Saturday, April 27, 2019

Guest Post: Financial Markets and Economic Update by Dorothy Jaworski

Never Satisfied

The markets never seem to be satisfied.  The Federal Reserve recently took heed of market and economic messages, ending its tightening campaign and beginning its “patience” campaign.  The yield curve had begun to invert in early March, 2019 in response to economic slowdown fears and a flight to quality began where demand for US Treasury bonds increased, pushing longer-term rates down.  I along with countless other managers and investors were finally happy.  Chairman Jerome Powell listened and stopped raising short-term rates.  The markets have always thought that the Fed tightens to keep an overheating economy and inflation in check, neither of which we have right now.  The Fed also announced that they would end the sales/runoff of their bond portfolio, affectionately known as “QT,” or quantitative tightening.  The markets hardly seemed satisfied with these two moves as they began building in rate cuts.  Rate cuts?  Who said anything about rate cuts?

But, what if rates are already too high?  The economy is slowing, as seen in the auto, housing, manufacturing, and retail sectors.  I’ve been watching the balance of the economic data releases shift to “weaker” over the past two months.  Growth around the world is slowing, too.  Every major economy, including the United States, European Union, China, Japan, Australia and New Zealand, and Great Britain (with Brexit issues), is dealing with weaker growth. 

Unemployment and Inflation

The Fed has to follow their dual mandate, which is to maximize employment and maintain price stability.  The Fed kept raising short-term interest rates because they felt unemployment under 4% was too low and would cause inflation (the traditional Phillips curve theory).  Yes, unemployment is low.  In fact, job openings are over 7.1 million and exceed unemployed persons of 6.2 million.  This has been the case for about the past twelve months.  The Fed worried that wage pressures would escalate because of skills gaps.  Yet, wages increases have been modest and did not contribute to higher inflation.   Consumer spending has weakened recently but is expected to resume its modest pace for the year.  High debt levels- consumer, business, and government- continue to weigh on growth, which should be between 2.0% and 2.5% this year.

Inflation remains well behaved, except for the March producer price index data release, which showed an increase of a surprising +.6% for the month.  Oil and gasoline price increases have caused this; oil has risen from $45 to $64 per barrel this year alone.  Before inflation bugs panic, one release does not make a trend.  Leading inflation gauges show a declining year-over-year pace of inflation.  The TIPS spread, or the difference between the 10-year Treasury and the 10-year Treasury inflation-protected yields, has fallen in recent months and is currently at 1.95%.  The weaker economy is keeping inflation in check.  And gold prices rose this year into February and March, but have fallen back to equal year-end 2018 levels today. 

Jamie Dimon

It is a not-so-well-kept secret that I admire Jamie Dimon, CEO of JPM Chase, and have followed his career since the late 1990s.  I admire his business savvy, his wealth of knowledge about the economy and the financial markets, his ability to deal with crisis, and his dedication to making people’s lives better through JP Morgan Chase Bank community initiatives.  His annual shareholder letter, like Warren Buffett’s, is a must-read for investors.  He touches so many subjects and isn’t afraid to criticize government policies that are holding our economy back.  Dimon believes that we will see weak GDP growth this year.  He warns that we could soon see poor liquidity and declining investor sentiment that will add to market volatility.

A Win for the Ages!

Did you have an opportunity to watch the Masters and witness Tiger Woods win his fifth green jacket?  He played the final round methodically, strategically, and did not let developments affect his play.  He watched others take the lead and then lose it…to him.  Once in the lead, he played to win.  He showed us that he can win despite the many setbacks he has endured, especially the physical ones of the past few years.  To me and to millions of supporting fans, Tiger’s win was one for the ages!  I will not forget that day!

The Outlook

I formulated my estimates for 2019 early this year and haven’t seen a reason to change them.  I estimated that real GDP growth would be between 2.0% to 2.5% for the year, which is at a slower pace than the +2.9% in 2018, but about equal to the average growth since 2011.  I had assumed that the Fed would not raise rates again.  The impact of the tax cuts has faded.  Interest rates have stabilized at lower levels, after falling dramatically since December, and the yield curve is relatively flat, with only 13 basis points between the three-month and 10-year Treasury yields.  The Federal Reserve made it clear that they would remain patient in assessing the economy and that they would not be raising short-term interest rates this year.  They recognize that growth is slowing here at home and around the world.  They stated that they did not want to cause an inverted yield curve and they meant it, as they realize that inverted curves are recession precursors.  I always believed that Chairman Powell would read the markets correctly and do the right thing.  He knows that market volatility has risen, the data has been weaker, and liquidity is reduced as M2 growth declines.  M2 growth is today at 4%, which is nearly one-half of what it was three years ago.  Yes, M2 matters.

Our current economic recovery is fast approaching a longevity record; growth through July, 2019 would set the new record at 121 months, surpassing the 1991 to 2011 recovery.  Unemployment is low at 3.8% in March, 2019 and inflation, as reflected in core personal consumption expenditures, was +1.8% in the fourth quarter of 2018.  I don’t expect much change in either of these measures.  Consumer spending has been weak in recent months, but as job growth continues at a steady pace, we should be able to see GDP growth of 2% or more.  However, don’t count on the usual spending boost from personal tax refunds as they are down by over $6 billion from this time last year.  And remember that the Fed stopped raising rates, so that should aid growth. 

While the guessing game has already begun about when the Fed will ease or lower rates, I think growth will be steady (if you call the low 2%s steady) enough to keep the Fed on the sidelines.  The markets seem to enjoy guessing what the future holds, especially when it comes to Fed policy.  I’m not playing the game right now although I mentioned earlier that I think short-term rates might be too high…

I finish writing this with a heavy heart.  I am watching video of Cathedrale Notre-Dame de Paris on fire.   Prayers and thanks for reading!  04/15/19

Dorothy Jaworski has worked at large and small banks for over 30 years; much of that time has been spent in investment portfolio management, risk management, and financial analysis. Dorothy has been with Penn Community Bank and its predecessor since November, 2004. She is the author of Just Another Good Soldier, and Honoring Stephen Jaworski, which details the 11th Infantry Regiment's WWII crossing of the Moselle River where her uncle, Pfc. Stephen W. Jaworski, gave his last full measure of devotion.

Tuesday, April 09, 2019

Bank Brand Value: Calculated!

I ask and ask and ask: what does brand get you?

Does it get you pricing power, shorter sales cycles, better employees, more loyal customers? Or does it get you increased expenses without measurable results?

Forbes calculated brand value in their "World's Most Valuable Brands" by taking anything that a company achieves over an 8% return on equity. Many people pay close attention to the ranking. Although I find the calculation to be arbitrary. What if the company is more capital intensive, and has to carry more capital than other companies? So the ROE is lower. Or what if a company is excellent at expense control? Driving ROE higher, but hardly due to its brand.

No, I do not like Forbes' calculation. It particularly doesn't work well for financial institutions. Which is probably why the first bank on their list is ranked 43rd. And it's Wells Fargo! Didn't help out Tim Sloan.

Bank Brand Value ("BBV")

So how would I calculate a financial institution's brand value? When I speak, I use great brand images such as Starbucks, JW Marriott, and Mercedes Benz. Why do these brands command higher price points than Dunkin, Best Western, and Kia?

Price points. A superior brand usually would command superior price points. And we can measure this by looking at a financial institution's cost of interest bearing deposits, and yield on loans, compared to other regional players that have similar balance sheets. Spread is usually 80%-85% of a community bank's revenues. An inferior or non-existent brand likely grows deposits and loans via decisions made in pricing committee.


Fortunately, we have good data via Call Reports to make the calculation. And I propose the BBV method so you can calculate and track your BBV.

The first step is to select regional financial institutions with a similar size, in the below case $1 billion - $10 billion in total assets. I selected a bank in this group, First Bank of Nashville, Tennessee, because I was recently there. I then searched for banks with a similar loan composition to First Bank; fifty-to sixty percent commercial and commercial real estate loans to total loans. I netted yield on loans by their npa's/loans so those banks with riskier loan books are discounted. Banks that achieve a better than median yield on loans after netting npa's/loans, with a similar loan book in a similar region, likely do so because they are perceived to deliver better value to customers. i.e. brand. And First Bank passes this test, achieving 78 basis points over the loan peer median.

I then ran a second peer group for cost of interest bearing deposits. I kept it regional, and the same asset size range. And used less than 30% funded with time deposits, as First Bank was funded 27% with CDs. I could not use transaction accounts because of financial institutions' reclassing transaction accounts to savings/ money market accounts to reduce their Fed requirement. 

Anything under the median cost of interest bearing deposits, I attributed to brand. This didn't work out so well for First Bank, as their cost of interest bearing deposits was 37 basis points greater than deposit peer median. 

And then I added those two numbers together, giving a pre-tax brand value, and then tax effecting it and calculate as a percent of net income. If the bank is publicly traded, as First Bank is (Ticker: FBK), you can then calculate the BBV percent of net income as the percent of market capitalization to get an aggregate brand value. If not a publicly traded bank, you can calculate the BBV contribution to net income and multiply by a peer p/e multiple to get your aggregate BBV.

My suggestion is that you trend your BBV, looking to continuously improve. In First Bank's case, I would look to maintain my loan BBV advantage, and continuously improve my deposit one. 

Imagine continuous improvement of BBV as a strategic planning SMART goal?

See the table. Calculate your own BBV. How did you fare?

~ Jeff