This week, we dig into (1) 2Q earnings season, (2) we look back at GS and MS over the last few years and trace lessons learned; and (3) we discuss investors’ insatiable appetite for the balance-sheet-light tech firms powering the next generation of banks.
Let’s get to it.
Earnings, Week 1: Big Banks with Trading Crush Results….
A historical anomaly took place this earnings season. Several large banks delivered record revenues despite record high unemployment and record high provision expenses.
We are not surprised. In April, we noted that this time is different: “the biggest banks of the land are issuing loans and soaking up liquidity – and are likely to outperform expectations.”
…While COVID-19 Credit Losses Loom
COVID-19’s economic impact continued to reverberate across the sector, as provisions for credit losses continued to mount.
Firms without offsetting trading arms were particularly hard hit: WFC, for example, set aside an additional $9.5Bn for credit losses alone.
MS was unscathed by credit provisions since they only originate secured loans collateralized by client equity holdings.
JPM and other banks booked record provision expenses due to their outsized consumer and commercial lending books. However, record trading results outpowered the provision build (which we expect will be released next year).
Forbearance Requests are at a Trickle
Banks reported that new requests for forbearance and deferrals have effectively petered out.
ALLY, for example, noted that their auto loan deferral policy has now reverted back to “business as usual,” and delinquencies (60+ days past due) have dropped by nearly 30%.
Buy, Build, or Rent: A Goldman Sachs vs. Morgan Stanley Case Study
This week’s earnings release highlighted the contrasting evolutionary paths of two storied Wall Street powerhouses, Goldman Sachs and Morgan Stanley.
The two investment banks managed to survive the last crisis, unlike peers, Lehman and Bear Stearns. That world had changed post-crisis. Both banks faced difficult strategic decisions on how to build their businesses exiting the Great Recession.
A wave of new regulations closed off many of the profit-making opportunities banks had enjoyed previously.
Morgan Stanley: Thoughtful Strategy, Deliberate Execution
Early on, MS – under the leadership of CEO, James Gorman, deliberately chose to diversify away from sales and trading, making a bold bet on the Solomon Smith Barney wealth management business that Citi was looking to shed.
In Gorman’s view, the steady, fee-based profits from wealth management could provide ballast for the potentially more-profitable (but definitely more volatile!) revenues printed by the investment bank.
Through a series of deft partnerships and acquisitions (taking control of SSB from partner, Citi, then adding complementary capabilities like Solium), MS steadily expanded wealth management’s scope.
Critically, MS also avoided the temptation to fast-follow GS into the competitive consumer banking space during the FinTech lending mania around LendingClub’s IPO.
This culminated in this year’s acquisition of online brokerage, E*Trade, bringing with it a massive customer base for MS’ wealth and investment tools, and helping drive down MS’ overall cost of funding to less than 1% (as of the February 2020 deal announcement).
Goldman Sachs: Charmed by its Past Glories, Now Racing to Catch Up
GS, led at the time by ex-trader, Lloyd Blankfein, took a radically different approach.
For years, the firm had been a clear powerhouse in sales & trading, building a reputation as the “go-to” shop for the complex, difficult transactions (for a price, of course).
GS started with a smart acquisition of GE Capital’s deposit base.
GS then committed the firm to the consumer banking platform, Marcus. Trying to catch up from a standing start, GS poured money ($3Bn and counting), talent, and energy into the business. GS has also inked high-profile partnerships with Apple and Amazon.
In recent years GS has doubled-down, building a consumer banking and corporate banking franchise that puts it in direct competition with major banks and FinTechs.
What are the results? It has been a struggle. The Marcus lending portfolio is flat YoY and unit economics questionable; flashy partnerships with Apple and Amazon are light on economics for the firm (a card that was advertised as “designed by Apple, not a bank”).
Where are we now? GS bias to “build in-house” has created a capex drag of billions for the foreseeable future. That bias is creating a wedge between GS & MS performance in earnings.
Meanwhile, MS’ acquisition of E*Trade delivers a fully intact business with technology, customers, and deposits. MS’ acquisition of Solium is delivering new leads for the wealth management business.
And yet, it’s still not clear what GS is trying to achieve: become the new JPMorgan (a role that Jamie Dimon seems perfectly happy to keep playing, thank you very much), or something else?
The reveal of the “grand strategy” at January’s investor day (a first for the firm) was underwhelming and the jury is still out on where they’re headed and whether they’ll get there.
The 2Q Scorecard: Turtle Beats the Rabbit?
To be sure, GS had a strong quarter and should take a victory lap. GS beat analysts’ expectations by the most in nearly a decade – driven by trading arm benefitting from market volatility.
However, the focus and discipline of James Gorman is paying off. Not only did MS benefit from trading, up nearly 70% YoY, which fueled record revenues of $13.4Bn, but the wealth segment also did its job in providing steady, stable ballast, and no blemishes from provision expenses.
For years, GS and MS were neck-and-neck in market cap. MS’ market cap is now $10Bn ahead at $82Bn. That gap seems likely to widen.
What are the lessons?
- Establish a strategy early, but choose carefully. MS recognized the world was shifting away from the pre-crisis trading powerhouses and deliberately set out to build a steady, fee-based, and capital-light organization.
- Invest in-house where you’re strong
- GS has poured $3Bn and counting into Marcus, trying to build from scratch, the kinds of FinTech capabilities others have spent years honing on the idea
- By contrast, American Express successfully built lending products in-house based on a decades-long history
- Don’t be afraid to place big M&A bets
- MS took on the Smith Barney business in two bites, half in 2009, and the rest in 2012, and valued the capability at $13.5Bn when it took control. E*Trade was of a similar scale, valued at $13Bn when the deal was announced in February
- GS has mostly made bite-sized tuck-in acquisitions, nothing transformational. GS arguably would be better off having bought LendingClub years ago (cashflow positive, 4x origination volume, etc.)
- Rent technology is the least risky path for most FIs
- Many banks are “renting” technology from FinTech solutions such as Better Mortgage, nCino, GreenSky, Q2, Jack Henry, Blend, and others
So what? How does that help me?
We believe consumer lenders can take away a few lessons from the battle between these storied Wall Street rivals:
- Strategize for the world of tomorrow, not yesterday
- As we’ve said here before, COVID-19 has accelerated the move towards a digital-first financial world. That doesn’t mean you need to walk away from what’s made you successful until now, but recognize that what got you here won’t get you to the next level
- Recognize your true strengths and find ways to fill the gaps
- Especially for firms that have under-invested in their technology, getting to a digital-first world means there’s a big build ahead
- It’s worth thinking hard about whether that build truly needs to be done in-house, or would be more successful if done in partnership with a FinTech that knows the space and can bring the latest technology to bear on your behalf.
- Place your bets, folks
- While we’d argue that for most lenders, a partnership with a FinTech is the right approach, there will be rare opportunities when a firm with truly complementary capabilities is open to a deal. If it accelerates your strategy, don’t be left behind – go for it
nCino’s IPO: “Cloud Banking” is the new SaaS
Earlier this week, Wilmington, NC-based banking-as-a-service platform nCino had its public market debut. The oversubscribed IPO popped more than 150% on its opening, and by the end of the week, it had reached a market cap north of $6.6Bn.
Throughout the day, nCino executives hammered home their view of the firm as a “cloud-based” banking platform, tying their business to the high-flying tech companies (and tech company multiples!) in investors’ minds.
Folks, this is banking 2.0. Whether nCino or similar shops, there’s a new breed of FinTechs emerging that focus on infrastructure and enablement, staying nimble and balance-sheet-light.
And investors are eating it up.
Banking 2.0 Is Coming
Looking a bit further over the horizon, another fundraising announcement this week shows that the next generation of competitors are coming faster than you might think.
For example, FinTech firm MANTL, led by CEO, Nathaniel Harley, announced the expansion of its Series A fundraise to $19MM this week. The firm, which provides digital account opening capabilities for banks and credit unions, saw a 705% surge in deposit volumes in April as clients used their platform to enable home-bound customers to bank digital-first. The round was backed by new and existing investors, including Point72 Ventures and Clocktower Technology Ventures.
In Other News This Week:
- Meet the one-branch bank that did more PPP lending than Citi (Fortune, 7/15/2020) With only $2.5Bn in assets, Cross River was able to make nearly $5.6Bn in PPP loans.
- Shadow Bank Weaknesses Forced Fed’s Market Rescue, Quarles Says (Bloomberg, 7/15/2020) A high-profile Fed official issued a warning about fast-growing and largely unregulated shadow lenders.
- Consumption Effects of Unemployment Insurance during the COVID-19 Pandemic (JPMorgan, 7/2020) JPMorgan Chase research found unemployed workers spent 10% more than they did before the pandemic.
- S. Retail Sales Rose 7.5% in June as Stores Reopened (WSJ, 7/16/2020) June’s store and restaurant reopenings likely increased U.S. retail sales for the second month in a row
- Home prices could fall in major cities as Americans sour on urban living, says Nobel Prize-winning economist Robert Shiller (MarketWatch, 7/15/2020) The COVID-19 pandemic could pose a significant risk to urban real estate.
- Banks Seek More FinTech Help for PPP’s Next Phase (American Banker, 7/10/2020) Small-business lenders continue to engage with cloud providers and other outside companies to automate the loan forgiveness process.
- Cross-Border Payment Systems Have Been Neglected for too Long (Financial Times, 7/13/2020) Global payment transfers Are expected to hit $30Tn by 2022, but 60% of cross-border B2B payments still require some kind of manual intervention.
- Goldman Puts Capital Fears to Bed for Now, With Help From Fed (WSJ, 7/15/2020) The Fed’s efforts to support the market gave Goldman Sachs a huge trading boost.
- JPMorgan Sets Aside More Than $10 Billion to Cover Coronavirus Loan Losses (WSJ, 7/14/2020) JPMorgan posted a second-quarter profit of $4.7Bn, which is down from $9.65Bn from the prior year period.
- Citigroup Profit Falls 73% as It Girds for Coronavirus Economy (WSJ, 7/14/2020) Citigroup’s profits were weighed down by the $7.9Bn that it set aside as COVID-19 pummels the industry.
- Wells Fargo Hits Rock Bottom. Can It Get Worse? (Bloomberg, 7/14/2020) Wells Fargo reported its first quarterly losses since 2008 and cut its dividends sharply.
- Here’s how PayPal is looking to boost its credit business by leaning into a buy now, pay later frenzy (Business Insider, 7/16/2020) How PayPal is looking to tap into the buy now, pay later trend among young consumers.
- My Quarterly Marketplace Lending Results – Q1 2020 (Lend Academy, 7/13/2020) LendIt Co-founder, Peter Renton’s latest quarterly investment results.
- Robinhood Upsizes Funding Round to Raise an Additional $320 Million at a $8.6 Billion Valuation (Business Insider, 7/13/2020) Robinhood, led by CEO, Baiju Bhatt, raised $320MM to boost its Series F funding.
- nCino CEO Focused on ‘Long-Term’ as Shares Surge 150% in Public Debut (Yahoo Finance, 7/14/2020) nCino, led by CEO, Pierre Naude, made its Nasdaq debut with shares skyrocketing by market closure.
- The Closest Images of the Sun Ever Taken Reveal ‘Campfire’ Flares (Science News, 7/16/2020) New ultraviolet images from the Solar Orbiter spacecraft show the closest images ever taken of the sun.