Odd Lots - The Massive Shift Underway in the US Banking System

Episode Date: July 27, 2023

When Silicon Valley Bank imploded, there was a lot of talk about the future of regional and community banks in the United States. Can they compete with the large, too-big-to-fail institutions? What will happen to their deposits and their cost of capital? But actually the challenges facing smaller banks long precede March's banking drama. Tensions have been building for years, and will likely continue to do so, even if things have stabilized over the last few months. On this episode, we speak with Scott Hildenbrand, the chief balance sheet strategist at Piper Sandler, who works hand-in-hand with smaller banks to address these issues. We discuss the competitive landscape, the threats to their business model and why he thinks massive consolidation is on the way.See omnystudio.com/listener for privacy information.

Hello and welcome to another episode of the Oddlots podcast. I'm Joe Wisenthall. And I'm Tracy Allaway. Tracy, it's been about, I guess, three months or so since the SVV blow up. And I don't know, people, it sort of seems like a thing of the past now. I'm trying to remember when I went on vacation. I guess it was March. So, yeah, yeah, I guess three months. Can I ask, before we start this conversation, are we going to call it a crisis or not? Because that seems to be a new terminology debate.

Well, yeah, it's a good question. I'm team anti-crisis, but also I remember you were on vacation, and I remember you're like, oh, God, I'm missing a financial crisis. And I was like, no, no, it's not a crisis. Enjoy your vacation. It's not worth, like. It was still the most interesting thing to have happened to banks in many, many years. It was very interesting. All right.

Well, let's agree to call it drama. Drama. That works for everyone. It was drama. I think that's right. And, you know, after that we, you know, there were all these questions like, why do we have thousands of, thousands and thousands of... Why do we have banks at all? We did. We had like an episode.

Why do we have private banks? Oh, that's true. Yeah, we did do that episode. Yeah. Why do we have private banks? Especially if the depositors can almost always be guaranteed to be bailed out. Yes. So it did raise some existential questions for banks. And one of them was the deposit insurance question that you just mentioned. But the other one was the nature or the breadth of the U.S. banking system altogether. And this is something that I think comes up. up after almost every bout of banking drama slash crisis. You saw it in the savings and loan crisis. Certainly after 2008, there was a lot of discussion about what should banks be doing.

Do we need this many banks or are we comfortable maybe with merging some of them, consolidating them into megabanks? And now, fast forward to 2023, a lot of that consolidation is happening again. And we are seeing some of these same questions raised. Right. And I guess there's like this sort of two ways of talking about consolidation. One is like could we see the giant banks just sort of like buy everyone else? And then we sort of have like a Canada style banking system where there's like eight banks or whatever. Or could it be like from the depositor perspective where they're just like, why wouldn't I just put my money at J.P. Morgan, the ultimate too big to fail bank. And then I sleep at night. And you know, and just why not? Right. And they have a good website and it works and all that stuff. And so there's just like, it's just like, it. It feels like there's all these forces put in a lot of stress on the thousands and thousands of smaller community and regional banks out there. Yeah. And at the same time, you know, this idea of small local banks is kind of embedded in the American psyche, I feel like. Certainly going back to it's a wonderful life. Everyone has this notion of a cozy community bank where everyone kind of knows each other. And so they put some value on that. But that's not the only way to have a banking system.

You could have a Canada-style banking system, as you just pointed out. So all these big existential questions at the moment. And to me, a bank is just an app at this point. No, for real. Like, I have a bank that does not have, like, physical branches that I go into. They might have one. You don't have intense personal feelings for your bank? No.

No, I have, like, it's like the app works. It doesn't crash. It's like, great, there's my bank. Anyway, so what is the future of banks and what is happening? And will we one day have a Canada-style banking system? I think even though things have quieted down, it's sort of a good time, actually, to take stock of what's happening. It is always a good time to talk about the meaning of banks in America. Well, I'm very excited today. We have the perfect guest, someone who works directly in this space and has for a long time.

We're going to be speaking with Scott Hildenbrand, chief balance sheet strategist and head of financial strategies at Piper Sandler. Scott, thank you so much for coming in. Hey, good morning, Joe and Tracy. Thanks for inviting me in. I'm thrilled. What do we actually just start with like, what is a chief balance sheet strategist and head of financial strategies at Piper Sandler? I wish I had a nickel for every time I've gotten that question, Joe. But no, so a chief balance sheet strategist really is I spend every day all day predominantly on the road working with the community banks all throughout the country. So if you think about it, there's about a thousand community banks that come through our group. I have a team of 35 of us.

Wow. And we spend every day all day looking at bank balance sheets from an interest rate risk perspective, a liquidity perspective. a capital perspective, an investor perspective, regulatory perspective. So think of sort of the top 50 banks and then everybody else. I sort of work with everyone else and think through on all of those issues that are certainly front and center as you two just chat a little bit about. Perfect guest. So next question, how busy have you been over the past three months? You know, Tracy, it's interesting. It's the first time I think my family and friends know what I do for a living. It has been incredibly busy to the point where I can't even go play golf with friends

without the word Silicon Valley, hedging, uninsured, all those types of terms popping up. And I do a fair amount of public speaking. And a lot of people want to hear about what's going on, what are others doing and thinking about post the drama. And I love the way you all described it, the drama around the Silicon Valley, etc. Would you say, do you agree it was not a crisis? I do. But I think it was also, it's a lot easier for me to say that now versus when Tracy was on vacation

and when it was happening that Sunday in March, when it felt it felt, it felt, It felt pretty quickly like it was getting out of control. But I think, as you said, Joe, I think over the last three months, we have seen some stabilization. I think everybody's calmed down a little bit, but there's still a lot to unpack and a lot of challenges coming. So why don't we do a little bit of looking in the rear view mirror first, and then we can move on to what we've been seeing currently. But what happened in March, how would you characterize the drama that we saw? Sure. I think what ultimately happened.

And, again, being an asset liability nerd. that I am. All I have done for 23 years is modeled balance sheets. So I take assets. I take the liabilities. I take changes in rates. And we try to determine the impact what happens to those balance sheets. One of the things that we were taught very early on, and almost everyone who's listening, who's ever modeled an interest rate risk for a bank will tell you that the deposit side of the world is the ultimate hedge against higher rates. Right. And so if you had told me, Joe or Tracy, five years ago you had me on here and you said, you know what, there's a bank that's all they're going to do was by treasuries and all of their deposits are in checking accounts. And by the way, they're going to

fail. I would have laughed at. I would have laughed at both of you. I wouldn't have come back. I don't know. You all are crazy. So literally in March, Tracy, to answer your question, I think everything was flipped upside down. What we had all learned was the fact that operating accounts and checking accounts are great until they're not. And what we've learned also is that while it's been a slow bleed, Joe, and you were sort of talking about this, we finally all now realize that there's really no contractual liabilities or deposits on a bank balance sheet anymore. People can move money a lot faster. Bank balance sheets are more athletic and nimble.

You couple that with really what happened, if you think about it too, is you think about from an M&A perspective, there was no M&A during 2020 and COVID for those couple of months, yet every single bank in the country did one. They didn't realize it. They got no assets. An enormous amount of deposits were dumped into the industry. they didn't ask for it. Major growth on a deposit front,

interest rates at zero, and no lending anywhere. So you think about how ballooned those balance sheets got. It's not like banks woke up overnight and all of a sudden became fantastically better at gathering deposits. So those balance sheets looked a lot different.

And then fast forward, we were a little late to the inflation game. You go up 500 basis points in a very short period of time. You have Twitter and the social media role here. And all of a sudden, everybody got spooked and dollars started running out, not like the WAMU days,

or not what's a wonderful life, it was three hours and $42 billion. That's what happened. Yeah, this is kind of the dark side of the app. Yeah, right. Yeah. Which is the flightiness of deposits. You can pull everything out with a click of a button now. I know, like, for our listeners, and I've had this explain, what is it about just

for sort of like banking, asset liability, nerdistry, like 101, probably even pre-101. Why is it the deposits are at interest rate hedge? Sure. So in theory, over the years, historically. most of us all have checking accounts. We've got savings accounts. And predominantly, if you think about it, banks make money not because of the asset side, the lending.

It's because they don't pay at market rates on the deposit side, right? Checking accounts, nobody really cares what you're making on your checking accounts. As long as the app works, you move your money around, you're good. I think what ultimately happened is for years and years, you'll hear the term beta. And it's not from an investor perspective. It's in the bank world. Everybody likes to try to project every time the Fed moves, How much does a bank have to move their deposit rates to keep money in?

And forever, it's kind of been this 30 to 50 percent. And I've never really subscribed to it. That's a separate topic. But typically, that's what we've seen historically. But unfortunately, what it doesn't measure is the fact that not only is it, you know, a rate that we have to pay, but dollars can move so much faster based on the technology. And I'd argue the demographics. Here's the bigger issue, if you think about it, from an asset liability perspective. I can't model the demographic breakdown well enough yet.

You think about my father's generation versus, you know, my future grandchildren's generations. And you think about how they view a bank, sort of the way you all were describing it today. There's a loyalty trust matrix. And you think about the loyalty, a lot of loyalty in my father's generation and very little trust. He gets a $2,000 check. He is going to a branch. He is going to make sure that money is in. He gets his lollipop.

He says hi, and he leaves. Then you think about the generations beneath below. There's a ton of trust. They'll move money around on phones. They don't even know the name of the bank they're banking at. They'll move it so quickly, but there's very little loyalty. And therein lies the difference in why we're struggling with how to determine how to manage and hedge a balance sheet from a deposit perspective.

Maybe the banking app should figure out a way to deliver lollipops. That's right. Can I ask another step back question, which is, you know, I was a banking correspondent soon after the 2008 financial crisis. And I remember the big hope of banks back then was, interest rates are going to rise and will finally be able to make money off of lending. What happened to that portion of it? That's the best question I've gotten around this topic over the last 90 or 100 days, Tracy,

and I'll tell you why, if I had a nickel for every bank that told me in January of 2022, so not too long ago, that they couldn't wait for rates to rise. We were prepared for rates to rise. Scott, we're going to look so good. It's coming finally. I mean, I, for honestly, I've been doing this 23 years. I could have taken the first 20 years off. Everybody told me rates were going higher.

They never moved, right? It was very low interest rate environment for 20 years. Finally, we see interest rates higher, Tracy. And it took about, I don't know, nine months until everybody called me and said, we need help hedging against higher rates. And I'm like, well, wait a minute. But ultimately what we didn't realize, right? What we didn't facet in is the fact that, yes, when the Fed hikes interest rates, and it's

why you saw 2022 in the first six months, we saw great margin expansion for banks, which was phenomenal. The asset side was resetting higher. Nobody was paying up for deposits because it wasn't based on the Fed. It's based on supply and demand. And we had so much supply of deposits after COVID that it took a while for anyone to have to pay. Then all of a sudden we had to pay as things started to catch up. Treasury rates got a lot higher, but here's the bigger problem. Everybody was looking at their balance sheet as if it would stay the same in terms of product mix, in terms of size. And ultimately what happened is everybody said, well, wait a minute, I can move money all over the place, not only to different banks, but banks were competing

against treasury rates, right? So all of a sudden, people move their money around a lot faster. So we always say it's not changes in rates that caused it. It was the way and how athletic bank balance sheets are today versus where they used to be. And it moves a lot faster, Tracy, and that's where people got caught. Just a follow-up based on that. But how much of the concerns that banks tend to have are shaped by things in the stress test. So I'm thinking back, worst case scenario of the banking stress test for a long

time was a recession and rates going very, very low. It didn't really have much, as far as I can remember, like there wasn't that much modeling based on rates going really, really high. So does that tend to shape bank behavior? Like, is that the scenario that they end up worrying about? This was the double whammy. You're right. If you think about, you know, if you pulled 100 CEOs throughout the country, and it was two years ago, even four years ago, 10 years ago, and you say, what's the worst scenario? They tell you, well, rates down to zero, probably means recession, we've got credit problems, et cetera. That's going to be a really tough environment for us. Where I think we didn't focus enough on is really understanding the impact that both technology,

social media and the demographic changes around the deposit front from a liquidity perspective in a higher rate environment. This wasn't a, we got to slow the economy down from because it's booming organically. This was, hey, we're going to throw way more money into your industry than you asked for. And then we're going to suck it out in record pace. And by the way, we're going to do it over a nine-month period. And hopefully you're prepared to handle that. Canadian women are looking for more. More to themselves, their businesses, their elected leaders, and the world are out of them. And that's why we're thrilled to introduce the honest talk podcast. I'm Jennifer Stewart. And I'm Catherine Clark. And in this podcast,

We interview Canada's most inspiring women. Entrepreneurs, artists, athletes, politicians, and newsmakers, all at different stages of their journey. So if you're looking to connect, then we hope you'll join us. Listen to the Honest Talk podcast on IHeartRadio or wherever you listen to your podcasts. I want to talk more about the demographics and really get these sort of like long-term structural changes. But before we do, I just want to sort of like ask one more question about this sort of like post-SVB environment. Like KRE, the regional bank ETF is actually still lower than it was on March 13th. Like they've stopped spiraling, but the valuations.

You mentioned, I guess, like, deposits have been stable. But can you talk about, like, there has clearly been this huge repricing of the sector that has not bounced back since then? I mean, it's flat. Like, there's not, everything else is rarely. What about this moment, either sort of perceptually or business-wise, like, really has changed how people view the viability, the business. this prospect of these banks. Right. Well, as you know, and both M&A and in valuation, unknown is a problem, right? And so you've got a few unknowns, Joe. You've got, you've got regulatory issues coming, further stress, more capital. What is it going to be? That's obviously whatever it is,

we all know it's going to hurt earnings, right? So you got it for the regional. Correct. Yes. It'll trickle down. There'll be some impacts. And then, you know, you also have, and I talk to a lot of investors, to your point, Joe, you know, almost half the banks in the country trading below their tangible book value. It's almost weird for me to say that. And we really haven't seen any credit losses yet. The problem is almost every investor I talk to, whether it's unknown around what we just talked about the regulatory environment or, quite frankly, unknown around interest rates, or the final one, you know, is unknown around credit. And I haven't met an investor that's excited about the credit environment, which we're headed into. And I think the real problem is, we're sort of stuck in this nobody knows mode. I'd rather us, you know, let's take some hits here. Let's have some credit concerns and start to deal with them. We're kind of waiting and waiting for the hurricane, but it hasn't come. And it might not be a major hurricane. It might be small. We just don't know. And so from a valuation perspective, it's tough for anyone to invest in

anything from that perspective. And just real quickly, the deposits have settled down. Correct. Okay. So Joe mentioned the KBW Regional Bank Index. Can you talk a little bit more about the differentiation that we've seen between the big banks, so the J.P. Morgans of the world, which seem to have been massive beneficiaries of these liquidity issues, the regionals, and then the really small community banks, because I think a lot of the community banks ended up getting lumped up in the regional category, but actually they seem to do okay. Right. And I think the biggest challenge right now is exactly the way you lay it out. If you think about it, the largest banks in the country rely a lot less on deposit in, loan out, right? They make a spread, but they don't

live and die by their spread business. The smaller, Tracy, the bank you get to, the more they rely on spread business. And that's a problem when you've got an inverted yield curve. You've got deposit costs continue to elevate. They've stabilized, Joe, to your earlier point, they've stabilized from a balance perspective, but I don't believe we've stabilized yet on how much it cost me to keep people here or the concern around how much I'm going to cost to keep people here. So you've got margin compression for the smaller institutions who have very little fee income. You think about J.P. Morgan, they've got revenues all over the place in all different business lines. You go down to the smallest community banks in the country and they live and die by deposit in, loan out, make the

spread, manage that spread, and pay for everything they need to pay for. So that's the simplistic view, Tracy, of the differences as you go down. There's obviously some others as well. There's obviously some others as well. Scale here is unfortunately playing a game. I'm going to play a large role in the game, excuse me, as we think about it. I sound like an investment banker in that that leads to M&A, but it's really true if you think about scale in a world that I think across the board, bank margins will continue to be lower apples to apples in any rate environment because we're probably going to have to hold a little more liquidity, probably got to hold a little bit more capital, and certainly having the rearview mirror of what happened at Silicon Valley. Yet, Tracy, to your point, there's

maybe five banks that look like Silicon Valley at a $4,000, yet the others are going to pay for some of that as well. And that's hard. You know, right around the time of Silicon Valley, I think I did a little bit of traveling. Tracy and I were in Chicago, for example, not long after that. I went to like a wedding in Boston. And the only reason I bring that up is like when you're in a new area, I find you just see all these banks you've never heard of. These like tiny local banks, like, you know, I'm probably making it up. But it's like the like, you know, the med, for community savings bank outside of Boston and the sort of, you know, third bank of Illinois. And just all these like branches.

Talk to us about like essentially setting aside rate compression and rates go up and down. We don't really know what the future. Like this sort of like operating business these days that they're in and the sort of challenge they have of like bringing in new depositors for local bank. Again, when I could just like go on, you know, job.com. You're right, Joe. And it's one of the things I do too. It's just I happen to know all those banks. I travel around, but it's the same one.

I'm like, oh, that's where that's located. But as you think about their business, right? Yeah. All of those smaller banks, most of those smaller banks were started in the community, folks at the schools, at the churches, at the country clubs, started this bank in town, and everybody kind of banked in that town. And you think about that worked for a long period of time. Back to that loyalty trust component, there was a lot of loyalty to who you banked with.

You fast forward to sort of where we are today, and you think about the, the Democratic graphic changes. You think about 10, 15, 20 years ago, Joe, a bank balance sheet, the community bank world, had almost half of its deposits were in CDs. I bring that up because if you think about it, that gave banks time. You have a one-year CD on your balance sheet. Rates don't move on those deposits for a year no matter what rates are doing. You fast forward to where we are today, and you think about two things. The average age of a CD holder is a lot higher than you would guess at almost any institution in the country. Who is the youngest person who even owns the C. of the United States. I'm looking for that individual because I want to know who it is. But you're right.

It's, it is really, that demographic has changed, but that's a really important point because as banks are trying to grow deposits, they're out there trying to reach in CD world. Yet I do a fair amount of interviewing for folks that originally Sandler-O'Neill, now Piper Sandler, want to come to New York, learn about community banking and way smarter than I am. And they ask me questions I can't answer, but I always have a question they can't answer. Do you know what a CD is? And they'd never heard of it, whether it was banking or music, and yet then I'll go to the next boardroom I'm in, the next bank, and they're saying, now we're going to fill the liquidity hole. We're going to go out and run a 15-month CD special. The game has changed. The demographics have changed. People want CD rates with money, market,

flexibility and operational flexibility. And that is the biggest dynamic we're seeing for the smaller community banks. And that's what happened. Back to Tracy's earlier question, the deposit world and how much we can hedge with the deposits is going away quickly without those CDs. We have no contract liabilities on most bank balance sheets anymore. On the deposit beta point, I mean, there are some banks out there that are offering very competitive rates, at least compared to others. And you are the perfect person to answer this question, but what are they doing that others are not? And, you know, I get that scale is a factor here. So if you're big, you can maybe afford to return a little bit more to depositors. But maybe for some of the non-meagest,

banks. Is it riskier lending? Right. Great question. And most of it comes, honestly, Tracy, from supply demand. And what I mean by that is if you go and did a scan of one of the, and it's a very high level metric, but one of the metrics I love to look at for banks in the country is loan to deposit ratio. And when you start seeing that number get closer and closer to 90%, then up to a hundred percent, you better bet that those institutions, that's where you want to keep your money because they're going to pay. They're going to pay whatever they have to pay to keep money in there, both from a liquidity metric, a regulatory metric to keep that loan to deposit ratio within reason so that they're not an outlier, right? And so you're seeing a little bit of that. You're seeing a little bit of,

quite frankly, most banks will tell me right now they're willing to pay those. You see those today. I was in Chicago. I was in an airport, I headed to the airport. And on my car ride this morning, I saw a CD for 535. I thought to myself, the same thing. Does that mean a typical bank margin three and a half percent. Are they putting on loans at nine percent? Most banks aren't. So it begs the question of you're going to see margin compression. I think I've never met a bank that told me they're going to be less in assets next year than they are this year. I think you're going to meet a lot of new banks that are going to be a lot smaller than they were a year ago because all of a sudden doesn't make a ton of sense financially. But right now we're still stabilizing and willing to

pay up a little bit. But over time, Tracy, as that stabilizes those rates, I expect them to start to come down a little bit because I don't see loans catching up and making the equivalent yields that you need to. Can we talk about sort of non-interest costs for the bank? And I'm thinking, you know, there's a million stories that we've probably run about J.P. Morgan going out and hiring a thousand people who understand artificial intelligence. Right. You know, it's like, and like I, again, I imagine that like Cambridge Community Bank Corp is not an attractive place for an AI expert or with that But, like, you know, like, what is they going to mean about the sort of like product gap that exists between these megabanks that have like huge tech teams and the local? Yeah.

That by far keeps, I think, a lot of bank CEOs that we're talking about today, he or she, up at night because the gap is widening, right? The gap continues to widen. And it's not even the technology. It's the combination of the technology and your users, right? You think about the average demographic again going back to how. much more in demand those technology skills and tools are for a bank to offer, both for hiring and also to gather deposits, gather customers. And so that is an enormous cost. That and fraud are two of the biggest costs for banks today. It's really challenging. Talk about fraud and how

that manifests as a cost for those. Sure. I mean, you think about it. And, you know, if you've ever gotten a text from your bank saying, hey, we just noticed you paid, you know, somewhere and you're not even in that state, we took care of it for you, and then they have to go work it out and try to go get it back. They're not getting every dollar back. That's just a cost of doing business in the bank world. You combine that with margin compression on your real business. How much you got to pay for technology to get talent and the technology in there. And it's another big drag on earnings overall at the institution. So I remember a lot of these themes from the post-2008 banking environment. And there was this big question of, well, why would anyone start a bank? Because

we have higher regulation. We had sluggish economic growth at that time. The tech spend was already an issue. The idea that, well, opening up brick and mortar bank branches is very expensive. We can't do that anymore. Is there a bull case for starting a bank nowadays? And I remember, again, post-2008, I think there was one bank that opened in like 2010 and then one new bank, a de novo bank in 2013. And I went to see it. It was this little Amish bank in Lancaster County in Pennsylvania called Bank of Bird in Hand. And it was honestly the most adorable bank that I have ever seen.

Anyway, side note. Well, that's one of the big things that you, I like just using the word de novo. We don't get to say it anymore, right? It's tough, Tracy, from an investor perspective to say, I'm going to, I'm going to start a bank. When on earth am I going to get my money back, right? it's going to take a lot longer than it did 10, 50, well, 15, 20 years ago now I'm getting older. That's part of the problem. You're not seeing a lot of the de novo world because both from a regulatory perspective and just

apples to apples, earnings for banks on average are going to be harder and harder to come by, which again just makes the return longer and longer. And folks say I could go invest in something else and probably get my money back a lot faster because we used to look at the stats, M&A, this is an interesting component, M&A really never changes in terms of how many banks sell a year over a 20, 25-year period. But for half of that time frame, we had a lot of de novo's. Now we don't, and that's why you're seeing the shrinking of the size of the banks a lot more, even though M&A is in a little bit of a rain delay right now.

De Novos are tough to come by, tough to get people excited about. Once in a while, though, you'll see some pop up, and you hear some people talking today around, you know, look, now I'm not at Silicon Valley. I'm at J.P. Morgan, and I'm just a number. And so there is still the relationship side. Is there a way to marry the technology and the, and the relationship? Sorry to interrupt you, Joe. No, that's great.

No, you didn't. I was interrupting you, but it's because you sort of anticipated my next question. So, like, community banks strike me as one of those things like mom and apple pie and baseball, which is like everyone loves the idea of the community bank, right? And politicians, you know, my understanding is that actually in D.C., the community banks are, like, pretty well represented and that politicians like to, like, make sure it's like, you know, well, my bank and my constituents bank and, you know, Tulsa get the same treatment as the fantasy New York banks and all that stuff. What would be lost in terms

of like what is different about community banks in terms of both the relationships, but also like their asset mix and the type of business that they do that goes away if they have trouble remaining robust business? I think we've got a great example of it. And it was so many other things going on, Joe, that we didn't maybe notice it all the way. I give such tremendous credit. it to the community bank space during COVID. Because if you think about how quickly they reacted on the triple P and were able to get out and meet their customers' needs at a very, very challenging time, it was a short window of challenge, right?

But it was a very scary time in terms of the small business side of the world being helped out. And the largest bank said, we understand what you want us to do, but we remember 08 and how much I got in trouble for getting involved in this. So we're going to slow play it a little bit, whereas the small community banks, I'm telling you, I was really proud to know a lot of them. I had a friend call me who said his father ran a business, a small business. He said, hey, could you get my dad? He banks at XYZ Bank.

Could you actually get him in touch with that? I called the Treasure. We made the connection. He got his money. And it just felt really good that there was that dynamic. So I think there's something there, Joe, that I think banks do a great job of executing their, helping their clients. They do a poor job in marketing. Is there something, I mean, I think that's a great example.

Is there something in the asset side or the loan side where there are still like, whether it's real estate, certain types of real estate transactions, maybe like medium and small business type loans like that's like, I want to build a little factory and where actually there's like a clear advantage to like the local bank that knows the space. Yes. Because that's like the theoretical idea. They know the community and they can do this. But like talk to us about how that actually, how that plays out.

Sure. It plays out a lot. And I'll tell you, the asset side is really becoming where banks can try to differentiate themselves on service and relationship and knowing the community. I know my dad's on a board of a country club, and he's probably embarrassed. I'm even talking about it. But he was telling me how the bank that was serving the country club, they wanted to do some work and wanted to get a loan.

But the loan was like $2 or $3 million. And they think that's a lot of money. To a large bank, that's almost not worth the time, the risk, the headline risk. He said there was two or three small community banks, willing, hustling, wanting to be helpful, know the market really well. And so that's a great example again. I just think the nimble and athleticness of a community bank versus the largest is really one of the advantages that are there that they need to play up more. They need to do a better job of that, I think. Canadian women are looking for more. More to themselves, their businesses, their elected leaders,

and the world are out of them. And that's why we're thrilled to introduce the honest talk podcast. I'm Jennifer Stewart. And I'm Catherine Clark. And in this podcast, we interview Canada's most inspiring women, entrepreneurs, artists, athletes, politicians, and newsmakers, all at different stages of their journey. So if you're looking to connect, then we hope you'll join us. Listen to the Honest Talk podcast on IHartRadio or wherever you listen to your podcasts. Okay, so smaller banks might have better relationships, might do a better job of small business lending or supporting the individual community. The big banks have economies of scale that make it possible to earn a relatively decent. return at various times. I'm going to ask the big question, but putting it all together, what does the ideal banking system in the U.S. actually look like? How should we balance the

small banks with the bank? Yeah, great, great question. And again, it's a very difficult one to answer, you know, spot on, Tracy, but my own gut, my own kind of experience, if we're at 4,000 banks right now, we're probably heading somewhere towards, I was talking about something that last night, maybe a couple of hundred banks over the next 10 to 15 years. And I think there's room for the largest. And I think there's room for the community bank world. And maybe I'm being a little like, yeah. We might only have a couple of hundred banks. I'm thinking over the next 15 to 20 years. And I think what you're going to see are you're going to see great bankers merging together to really start creating more of the midsize smaller regionals that can deliver better service

and have more economies of scale. I really believe that, and I'm probably going to get yelled at for saying the number. And maybe it's a bigger number than that, Joe. But in my mind, the way I think about it, when I started, there was double the amount of banks. You know?

And so we're heading in some form of that direction, partly because of what Tracy said, De Novos aren't really out there to fill the need. And there's a lot of benefits from putting a couple of these great banks together so that they can offer a wider scale, economies of scale, better technology, better cyber security components.

So I think you're going to see less banks, but I think more of them will be able to battle the largest ones if they team up a little bit. Are there some companies making a fortune basically offering white label apps and fraud prevention services, et cetera, so that these banks don't actually have to have any of that expertise in house? Yeah, I would tell you, and you hear a lot in our world, the fintech world. Yeah. The fintech world has been great for the community bank space because there's a lot of teaming up, right? The fintech world does a great job creating an app, creating a mechanism that tracks, to your point that, or loan origination, or whatever they can. And the banks really opened their eyes about five or six years ago and said, we can

really team up here. We've got great balance sheets. Love to work with the fintechs on combining and finding the right technology again so I can battle the largest companies that we compete against. Just going back to the demographics point, is there anything that you're seeing that's interesting on that front in terms of banks trying to either make deposits more sticky or maybe attract that new sort of younger base of depositors. Right. There hasn't been anything that's been completely outside the box that I've seen yet. And I'm always kind of looking for it. One little

little anecdote I had a couple of years ago, maybe two years ago, three years ago now, I remember speaking with our interns, this is about 30 of them. And I asked each one individual, I said, why do you bank, where you bank. And 50% of the folks in that room, maybe 60% said to me, well, I bank where my parents bank. And so that was like, okay, the community bank world has a chance here to try to capture the beginning, right? You have the beginning of it. Do you know what the other folks were saying? Well, my bank offers a free one-year membership to Spotify. So I googled what Spotify. I don't know anything, right? So I Google what Spotify is. And I realized it's the same version, Tracy, of what we were doing 20, 30 years ago. You remember the stories of getting a free toaster if you opened up a checking

account. It's trying to change the sort of component that leads you to do it, but it sounded very similar to that process. So I see some of that working, things like that. But I also think it's the education side of it. It's offering your branch now isn't a branch the way we used to think of it. It's more of a community center. It's almost like a Starbucks. Come on in, hang out, you know, get to just spend some time here. You'll meet other folks that are doing some business like you. Well, things like that I'm seeing a little bit. And that tends to sometimes work as well. Wait, Tracy, what's the coffee shop that's, like, in our building? I was just thinking about that one.

I think it is. It's like a Capital One bank branch slash coffee shop as far as I can tell. I keep meaning to go in there. And people are in there all the time, like drinking coffee and eating scones and, you know, I guess maybe take out a mortgage. It's like right on our block. We should definitely go there soon. Yeah. A field trip to the local bank branch.

You know, Tracy asked about the demographics of depositors. you told the story of your dad on the board of a country club. And so I have a certain image of like what the age of board of a country club is. And I have a certain image in my head of like the type of people at banks who have relationships with the board of a country club. Can you talk about the demographics on the employment side of the banks and like hiring new talent and the challenge is there? Sure.

No, that's another one that I see a lot of and as you travel around. And, you know, one of the things people will tell you, one of the drivers of M&A, is succession planning. Very, very difficult to get folks to find the talent, to find the individuals that really want to run these community banks. So at times, when you look at a deal getting done, sometimes it's really done because from a succession planning perspective, you'll see that more and more. So I think there's a real challenge there, both from an excitement. Again, I think it goes back to, you know, banks do a great job on social media in terms of monitoring their employees. what I think they do a terrible job of is marketing and getting the excitement about how they're different, what they're doing to try to attract that younger talent in because what used to be is everyone used to go to the top five or six banks in the country.

They had great training programs. And then those individuals would leave those training programs and go run all the community banks in the country. They don't really have those programs anymore. And so it's difficult. Yeah, it's difficult to find individuals that really want as much as they used to be. And so that is a real challenge. As you think about a growth component of most boardrooms I'm in, the average age is on the higher side, for sure. And that makes it challenging if you think about the demographic overhaul we're going through.

It's not just lending. It's the deposit side that we don't, banks don't underwrite their depositors like they underwrite the loans. And we've got to start doing that with better representation on the board of folks that are truly going to baby try to help you from a social media perspective, from other ways to gather those deposits. and meet new demographic needs. So just going back to March's banking drama, so it feels like some of the really extreme deposit moves have started to moderate now. And at the same time, you have the Fed coming out

with potentially additional capital requirements for larger banks. I take the point that you'll probably see some compression on net interest margin going forward as people have to compete with deposits. But what's the next big, I guess, concern or thing that's keeping up bank executives or your clients? Sure. I think it's the, you know, you kind of go from the unknown, like you said, we're going to have higher capital

requirements, which are going to drag into earnings, which is ironic because Silicon Valley's problem wasn't capital. But anyways, well, I digress, right? But we'll move forward. I think then you start thinking about what's keeping them up at night is the fact that perception or reality, I've got to manage my balance sheet differently from a liquidity perspective, and that's also going to cost money. And what I mean by that is we used to think about, and this is a little bit in the weeds, Joe and Tracy, so I apologize if it's too much. But one of the things we do when we project out an earnings stream of a bank based on changes and interest rates is we have to assume how long those deposits, how sticky they are, right? There's no actual contractual maturity for a lot of

those. But typically what people would do is they'd go back 30 years and they'd say, on average, a checking account lasts about seven years. So that's great. It gives us a lot of protection. in that rising rate environment, right? In theory, the problem is the examiners are going to come in now and say, seven years, that's historically fine, but I'm not buying into that anymore. What I now need to look at is you can tell me seven years, but it's also seven years with a one-day call option, that those dollars can leave out at any point in time. That puts a lot more pressure on the types of lending you do, the types of balance sheet you're running, which ultimately Tracy gets to your point. Earnings again are going to be under pressure from that perspective. And I would argue,

to apples. That's Sunday night, the first thing I said to myself when I read the press release about signature in Silicon Valley, as I said, maybe this country only wants to have five banks. Right. You know, that's the first thing I said to myself because apples to apples, Trace, you're going to put your money, let's say you're the treasurer of a corporation that was banking at Silicon Valley over that weekend. You got bailed out, right? But that Monday morning, you weren't going to your board and saying, you know what, I'm going to move our deposits to bank XYZ you've never heard of. Right. I'm going to Jamie Diamond at J.P. Morgan, and I'm going to bank there. And that's to me why apples to apples, a community bank's going to have to pay more for

liquidity than the largest banks in the country. That keeps them up at night. And hedging in general, I run our derivative business separate of some of the other things I do. Our derivative business is skyrocketed because derivatives are used to hedge interest rate risk. And we used to not have to use them as much because the deposit side of the world. Now with this deposit concern around the optionality risk, for lack of better terms, derivative use is exploded. I'd like to think it's because I'm really good at it. It's not. It has nothing to do with me and has everything to do with the market and I work on a wonderful team. But that's really what's going on from that perspective. This was the missing piece because, you know, we talked to Terry Duffy. Yeah. And he's like,

no, you'd have to, like, if you wanted to like hear about their hedging business, they don't do it through the CME, they do it through the banks. And you're, that sounds like they really were cranking it up. One of the things I do is I go to boards and I go to management teams. I look at the balance. I look at the interest rate risk position, and I say you have now some exposure here. Yeah. Let's show you the derivative transactions. That makes sense. Are there particular products that are getting really popular?

Yeah. I would say there's a few. Most of them are a lot of folks have a lot more mortgage book. Their mortgage book is a lot bigger than they wanted it. Right. Back in 20 and 21, everyone has a mortgage. It's not going anywhere. So what a lot of banks are doing is swapping that fixed rate asset to a floating rate

to reduce their interest rate risk from a higher for longer perspective. That's one area. the other areas on the liability side, it's the reverse, but the same concept. They're paying fixed on interest rate swap on the liability side and locking up their cost on short funding for a long period of time. Those are very, very popular transactions on the derivative front. So I just have two questions. One is a short one, and you were, because you were talking about the flightiness of deposits. Someone once told me, like, I guess in the old days, they're like, once people are in a bank, they're more likely to get divorced than change banks. Was that true?

Yes. That's why checking it. Yeah. were the golden egg. Everything else was secondary. I wanted your checking account. And that's why it was still worth to build bank branches. Because if you just get them in the door, it's a lifetime of money. Okay. One last question. And this is sort of the big question mark to me. Like, you're like, well, maybe we'll just want six banks in this country. But maybe in 20 years we'll just be down to 200 banks. Is there the political willingness to let that happen? Because, you know, there was concerned when SVB, like, we can't let Jamie Diamond buy it. Right. And then the First Republic, they did sell to JP Morgan. But there's a lot of anxiety.

and again, people have politicians, have a real affinity. It's kind of like, I mean, I think it's like baked into America, right? That like we didn't have cross state banks for a long time. Like the distribution of banking is like kind of a core American thing for better or worse. So can you talk a little bit about just sort of the regulatory willingness to allow the consolidation that you anticipate? Will it let it happen? Yeah. No, great question.

And it flip-flops, right? One moment I'm reading about another deal that's not going to go through. and they'll claim it took too long from a regulatory perspective, but then you'll hear Yellen kind of encouraging the fact that we're going to see a lot of a lot of M&A. And I think you're right, though. And one of the arguments against my comment about the amount of banks in this country is absolutely political. You're absolutely right, Joe. And it's probably why I will, I will be wrong on my number. And that's okay. I hope I'm wrong. But in my mind, mathematically the way I see it, if we're really trying to compete against folks that basically have a free blanket of there, there's no uninsured to, at the top five? What can I do to compete against? And that's why I said what I said in terms of that. Scott Hildenbrand, Piper Sandler. Thank you so much for coming on the odd loss. There's a great conversation. Joe, Tracy, thank you both. And I appreciate everything you're doing. Thank you. Tracy, I thought that was a great conversation. And setting aside, like, the rate hedging, and I'm glad we finally talk, the rate hedging and all this. Like, you do. You look around and you're

like, how can they compete? Yeah. It seems tough to Scott. point, how do you compete against people who not only have economies of scale, but also seem to have de facto unlimited deposit insurance? And I guess the arc of history is that the number of banks in the U.S. has been consolidating. But to the beginning of the discussion and the point that you made at the end of it, there is also this tension where it feels like there is a big portion of America that has this idealized version of a community bank in its mind. And there are actual benefits. So I Remember, there was an FDIC study. I guess it's super out of date nowadays, but maybe 10 years ago where they talked about the

proportion of small business loans on smaller bank balance sheets versus the bigger ones. And of course, the smaller banks have a lot more exposure to smaller businesses. That makes sense. But on the other hand, how do you compete and make money against a JP Morgan that is spending a lot on technology and also has these regulatory advantages? Although it also has some disadvantages in terms of capital. But still. That's right. So it does have higher capital costs. Maybe you solve the problem by like, yes, you have a lot of consolidation, but then also, you know, the sort of like hand-shaking meme of like old-timey community banks with modern fintechs that lets you have the sort of best of both worlds where they know the local country club board, but they can also have like AI enabled fraud detection. That would truly be the ideal. I'm going to instinctually say it's probably more difficult to do than to just talk.

about it. But Joe, we need to take a field trip to, not to the local bank branch that's below our offices. We need to go to Lancaster, Pennsylvania, check in with Bank of Bird in hand. I'd love to do what they're doing. I think we should do it. Yeah. Let's go. All right. Shall we leave it there? Let's leave it there. This has been another episode of the All Thoughts podcast. I'm Tracy Allaway. You can follow me on Twitter at Tracy Allo. And I'm Joe Wisenthal. You can follow me on Twitter at the stalwart. follow our producers, Carmen Rodriguez at Carmen Armin and Dashel Bennett at Dashbot, and check out all of our podcasts at Bloomberg under the handle at podcasts. And for more Odd Lots content, go to Bloomberg.com slash Odd Lots, where we have a blog, we post transcripts in a newsletter, and check out the Discord. Discord.G.g. slash Odd Lots where listeners are chatting 24-7 about all these topics. Really fun place to hang out online. And if you enjoy Odd Lots, if you like listening to ComptLOTS, if you like listening to ComptLOTS, where listeners are chatting 24-7 about all these topics, really fun place to hang out online.

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