
Right, And I think the biggest challenge right now is exactly the way you lay it out. If you think about it, the largest banks in the country rely a lot less on deposit in loan out right. They make a spread, but they don't live and die by their spread business. The smaller tracy the bank you get to, the more they rely on spread business, and that's a problem when you've got an inverted yield curve. You've got
deposit costs continue to elevate. They've stabilized, Joe A to your earlier point, They've stabilized from a balance perspective, but I don't believe we stabilized yet on how much it costs me to keep people here, or the concern around how much I'm going to cost to keep people here. So you've got margin compression for the smaller institutions who have very little fee income. You think of out JP Morgan, They've got revenues all over the place in all different
business lines. You go down to the smallest community banks in the country, and they live and die by depositing loan out, make the spread, manage that spread, and pay for everything they need to pay for. So that's the simplistic view, Tracy of the differences as you go down, there's obviously some others as well. Scale here is unfortunately playing a game, going to play a large role in
the game. Excuse me as we think about it. I sound like an investment banker in that that leads to M and A. But it's really true if you think about scale in a world that I think across the board, bank margins will continue to be lower apples to apples in any rate environment because we're probably going to have to hold a little more aquidity, probably got to hold a little bit more capital, and certainly having the rear
view mirror of what happened at Silicon Valley. Yet Tracy, to your point, there's maybe five banks that look like Silicon Valley out of four thousand. Yet the others are going to pay for some of that as well, and that's hard.
You know.
Right around the time of Silicon I think like I did a little bit of traveling. Tracy and I were in Chicago, for example. Not long after that, I went to like a wedding in Boston, and the only reason I bring that up is like when you're in a new area, I find you just see all these banks
you've never heard of, these like tiny local banks. Like you know, I'm probably making it up, but it's like the like you know, the Medford Community Savings Bank outside of Boston, and the sort of you know, Third Bank of Illinois, and just all these like branches talk to us about like essentially sitting aside rate compression.
And rates go up and down.
We don't really know what the future like this sort of like operating business these days that they're in and the sort of challenge they have of like bringing in new depositors for a local bank. Again, when I could just like go on you know, job dot com.
You're right, Joe, And and it's one of the things I do too. It's just I happen to know all those banks as I travel around, but it's the same and I'm like, oh, that's what that's located. But as you think about their their business, right, yeah, all of those smaller banks, most of those smaller banks was started in the commun unity folks at the schools, at the churches, at the country club started this bank in town, and everybody kind of banked in that town, and you think
about that worked for a long period of time. Back to that loyalty trust component, there was a lot of loyalty to who you banked with. You fast forward to sort of where we are today, and you think about the demographic changes. You think about ten, fifteen, twenty years ago, Joe a bank balance sheet, the community bank world had almost half of its deposits were in CDs. I bring that up because if you think about it, that gave banks time. You have a one year CD on your
balance sheet. Rates don't move on those deposits for a year, no matter what rates are doing. You fast forward to where we are today and you think about two things. The average age of a CD holder is a lot higher than you would guess at almost any institution in the country.
Clus the youngest person who even owns the CD of the United States.
I'm looking for that individuals. I want to know who it is. But you're right, it is really that demographic has changed. But that's a really important point because as banks are trying to grow deposits, they're out there trying to reach in CD world. Yet I do a fair amount of interviewing for folks that originally Sandor orneil Nolt, Piper Sandler want to come to New York learn about community banking and way smarter than I am. And they ask me questions I can answer, but I always have
a question they can't answer. Do you know what a CD is? And they've never heard of it, whether it was banking or music. And yet then I'll go to the next boardroom. I'm in the next bank of the Sey. Now we're gonna fill the liquidity hole. We're going to go out and run a fifteen month CD special. The game has changed, the demographics have changed. People want CD
rates with money market flexibility and operational flexibility. And that is the biggest dynamic we're seeing for the smaller community banks. And that's what happened. Back to Tracy's earlier question, the deposit world and how much we can hedge with the deposits is going away quickly. Without those CDs, we have no contractual liabilities on most bank balance sheets anymore.
On the deposit beta point. I mean, there are some banks out there that are offering very competitive rates, at least compared to others, and you are the perfect person to answer this question, But what are they doing that others are not. And you know, I get that scale is a factor here. So if you if you're big, you can maybe afford to return a little bit more to depositors. But maybe for some of the non megabanks, is it risk your lending? Right?
Great question, And most of it comes honestly tracy from supply demand. And what I mean by that is if you go and did a scan of one of them, and it's a very high level metric, but one of the metrics I love to look at for banks in the countries loan to deposit ratio. And when you start seeing that number get closer and closer than ninety percent, then up to one hundred percent, you better bet that those institutions that's where you want to keep your money,
because they're going to pay. They're going to pay whatever they have to pay to keep money in there, both from a liquidity metric a regulatory metric to keep that loan to deposit ratio within reason so that they're not an outlier, right. And so you're seeing a little bit of that, you're seeing a little bit of quite frankly, most banks will tell me right now they're willing to pay those you see those today, I was in Chicago.
I was at an airport head of the airport, and on my car ride this morning, I saw a CD for five thirty five. I thought to myself, the same thing. Does that mean a typical bank margins three and a half percent? Are they putting on loans at nine percent? Most banks aren't or they're you know, so it begs the question of you're going to see margin compression. I think I've never met a bank that told me they're going to be less than assets next year than they
are this year. I think you're going to meet a lot of new banks that are going to be a lot smaller than they were a year ago, because all of a sudden doesn't make a ton of sense financially. But right now we're still stabilizing and willing to pay up a little bit. But over time, Tracy, as that stabilizes those rates, I expect them to start to come down a little bit because I don't see loans catching up and making the equivalent yields that you need to.
Can we talk about sort of non interest costs for the bank, and I'm thinking, you know, there's a million stories that we've probably run about JP Moore and going out and hiring a thousand people who understand artificial intelligence right now, you know, it's like and like, I again,
I imagine that like Cambridge Community Bankcorp. Is not an attractive place for an AI expert or with But like you know, like, what is that going to mean about the sort of like product gap that exists between these megabanks that have like huge tech teams and the local.
Yeah, that that by far keeps I think a lot of bank CEOs that we're talking about today he or she up at night because the gap is widening. Right, The gap continues to widen. And it's not even the technology, it's the combination of the technology and your users. Right. You think about the average demographic again going back to how much more in demand those technology skills and tools are for a bank to offer, both for hiring and also to gather deposits, gather customers, and so that is
an enormous cost. That and fraud are two of the biggest costs for banks today.
It's talk about fraud and how that manifest is a cost for.
Those Sure, I mean you think about it, and you know, if you've ever gotten a text from your bank saying, hey, we just noticed you paid you know somewhere and you're not even in that state. We took care of it for you, and then they have to go work it out and try to go get it back. They're not getting every dollar back. That's just a cost of doing
business in the bank world. You combine that with margin compression on your real business, how much you got to pay for technology to get talent and the technology in there, and it's another big drag on earnings overall at the institution.
So I remember a lot of these themes from the post two thousand and eight banking environment, and there was this big question of, well, why would anyone start a bank? Because we have higher regulation, we had sluggish economic growth at that time. The tech spend was already an issue, the idea that while opening up brick and mortar bank branches is very expensive, we can't do that anymore. Is there a bowl case for starting a bank nowadays? And
I remember again post two thousand and eight. I think there was one bank that opened in like twenty ten, and then one new bank, Denovo Bank in twenty thirteen, and I went to see it. It was this little Amish bank in Lancaster County in Pennsylvania called Bank of Birdenhad, and it was honestly the most adorable bank that I've ever seen anyway.
Side note, well, that's one of the big things that I like. Just using the word, the word Denovo. We don't say it anymore. Right, It's tough tracy from an investor perspective to say I'm going to I'm going to start a bank, when on earth am I going to get my money back?
Right?
It's going to take a lot longer than it did ten, well, fifteen, twenty years ago. Now I'm getting older. That's part of the problem. You're not seeing a lot of the Denovo world because, both from a regulatory perspective and just apples to apples, earnings for banks on average are going to be harder and harder to come by, which again just makes the return longer and longer. And folks say, I could go invest in something else and probably get my
money back a lot faster. Because we used to look at the stats M and A, this is an interesting component. M and A really never changes in terms of how many banks sell a year over a twenty twenty five year period, but for half of that timeframe, we had a lot of denovos. Now we don't, and that's why you're seeing the shrinking of the size of the banks a lot more. Even though M and A is in a little bit of a rain delay right now. Denovos are tough to come by, tough to get people excited about.
Once in a while, though, you'll see some pop up and you hear some people talking today around you know, look, now I'm not at Silicon Valley. I'm a JP Morgan, and I'm just a number, and so there is still the relationship side. Is there a way to marry the technology and the and the relationship. Sorry interrupt you, Joe.
No that's great, But no you didn't.
I was interrupting you, but it's because you sort of anticipated my next question. So, like, community banks strike me as one of those things like mom and apple pie in baseball, which is like everyone loves the idea of
the community bank, right, and politicians. You know, my understanding is that actually in DC, the community banks are like pretty well represented, and that politicians like to make sure it's like, you know, well, my bank and my constituents banked, and Tulsa get the same treatment as the fantasy in New York.
Banks and all that stuff.
What would be lost in terms of like what is different about community banks in terms of both the relationships but also like their asset mix and the type of business that they do that goes away if they have trouble remaining robust business.
I think we've got a great example of it. And it was so many other things going on, Joe, that we didn't maybe notice it all the way. I give such tremendous credit to the community bank space during COVID because if you think about how quickly they they reacted on the triple P and were able to get out and meet their customers' needs at a very, very challenging time. It was a short window of challenge, right, but it was a very scary time in terms of the small
business side of the world be being helped out. And the largest bank said, we understand what you want us to do, but we remember and how much I got in trouble for getting involved in this, so we're gonna slow play it a little bit. Whereas the small community banks, I'm telling you, I was really proud to know a lot of them. I had a friend call me who said his father ran a business, a small business. He said, Hey, could you get my dad, he banks at XYZ bank?
Could you actually get him in touch with I called the treasure. We made the connection, he got his money, and it just felt really good that there was that dynamic. So I think there's something there, Joe that I think banks do a great job of executing their helping their clients. They do a poor job marketing.
Is there something I mean, I think that's a great example. Is there something in the asset side or the loan side, whether there are's still like whether it's real estate, certain types of real estate transactions, maybe like medium and small business type loans.
Like that's like I want to know, build a little.
Factory and where actually there's like a clear advantage to like the local bank that knows the space, because that's like the theoretical idea, they know the community and they can do this. But like talk to us about how that actually how that plays out.
Sure it plays out a lot, and I'll tell you the asset side is really becoming where banks can try to differentiate themselves on service and relationship and knowing the community. I know my dad's on a board of a country club and he's probably embarrassed I'm even talking about it, But he was telling me how the bank that was serving the country code I want to do some work and wanted to get a loan, but the loan was like two or three million dollars, and they think that's
a lot of money to a large bank. That's almost not worth the time, the risk, the headline risk. He said, there was two or three small community banks willing, hustling, wanting to be helpful, know the market really well. And so that's a great example. Again, I just think the nimble and athleticness of a community bank versus the largest is really one of the advantages that are there that they need to play up more. They do a better job at that. I think.
Okay, so smaller banks might have better relationships, might do a better job of small business lending or supporting the individual community. The big banks have economies of scale that make it possible to earn a relatively decent return at various times. I'm going to ask the big question, but putting it all together, what does the ideal banking system in the US actually look like? How should we balance the small banks with the bank? Yeah?
Great, great question, and again, it's a very difficult one to answer, you know, spot on, Tracy, But my own gut, my own kind of experience. If we're at four thousand banks right now, we're probably heading somewhere towards. I was talking about some of the last night, maybe a couple of hundred banks over the next ten to fifteen years. And I think there's room for the largest, and I think there's room for the community bank world. And maybe I'm being a little light, Yeah.
We might only have a couple of hundred banks.
I'm thinking over the next fifteen to twenty years, and I think what you're going to see or you're going to see great bankers merging together to really start creating more of the mid size, smaller regionals that can deliver better service and have more economies of scale. I really
believe that. And I'm probably going to get yelled at for saying the number, and maybe it's a bigger number than that, Joe, But in my mind, the way I think about it, when I started, there was double the amount of banks, you know, And so we're heading in some form of that direction. Partly because of what Tracy said,
Denovo's aren't really out there to fill the need. And there's a lot of benefits from putting a couple of these great banks together so that they can offer a wider scale, economies of scale, better technology, better cyber security components. So I think you're going to see less banks, but I think more of them will be able to battle the largest ones if they team up a little bit.
Oh, there are some companies making a fortune basically offering white label apps and fraud prevention services, etc. So that these banks don't actually have to have any of that expertise in house.
Yeah, I would tell you when you hear a lot in our world, the fintech world. The fintech world has been great for the community bank space because there's a lot of teaming up right. The fintech world does a great job creating an app, creating a mechanism that tracks to your point that or loan origination or whatever they can. And the banks really opened their eyes about five or six years ago and said, we can really team up here.
We've got great balance sheets. Love to work with the FinTechs on combining and finding the right technology again, so I can battle the largest companies that we compete against.
Just going back to the demographics point. Is there anything that you're seeing that's interesting on that front in terms of banks trying to either make deposits more sticky or maybe attract that new sort of younger base of depositors.
Right, there hasn't been anything that's been completely outside the box that I've seen yet, and I'm always kind of looking for one little, little anecdote. I had a couple of years ago, maybe two years ago, three years ago now, I remember speaking with our interns, is about thirty of them, and I asked each one individual, I said, why do you bank where you bank? And fifty percent of the folks in that room, maybe sixty percent said to me, well,
I bank, were my parents bank. And so that was like, okay, the community bank world has a chance here to try to capture the beginning. Right, you have the beginning of it. Do you know what the other folks were saying, Well, my bank offers a free one year membership to Spotify. So I googled what spot I don't know anything, right, So I google what Spotify is and I realized it's the same version, tracy of what we were doing twenty thirty years ago. You remember the stories of getting a
free toaster if you opened up a check account. It's trying to change the sort of component that leads you to do it. But it sounded very similar to that process. So I see some of that working things like that, But I also think it's the education side of it. It's offering. Your branch now is in a branch the way we used to think of it. It's more of a community center. It's almost like a Starbucks. Come on in, hang out, you know, get to just spend some time here.
You'll meet other folks that are doing some business, like you. All things like that. I'm seeing a little bit and that tends to sometimes work as well.
With Tracy, what's the coffee shop that's like in our building?
I was just thinking about that one.
I think it is. It's like a Capital One bank branch slash coffee shop.
Yeah, you need to go in there, and people are in there all the time, like drinking coffee and eating scones and you know, I guess maybe take out a mortgage. It's like right on our blog, we should definitely go there soon.
A field trip to the local bank brand, you know.
Tracy asked about the demographics of depositors. You told the story of your dad on the board of a country club, and so I have a certain image of, like what the age of the board of a country club is, and I have a certain image in my head of like the type of people at banks who have relationships with the board of a country club. Could you talk about the demographics on the employment side of the banks and like hiring new talent and the challenges.
There, sure, no, That's another one that I see a lot of. And as you travel around and you know, one of the things people will tell you one of the drivers of M and A is succession planning. Very very difficult to get folks to find the talent, to find the individuals that really want to run these community banks.
So at times when you look at a deal getting done, sometimes it's really done because from a succession planning perspective, you'll see that more and more so, I think there's a real challenge there both from an excitement again, I think it goes back to you know, banks do a great job on social media in terms of monitoring their employees.
What I think they do a terrible job of is marketing and getting the excitement about how they're different, what they're doing to try to attract that younger talent in because what used to be is everyone used to go to the top five or six banks in the country. They great training programs, and then those individuals would leave those training programs and go run all the community banks in the country. They don't really have those programs anymore,
and so it's difficult. Yeah, it's difficult to find individuals that really want as much as they used to be, and so that is a real challenge as you think about a growth opponent. Of most boardrooms I'm in, the average age is on the higher side for sure, and that makes it challenging. If you think about the demographic overhaul we're going through, it's not just lending, it's the
deposit side that we don't. Banks don't underwrite their depositors like they underwrite the loans, right, and we've got to start doing that with better representation on the board of folks that are truly going to baby try to help you from a social media perspective, from other ways to gather those deposits and meet them new demographic needs.
So, just going back to March's banking drama, so it feels like some of the really extreme deposit moves have started to moderate now, and at the same time you have the FED coming out with potentially additional capital requirements for larger banks. I take the point that you'll probably see some compression on net interest margin going forward as people have to compete with deposits. But what's the next big I guess concern or thing that's keeping up bank executives or your.
Sure I think it's the you know, you kind of go from the unknown. Like you said, we're going to have higher capital requirements which are going to drag into earnings, which is ironic because Silicon Valley's problem wasn't capital. But anyways, well why digress, right, But we'll we'll move forward. I think then you start thinking about what's keeping them up at night is the fact that perception or reality, I've got to manage my balance sheet differently from a liquidity perspective,
and that's also going to cost money. And what I mean by that is we used to think about and this is a little bit in the weeds Joe and Tracy, so I apologize, Hi, it's too much. But one of the things we do when we project out an earning stream of a bank based on changes and interest rates is we have to assume how long those deposits, how sticky they are. Right, there's no actual contractual maturity for
a lot of those. But typically what people would do is they go back thirty years and they'd say, on averages, a checking account lasts about seven years. So that's great. It gives us a lot of protection in that rising rate environment. Right in theory. The problem is the examiners are going to come in now and say seven years. That's historically fine. But I'm not buying into that anymore.
What I now need to look at is you can tell me seven years, but it's also seven years with a one day call option that those dollars can leave out at any point in time. That puts a lot more pressure on the types of lending you do, the types of balance sheet you're running, which, ultimately Tracy gets to your point, earnings again are going to be under pressure from that perspective, and I would argue apples to
apples that Sunday night. The first thing I said to myself when I read the press release about Signature and Silicon Valley is I said, maybe this country only wants to have five banks, right, you know, That's the first thing I said to myself, because apples to apples, Tracey,
are you gonna put your money? Let's say you're the treasure of a corporation that was banking at Silicon Valley over that weekend you got bailed out, right, but that Monday morning, you weren't going to your board and saying, you know what, I'm gonna move our deposits to bank XYZ you've never heard of. I'm going to Jamie. Now I'm in a JP Morgan and I'm going to bank there. And that's to me, why apples to apples. A community bank's going to have to pay more for liquidity than
the largest banks in the country. Not that keeps them up at night. And hedging in general, I run our derivative business separate of some of the other things I do. Our derivative business is skyrocketed because derivatives are used to hedge interest rate risk, and we used to not have to use them as much because the deposit side of the world. Now, with this deposit concern around the optionality risk for lack of better terms, derivative use has exploded.
I'd like to think it's because I'm really good at it. It's not. It has nothing to do with me, and it has everything to do with the market. And I work on a wonderful team. But that's really what's going on. From that perspective.
This was the missing piece because you know, we talked to Terry Duffy. Yeah, and he's like, no, you de have to like if you wanted to like hear about their hedging business. They don't do it through they ce and me. They do it through the banks. Yes, and you're it sounds like they really were cranking it up.
One of the things I do is I go to boards and I go to management teams. I look at the balance you, I look at the interest rate risk position, and I say, you have now some exposure here, let's show you the derivative transactions. That makes sense.
Are there particular products that are getting really popular.
Yeah, I would say there's a few, and most of them are are a lot of folks have a lot more mortgage book. Their mortgage book is a lot bigger than they wanted it. Right back in twenty and twenty one, everyone has a mortgage. It's not going anywhere. So what a lot of banks are doing is swapping that fixed rate asset to a floating rate to reduce their interest rate risk from a higher for longer perspective. That's one area. The other area is on the liability side. It's the reverse,
but the same concept. They're paying fixed on interest rate, swapping the liability side and locking up their costs on short funding for a long period of time. Those are very very popular transactions on the derivative front.
So I just have two questions. One is a short one, and you were because you're talking about the flightingness of deposits. Someone told me, like, I guess in the old days, they're like once people are in a bank, they're more likely to get divorced than change banks.
Is was that true?
Yes, that's why checking it gaines. We're the golden neck. Everything else was secondary. I wanted your checking again.
And that's why it was still worth to build bank branches, because if you just get them in the door, it's a lifetime money.
Okay.
One last question, and it's sort of the question mark to me, like you're like, well, maybe we'll just want six banks in this country, but maybe in twenty years we'll just be down to two hundred banks.
Is there the political willingness to.
Let that happen, because you know, there was concerned when SVB, like we can't let Jamie Diamond buy it, right, And then First Republic they did tell the JP Morgan. But there's a whole lot of anxiety. And again, people have politicians have a real affinity. It's kind of like, I mean, I think it's like baked into America, right, but like we didn't have cross state banks for a long time. Like the distribution of banking is like kind of a
core American thing, for better or worse. So can you talk a little bit about just sort of the regulatory willingness to allow the consolidation that you anticipate, Will it let it happen?
Yeah, no, great question. And it flip flops. Right one moment, I'm reading about another deal that's not going to go through, and they'll claim it took too long from a regulatory perspective.
But then you'll hear Yellen kind of encouraging the fact that we're going to see a lot of a lot of M and A. And I think you're right though, And one of the arguments against my comment about the amount of baks in this country is absolutely political from You're absolutely right Joe, and it's probably why I will I will be wrong on my number, and that's okay.
I hope I'm wrong, But in my mind, mathematically, the way I see it, if we're really trying to compete against folks that basically have a free blanket of there there's no un insured deposits at the top five, what can I do to compete against it? And that's why I said what I said in terms of that.
Scott Hildenbrand, Piper Sandler, thank you so much for coming on the odd last.
There's a great conversation.
Joe Tracy, Thank you both, and I appreciate everything to do.
Thank you, Tracy. I thought that was a great conversation. And setting aside like the rate hedging and I'm glad we finally talking the rate hedging and all of this, Like you do you look around and you're like, how can they compete?
Yeah, it seems tough. To Scott's point, how do you compete against people who not only have economies of scale but also seem to have de facto unlimited deposit insurance? And I guess the arc of history is that the number of banks in the US has been consolidating, but to the beginning of the discussion and the point that
you made at the end of it. There is also this tension where it feels like there is a big portion of America that has this idealized version of a community bank in its mind and there are actual benefits. So I remember there was an FDIC study I guess it's super out of date nowadays, but maybe ten years ago where they talked about the proportion of small business loans on smaller bank balance sheets versus the bigger ones. And of course the smaller banks have a lot more
exposure to smaller businesses. That make sense, But on the other hand, how do you compete and make money against a JP Morgan that is spending a lot on technology and also has these regulatory advantages, although it also has some disadvantages in terms of capital, but still.
That's right, so it does have higher capital costs. Maybe you solve the problem by like, yes, you have a lot of consolidation, but then also you know the sort of like handshaking meme of like old timey community banks with modern FinTechs that lets you have the sort of best of both worlds where they know the local country club board, but they can also have like AI enabled fraud detection.
That would truly be the ideal. I'm gonna instinctually say it's probably more difficult to do than to just talk about it. But Joe, we need to take a field trip to not to the local bank branch that's below our offices. We need to go to Lancaster, Pennsylvania, check in with Bank of Bird and Hands.
I'd love to see what they're doing.
We should do it. Yeah, let's go.
All right?
Shall we leave it there?
Let's leave it there.
This has been another episode of the All Thoughts podcast. I'm Tracy Alloway. You can follow me on Twitter at Tracy Alloway.
And I'm Joe Wisenthal. You can follow me on Twitter at the Stalwart. Follow our producers Carmen Rodriguez at Carmen Arman and dash El Bennett at Dashbot. Check out all of our podcasts at Bloomberg under the handle at podcasts, and for more odd lots content, go to bloomberg dot com slash odd lots, where we have a blog we post transcripts in a newsletter, and check out the discord Discord dot gg slash odd lots, where listeners are chatting
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