Bank Earnings Takeaways with American Banker Reporter Polo Rocha
This episode of Fintech Layer Cake podcast features bank earnings takeaways with American Banker Reporter Polo Rocha. Listen to the show on iTunes, Spotify, or your favorite podcast app and find the transcript, below.
Intro
Welcome back to Fintech Layer Cake, where we uncover secret recipes and practical insights from fintech leaders and experts. I'm your host, Reggie Young, Senior Product Lawyer at Lithic. On today's episode, I chat with American Banker reporter, Polo Rocha, who covers consumer finance and national banking trends. We cover what's happening in current bank earnings season, the state of regional banks when you're out from SVB, and much more.
While we focus on earnings from public banks, it generally applies to fintech sponsor banks. We cover this a little bit in the episode, but a lot of fintech sponsor banks aren't public since you can't easily get summaries of their earnings. These are general lessons and general trend observations that Polo has seen in the state of community and regional banks, which includes the subset that sponsor fintech programs. It's useful context for anybody thinking about what the current state of fintech sponsor banks' health is and what the year ahead looks like. I actually thought his summary of the key headwinds that banks are facing in 2024 was particularly useful, and I plan to watch those items quite closely for the rest of the year.
Fintech Layer Cake is powered by the card issuing platform, Lithic. We provide payments infrastructure that enables companies to offer their own card programs. Nothing in this podcast should be construed as legal or financial advice.
Full Transcript
Reggie Young:
Polo, welcome to the Fintech Layer Cake podcast. Super excited to have you today and for our conversation, in part because of a ton of respect for American Banker, excellent outlet. Pretty much every lawyer in financial services I know or in fintech that I know reads it regularly, including myself. So if folks aren't familiar, you should go bookmark American Banker like I do.
But also before that, you worked at the prestigious Badger Herald many years ago in Madison, Wisconsin, which is actually where we first met. Funny backstories, we both worked at this college newspaper alongside each other, and neither of us had any financial services interest whatsoever at the time. And fast forward, and lo and behold, here we are. I realized a few years ago I was reading American Banker pieces with Polo’s byline. So super excited to get you on the podcast because I know you have a ton of knowledge and are pretty deep on a lot of the stuff that's happening in banking and the state of banks and health and whatnot. So welcome to the podcast.
Polo Rocha:
Yeah, no, thank you for having me. Yeah, it's been fun to reconnect all these years later and talk about banks and fintech.
Reggie Young:
Yep. First, we're going to cover two big topics today, bank earnings and then the general state of regional banks a year out from SVB. We're recording this, I believe it's April 24th. So in case listeners want some timing context, we are in the middle of bank earnings right now, which is an area that Polo focuses a bit on. So would love to start out just by helping to educate a lawyer like myself on what do you look for in bank earnings? What are some of the key metrics you look to?
Polo Rocha:
Yeah. Usually, it really depends on what part of the cycle we're in. I think right now, when we open up a bank earnings report, we look very closely at their net interest income. And so that's the difference between when a bank makes an interest on its loans and what it pays an interest to its depositors. High interest rates have definitely let banks charge more on their loans, but they've also had to pay more to their depositors. That difference, net interest income right now is a big metric that I think investors are looking at.
And then just broadly, I think there's been concerns here and there about the health of banks’ borrowers and how well their borrowers are keeping up on their loan payments. I think there's some metrics like delinquency rates on loans, charge-off rates, problem loans. Banks disclose a series of metrics, like layout, how challenged are bank borrowers. Right now, the economy is fine, but I think there's worries about that turning at some point. So when we look at earnings reports, really at this point in the cycle, it's net interest income and credit quality. There's many ways to measure that but certainly will vary at each bank.
Reggie Young:
Got it. And for those two key areas of focus, are there any particular trends or red flags or good things that you're seeing in the earnings calls right now?
Polo Rocha:
Yeah. I think right now, the trend you're seeing across the banking industry is a decline in profitability. Banks are having to pay more in deposits, and that's causing them they have to pay interest to their depositors more and more. And so that's really cribbing how much money they can make overall. It's worth keeping in mind that the industry is still pretty profitable. Don't want to overstate the declining profitability, but some banks are having to pay more than others. And so some banks are having some bigger kind of profitability pressures. Even the big banks, JPMorgan Chase, biggest bank in the country, they reported some somewhat disappointing news on net interest income, and investors, their stock went down 6%, which is for the country's biggest bank, it's a pretty big amount. I think that's definitely one of the trends we're seeing, regional banks seeing more pressure there in some ways.
The other trend we're seeing is on the credit quality front. We are seeing things start to get marginally worse. We're seeing credit card customers start to fall behind on their credit card bills more than they have. It's not at 2000 late levels by any means, but certainly worse and more could be. And then some business customers are also falling behind on their loans, and some of those commercial real estate properties that I've been much worried about among investors, I think the outcome there will be more nuanced than some investors worried. But we are starting to see those kind of one-off property and trouble and cannot pay back the bank type of situations.
Reggie Young:
Yeah, I know that's been a huge headline in San Francisco the past few months, what's happened with all the commercial real estate out there, which I want to circle back to a little bit later in the episode. I've also been hearing just auto lending is getting absolutely wrecked. That's a whole like, behaves differently, has different characteristics and a lot of credit card loans, but also an interesting bellwether.
One quick note for listeners, I think this is interesting, is Polo is talking about a lot of the earnings that we can see from public banks. Polo and I tried to chat about this, and I think it's interesting. Actually, a lot of the fintech sponsor banks are not public. And so these are names you can't necessarily directly see, but you can get a sense of how a lot of fintech sponsor banks that are more like community or regional banks, how well their health is by looking at general industry trends. So I just want to give that comment.
Polo Rocha:
To that point, while they certainly do some novel activities when they're working with fintech companies in ways that are beyond your traditional community bank model, these banks are still out in their community, they have to get money from their community. And so that means that if Chase is paying customers 4.5% on a certificate of deposit, that community bank is going to have to compete with Chase unless Chase is in their community. Maybe it's a rural area that Chase might not be at, or Bank of America or Wells Fargo. So yeah, certainly, there's new activities that these more fintech-friendly banks are engaged in. But they're still banks, and I think there is still some fear to some of those same pressures, particularly on the deposit front.
Reggie Young:
Yeah, it's interesting. We think a lot in fintech, we talked about like, oh, banks just need to staff up, especially in the current fintech market where there's a bunch get sent orders, like oh, banks just need to staff up, add people. But the reality is they have an entire army working on their normal business. So they have a bunch of headcount, and sometimes those people are doing both the local loans to small businesses and also fintech partnerships. It's a whole operational employee consideration that isn't often talked about. Besides interest income and the state of credit, are there any other trends you're seeing in banking so far?
Polo Rocha:
Well, I think one positive thing for banks right now is that capital markets activity is back. I think even at these high interest rates, they're starting to look at merging with other companies again. Yes, interest rates are high, so issuing debt right now is not necessarily cheap. But I think companies have realized that maybe interest rates are going to stay where they are, so let's just borrow now or refinance loans that are coming due.
And what that means for banks is banks are the ones that put all these deals together, do the underwriting on the corporate debt and whatnot. I think as it relates to the pressures that banks are seeing on profitability, like interest income, this has been a line of non-interest income, fee income. The bank fees are starting to do a little bit better, thanks to this kind of return of the more Wall Street business or even the more regional method of that Wall Street financing. And regional banks may be offering those same debt underwriting services to a smaller corporate borrower that doesn't really tie to the bond market for stuff. That's all starting to come back for banks after a dearth of activity. That's been good for their profitability.
Reggie Young:
Yeah, it makes sense. It'll be interesting to see how it keeps playing out. Looking more prospectively, looking ahead, what are some of the biggest obstacles you think that these banks are facing for the rest of 2024?
Polo Rocha:
I think the challenge about commercial real estate, which regional banks have more exposure to, it's a slow-moving picture. A lot of the worries about office leases, maybe apartment buildings in areas that have maybe too many apartments after a lot of building happened, but those kinds of leases run out every few years or so. So I think that's going to be a more gradual story. And to the extent that we do see stress, it will play out over time.
I think right now, really, the regulatory hurdles are pretty significant for the banking industry, particularly the regional and big banks. The Fed is coming down with some new rules that may end up being softened after a lot of industry pushback but are still tougher on banks, and the banks saw during the Trump administration. The regulatory picture is certainly an obstacle. Just behind the scenes, there's just a lot of activity. The supervisors and regulators much like they're going into these fintech-friendly banks and asking questions about, is your business performing on all levels compliance-wise, whatever.
Big and regional banks, I think, are starting to see or have been seeing more supervisory questions on just a range of things. I think that continues to be a challenge, and then just high interest rates. I think high interest rates have been, at least at this level, not so great for banks. It doesn't look like the Fed is cutting rates as soon as markets hoped. That's what's going to continue to be a challenge, our much longer rates stay at these levels.
Reggie Young:
Yeah, interesting. I think in the fintech news arena, there has been a lot of coverage of, oh, limits on overdraft fees at CFPB is proposed, and that’s going to pinch or reduce banks’ revenue and viability a little bit maybe. But you're right, your first comment, there's a lot of other rules that, from a fintech perspective, I may not think of. There's a lot of Community Reinvestment Act proposals and the merger guidelines that are currently being worked on definitely have big implications for a lot of fintech bank sponsors, obviously, all banks of all sizes, community and regional. Yeah, fascinating stuff.
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Reggie Young:
Would love to switch over now to more the state of regional banks, given that we're recording this a little over a year after the Silicon Valley Bank collapse happened and obviously some other bank failures and collapses that happened following that. When you're out from that event, where do things stand?
Polo Rocha:
Big picture is the industry stabilized a couple of months after Silicon Valley Bank, when you look at the big worries that emerged in the weeks after about regional banks as a whole. I think the worst case scenario did not necessarily play out a yes, First Republic, which was in trouble right away, would soon fail and be bought by JPMorgan Chase. There's been some pressure with New York Community Bank, which has its own case of all the concentration in New York rent-regulated apartment buildings.
Certainly, the regional banks have had these profitability pressures that we talked about as they needed more funding post SVB. Maybe some dialed up how much they paid on interest to depositors. The deposit picture certainly got more competitive with interest rates where they are. Certainly, those continue to be pressures. And there are these worries, like I talked about commercial real estate, particularly some of the regional banks that have overly large concentrations. It remains to be seen. But I think even though things stabilize, I think there's still investor worry, and any sign of bad news from a bank can become really bad news. That's what happened with New York Community Bank. Their stock was dangerously close to zero, and they had to get a capital infusion from Steven Mnuchin and company. So any kind of inkling of bad news drives a significant market reaction. I don't know if we're fully out of the woods yet. And I think that's what is driving some investors' concerns.
Reggie Young:
Yeah, it's interesting to watch that negative feedback loop happen around certain banks, definitely makes me appreciate the psychological role that the FDIC and banking regulators generally play, instilling confidence or whatnot.
Polo Rocha:
Yeah, no, no, totally. And I think as it relates to the feedback loop, I think there's kind of a distinction between headline grabbing stock declines, including ourselves. Maybe we'll say, the stock went into turmoil. Obviously, that's bad news for the banks’ shareholders who are seeing their investment decline, and maybe new investment needs to come in to fix the bank, and that makes your investment even less valuable. But ultimately, what matters for a bank and whether it stays alive or not is also its depositors and whether they panic.
What happened with Silicon Valley Bank was most of its depositors were not covered by FDIC insurance, and so they had an incentive to pull their money out as soon as things got bad. I just don't know that depositors, frankly, read the news about their banks’ health all that much. I think there's this interesting tension between- and I guess it's good that a bank’s stock can suffer, but as long as depositors are mostly sticking around, it's really- I don't want to say that big of a deal, but it's certainly not as catastrophic as it could be.
Reggie Young:
No, definitely. I think it's Daniel Kahneman, may have been Amos Tversky’s, one of the quotes about summarizing behavioral psychology of things are not as important as you think they are while you're thinking about them. And I think fintech financial services spends a lot of time thinking about, oh, my god, the healthiest banks, to your prior point, these banks have normal businesses with local depositors that don't read these sorts of headlines at all and aren’t keyed into this stuff.
Polo Rocha:
Yeah. I think it's fair to say our Silicon Valley Bank and its peers were a lot shakier than your average regional bank. And yes, I think there's some long-term questions about regional banks being able to compete with big banks in terms of technology investments, and that's what's driving this kind of decades-long trend in consolidation of the bank industry. But ultimately, certainly, some have more trouble than others, and the commercial real estate portfolios may be more of a mess at one bank than another. But broadly speaking, these banks are built on a much shakier foundation, and they have to be, because regulators are supposed to go in there and make sure that they're not getting out over their skis in any one way.
Reggie Young:
Yeah. Speaking of regulators, I'd love to hear what you think some of the biggest lessons and takeaways from the 2023 bank collapses were. That can be from a regulator’s perspective or just in general, what are some of the lessons we've learned?
Polo Rocha:
Well, I think one big one is really the stability of depositors. And a renewed focus on having high levels of uninsured deposits is certainly bad news and certainly can drive what one might have thought were previously sticky customers turns out that they might not be so sticky when there's a lot of money at stake. I think another big lesson is interest rate risk and a bank's vulnerabilities of interest rates rise. Interest rates had been pretty low for 20-or-so years, probably less. Really, after the financial crisis, the Fed cut rates to basically zero and only lifted it soon after.
Reggie Young:
It’s so funny to me how people complain about how interest rates and mortgage rates are so high. It's like, yes, they're high relative to what they were three years ago, but they're still below historical averages. It's just mind blowing to think about how much our public psyche is rooted to this 0% interest rate.
Polo Rocha:
Yeah, totally. Banks are run by people who maybe did not have extensive experience when interest rates were at those levels. And I think we all have our own biases. Maybe some of that was at play here. I think with Silicon Valley Bank, they just bought a bunch of long-term bonds that basically flopped when interest rates rose and eroded their value. That was all out there in public. But I think when depositors realized it after Silicon Valley Bank announced, oops, we have to rearrange our balance sheet, that's what sparked the panic.
And it all goes back to a small amount of banks took on, I think, far more risk than they should have on the interest rate side. And that’s a really basic banking 101 part of risk management, but it was forgotten about for a long time. The 2008 crisis was really not about interest rate risk. It was about credit risk and the complexity of the financial system with all these complex instruments built on mortgages that maybe were somewhat rocky. That was like a credit crisis. And we've designed a bunch of rules to guard against that type of scenario. The big banks have a lot more capital, regional banks have a lot more capital, but there's still this kind of very basic interest rate risk goes back to the early days of banking. I think there is some mistakes there.
And then there are some of the mechanical issues that we saw in terms of banks. Some of them are,I guess, not as plugged in in the mechanical way of getting the emergency funding from the Fed that they might need the Fed discount window. I think there's some mechanical issues that I think regulators are working out just to make sure that, a, do those bells and whistles work, and b, can banks actually tap them, because once you tap them, you're in trouble. So I think there's some questions about stigma and some more mechanical questions about ability to access these funding sources that I think we're still working out.
Reggie Young:
Yeah. These emergency funding sources are so funny to me. I remember this happening in COVID, the Feds set up some emergency lines of credit. It was really about signaling to the market that they were willing to invest and provide these lines of credit to financial institutions in need. It didn't matter that these FIs barely use them at all. It was just a signaling, like we're here to backstop and be a support. Super interesting aspects of banking.
Polo Rocha:
Yeah, totally. This is why the Fed was set up all these many years ago, is to provide good banks emergency funding to get them through crunches. Whether Silicon Valley Bank and others were good banks, certainly, they had good assets, just very underwater assets. These are critical to our financial system, these tools. Make sure that whenever there is panic, because that's just a natural part of economic cycles, it seems, we have the tools in place and the ability for folks to use them to get through the crunch, and make it through the next day or month.
Reggie Young:
Definitely. Polo, this has been awesome. I appreciate you coming on and giving me and our listeners an overview of bank earnings, what we're seeing and how they work and the state of banking here up from Silicon Valley Bank. If folks want to read your wonderful reporting or get in touch with you, where should they go?
Polo Rocha:
Yeah, you guys can just go to americanbanker.com. We've got a strong team that covers regulation, banking, like me, fintech, these policy questions that are at the heart of the intersection of all that, or you can find me on LinkedIn at Polo Rocha, and happy to be in touch.
Reggie Young:
Awesome. Thanks so much for coming on the podcast.
Polo Rocha:
Thank you. This is a lot of fun.
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