Tuesday, November 28, 2023

Describe the Future of Banking in Buzzwords

I asked Google Bard, a large language model tool, the following: "Describe the future of banking in the United States in buzzwords." Here is what it came up with...

Sure, here is a description of the future of banking in the United States in buzzwords:

  • Hyperpersonalization: Banking services will be tailored to the individual needs and preferences of each customer, using data analytics and artificial intelligence.

  • Embedded finance: Banking services will be integrated into everyday activities, such as shopping, paying bills, and managing finances.

  • Decentralized finance (DeFi): DeFi technologies, such as blockchain and cryptocurrencies, will disrupt traditional banking models and create new opportunities for financial inclusion.

  • Open banking: Open banking APIs will allow third-party providers to access and share customer financial data with their consent, enabling new and innovative banking products and services.

  • Banking as a service (BaaS): Banks will provide their core banking infrastructure and services to other companies, such as retailers and telecommunications providers, to expand their reach and offer new products and services.

  • Voice banking: Voice assistants will become a primary way for customers to interact with their banks, providing convenient and hands-free access to banking services.

  • Data-driven decision-making: Banks will use data analytics to make better decisions about product development, marketing, and risk management.

  • Artificial intelligence (AI) and machine learning (ML): AI and ML will be used to automate tasks, improve customer service, and detect fraud.

  • Cybersecurity: Banks will continue to invest in cybersecurity measures to protect customer data from cyberattacks.

These buzzwords represent some of the key trends that are shaping the future of banking in the United States. Banks that are able to adapt to these trends will be well-positioned for success in the years to come.

Should I start to worry?

~ Jeff

Thursday, November 16, 2023

How Will We Fund That Low Rate, Low Covenant Loan?

Emily McCormick's (Bank Director Magazine) most recent Common Threads newsletter post on LinkedIn got me thinking. How did that 5.5%-6% loan, described by Jeff Rose, CEO of Ambank Holdings, get to committee or even make it past the lender?

Banking is one of those businesses that requires bankers to be less stupid than their competitors. And when competitors start funding 6% loans with 5% money, they start pulling those in their competitive eco-system with them. Or they'll lose the loan. At closing, we don't know how well that loan will perform during an economic downturn. But we priced no credit spread into it. Heck, we didn't price cost into it, or interest rate risk, or liquidity risk, or risk-adjusted return on capital. 

So how can such a loan make it past the lender on that sales call?

Culture. As one bank CEO once told me, "you can't believe the improvement in lenders' negotiating ability when you tell them it's ok to lose the loan."

I recently spoke at the ABA Bank Marketing Conference on why product management is greater than product (a chapter in my book, Squared Away). In such a culture, you would have a director of product management, likely the CMO. But the product managers themselves would be sprinkled throughout the bank as close to the product as feasible. So the product manager for, say, the commercial real estate product would be an up-and-coming middle manager in that department. And he/she would be tasked with the continuous profit improvement of the commercial real estate product.

In comes Lender Hotshot wanting to do that 6% deal. If transfer priced at the FHLB blended 4-year borrowing then Hotshot would be assessed a 4.9% cost of funds, generating only 1.1% spread. If the prior quarter's CRE product spread was 3%, then Hotshot's loan would reduce the profitability of the product. If Hotshot went further out on the yield curve and was assessed, say, a 5.3% cost of funds, now he/she would only get a 0.7% spread on that loan. Multiply that by all the hotshots you have out there trying to produce volume.

But if Hotshot is only held accountable for volume, he/she is all good, right? Hotshot sits high on the lender production board.

But if the culture is continuous improvement, and the yardstick is profit, would this be so? If Hotshot was held accountable for the continuous profit improvement of his or her loan portfolio, credit quality, spread growth, would they even consider doing that six percent deal let alone bring it to their boss or a loan committee where committee members would ask "why so thinly priced" or "why the seven-year deal." The unspoken answer: "I have a $25 million production goal and this is what needs to be done to get the deal done." We created this culture.

In the product management culture, it would matter. That sharp SVP of CRE would have an interest in appropriately priced deals. He/she would interact with Hotshot to determine if there are product features that could help get deals done that don't reduce the profitability of the CRE product.

And Hotshot would get their quarterly profitability report, that not only measures their book of business, but also highlights those lenders that are top quartile in terms of profitability, spread growth, profit improvement. Maybe Hotshot will want to be on those lists. Maybe Hotshot is incented to be on those lists. Maybe Hotshot has been given permission to walk away from that six percent deal. Armed with that leverage, maybe they can get a better deal from that borrower. Or at least not hurt the profitability of his/her portfolio, the CRE product, or the bank's net interest margin.

But to get that culture. You have to measure it.

~ Jeff

Friday, November 03, 2023

Guest Post: Financial Markets & Economic Update 4Q23 by Dorothy Jaworski

Financial Markets & Economic Update - Fourth Quarter 2023


Summer Update

On this warm October day, I am staring at my Bloomberg screen, still heartbroken over the Phillies Phailure.  Now, all of our hopes ride with the Eagles.  Interest rates are all elevated, with the 2-year Treasury yield at 5.01% and the 10-year at 4.85%, which is up by over 100 basis points since June 30, 2023.  Most of the inversion between these two yields is gone.  The 3-month T-Bill is at 5.45%, so there remains some inversion to the 10-year yield.  Stocks are down again today and have been down all week.  Gold has reclaimed $2,000 per ounce and its status as a safe haven, with all that is going on with war in the Middle East.  Too bad Treasuries are not as much of a safe haven.  Markets sent Treasury yields higher in reaction to huge deficit spending and a Federal Reserve intent on pushing rates higher, keeping them “higher for longer” with large price risk as everyone has learned for the past three years.

Some argue that, because we saw real GDP rise by +4.9% in 3Q23, that the economy is robust and strong.”  Yes, it was for that quarter, but, if you read my last newsletter, the summer of fun meant that quarter would be stronger, as the last stages of pandemic pent-up demand saw excess savings spent with abandon.  YOLO- You Only Live Once!  People traveled on vacations with their newly renewed passports, enjoyed entertainment (can you say Taylor Swift and Barbie?), and ate out at their favorite restaurants.  Now the harsh reality will sink in and El Nino is sure to give us a cold winter.  Inflation is still elevated, even while it slowly declines from 2022’s peaks.  We will continue to fall toward the Fed target of 2.0% but it takes time and patience.


Index of Leading Economic Indicators

I just finished studying a chart of the year-over-year changes in the index of leading economic indicators, or “LEI,” going back to 1960.  For every period of sustained y-o-y declines in LEI, recession has either begun or followed quickly.  The LEI fell again in September, 2023 by -.7% and is down y-o-y by -7.8%.  The index began to decline in March, 2022 (no surprise that the Fed started tightening that month), and has been down for 18 months in a row; the LEI is down -11.1% since March, 2022 to 104.6.  In July, 2022, the LEI began to decline y-o-y, yet we have not been in recession or see one imminently.

The chart showed eerily similar patterns of declines in 1990 and 2000-2001.  Unsurprisingly, the largest declines occurred starting monthly in March, 2006 and on a y-o-y basis in September, 2006 and continued to November, 2009.  The largest monthly decline took place in May, 2009 at -27.2% y-o-y with the index reaching a low of 75.7.  We all remember the Great Recession, which began in 2007, but the LEI knew it as early as March, 2006.  This time will be no different and patience is required.

By the way, there are sister indices to the LEI, the coincident for current conditions and the lagging index for 6 to 9 months ago.  Both are relatively stable, indicating the economy has been and currently is okay.


Are Rates Restrictive?

Do you remember what it means for Fed policy to be “restrictive?”  It means getting the Fed Funds rate above inflation so that a positive number, or real rate, would result after subtracting inflation from the Fed Funds rate.  Every inflation measure that I track closely is below current Fed Funds of 5.50%, resulting in restrictive rates of varying degrees.

Fed Funds is 1.40% over September’s annual core CPI of 4.1% and 1.80% over annual headline CPI of 3.7%.  Fed Funds is 3.10% over 3Q23 core PCE of 2.40% and 2.60% over the PCE deflator of 2.9%.  Fed Funds is 1.10% over the annualized 3Q23 employment cost index of 1.1% and is 1.30% over the most recent data for wage growth of 4.2%.  So, yes, rates are restrictive.  And the FIBER leading inflation index and M2 money supply are both falling year-over-year, by -1.2% and -3.6% respectively, so inflation will continue to trend downward.  Fed Chairman Powell stated “You know restrictive only when you see it.”  Well, you be the judge… I believe that the Fed is done raising rates; they just don’t know it yet.  And looking ahead to the 2024 Presidential Election, they clearly would want to be on the sidelines.


Risks to the Economy

We were growing real GDP 2.1% to 2.7% for the four quarters ended 2Q23 and then experienced an outlier of +4.9% in 3Q23.  Yeah, the summer of fun.  Consumer spending accounted for one-half of GDP.  Businesses built inventories adding 1.30% to GDP.  Housing made a small positive contribution after a string of negative quarters.  Much of the data was weak, so it’s doubtful that we can keep repeating this pace.

The risks are many.  We have an aggressive Fed threatening more rate hikes.  Long-term interest rates just increased by 100 basis points in the past few months, in a time when inflation is falling.  Government spending and huge budget deficits are upsetting investors.  Mortgage rates are now close to 8.00%; affordability is at its lowest point since 1989, according to the National Association of Realtors.  Low inventories of homes has hurt sales.  No one will give up their 3.00% mortgage for an 8.00% one.  Usually high interest rates would put a damper on home price increases and we might expect prices to outright decline.  But not in this market.  Prices are stubbornly high and rising, with August y-o-y increases of +2.2% for the Case Shiller 20, +2.6% for Core Logic, and +5.6% for the FHFA. 

China is having its own economic troubles and supply chains could suffer again.  And what a time for the UAW to go on strike- demanding outsized pay raises and slowing production at the Big Three automakers and hurting their suppliers.  Thankfully, they appear to be close to agreement.  According to Cox, one-half of Americans cannot afford a new car.  Sales will be affected by both the strike and affordability.

Some banks have tightened credit and there is also weakening demand for bank credit as small businesses are hurting from higher costs and higher interest rates.  Huge amounts of government debt and business debt, including commercial real estate, are repricing over the next two years at higher rates.  Real bank credit (excluding inflation) has been falling for the past 12 to 24 months.  Generally, GDP would be falling in this situation.

Finally, one more thought about the Fed.  They have raised interest rates by 5.25% since March, 2022, let almost $1 trillion of their bond portfolio mature without replacement and allowed M2 money supply to decline y-o-y starting in December, 2022 for the first time since the 1940s and at the fastest pace since the 1930s.  September was -3.6% and July and August were both -3.9%.  Leads and lags for M2 changes are thought to be 12 to 18 months.  The Fed has been pushing inflation lower, but, if they really believed in policy lags and looked at the LEI and M2 y-o-y declines, they would ease right now.  I wonder what Maestro would do.


Where is Recession?

Be patient.  It will come.  High interest rates- both short-term and long-term- an aggressive Fed, the LEI, and an inverted yield curve are all precursors of a recession.  The yield curve is less inverted than it was earlier this year, due to large increases in longer-term rates.  This actually plays into the recession forecasts.  The inverted curve is the precursor of recession, but it is the re-steepening of the yield curve that is the sign of imminent recession.

I mentioned the LEI earlier.  It has been falling on a monthly and y-o-y pace that is always associated with recessions- big ones and small ones.  Do not ignore this and other indicators as they always teach us something.

M2 is falling.  Inflation is responding by falling.  It was the massive increase in M2 in 2020 and 2021 (and beyond!) along with pandemic-related supply chain disasters that led to inflation.  It will be the decline in M2 that reduces it.  The FIBER leading inflation index is still falling on a y-o-y basis, and is currently -9.2% from its high in March, 2022.

The major surveys, including ISM, S&P, and the local Philly Fed, continue to show weakness in terms of current conditions and outlook.  Inflation has tamed down in most of them.  Stock markets have been very volatile and are mostly down since the summer months.  Are they all sensing that the summer of fun is over?  Profits have been mostly positive for the 3Q23, but probably not enough to make the past 12 months positive.  We shall see.


I was in Switzerland in July and I regret that I did not have the time to visit CERN, the home of the Large Hadron Collider.  The LHC has been running heavy ions through the system for the past five weeks, ending on October 30th.  What will we learn from this?  Maybe the LHC really is changing our world, turning economics upside down, and leading to outcomes that are unexpected given our knowledge of the past.  As always, thanks for reading!


D. Jaworski 10/28/23

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.