31: Welcome Aboard Starship Bank

him from other banking analysts? All right, Well, David was known for working at this research shop called Credit Sites. I don't know if you've heard of them. They have a bit of a Parish bias, some people would say. But what David did really well is in the run up to the financial crisis, he spotted a whole bunch of the risks in the banking system that not that

many other people saw. And then after the financial crisis, he was one of the banking analysts putting out some really really interesting research out on the business of being a bank, what was permanently broken and what could be fixed. Yeah, this has become a really big topic. People have been talking for the about this for a while, but in the last several months, it seems like there's been this big surge in people talking about this question of is

the traditional banking business model structurally flawed? In other words, not just a slow recovery from the financial crisis, but some sort of permanent impairment. Right, This is the classic structural versus cyclical debate. Are things like fixed income the bond trading business is going to come back or has something permanently changed that means they're basically dead forever? And

we're definitely going to ask David how he feels about that. Well, this is a huge question because there's so much writing on the health of the bank, so much money is in the banking sector, so much wealth, and so this question of can the banks actually recover or they doomed to be much smaller than they were on the early part of the century is absolutely massive. So I'm looking forward to getting the answer. All right. Here is David Hendler.

He is the former banking analyst at Credit Sites and he is now founder and principle at his own risk advisor of Viola. David, thanks so much for being with us. Thank you for your time. So I supposed to be begin You built this reputation as the guy who saw a lot of the risks coming before the financial crisis. How did you manage to do that? That's funny you

should ask um. Basically, I started on the bye side at a conservative life insurance company, New York Life, and they taught me some very good old age investment principles, you know, where credit analysis was emphasized and uh, you know, being I guess cautionary or skeptical when uh, you know, new issue bonds were sold two investors as sucial investors or secondary bonds were sold to be you know, a little skeptical and not just take the up case, you know,

stress tested for the down case and then if you felt comfortable and the spreads were and yields were you know, amenable, you you know, you would do the deal. So I think it's my early days on the by side in the early to mid eighties. So what did you see prior to the crisis, specifically that others were missing? Well, I had been doing UH bank and finance analysis probably for close to twenty years, So I saw a couple

of cycles. I saw the nine eighties energy bust, in real estate bust and EXUS New England, California, and the SNL debacle of the nineteen eighties, and I and and then I saw, um, you know, the tech wreck of the early two thousand, so I kind of understood how things that look too good to be true usually were. And you try to try to get ahead of the decline by you know, writing reports and warning your customers

are investor base about the upcoming difficulties. Then as it plays out, try to figure out if there's a risk adjusted return opportunity on the on the upside. Once you know, most people see it and they sell out, and they're overly worried because you know, I just thought it never could be this way before. Kind of like, you know, the real estate markets are so strong in New York City in the luxury area and people think it will

never go down. I think that's a negative signal there, David, did any of your report before the crisis get you into trouble? Because some of the stuff you were saying back then was really controversial. What do you mean by trouble? I mean I would say that at times at times, um, you know, companies they wouldn't like it, and they would call me about it or quote people that I worked for about it. And you know usually, um, you know, we just heard him out and that was it. Um.

So you know there was there was some friction. You know, investors didn't do that. I would say, I say it was more you know, the companies I covered. Let's uh, let's spin it forward today. Right now, we're in this period where people aren't so much concerned about a banking collapse or anything like that, but concerned that the business model of the major banks is just sort of in either a permanently low state or a state of sort of long decline, and that the business model that was

thriving pre crisis will never come back. What's your take on that? And why are we seeing such a difficult time for banks to hit goals of profitability? We see these continued layoffs. What's going on now right Well, you know, my thirty odd year career watching the bank sector in the US, primarily, I mean there there wasn't really many years that you would call normal. There's always like booms

and busts and maybe some quiet periods in between. So I think what's happening is, you know, we have a demographic shift from the baby boom whars, who are on average fifty eight years old and they're retiring, and maybe they don't have enough money to retire, So what's going to happen with them? Can they put all their money in the stock market now because the bond market doesn't have enough interest yield to support their minimum living standards?

I don't know. I think it's kind of risky. So I think you know you have that shift as well as the Millennias, who have a certain way of life that you know, favors urban dwellers, walkable commutes. But you know what, it's getting expensive. And they heard lately that on another media source that maybe the suburbs is a

better deal. Um, And you're seeing in a lot of suburbs they're making little town centers that simulate sort of a Brooklyn, you know, parts of New York City experience, and you can get on the train and go into the real thing once in a while. So, um, I think you know that demographic shift is shifting how banking is pitched distributed. You know, people don't go into the branch anymore that these there are smartphones to make deposits, so nobody really knows the bank anymore except it's an

app or something. So I think you know that's one change that's reducing employment. Um, I think it increases risk if you don't really know people on a humans fashion like face to face. I think there's a lot of threats like runs on the banks because you don't really know anybody. When you get panick, you need to talk to someone, but you never did, so how do you do it? You know? I think that's one trend. You know.

The other trend is big data disintermediating back of offices UM, computer type systems types as well as you know, different types of loan officers UM. So you know, big data, cloud, bitcoin, blockchain. You know, that's all reducing So it's like a human thud cuts everywhere you look, there's some sort of threat change and um, you know. Then there's a lot of credit building up again in credit cards. We just pierced

one trillion and outstandings for the first time. I think it's gonna double in size as the millennials use the credit cards to realize their dreams by borrowing money, and a lot of them are gonna get into trouble. They're just humans like everybody other generations. So, um, commercial real estate I think is gonna have some problems multi family,

which everyone thinks is a ticket to gold. It's I've seen it in my own buying and selling in different craze periods in the eighties and nineties and two thousands. So you know, trees don't grow to the sky, and you have to see when it's overdone and try to get people to focus on it, because when they have a house and it's going up at price, they don't want to hear a story that housing is going down. It hurts their own personal pocketbook. They just don't want

to face the reality. What about interest rate risk, David, I remember this is something you talked a lot about a few years ago, and since then, you know, rates have stayed pretty low. We had one rate hike from the Fed. We're talking about another one possibly this month

or next. Is that a risk for the banks? Well, I think what's happened is rates have stayed low so long that some of the things I talked about a few years ago, they kind of um the yields rolled into a lower environment, whether it was the investment securities, the cash securities like MBS mortgage backed securities, or you know, different types of derivatives that simulate you know, investment views or mbs, So I think, uh, you know, rates banks maybe you know, take a little bit more risk on

the on the cash side, it's hard to simulate it as much on the synthetic derivative side. It's kind of played out in a way. But you know, when rates rise, you know, nobody really knows how sensitive deposits are to hire rates. So far, with the basis point move, that has not been you know, a huge outmigration from bank deposits. But we'll see how it goes, if how gradual the fet is um the pace and how you know deposits react as deposits could read price faster than bank loans

could be or securities yields. What about the decline of these trading businesses, So we continue to see the major Wall Street banks slim the ranks of their trading. They always talk this was a bad quarter for trading and there wasn't a volatility. Is that business ever going to thrive in a big way again? It's going back to its core purpose, which is capital creation to grow businesses or consumer asset classes less speculative by far less speculative.

So I you know, under the current regime, Dot Frank BOSEL three and all the implementations. And know what we saw in the you know two thousands. You know, you're not going to see for a while whether that gets rolled back with different political movements, whether it's Bernie Sanders or Donald Trump or even Hillary Clinton. You know, we'll see um. But for the time being, you know, trading

desks have been derisked. Um. You know, if you want to, you know, gamble, you know, you gotta do it in non regulated markets or sports fantasy leagues or so you would say. The main problem, the reason those desks aren't as profitable, essentially they've been stripped of their ability to gamble. Correct, David, give us a snapshot of what the Bank of the future is going to look like, say in ten or twenty years, is it going to be recognizable to what

we have today. Well, it's gonna I was just anticipating that question. I think it's gonna be a little like you know, you know, Johnson Space Control, Mission control. You're gonna have you know, a few dozen really smart guys and women running the bank, and then a lot of it's going to be automated and cloud distributed. You're not gonna have you know, you're gonna have you may have more robotic investment management. I mean the by sides really

at risk. I think there was a story about Fink at black Rock saying there's would be a wave of consolidation and asset management. UM. So you know, people the younger generation is more comfortable doing businesses on a smartphone or Skype or whatever. So it's gonna be a lot less people pushing out even more credit. Um. But there's risks because you know, the best way to you do credit businesses is to look at someone's eye and decided that person really gonna pay me back. And I'm not

sure if fintech has solved that. Yeah, it doesn't sound like then you're very optimistic about some of they's new marketplace lenders or other attempts to make lending more efficient. If you think there's still a value in looking at someone in the eye, yeah, I would agree, or being in the same room and having a context about what's going on. So you know, fintech is going to go through an evolution of fits and starts of discovery of what sort of works and maybe it being overdone and

it doesn't work. And I think we're starting to see some models, you know, break down a little, even though there was a lot of fanfare for things like lending club UM and others, you know, where the algorithms don't capture the human element precisely, and uh, they get carried away standing credit automatically. Are there any technologies you mentioned mobile it's going to be a key avenue banking. You

mentioned the cloud. Are there any technology other technologies that you are actually quite bullish on or that you think will be really important? I mean maybe yeah, some of the lending clubs won't live up to the hype. But are there areas that you think right now are being underestimated that are going to change the nature of finance? Well, I think you know, where you can make mundane practices more efficient and less intrusive on somebody's lifestyle, like you know,

quick pay or Venmo or PayPal. You know, I think things like that have been I think successful, Like more on the transaction process s side, where going to the bank and getting your past book stamped with interest, which is what I did when I as a kid, you know, on my paper route, say, um, depositing that check. You know, you just don't need to do that anymore, so I think there's you know, lifestyle efficiency, productivity applications and activities

that you know, make banking just easier on everybody. What about blockchain you mentioned that earlier. Do you think I mean, there's a lot of hype about that, but I haven't really grasped how that's going to change things. Do you see a significant role for that technology in finance? I mean, I'm not an expert in it, but you know it's trying to make things more transparent for the ledger of different activities, whether it's trading or you know, payment systems.

We have massive amounts of payments going one way or another. Um, so I think it's going to help on the efficiency side. And uh, you know what's happening with banking, and I said this in different reports and different talks, is that it's really becoming a commoditized business. We have to brand it to get loyalty so that you could reuse the product, the investment the product across more users and people. So

you know, you need a strong brand. And when you have brands, you have to deliver on the brand concepts. So you know, banks like Chase should continue to do well. Banks like City self to prove themselves again, even though they kind of with the first big bank to do mass marketing of credit cards back in the seventies and eighties, Bank of America's trying to get that brand of you know, reliability across mortgages and credit cards and you know other activities.

So um, I think that's the key. Do you have a brand and then you leverage the efficiency that technology presents to your customer base. So it's brand and human element. David Hendler, thank you very much for joining us. I think there's gonna be a fascinating debate and conversation to track in the coming years, and we hope you'll come back at some point for a update on how things evolved. Thanks so much, Thank you, Tracy. I think this is going to be a really interesting topic that we're going

to be talking about from many years. And I feel like this is an area the future of the bank that everyone is sort of clawing around for an answer, and I just don't feel like, uh, I just feel like there's gonna be like a huge mystery we're all gonna be talking about. Well, I suppose in ten or twenty years we'll have to reconvene all thoughts and figure

out where we've come out. But I do like the idea from David of having bankers sort of like pilot the Starship bank, right, like everyone, you just have a couple of people who are sitting in front of a computer and they sort of control it and direct this massive organization, and you don't need as many people anymore. But the other interesting thing he brought up was the trade off. Right, if everything is electronic and you're not really interacting with people in person anymore, is that bad

for credit management? Yeah? Yeah, exactly. It seems like there's kind of a contradiction. So on the one hand, you have the person sitting behind the Starship enterprise with all this technology around them, But on the other hand, as you pointed out, there's still no better way to assess someone's credit viability that talking to them and actually getting to know them. So it feels like this is something

we're going to be wrestling with for a while. I mean, we talked about a couple episodes ago what's going on with Lending Club and the attempts to use big data or whatever to assist credit worthiness, But it doesn't sound like that issue has been solved yet. It still sounds like there's a contradiction here. No, I don't think anyone's cracked it just yet. So we'll have plenty of stuff to have plenty of talk about, and I look forward to Odd Lots episodes in the year twenty thirty six

where we see how this all developed. All right, I'll see you then. Thanks everyone for listening to the latest episode of the Odd Lots Podcast. I'm Joe Wisn't All. You could follow me on Twitter at the Stalwart and I'm Tracy Alloway. I'm on Twitter at Tracy Alloway. Thanks for listening.