Yahoo Finance Third-Quarter Bank Earnings, Subprime Mortgages, and the War on Cash Continues
The big U.S. banks kicked off third-quarter earnings season, and the results were pretty strong. Plus, Wells Fargo (NYSE: WFC) reported some much-needed good news. Elsewhere in the financials sector, it looks like zero-down subprime mortgages could be making a comeback, PayPal (NASDAQ: PYPL) is taking a big step toward monetizing its popular Venmo app, and Square's (NYSE: SQ) CFO departure is putting tremendous pressure on the stock.
In this episode of Industry Focus: Financials, host Jason Moser and Fool.com contributor Matt Frankel discuss all of these news items and more.
A full transcript follows the video.
More From The Motley Fool
This video was recorded on Oct. 15, 2018.
Jason Moser: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market each day. It's Monday, October 15th. I'm your host, Jason Moser. On today's show, we're going to talk about subprime mortgages, we're going to give Matt Frankel an opportunity to preview the Money 20/20 show, we're going to talk a little bit about earnings season because hey, I'll tell you, that's gotten started now. We've got banks all over the place here.
As always, joining me today is certified financial planner Matt Frankel. Matt, thanks for joining us this week! I know you've got a busy couple of weeks here coming up with earnings season starting and travel. I appreciate you being able to whittle out the time here for us today.
Matt Frankel: Of course! I love this time of year, earnings conferences and all kinds of fun stuff. And football!
Moser: Yeah, football! I don't know that I want to dig too terribly much into this past weekend because it kind of sucked for both of us. Carolina gave up a close one there, and man, Wofford just got hammered by Furman. Matt, the worst part about that is that my wife went to Furman. So, we have this never-ending back-and-forth in the house. At least with football season, it's just one game, and that's it. I need to get to basketball season here, maybe we can erase this loss. It's going to be a tough year here. She's going to be talking this one up for a while to come. But, hey, she deserves it. Furman really showed up, played a great game. Congratulations Paladins! Wofford will get it next week.
Let's talk about earnings first and foremost, though, Matt. Big week here with JP Morgan, Citigroup, Wells Fargo, Bank of America (NYSE: BAC) earnings just came out this morning. A lot of common themes out here we've talked about in these shows leading up to this week. Strong net interest margin growth, it looks like. Credit quality is looking good. Tax reform is playing out, I think, on these bottom lines, as we expected.
Give me your 50,000-foot view here. What do you think about these big four? What do we need to take note of?
Frankel: For starters, banks are one of the more predictable sectors. You generally don't see too many surprises when it comes to earnings. For example, it's generally easy to analyze a bank's deposit base, how much interest they're getting on their loans and make a good guess of where their earnings are going to fall.
Having said that, the general word I could use is good. Everything's looking very good. Tax reforms boosted earnings. Three of the four banks beat earnings expectations. Profitability is getting higher. Loans and deposits are growing in most of the banks. With the exception of Wells Fargo, deposits are up 4% across the board. Loans are up nicely. Banks are getting more efficient because of technological advances in the industry.
We've been talking nonstop the past few episodes about the war on cash. The big banks are also a beneficiary of that. Zelle is their big app that's saving them some money on deposit costs and things like that.
Moser: Let me ask you a real quick question here before we go on. One thing we talked about here is tax legislation. Tax reform has certainly helped a lot of these businesses, and banks are no exception there. How much of this profitability, do you think, is due to share repurchases? Is it contributing? Is it material? Is it something we need to keep an eye on? Where do share repurchases fall in these big banks' earnings reports this quarter?
Frankel: It's definitely playing a pretty big role. The equalizer is looking at the revenue figures. Revenue's up 1-4% generally across these big banks. That puts in perspective how much of the growth is due to share repurchases and how much is due to actual growth in the business. Numbers like loan growth and deposit growth don't really have much to do with repurchases. But when you see that earnings are up 43% year over year in Bank of America's case, a lot of that is tax reform and share repurchases, absolutely. It's important to give yourself a rundown of all the numbers, not just look at the headlines, to see where the growth is coming from. You're right, share repurchases is a big part of it, especially in Wells Fargo's case. They had a record-breaking share repurchase this quarter.
Moser: That's good advice. It's important to note, we're not just picking on banks. Share repurchases is the flavor of the quarter here. I think a lot of these companies are really benefiting from that. And that's OK. Maybe you could make the argument that it's not trickling down to Main Street, as some might like. I would counter that by saying, if you are invested, then you are feeling that, and that's a good thing. It's a good excuse, if nothing else, to get invested, right? You need to be playing the game in order to be able to win.
We were talking before taping about Wells Fargo. You felt like this is the bank that deserves a little bit of extra attention this quarter. It was what surprised you the most this earnings season so far here. Tell us a little bit about what surprised you, and how the bank is benefiting from that?
Frankel: It was the first quarter in some time where I thought Wells Fargo didn't have a terrible earnings report. It's not so much that they did great, it just wasn't terrible. The bad thing is that Wells Fargo isn't growing. They're the only bank that didn't grow their loans and deposits significantly. The reason for that is because the Federal Reserve won't let them grow right now until they substantially improve their business practices.
Having said that, there have been some encouraging signs pretty much all around the business. They originated 10% more car loans than they did a year ago. Small business loans are up 28%. Home equity loans, 16%. Personal loans were up, as well. While they can't grow their assets past where they were at the end of 2017 yet, they are showing some promising signs of growth. They returned to a more reasonable level of profitability, 12% return on equity, 1.27 return on assets, which is a substantial improvement from last quarter. Efficiency also improved from last quarter. As I mentioned, they repurchased almost $7 billion of stock. Almost 3% of the entire outstanding shares were repurchased in this quarter alone to take advantage of their depressed valuation.
All in all, I would say that Wells Fargo was the surprise of earnings season so far. It's a little early to say that they're turning a corner until the Fed lifts their penalty. But they definitely have the kind of numbers that investors want to see.
Moser: There's nothing wrong with that. Whether they're actually turning a corner or not, Wells Fargo plays such a big part in our economy as its status as a home lender is so crucial. Poor business practices aside, it's hard to imagine our economy without Wells Fargo. We've been very critical of some of the mistakes that they've made, but perhaps fresh leadership here will be able to get this bank back on the right path here. It sounds like they are possibly making that turn there.
If we look at the way these four banks have performed year to date, it's not been the most stellar year for these big banks thus far, not when you compare them to what the greater market has chalked up thus far. Knowing what we know now, seeing these reports and looking at the roles these banks play, where is your money going? If you have to look at these four banks, what's the one bank you feel like investors really need to have their eye on here? Not only for the remainder of the year, but really for the next three to five years, as we invest here, what's the one bank that really stands out to you?
Frankel: I've said before that Bank of America is my favorite among the big four. I own it, I have for some time. If the recent dip in the share price persists, I might buy a little bit more. I like Bank of America. I think they have fantastic leadership. They've improved so much since the financial crisis. All around, their numbers look great. They're growing their brokerage at a 20% annual rate, just to name one thing. They're doing great at embracing technology. I think they said they're investing $3 billion a year just in technology, which is more than any of the others.
When it comes to the interest rates, rising rates, Bank of America, it's interesting to note, has the highest proportion out of the big four of zero-interest deposits, meaning that they don't have to pay interest. As the interest rates they can charge on loans get higher, they don't have to pay any more for those deposits. That gives them a big advantage over the rest of them if we start to see long-term interest rates continue to rise, as they have been over the past few weeks.
Moser: Banking is one of those industries, truly, where scale does present a big advantage. That's an interesting number, $3 billion invested in technology. That's fascinating. I've seen a lot of these commercials here over the last few weeks, in regard to their voice-activated software, similar to something like Amazon's Echo. Bank of America calls their voice platform Erica. Have you seen that?
Frankel: I have. It comes from the end of their name, Bank of America.
Moser: [laughs] I figured that.
Frankel: Silly name.
Moser: Not just a hat rack up here, Matt.
Frankel: I know! It's a silly name. They win awards for their mobile platform. They have the best online banking functionality, they win awards for that year after year now. They're doing great in increasing the number of customers who are using mobile deposits and things like that faster than their competition. Over time, that's going to be a big cost advantage. I think it's why you've seen their efficiency ratio get better much faster than the others.
Moser: That's good stuff. I'll be interested to see how that takes hold. I don't know that I've necessarily given voice recognition software, stuff like that, as much of a weight, perhaps, in finance. I've never really felt like I wanted to talk to Alexa, for example, to get a balance or transfer funds. I always feel like there's going to be some glitch, where I say, "Transfer $100," and she accidentally transfers $1,000, and then something happens, and I have to clean up a mess.
Frankel: Plus, who wants to hear their balances that account numbers out loud and things like that?
Moser: It does seem a little bit odd, yeah. [laughs] But, hey, you've got those wireless headphones now. Some people are walking around with those things. Maybe that's where it really comes into play.
Let's take a look here really quick, before we get on to another topic, I wanted to follow up our discussion on banks with this article I was reading last week. You and I did a double take, we both saw this. Thousands Line Up for Zero Down Payment Subprime Mortgages. And I thought when I read this initially, "Wait, this has to be referring to something that happened in the past that's not going to happen again." But sure as shooting, this is a situation where borrowers are now getting the opportunity to line up to get, basically, zero down payment mortgage for a house.
On the one hand, I love the fact that we have an economy that can give people a chance like this. On the other hand, these are not borrowers with really good credit scores. With no skin in the game and a bad credit score to begin with, especially in an environment where, apparently, the FICO score is as high as it's ever been for most, I don't know that this is really a good idea. What do you think about this?
Frankel: From both an investor's perspective and a financial planner's perspective, I always say that there are three things that you need to have in an ideal mortgage candidate. You need proof that you can pay it back --good income, stable employment, things like that. You need a strong credit history. And, you need a down payment. You need to have skin in the game. In the past, I've said that if you're missing one of those, it's not terribly troubling. For example, if you have low credit but you're putting 20% down and you have a great job, it could certainly make sense to give you the loan. When you're missing more than one of those things, like in the mortgages that are starting to pop up now, no down payment and no strong credit history, that's when I start to worry a little bit. During the financial crisis, we saw people who got mortgages without having all three. Those aren't coming back just yet, but this is definitely not a step in the direction I want to see.
It is worth mentioning that these are primary residence only homes. These are not investment mortgages. That's also a big distinction of what we saw leading up to the financial crisis. But even so, borrowers lacking two of the three major components that you should have when you get a mortgage, that's kind of troubling to me.
Moser: I should say, too, it does appear that the financial institution that's backing this up, there is an education component here that is required. And I applaud that, I think it's good. I'm just not quite sold on the idea. But perhaps this is a small test, they look at this as something that might be worth expanding in the future. They'll use some of the data and the learnings from this and that'll help dictate, perhaps, what they do in the future. Just a bit of an eye-catcher. One way or the other, we'll learn more here in the coming years as to whether it works out or not.
Matt, last week, we were talking about these companies that we love so much, this war on cash basket, Square and PayPal and Mastercard and Visa. And I said, "Hey, let's put out a poll and see what people think about introducing a regular weekly segment talking about these four companies, catching people up on any newsworthy items." Matt, the people have spoken. 84% of the voters in this poll said, "Yes, you need to introduce a regular weekly segment talking about the war on cash."
I don't know, Matt, 84%. It was terrific turnout, close to 300 votes or something like that. That's enough. Is that statistically significant? I don't know, but it made me feel pretty good. We're going to go ahead and introduce a regular weekly segment on the war on cash. We're going to talk about the companies that make up the war on cash basket, and any newsworthy items that may have popped up, and there were a few.
Let's go ahead and hit the biggest item. I think you and I will both agree this is the biggest item. Square is losing its most public face to the company, in CFO Sarah Friar. Granted, Jack Dorsey is the CEO. But splitting time with Twitter, Sarah Friar is the one we see out there all the time talking up Square's book. She's done a great job at it. She is going to be taking off. She is actually going to accept a CEO position at a company called Nextdoor, which is a social networking company that focuses more on neighborhoods.
While we are happy for Sarah, and congratulations, certainly, on the CEO job, I'm not going to sit here and tell you this is a good thing for Square. She really has been a tremendous leader for the company. What do you think about this, Matt?
Frankel: I think she's been an absolute rockstar for the company. At the same time, the stock is down about 30% over the past couple of weeks. Does any one person make a company worth 30% less virtually overnight? No. I'm not going to say this is a non-event like the Jack Dorsey stock sale the other week or the negative reaction to the Square Installments. Those were both non-events from a long-term perspective. This is an event. But for one, I have no reason to believe Jack Dorsey won't put the right person in the CFO role to replace her. Hiring has been one of his strengths in the past, I think we can agree.
Does losing her make the stock worth 30% less overnight? Absolutely not. Hopefully, one of these days, I'll be able to shut up about Square for more than a day or two, so I can add to my position. It hasn't happened in quite a while. I view this as a buying opportunity. Like I said, I'm sad to see Sarah Friar go. She's the one who really is pushing the long-term monetization of their banking services to consumers, like Square Cash that we've been talking about. At the same time, I think Square will be just fine over the long run, even without Sarah Friar.
Moser: I tend to agree. You never want to see a company where everything hinges on one person. You want to probably avoid investing in those types of businesses. I don't think Square is that type of business. Given Jack Dorsey's role, I think you're right, he's made hiring a priority of his because he's not really the day-to-day operations guy over at Square. He's really making sure that he's hiring people that can keep him abreast of what's going on and can not only execute strategy but really help dictate strategy. I have every reason to believe that he and his team there will fill that role with someone who is very capable of keeping the company on the path that it's on. That's the nice thing, I think they're really on a great path right now. They've got a lot of strategy laid out there in what they want to do. So, I don't think this is something where you're bringing someone in to change something. You're really bringing someone in there to keep things going in the same direction they're going. Who knows when they'll get somebody in there? I have to believe it's a pretty attractive job. We will see.
In PayPal news, there are a couple of things that came up here with PayPal. One that I saw, it's an interesting perspective for me, looking at the population of folks out there who perhaps don't have a banking relationship. PayPal will let customers deposit and withdraw cash now at Walmart stores. That of course comes with a fee, and it's not a cheap one, either, $3. But I think, again, it's something that PayPal is doing in order to be able to offer something for everyone out there who's looking for a way to access their money one way or the other, whether they have a banking relationship or not.
The other item that came out, I thought was a little bit more newsworthy. It's in regard to Venmo, their popular money-transferring app that we see a lot of younger folks using. I think it's very popular with the millennial generation. They are going to start charging Venmo account holders when they make those instant money transfers on the platform. I think it was interesting from the point that when the news first came out on social media, Twitter specifically, you saw people jump the gun there and think, "This is insane! I'm deleting Venmo, I'm not going to use Venmo anymore."
I think they were a little bit unclear as to what this actually meant. A lot of people out there thought this meant Venmo was going to be charging their account holders for all money transfers. To be clear, this is for those instant transfers, right?
Frankel: Yeah, it's just for the instant transfers. When I saw this news, my first reaction was, maybe it's a little too soon. A lot of the reactions I was reading on Twitter said things to the effect that there are so many free ways for people to send money nowadays, that maybe Venmo jumped the gun on trying to monetize its service, and it's doing it the wrong way. This is just the instant transfers, but that's what millennials want. Millennials are very anti-fee. I don't think Jason's a millennial, I'm not.
Moser: [laughs] I wish!
Frankel: I missed the cut off by a few months, depending on who you ask. Millennials want free and they want quick. Most of the millennials I know that use Venmo use it because it's free and want their transfers done instantaneously. I think the fee was like $0.25 for an instant transfer. There was a fee, but it was very cheap. Now, if you're transferring $200, it's a $2 fee. That's not nothing. Like I said, my gut reaction was that it might be a little too soon, and that they should focus on growth instead of monetization at this point.
Moser: Yeah, it's very possible. They've noted more than once that they aren't making a lot of money from this. It's not a profitable part of the business thus far, but they definitely see it as something that should be material to the PayPal model years down the line. Instant transfers are one way. They obviously have the Venmo Visa card, which is another way. It'll be interesting to see how they manage this.
It's worth noting, too, there is a risk that any financial institution takes on when they make that transfer available immediately. Ideally, you'd like to see them be able to use the data to make those types of decisions and perhaps do it in a fee-friendly way. But I guess time will tell here. We'll see how management figures their way around that one. Certainly something to keep in mind.
Matt, let's take a real quick look here. Next week, you are going to be going out to Last Vegas for the Money 20/20. It's the 20/20 vision. Don't get it confused with 2018. Give us an idea. You've been to this conference before, you're headed back this year. It's an exciting time, you get to have some interviews out there and stuff. Tell us a little bit about what you have planned.
Frankel: I've been to the conference four out of the past five years. The best way I can describe it is a Woodstock for fintech. It's over 10,000 people. It's at the Venetian in Las Vegas. Pretty much every fintech company as well-represented there. I know I'm meeting with a few of the CEOs that we talk about. I'm not going to name any names just yet. There's always some big announcements that are made at the conference. FICO just recently sent an email blast to all the attendees, teasing that they have a big announcement. Last year, they announced that Uber was putting out a Visa card. That was the one I covered last year. There's always some really interesting people to meet and things going on. You can learn the latest fintech trends before anyone else. Cryptocurrencies are, of course, a big part of it. I've gotten probably 500 emails from the cryptocurrency companies that are going to be there. [laughs] That's always a fun part of it. Some are great to talk to, some are kind of strange. And there's always some celebrity guests there. Richard Branson's giving the keynote this year. Shaquille O'Neal is going to be there, who I've always wanted to meet, not for investing reasons but I've always been a big fan.
Moser: We'll hope for the best there, and we'll wait and see what you bring back to us.
Let's tap into Twitter here real quick for the week. I did mention earlier the poll that we put up there. I appreciate everybody voting for that. That really was fun to see, that we had such strong support for a weekly segment on the war on cash. We'll keep that up.
Mabel @TeachMeToInvest -- Mabel actually was an intern one year here at The Fool. She responded, said, "I'm loving the podcast. Whatever the decision is, I'll be listening." Mabel, thank you so much! Those are really nice words!
Another interesting one I got this morning from my friend Rory Karen in Ireland, @RoryKaren, he works with Rubicoin. He posted a tweet pointing me to an article from The Economist that was talking about how millennials are now the largest group of pet owners in America. Increasingly, pets feature in their owners' budgets. Listen, from a financials perspective, this matters. If you're talking about your household budget and what you're doing with the money you're making, well, that's what we're talking about here, and pets are a big deal. As an owner of three dogs, I certainly get it. I mean, you know, kind of go in there and do whatever you want from. And I think we could probably put together our basket of stocks ideas that just sent her around pets and the market opportunity there. Just was an interesting one to consider there and hey, there's big opportunity in the pet market out there. OK, hey, Matt, we're going to wrap it up here real quick here with One to Watch earning season in full tilt, so there will be plenty to choose from. What is your One to Watch for this coming week?
Frankel: I keep my eye on Synchrony Financial. They are one of the big issuers of stored credit cards and they are an online bank. They report earnings on Friday and there are some couple of things I'm watching for. No. 1, they announced recently that they lost their partnership with Walmart, which is a big deal. This is like when American Express lost its Costco partnership. This is the big thing in this business. So, I'm interested to see how are they planning to rebound from that. They said at the time of the announcement that they we'll be able to replace all that lost revenue within a couple of years. So, I want to know how. They're a credit card business, so they're going to be a big beneficiary of rising interest rates. Because the big banks surprised us with, their default rates dropped, their credit quality is improving. I want to see if Synchrony is trending the same way. It could be a big profitability boost for the company.
Moser: And the ticker?
Frankel: SYF.
Moser: OK, good deal! I'm going to be watching Ameris Bancorp, ticker ABCB. They are a little community bank based out of Moultrie, Georgia. Folks who have followed me for any period of time know I've been following this bank for quite some time. They have earnings coming out on Friday. It's always been a story of growing their assets under management. Growth from the financial crisis was a neat part of the story early on with a lot of those failed institutions from the Great Recession. They essentially had these FDIC-aided acquisitions, which pretty much protected them from any downside while helping them grow out the actual customer base and asset base there. This is a very well-run bank that has seen a little bit of a pullback recently with the market volatility. Still, I think, a lot of things to like about what they're doing. Still just a small cap, you know, and we talk about big banks. So, it's just a $2 million market cap bank here.
But, earnings out on Friday. I'll be interested to see what they have to tell us. Also, just to note, we have PayPal earnings coming out this week, as well, on Thursday. We'll certainly cover that on next week's show. Next week's show, Matt, we're looking forward to everything you have to offer us from the Money 20/20 show out there in Las Vegas. Hopefully, you're not going to be telling us any stories of lost wages while you're at it. [laughs]
Frankel: No, actually when I talk to you I'll just be gotten there. So,... [laughs]
Moser: Beautiful, alright! Good deal! Safe travels, there! Looking forward to next week!
Frankel: Thank you!
Moser: As always, people on the program they have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. This show is produced by Austin Morgan. For Matt Frankel, I'm Jason Moser. Thanks for listening! See you next week!
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Jason Moser owns shares of MA, PayPal Holdings, Square, TWTR, and V. Matthew Frankel, CFP owns shares of AXP, Bank of America, and Square and has the following options: short December 2018 $90 calls on Square. The Motley Fool owns shares of and recommends AMZN, FICO, MA, PayPal Holdings, Square, and TWTR. The Motley Fool owns shares of V and has the following options: short January 2019 $80 calls on Square. The Motley Fool recommends Costco Wholesale. The Motley Fool has a disclosure policy.
