July ’18

The BAN Report: Big 4 Bank Earnings / Powell Signals More Rate Hikes / GE Capital’s Shadow / Papa John Exits Stage Left-7/18/18

Big 4 Bank Earnings
The nation’s four largest banks have now released their second quarter earnings with Bank of America and JP Morgan Chase delighting the markets, while Citigroup and Wells disappointed.    Broadly though, banks had good second quarters and we expect good numbers from the regionals and from the FDIC’s Quarterly Banking profile later this month. 
Bank of America
B of A hit on all cylinders in the second-quarter, successfully growing revenue while continuing to cut expenses.    
The second-biggest U.S. lender said that second-quarter profit surged 33 percent to $6.8 billion, exceeding the $5.92 billion estimate of analysts surveyed by FactSet. Executives said it was the 14th straight quarter the company posted positive operating leverage, or increased profit by turning levers including costs. The company’s shares rose more than 4 percent at2:30 p.m. New York trading.
The Charlotte, North Carolina-based bank said it managed to boost revenue while cutting expenses more than analysts had expected. The lender trimmed costs by 5 percent to $13.3 billion, beating the $13.5 billion forecast of analysts surveyed by Thomson Reuters. Meanwhile, revenue rose 3 percent to $22.6 billion, compared with the $22.3 billion estimate, excluding a year ago-gain tied to a business sale. The company’s earnings per share surged 43 percent to 63 cents per share, crushing the 57 cent per share estimate.
Still, of all the figures on the bank’s income statement for the quarter, the most stark change was a 43 percent drop in the bank’s income taxes to $1.7 billion from $3 billion. That looked to be the single biggest factor in the bank’s profit increase in the quarter. The Trump administration’s tax cut, which took effect this year, also allowed the company to announce a new $500 million technology investment, Bank of America said.
Bank of America grew their non-mortgage consumer loans by 7% from the prior year, while their peers were flat.     The concern obviously is higher rates will increase defaults, but so far, so good.   Our commercial banking colleagues at B of A have mentioned that B of A has not been as aggressive, so perhaps there is a concerted effort to re-balance the portfolio with more consumer loans.
Wells Fargo
Wells Fargo reported lower revenue and profit for the second quarter, falling short of expectations as it tries to move on from its regulatory issues.
The bank said Friday that earnings per share were 98 cents on a GAAP basis, including a 10 cent per share tax expense. Not counting that expense, EPS of $1.08 fell short of Wall Street’s $1.12 estimate for the quarter.
Revenue came in at $21.55 billion. Wall Street had expected revenue of $21.677 billion, according to Thomson Reuters. Net income of $5.19 billion was also shy of expectations, which called for net income of $5.47 billion.
“The broad-based weakness of Wells Fargo’s results is troubling, with many indicators such as deposits, commercial and consumer lending trending down. It appears that the slew of scandals that Wells Fargo has been involved in are taking their toll,” said Octavio Marenzi, CEO of capital markets management consulting firm Opimas. “Compared to JPMorgan’s excellent results earlier today, Wells Fargo is looking rather hapless, unable to get it right.”
We think Wells Fargo’s issues are unique and it just has taken them way too long to dig out from the various scandals.    A marketing campaign launched in May should help and is long overdue.      
Citigroup
While Citigroup topped earnings estimates, the market was disappointed with top-line growth.
Citigroup shares fell Friday after the banking giant reported weaker-than-expected quarterly revenue. The company’s earnings per share, however, topped estimates.
Citigroup delivered disappointing results for deposits and trading. Deposits for the quarter totaled $996.7 billion, below a StreetAccount estimate of $1.009 trillion. Meanwhile, fixed income trading revenue came in at $3.08 billion, slightly under a forecast of $3.11 billion. Equities trading took in $864 million, while analysts polled by StreetAccount expected a total of $1.1 billion.
“In the shadow of rival JPMorgan, Citigroup’s results pale in comparison. The bank’s growth in earnings was almost entirely driven by a lower corporate tax rate, rather than Citi’s underlying operations. Citigroup’s revenue growth was tepid at only 2%,” said Octavio Marenzi, CEO of capital markets management consultancy Opimas. “While expenses also declined in line with revenues, Citi will have to continue to pay close attention to expense management in the coming quarters.
The poor trading performance is puzzling, as higher volatility has been good for the trading markets.   Other peers like JP Morgan Chase and Goldman had strong trading quarters.
JP Morgan Chase
JP Morgan Chase had a solid quarter, blowing out analyst estimates.
Profit surged 18 percent, clobbering analyst estimates for a 9.4 percent increase. Earnings per share were $2.29 in the quarter, beating the $2.22 estimate. It was the 14th straight quarter that J.P. Morgan topped analysts’ estimates, according to Barclays analysts. The company’s revenue increase was less stark, rising 6 percent to $28.4 billion.

In the company’s trading division, led by Co-President Daniel Pinto, markets revenue rose 13 percent to $5.4 billion, exceeding analysts’ estimates by a half-billion dollars. J.P. Morgan said at the end of May that it expected revenue from its trading division to be about flat from the year earlier because of several one-time charges, including a $100 million hit related to a tax-oriented fixed income unit. Analysts had expected bond and stock trading of $4.88 billion, according to a consensus from FactSet.

“There were more catalysts in the market” that helped spur volatility and therefore trading, especially in the second half of the quarter, said Chief Financial Officer Marianne Lake. Ironically, it was signs of instability in global order that helped spark trading, including the escalating U.S.-China trade dispute, unrest in emerging markets and the European Union, she said. 

A high five for their investor relations group is in order, as they lowered expectations and then benefited from market volatility.   
Powell Signals More Rate Hikes
Federal Reserve Chairman Jerome Powell testified this week in front of the Senate Banking Committee, touting a strong economy and signaling more rate hikes.
Mr. Powell affirmed the Fed’s plans to continue with gradual rate increases, and he said it was too soon to say if trade disputes might interfere with those plans. The central bank’s rate-setting committee “believes that—for now—the best way forward is to keep gradually raising” its benchmark short-term rate, he said.
The addition of the qualifier “for now” to Mr. Powell’s statement was new, emphasizing that policy decisions aren’t on autopilot. The phrase also signaled less certainty about the rate path as the Fed raises its benchmark rate toward a so-called neutral level that neither spurs nor slows growth.
The Fed raised that rate in June by a quarter percentage point to a range between 1.75% and 2%, the second such increase this year. Most Fed officials penciled in a total of at least four rate increases this year and three more next year.
Most of them expect they will need to raise the rate to a neutral level, which could be reached in the next year, but they haven’t resolved whether or how much higher to go after that.
The Fed’s going to see how the US trade disputes with the EU and China resolve itself.    Obviously, trade disputes often lead to higher inflation, which means the Fed may need to raise rates faster, but that obviously depends on how broad price increases impact the economy. 
GE Capital’s Shadow
GE Capital wasn’t central to the plans unveiled last month to restructure the company around its power and aviation businesses. The lending unit, which once financed things including oil-drilling ships and overseas car loans, previously accounted for as much as half of GE’s profit and helped fund its dividend. Then the financial crisis hit, and GE Capital nearly sank the entire company.
Former CEO Jeff Immelt sold most of the assets late in his career, but some of the less-desired pieces continue to be a drag, including a $15 billion commitment to an insurance business that caught even board members and senior executives by surprise.
Despite years of shrinking, GE Capital still has about $146 billion in assets, including a large airplane-leasing business, a defunct subprime mortgage operation and more than $3 billion in a collection of variable-rate Polish residential mortgages.
GE is now essentially unwinding much of the entire operation, with plans to sell $25 billion in energy and industrial finance assets by 2020.
While the finance function is helpful, similar to getting a loan from a car dealer, customers aren’t necessarily getting better terms than they would from a third-party institution, one industrial executive said. But bundling the lending in-house gives buyers the impression they are getting a good deal, the person said.
As GE Capital has shrunk by about 75%, the asset sales have tended to be the better performing units, thus making the remaining franchise less and less attractive.    It would have been better for GE to sell the lower-performing units at a loss, so that the remaining franchise was more attractive.    Additionally, when GE exited the long-term care business, for example, they were stuck with some toxic portfolios, which is why they took a $15 billion charge earlier this year.
Papa John Exits Stage Left
Just a few days after an explosive report in Forbes, Papa John founder John Schnatter resigned as Chairman of the Board and as the public face of the company.
John Schnatter—the founder and public face of pizza chain Papa John’s—used the N-word on a conference call in May. Schnatter confirmed the incident in an emailed statement to Forbes on Wednesday. He resigned as chairman of Papa John’s on Wednesday evening. 
The call was arranged between Papa John’s executives and marketing agency Laundry Service. It was designed as a role-playing exercise for Schnatter in an effort to prevent future public-relations snafus. Schnatter caused an uproar in November 2017 when he waded into the debate over national anthem protests in the NFL and partly blamed the league for slowing sales at Papa John’s. 
On the May call, Schnatter was asked how he would distance himself from racist groups online. He responded by downplaying the significance of his NFL statement. “Colonel Sanders called blacks n—–s,” Schnatter said, before complaining that Sanders never faced public backlash.
Schnatter also reflected on his early life in Indiana, where, he said, people used to drag African-Americans from trucks until they died. He apparently intended for the remarks to convey his antipathy to racism, but multiple individuals on the call found them to be offensive, a source familiar with the matter said. After learning about the incident, Laundry Service owner Casey Wasserman moved to terminate the company’s contract with Papa John’s.
This week, John Schnatter said resigning was a mistake and that the Board acted too quickly.    We disagree – he may have been misunderstood and had no ill-intent, but that’s not the point.    If one is the public face of a company, he or she needs to be on guard all the time.   Multiple companies and organizations from major sports teams to universities are severing ties, so what is the Board supposed to do?   Usually, Boards (Wells Fargo, for example) act too slowly during PR crises when swift action is needed.    Moreover, if you don’t want the scrutiny of being public, stay private.    

The BAN Report: Banks Downsize Headquarters / The Open Workspace Fallacy / Kylie Jenner Worth $900MM? / US Cities Americans are Abandoning-7/13/18

Banks Downsize Headquarters

In order to cut costs, banks have been reducing office space at headquarter locations and building operation centers in low-cost areas, according to a report from Jones Lang LaSalle.

The larger financial institutions occupy more than 150 million square feet of office space across the United States, with almost 100 million square feet located outside of their headquarters cities. Given the need to drive efficiency through integration, we expect to see a portion of this space resized as companies digitize functions, allowing them to consolidate operations. Some companies may even choose to leave their established headquarters locations in favor of lower-cost environments as a way to retool operational efficiencies quickly and manage costs.

Over the next five years, we could easily see their corporate office space needs reduced by 25 million square feet. A large share of this will take place in their headquarters markets as growth/ expansion continues in the established, secondary/emerging and unexpected operations hubs we identified earlier.

Given recent trends in this cycle, new and expanded operations hubs could total10 to 15 million square feet in the U.S. (3 to 5 million square feet annually).

With change being certain, financial services institutions will be working to optimize operations to reach greater efficiency, serve their customers better and manage costs effectively—in short, to be successful. While a challenge, this unprecedented change provides the opportunity to identify the right balance between headquarters and operations space.

For financial services companies, corporate headquarters are usually in large and expensive cities, so shifting workers to operational hubs in lower-cost locations makes economic sense, especially since these emerging cities are attractive young talent.   For example, Salt Lake City is Goldman Sach’s fourth largest location in the world.   Of course, the downside here is that senior management will be more disconnected from their workforce.   

The Open Workspace Fallacy
Open workspaces have been the trend in office design, as companies shift from private offices to a more collaborative environment.    A recent study by Harvard Business School suggests that open environments lead to less collaboration.
In two intervention-based field studies of corporate headquarters transitioning to more open office spaces, we empirically examined—using digital data from advanced wearable devices and from electronic communication servers—the effect of open office architectures on employees’ face-to-face, email and instant messaging (IM) interaction patterns. Contrary to common belief, the volume of face-to-face interaction decreased significantly (approx. 70%) in both cases, with an associated increase in electronic interaction. In short, rather than prompting increasingly vibrant face-to-face collaboration, open architecture appeared to trigger a natural human response to socially withdraw from officemates and interact instead over email and IM. This is the first study to empirically measure both face-to-face and electronic interaction before and after the adoption of open office architecture. The results inform our understanding of the impact on human behaviour of workspaces that trend towards fewer spatial boundaries.
If you’ve ever been on a crowded subway or elevator, this should not be surprising.   You can’t force people to interact with each other, and a lack of privacy or space makes people retreat to their headphones, email, and smartphones.   What’s remarkable here is why a study like this has taken so long – companies have radically transformed their office environments with no evidence that it works!

Kylie Jenner Worth $900MM?

Reality star Kylie Jenner has leveraged a successful fashion brand to be worth nearly one billion dollars, according to Forbes.

Just 20 when this story publishes (she’ll turn 21 in August) and an extremely young mother (she had baby daughter Stormi in February), Jenner runs one of the hottest makeup companies ever. Kylie Cosmetics launched two years ago with a $29 “lip kit” consisting of a matching set of lipstick and lip liner, and has sold more than $630 million worth of makeup since, including an estimated $330 million in 2017. Even using a conservative multiple, and applying our standard 20% discount, Forbes values her company, which has since added other cosmetics like eye shadow and concealer, at nearly $800 million. Jenner owns 100% of it.

Add to that the millions she’s earned from TV programs and endorsing products like Puma shoes and PacSun clothing, and $60 million in estimated after-tax dividends she’s taken from her company, and she’s conservatively worth $900 million, which along with her age makes her the youngest person on the fourth annual ranking of America’s Richest Self-Made Women. (We estimate that 37-year-old Kardashian West, for comparison, is worth $350 million.) But she’s not just making history as a woman. Another year of growth will make her the youngest self-made billionaire ever, male or female, trumping Mark Zuckerberg, who became a billionaire at age 23. (Snapchat’s Evan Spiegel also became a billionaire in his early 20s, though it’s less clear when he passed that threshold.)

The internet went crazy that Forbes characterized Ms. Jenner as “self-made.”   Nevertheless, it’s an amazing story that a family famous for doing nothing can produce billionaires!

US Cities Americans are Abandoning

USA Today reviewed population migration patterns and migration from the Northeast and Midwest to the Sun Belt continues unabated.

Each year, roughly 40 million Americans, or about 14% of the U.S. population, move at least once. Much of that movement includes younger people relocating within cities, but it is trends of Americans moving to warmer climates, more affordable areas, and better job opportunities that have largely determined migration patterns in recent decades.

Because of those long-term patterns, as well as the recent period of economic recovery, cities in some parts of the country have lost tens of thousands of residents.

To find the 50 U.S. metropolitan areas that have had the largest net decline in population as a result of migration between 2010 and 2017, 24/7 Wall Street reviewed population figures from the U.S. Census Bureau’s Population Estimates Program.

The 50 cities where the most people are moving away from can primarily be found in the Northeast, Midwest, and West Coast, particularly in states like Illinois, Michigan, Ohio, and New York. Among the cities where people are leaving in droves are places such as Chicago, Detroit, St. Louis, New York, and Los Angeles.

This trend stopped during the Great Recession but has picked up pace again.   High-tax and high-cost areas are going to have to do a better job retaining their population.   States like Connecticut have tried to raise taxes on their wealthy residents, which led to people exiting the state.

The BAN Report: Luxury Home Sales Stall / How I Learned to Stop Worrying and Love Brokered Deposits / Hedge Fund Star Dims / Job-Hopping Spikes / New Ruling Allows Banks to Lower Costs for Small Balance CRE Loans-7/5/18

Luxury Home Sales Stall
Sales for the most expensive homes have stalled in many markets, as buyers are skittish.   Take Orange County, California for example.
In Orange County, homes listed for more than $1.25 million account for about a third of all inventory but only 14 percent of demand, according to market-data provider Reports on Housing. Many properties are expected to sit for months — in some cases, for more than a year — before going into escrow for a sale.
Sales of high-end properties can be idiosyncratic, since the pool of potential buyers is small. But these data suggest that the broad gauges of home prices, which have climbed steeply for years, are masking some wobbliness at the top. Orange County attracts enough wealth to make it a cautionary case study in what the elite are — and aren’t — willing to pay for real estate and where the balance sits between buyers and sellers.
Deepening the doldrums of the region’s luxury sector are recent increases in interest rates and fears about further tightening by the Federal Reserve, said Bill Cote, a Newport Beach, California-based agent with Coldwell Banker.
Aside from tax reform’s limitations on mortgage deductions, we suspect that the new beneficial ownership rules make it nearly impossible for shady foreign buyers to conceal ownership in US luxury properties.    There’s a direct correlation between listing price and days on the market, as it increases at every category.    Under a $1MM, expected days on the market suggest tight supply, but over $2MM, it jumps to 225 days and 427 days at $4MM or more.  
How I Learned to Stop Worrying and Love Brokered Deposits
According to an academic study conducted by the Utah Center for Financial Services, brokered deposits were unfairly blamed for bank failures by the FDIC.    
“Brokered deposits have proven to be a stable and reliable source of deposits,” said Barth, who is a distinguished scholar at Auburn University and is a former bank regulator. His work and numerous publications, focused of financial services, are well known and highly regarded. He believes the FDIC should update its policies regarding brokered deposits and recognize the stability of this form of funding as well as the lower sourcing cost and accessibility.
Brokered deposits generally involve a third party in the placement and are now issued by many banks to diversify their funding. Barth intensively examined allegations made by the FDIC and others that brokered deposits were the cause of the Great-Recession and other economic crises.
Barth scrutinized 59 studies and “found no direct causal relationship between brokered deposits and bank failures.”  Barth believes most deposits classified by the FDIC as “Brokered Deposits” are now a well understood and accepted source of funds that help banks innovate business models and offer convenience and return for customers. He found that these deposits help diversify funding and add to the soundness of well-run financial institutions.
While this study is interesting (here is the complete report), we don’t expect the Agencies to re-evaluate their positions on brokered deposits.   We would like to see the Agencies reverse their positions though on brokered deposits for troubled institutions.    When a bank receives a consent order, it is typically prohibited from renewing any brokered deposits, which often means that a bank’s funding costs rise, thus worsening margins for a bank that is in trouble.    But, suspicion of brokered deposits is dogma at the Agencies. 
Hedge Fund Star Dims
Many of the superstars in the hedge fund industry, such as John Paulson, Bill Ackman, and now David Einhorn have seen their stars fade the last few years.    David Einhorn has lost more than half of his assets under management in the last three years, for example.   
For years, David Einhorn’s investors didn’t seem to mind his unusual ways—the aloofness toward clients, midday naps, unpopular stock picks, late nights on the town. Until the billionaire hedge-fund manager fell into a slump.
After more than a decade of winning on Wall Street, Mr. Einhorn’s Greenlight Capital Inc. has shrunk to about $5.5 billion in assets under management, his investors estimate, from a reported $12 billion in 2014, and his investments are struggling.
“My patience is wearing thin,” said Morten Kielland, chairman of investment-management firm Key Family Partners SARL and an early Greenlight investor, who said he has withdrawn much of his firm’s money from the fund. “This is unbelievable.”
The value of an investment in Mr. Einhorn’s main fund was down 11.3% at the end of 2017 from 2014’s end. The S&P 500 grew 38.3%, including dividends, in the same period. The average stock-focused hedge fund gained 18.3% in the period, according to HFR, a firm that tracks hedge funds.
It’s hard to remember a time when so many superstars have had terrible years.   Some have wondered whether value investing is dead as an investing strategy, for example.    Too many of these managers are too arrogant to learn from their mistakes and investors are rightfully fleeing for emerging managers. 
Job-Hopping Spikes
Workers are choosing to leave their jobs at the fastest rate since the internet boom 17 years ago and getting rewarded for it with bigger paychecks and/or more satisfying work.
Labor Department data show that 3.4 million Americans quit their jobs in April, near a 2001 peak and twice the 1.7 million who were laid off from jobs in April.
Job-hopping is happening across industries including retail, food service and construction, a sign of broad-based labor-market dynamism.
Workers have been made more confident by a strong economy and historically low unemployment, at 3.8% in May, the lowest since 2000. 
The trend could stoke broader wage growth and improve worker productivity, which have been sluggish in the past decade. Workers tend to get their biggest wage increases when they move from one job to another. Job-switchers saw roughly 30% larger annual pay increases in May than those who stayed put over the past 12 months, according to the Federal Reserve Bank of Atlanta.
More than one in seven of the nation’s 6.1 million jobless Americans in May were voluntarily unemployed, having left a previous position to look for another, the highest share of voluntary unemployment in more than 17 years.
Many proactive employers are focusing their efforts on worker retention, as job-hopping is increasingly picking up.    Unfortunately, most employees won’t see a large salary bump unless they change employers.
New Ruling Allows Banks to Lower Costs for Small Balance CRE Loans
A new ruling has given banks a significant competitive advantage for the origination of small balance commercial real estate loans. Last month, federal bank regulatory agencies increased from $250,000 to $500,000 the threshold for CRE loans which require a third party appraisal. The ruling is a much needed update to the lower limit which was established in 1994.
Banks are still required to obtain an appropriate evaluation for loans under $500,000. Wall Street firms, institutional investors and private lenders have increasingly utilized evaluations when underwriting commercial real estate. Banks have long been at a competitive disadvantage in the small loan space, require borrowers to spend in excess of $2,000 for formal appraisals. In many cases, the cost of the appraisal can affect the economic viability of the acquisition or refinance. Further, waiting 30-45 days for an appraisal largely negates one of the largest advantages banks possess…speed.
According to Chase Belew with AMS, a firm which provides nationwide CRE evaluations, the cost for evaluations is typically 60-70% lower than the cost of a certified appraisal, and reports can be delivered in 7-10 days in most cases. Proper evaluations rely on the same methodology and research as appraisals, including the use of market comparables and value estimates based on in place or market income and expenses with verifiable cap rates. Evaluations also include a comprehensive on-site analysis of the asset and surrounding area to evaluate the subject’s condition and how it compares to competing properties. The proliferation of sales and leasing data through sites such as CoStar has further aided the accuracy of evaluations. 

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