Plugged In - A Banking Podcast
Plugged In brings you raw, honest takes on all things in the banking industry. That means you aren’t going to get some buzzword-filled, cliche podcast – you’re getting an unfiltered look into topics in the financial world no one else is talking about. Your hosts, Al Dominick and Steve Williams, will talk to top players in the industry about what matters now, and what will shape the future.
To groove along with Al and Steve's song references each episode, check out the official Plugged In Spotify playlist: https://open.spotify.com/playlist/1Z7NWPIQuaXQlfHxLWJb3g?si=o552CzjwTr6R4mx13NmOBA
Plugged In - A Banking Podcast
Ep 26: What does it take to be a successful bank? // Tom Michaud
Tom Michaud, the President and Chief Executive Officer of Keefe, Bruyette & Woods, is back! This time, he joins Steve and Al to answer the question bankers across the country want to know: How to compete with big institutions and non-banks.
On the show, they get into common mistakes banks make, takeaways from KBW’s Winter Financial Services conference, and why they think the industry outlook right now is relatively positive. While fusing industry insights with the beats of timeless tunes from U2, the White Stripes and a few other favorites, Tom reminds listeners: the stocks had a 35% rally from the end of October to year end.
Coming up, a very special episode of Cornerstone Advisors. Plugged In, I'm Al Dominic, joined by the incomparable Steve Williams. Yeah, and we've got a powerhouse guest today. I'm talking the man, the myth, CEO of Keefe, Bruyette and Woods. That's right. We're talking the business of banking and leadership with Tom Michaud.
Tom Michaud:Tom what's happening. Al good morning. Thank you for the very kind introduction and keeping expectations really low for me.
Al Dominick:Tempering expectations because, you know, here's a guy that I've known for quite some time. I've had the great fortune of being able to introduce him on stage at various places, but this is only the first time in Plugged In history we've been able to welcome a guest back. So Tom's making history by being our first two-time guest on this bank leadership focus series. I'm just like a little round of applause for being so bold.
Steve Williams:Bravo, bro, about snaps for the sorority girls.
Al Dominick:All right. Well, we'll snap it out with Tom throughout this episode. Two-time guest quite the accolade. Now, when Tom joined us the first time, a tradition was born on Plugged In. And we remain super keen on bringing you insights from standout execs in the banking space, but we've decided this cornerstone twist that Tom was party to in the beginning has to continue. So we've been diving into some classic tunes that really echo the rhythm of our conversations. So I know Tom's excited to see what music will pull for him this time. Is that a fair?
Tom Michaud:assumption, steve, I will admit it, I'm a Yankee fan and I spent many decades knowing which reliever was coming into the game by the music, so I look forward to seeing what music's going to be played.
Al Dominick:Tom's always teasing me. That's why I carry my Red Sox hat close by, because we're not pulling any Enter Sandman by Metallica, as great as Mariana Rivera was. We are going to limit the Yankee stuff. We're doing no dropkick Murphys because the Red Sox aren't coming into this conversation. We really are getting into the business of banking and the way I thought we could just kind of get up and rolling is to remind Tom that the song that really started this whole thing off came from U2 and their one album, and there's a song from Octoom Baby that asks the age-old question is it getting better or do you feel the same? So we thought we'd merge industry insights with lyrics like these really to just get Tom's perspective on things. You and I have been to various events over the first few months of the year. I'm curious. I was just down in Boca at your Winter Financial Services Conference. What are some of the bigger themes or takeaways that kind of fell into your notebook that you'd be willing to share with us?
Tom Michaud:Well, I think my first takeaway and yes, we had our biggest regional bank conference ever last week. We had close to 1,000 attendees and it was our 31st annual. So the first takeaway was the demand from investors was high. We had great turnout from the institutional investor community, and also some of the biggest long-only owners of bank stocks in the country were there. So I think that was the first takeaway is that interest is really high in this group, and I think that's for a couple of reasons. Number one is don't forget the stocks had a 35% rally from the end of October to year end.
Tom Michaud:That got everyone's attention, and I think also there's a view that we're at a turning point on a variety of fronts. One of the turning points is a really good turning point, which is we think revenues are going to start growing again by the end of the year. We're going to have a little bit of exit velocity as we come out of 2024. And that really speaks to possibly the heat, or probably the heat coming off, competition for deposits, and that banks will start to get some net interest income growth going again. So I think that's one shift that investors were interested in hearing more about. I think the other shift, though, is there's a sense we're in the earlier stages of a credit cycle. Now, this credit cycle, in our opinion, is a normalization of credit costs, and I think Al you may have heard me say in the past, the surprise when credit costs go up shouldn't be that they've gone up, the surprise should be for how long they've been zero because, no bank can run its bank and underwrite to zero risk.
Tom Michaud:It just doesn't happen. So we've got 25 basis points of provisions in our model for this year and that probably is still below the over the cycle average. So it could go higher from there and I think that investors want to get a feel for what's happening, especially in the area of commercial real estate.
Steve Williams:Yeah, I want to ask you, tom, real quick on that Are the investors digging into the numbers? You hear a sound bite. Someone says there's a trillion dollars of value loss in CRE and there's this big office in San Francisco or Manhattan. But if you dig into a lot of the regional bank numbers, there's this percentage of office that a 50% loan to appraisal with guarantees and cross collateral. Are investors digging into that to kind of demystify some of this risk?
Tom Michaud:What I try to speak about is there is not one brush for the whole industry, painting the whole industry. I personally believe that there are three banking industries they're the top 25 banks, they're the mid-sized banks and then the 97% of banks in America that are below 10 billion in assets. So there are three different really industries and they all kind of do different things. So and then the same thing with commercial real estate. Wells Fargo's got over 10% reserves against their urban large office buildings. That's completely different than what an Indiana regional bank is going to do. Their median loan size is going to be a lot smaller, chances of there being a personal guarantee being a lot higher, chances of that building having tenants that include medical or legal or local businesses higher, not to say there won't be losses.
Tom Michaud:And also, another way to look at it is you got to look at the 2020 and the 2021 originations when interest rates were near zero, especially what kind of growth happened there. You have to stress, test those portfolios for current rates. That's just a math combination. There will be challenges in those markets, but I just don't think the final outcome will be the same as what you read about in these big cities. Then don't forget the influence of non-banks. We think at least half of that credit that you just mentioned are owned by non-banks. They're inside the CLOs and the CMOs insurance companies. Private credit Banks aren't the only owners of those mortgages. Thank you.
Al Dominick:Yes, Steve, that's a great question. I keep hearing it brought up in public settings and also private ones. The whole CRE concentration risk that people take the broad brush to. I like Tom's response because I've been hearing different banks CEOs that are publicly traded say hey, let's not confuse where we are with where this market narrative has been drawn.
Steve Williams:One great CFO last Friday. I'll real quick say I had to explain to my investors how many of our offices don't have more than two floors. These are suburban, like medical, they're solid and the average loan might be $2 or $3 million on these things.
Tom Michaud:I was with a Montana bank CEO recently and with a group of folks, and we were just talking about business. I asked him. I said can you tell us a little bit about your rent-controlled mortgage portfolio? He said, oh, you mean the one with $0 in it? I said, yes, that one.
Al Dominick:We won't guess the name of that executive. We could throw a few darts and see Tom acknowledge that. We're going to pull some music out. Steve, you know how we like to roll unplugged in. There's a song with the lyric every single one's got a story to tell. Everyone knows about it. It's sung by Jack White. He actually was kind of gruff about the whole thing, but this is Seven Nation Army by the White Stripes. I just had to pull this one up because everyone's got a story to tell. Like you just acknowledged, tom, it depends on if you're an individual, if you're looking at the industry. One of the stories I think we should talk about is how scale is working while consolidation has been on pause the last few years. I pulled this directly from a slide I saw you present. I thought you put that up before Capital One announced this acquisition of discovery. Can we unpack this key point with some current perspective?
Tom Michaud:Absolutely. Also, I have to tell you something I said to my firm was take a close look at the investor deck that Capital One presented, because as somebody who makes those for a living, I know how many versions of that deck there must have been before they had the final round. I can tell you a lot of really thoughtful individuals looked at every word in that deck. When you look at it, there's not a lot of accidental comment is my opinion. I looked at the first page for investors where they said the reasons why they did the deal. Bullet point number one was scale. Bullet point number two was to build a competitor for the largest banks. That's exactly what I've been thinking and what I've been saying is scale has been working and we need more competitors for four banks, for the biggest four. If there is no consolidation, we will be cementing the fact that these are the four big banks we're going to have. They will probably grow faster than the rest of the market and they will be even bigger as a percentage of the industry in a couple of years. Also, the non-banks will be bigger, because so often I had a chance to read the speech that interim controller Sue gave when he came out with his new M&A regulation proposal. I read it and it was interesting because he did also get to a theme that I think is important, which is we have to stop talking about the industry. We don't want. At some point which I think is now we need to talk about the industry. We do want. What do we want banks to do? What do we want the industry to look like? Rather than just sort of dismantling it activity by activity, one at a time, let's talk about what we do want them to do. He did introduce that topic in that speech, but in that speech he never once mentioned non-banks. Remember, banks have been losing market share to non-banks for really ever since Dodd-Frank came into play. That's been de-risking the banking industry and it's been going somewhere else. I believe there are going to be very big ramifications. If this continues to play out, we will get to a point where small business will be yelling that they don't have proper access to credit because you will have the mid-sized banks possibly not in position to service them like they have in the past. That's a for example, I think, with regards to the Discover Capital One deal, which we're not an advisor on, so I'm free to speak about is that, yes, they are going to do it for its scale as well, as it's building a competitor for the big four. Then there's another piece to it, which is the non-bank piece. Discover has one of the four networks that matter. The two dominant ones are Mastercard, visa. Then you've got American Express, which is very important, and then you've got the fourth place, finisher, which is Discover.
Tom Michaud:Imagine if Apple bought that and that could be split out and sold to Apple. There's argument about we don't need bigger banks. Would it be better if Apple bought it? If Apple bought it, then this whole thing could be turned in a different, non-regulated direction, which I think the outcome may not be. I mean, the outcome could certainly be anything. I can't determine exactly what the outcome would be. My own opinion is the banks are regulated, they have supervision better to have this activity in a regulated environment and allow competition rather than to draw the wall so high and not allow consolidation so it is forced to go outside of the umbrella. So my opinion is it's good that a bank has bought that.
Steve Williams:I agree with you If we take all the risk out of the system where no exams take place, because the thing that when you move all the things into the shadow bank industry they guess there's governance but there's not the good old regulatory exam which is a big part of how do we kind of keep an eye on things? And I don't think policymakers get that that when they think they're de-risking but they're just moving it.
Tom Michaud:I'll actually add. I think the important element there is the charge for a bank versus a non-bank is different, and I hope I'm not. No one thinks I'm saying anything negative about non-banks. They're very good organizations. They've driven a lot of value. Their market caps are very big and many of them are very well run. That being said, they exist to be fiduciaries for their investors. If they believe that underwriting credit is a bad idea for their investors, they will cease immediately.
Tom Michaud:If you're a bank, you have a different charge to your community. You have insured deposits, you have a bank charter, you have, I think, a little bit more engagement with your stakeholders to be there in good times and in bad, and it's a different feel, especially with the fact that you tend to have physical locations in your communities. I think that's the difference, and if we get to a moment where non-bank underwriters think it's a bad idea to make loans, we'll then hear a scream that I think, from small business, which are where half of the jobs in America are that we got a credit crunch and it'll be because the industry changed, because of the steps that are being taken now. So I'm sorry, steve, but I had to get that off my chest. You're probably saying Michelle, you're exceeding your answer time by about 50%.
Steve Williams:I think this is gonna come into policy in the next administrations as well. Like what do we do about this? So I appreciate the answer.
Tom Michaud:You really wanna ramp up that machine to get more off my chest, which is FTX, was an unfortunate and spectacular bankruptcy last year, right, unfortunately, that CEO has gone to jail for fraud.
Steve Williams:Right.
Tom Michaud:There's been no legislation or changes around the activities that led to that. Some of those activities have been illegal in the securities industry in the United States since the 1930s. Meanwhile, we've had an avalanche of bank proposals, so it just goes and tells you how the banking industry is the magnet for this type of regulation and it's just not a level playing field. And I would even argue that the non-banks would be comfortable with a level playing field. And if you want to see what an unlevel playing field looks like, just look at the mortgage market where, since the passage of the laws in 2008, where banks dominated mortgages in America, today they only make one out of every five. 20%. Non-banks make 80% of the mortgages in America, and that's due to regulation, not because banks don't want to do it Right.
Al Dominick:So, as you two are talking, I'm just jotting a few notes down. Steve and I have heard different folks almost lament the fact that we could be seeing, just you know, not four, but maybe like 10 megabanks and the erosion of the regional community bank space that we know and I think we love, and so we're really trying to figure out how to help people stay relevant and competitive in this really precarious time that we're all going through. I'll transition to our next song, because we've got to keep things light and moving and the lyrics go. Many is a word that only leaves you guessing, guessing about a thing you really ought to know. This, of course, steve is who?
Steve Williams:I'm stumped.
Al Dominick:Good, I finally stumped you after all. This time it's Led Zeppelin's Over the Hills and Far Away. Oh, I love that song.
Steve Williams:I don't think that's a good word. I know you do.
Al Dominick:That's why I had to say it in like such a terrible voice. Because if we're going to transition to that track, let's kind of explore the continued fallout from NYCB and Flagstard and really what's happened and why should we take note so that we can learn from maybe some of the challenges that created the recent you know misfortune.
Tom Michaud:Sure. So my opinion is that, you know, I started in the industry in 1986 as a credit analyst. Kbw at the time owned a division called Bankwatch, and that was during some of the Texas Energy Banking Crisis period, and it was a great experience for me because I learned a lot of some of the core principles around risk in banks, information and data about what's happened at whether it's New York community or whether it's the three banks that failed last year, there are a couple of common principles that I think that are worth observing. One is concentration. You know, when I learned at Silicon Valley that their top 10 deposit relationships had $13 billion of deposits at the bank, I was shocked. I mean, that's just not something you normally get as information. It came out in the after failure report. That's shocking. Also, when you look at some of the size of the loans that New York community was making, of course the impact is going to be significant. And then also when you look at the concentration of exposure by geography or by credit size or by asset class, I feel like it dramatically changes the risk profile.
Tom Michaud:And there's something that I've been saying a lot that I got to make sure that I'm cautious about saying which is well, this is very idiosyncratic. That's just New York community, or that was just, you know, first Republic relied too much on held to maturity accounting and fixed rate mortgages. But when you say it enough times, it's not as idiosyncratic, right. But I would look for companies. I think you know I did get a chance to talk to one bank in the New York City area at our conference last week who told me that their entire commercial office properties could be written off with profits in about three months they could write off 100% of those loans. So it's a diversified portfolio that could never bite that bank on the bottom. So because they're diversified, so I think there are a couple of core tenants.
Tom Michaud:And when I think about regulation, I'm a little surprised that this didn't come up earlier with the regulators, because we don't need more rules. We kind of need to just look at the principles, like have core deposits right, bank profitability matters, don't be over concentrated, don't pay up for hot money, be well capitalized. I mean, these are like basics that you think about, and so I think it's good to stay with the banks who are a little bit more traditional. And then I do also say something I said last year was while we had three spectacular, unfortunate bank failures. Let us not forget that there were 4,750 that didn't fail.
Steve Williams:I also think, tom, when we look at for citizens and New York community that were very opportunistic last year as signature and SVB which is to me I like when people are opportunistic and say I think I see value, I'm going to go for it I worry sometimes now that people see you know, if you bite off more than you chew, you might have more of a blowback than you would have in two. I think people are saying we've got to only bite off what we can kind of do in this environment right now and reduce some of that volatility risk. Yeah, 100%.
Tom Michaud:I should have thrown another principle out there, which is fast growth. You know, remember Silicon Valley grew 85% in one year, organically. That is stressful and in hindsight was a lot. They might have pulled it off if they hadn't used held the maturity accounting on the bonds, which they probably thought was the most conservative thing they could do at that time. So in hindsight you can unpack how they got to the decision, but nonetheless, managing growth. Not most banks don't grow like that and maybe you know, remember most banks grow about GDP growth and then some I mean basically as your resident DJ.
Al Dominick:As you two are talking, this is not a song that I was going to use, but it's like Tom Petty's felt so good, like anything was possible. As you two are talking, we should just have running down a dream, should be playing behind us. Let me ask you this, though as you two are talking, I'm curious. Banks endure not just because they have excellent customer experiences, but due to smart balance sheet management, and again, this is a theme that continues to come up in public conversations. Tom, you've already started to talk about some of the common mistakes that banks make, but if you're sitting, let's say, as a board member today, are there things that you should be paying a little bit more attention to than maybe you thought you would at the end of last year?
Tom Michaud:Well, first of all, I think the banking business can still be a very good business and I often think about what does it take to be successful? I mean, if a bank consistently grows earnings per share 8% a year for the next decade, they probably win. They probably feel like winners. It doesn't have to be Herculean in whatever you do, you just gotta do it consistently. And also, size alone isn't a deter. I said scale matters, that's on the median, but size alone isn't a singular determinant of success. Credit Suisse essentially just failed and it was a global SIFI. Okay, right, siti Group no offense offered here, but hasn't earned a double digit return on tangible common equity and an operating basis in quite some time. And there's several trillion dollars in assets. So just being big alone is in a determinant. So they're really good small banks. So you can be a small bank. I mean, I think of Scott Deusser's bank, which is not one of the biggest banks in the country but maybe one of the most consistent in terms of profitability, and he's driven enormous shareholder value. So I think it's quality over quantity, I guess, is what I would say.
Tom Michaud:But you also need to remember that if you're a banker, you are still an entrepreneur and a businessman. So you need to be adaptive and you need to look for opportunities. I personally believe there's opportunities to beat the big banks. The big banks are very good at many of the things they do and remember, you're talking to someone who started a firm with 75 people when I started at KBW. So I'm happy to be David and not Goliath, but because I think there are great opportunities and so scale is important.
Tom Michaud:Statistically it shows it works, but it's not an insurance that it's going to be successful. So you need to operate a sound bank. But I also wouldn't get so conservative that you can't grow and invest and I also, by the way. If I were running a bank today, I would run it like I owned 100% of it myself. I would not take the bait of quarterly earnings and I would build a great company over a long period of time and investors will sniff that out and reward you. Run the company like you own 100% of it and don't be scared to do so.
Tom Michaud:I give that all the time.
Steve Williams:Our Gonzo Award winner, dave Finley, at Lakeland, like someone who just has that discipline time and time. Now, and to answer your question, I would say, at the board level, I'm looking for a Ray Rock culture. I want smart people arguing all day long about risk-adjusted returns across the entire balance sheet, and I want the arguments to take place. That's the only way to get the truth. The other thing, though, to your point is I want to be risk averse there or have a moderate risk appetite. I don't want to blow it with my balance sheet, but I want to take some risk on marketing customer experience. I want to spend some money in technology. I've been saying we've got to take our two risk appetites and separate them that entrepreneurial appetite around new business versus my Ray Rock discipline on risk-adjusted returns. Well, you need your discipline.
Tom Michaud:Yeah, there's like a list of core principles, I think, also to be a talent magnet. I think the talent magnets will win the banks where everybody wants to work. I look for that. Also, the most accretive, best acquisition I've ever seen anybody do is organic growth, one client at a time. That's the best acquisition. That's what we try to do, which is have a really good service that is growing on its own organically.
Tom Michaud:Then, a conversation I had at the conference, something that I've been encouraging bank management to think about, is in a moment where the market is more thinking about, like we said earlier, exit velocity out of 2024. I don't want to say that current earnings don't matter, but exit velocity does. I would clear the deck, some of balance sheet capacity that's being used by non-core clients, because I think the winners on the I'd be thinking about what's the back end of this post-COVID moment going to look like. I think it's the banks that have capacity to grow organically and to serve their best clients are the ones that are going to win.
Tom Michaud:I look at what Sinovus did. They sold a bunch of assets in medical office buildings that were performing, but they didn't come with a lot of other business or deposits. They sold them to create capacity to go after their core C&I business. That's a fantastic trade. I'm watching Comerica, which, of course, is navigating a hundred billion but at the same time exiting mortgage warehouse, which is not a high value business, so they can focus on their core clients. At the end of the day, they'll be better rewarded for having done that, that's wanting to think like you own a 100 percent of it yourself.
Steve Williams:Right. Never cross 10 billion or a hundred billion with those deluded assets. Don't use up your time to make a crossing from a regulatory standpoint.
Tom Michaud:I'm going to do when you go to cross it. We recently wrote a report we call our Shoots and Ladders report, which I think Al, I know you and I think both of you have seen the slide we've used from that but just talks about how scale works until you hit a big regulatory threshold and then it doesn't. You got to rebuild. Unfortunately, that's the world we're operating in. It's disappointing because I got to tell you the subject to crossing a 100 billion. When you're a board of an $80 billion bank, you talk about it all the time. Don't think that it starts at 100. You better be well underway by the time you're 80.
Al Dominick:Right, well, you mentioned Sinovus. I just saw Kevin Blair and his CFO, I guess a day ago, when I listened to them talk about their business. It reminds me that quality never goes out of style. As you guys are talking about it, I also think the concept of building franchise value is something that will never go out of style as we think about how the business of banking continues to move and shift. Steve's talked about being opportunistic. Tom's talked about being I'll call it hyper-efficient, being a magnet for talent, really keeping that entrepreneurial spirit alive and well. That's something that is so critical for everyone in the financial space to really get their arms around it and figure out how can you add to your business's future, because it's not going to just happen if you sit and talk about it. You got to roll up your sleeves and get after it. It's part of the reason that we have this plugged in series just to inspire when and where you can.
Al Dominick:I promised again we were going to talk some songs. I got to give my wife, amy, some credit. Both Tom and Steve know Amy. She knew that we were doing this podcast today. I've been on the road almost non-stop. She said you've got to work in journeys lights, Because so you think you're lonely. Well, my friend, I'm lonely too. I got home to DC. I'm going to see my family and friends tonight. I hope you guys are able to do the same thing. I really want to thank Tom, we want to thank Steve and I want to thank all the listeners for getting plugged in yet again with Cornerstone Advisors. Our two-time guest, tom Michele, is going to take us out with, hopefully, a nice positive note, right, tom?
Tom Michaud:Exactly. I do think that the troubles of the COVID crisis are more in the rear view mirror. I think, while there's been a lot of pressure from non-banks, I think that that pressure feels to me like it's peaking, and so I still think there's a lot of great opportunities. I said if you grew at earnings per share 8% a year for a decade, you win. It doesn't have to be much harder than that, and so thank you for having me on, and I love talking about these topics, and I look forward to seeing everybody soon. Thank you.
Steve Williams:Tom, always for you guys, thank you.
