Bank Profits and Unwanted Buybacks

Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
Read More.
a | A

Happy bank earnings day.

JPMorgan's earnings beat estimates on improved trading revenue. Wells Fargo's earnings were down a bit quarter-on-quarter. While we're on the subject of Wells Fargo, here is the story of some Wells Fargo employees who are protesting sales quotas. In 2013, branch personal bankers "had to sell 20 products, such as a new account, overdraft insurance or travel insurance," per day; now the number is down to 15. I probably walk into a bank branch once every six months, and if someone tried to sell me travel insurance I'd walk straight back out, so I feel for these people. On the other hand, from Wells Fargo's perspective, if they're not selling unnecessary expensive products all day, what are they doing? Providing good free customer service to keep customers with checking accounts satisfied? How could that be economical? This does not seem like a job with rosy long-term prospects. Meanwhile here is a "financial crime specialist" at a Wells Fargo call center:

“People claim that they have been signed up for bank services that they never agreed to, like overdraft protection.”

Lewis has “no concrete proof” that bankers are signing up customers for these services without their knowledge in order to meet the quotas, but “that is the assumption”, he said.

If the financial crime specialist thinks that the financial crimes are coming from inside the bank, that's kind of a problem.

Short-termism.

Andrew Ross Sorkin writes about Larry Fink's annual letter to corporate chief executive officers; this year, it will criticize the rise of dividends and share buybacks as encouraging short-term thinking:

Mr. Fink says the move “sends a discouraging message about a company’s ability to use its resources wisely and develop a coherent plan to create value over the long term.” Moreover, he argues that “with interest rates approaching zero, returning excessive amounts of capital to investors” isn’t helpful because they “will enjoy comparatively meager benefits from it in this environment.”

A few weeks ago I described my simple dumb model of corporate finance, in which mature companies mostly can't coherently create value over the long term, and so give the money back to investors, whose job it is to find the next company that will create value over the next short term. This makes the investors' job harder, since they have to do the job of capital allocation rather than leaving it to corporate planning departments. It's much easier to hand your money to a good permanently growing company and let it invest wisely than it is to constantly find new projects to fund. Particularly when, as now, rates of return are low and new projects seem overpriced. So you can see why Fink might want companies to get better at investing BlackRock's money for him. His proposal is to raise taxes on investments sold after 1-3 years, and lower taxes on investments sold after 3+ years, "potentially dropping to zero after 10 years," to discourage short-term behavior. 

My simple dumb model also involved investors taking the money that public companies pay out in dividends and buybacks and investing it in private companies, which is where the long-term value-creation plans live these days. But here is a good and sort of dispiriting post from Redpoint venture capitalist Tomasz Tunguz about how richly valued those private investments are, finding that "many private growth rounds occur at about twice the forward multiples of the public markets." This is new: 

Some historical context: in the past, private markets paid smaller multiples than the public markets. After all, investors bear substantially more risk investing in startups than established businesses. Today, private market investors’ optimism has inverted the multiple curve, and earlier investors are valuing businesses at substantially larger multiples. This inverted multiple curve has created an investor risk bubble.

Elsewhere in long-term versus short-term shareholders, the UK Labour Party Manifesto includes a call to "change takeover rules to enhance the role of long-term investors by restricting voting to those already holding shares when a bid is made," which seems obviously misguided to me, but then I am an efficient-markets kind of guy. To me, a share of stock is worth the present value of its future cash flows, and you'll sell your stock to a corporate buyback or a merger arbitrageur or whatever if the price that's offered is higher than the present value of those cash flows, and if it's not you won't. The purpose of finance is to put the short and the long term on an equal footing for comparison, by making the price you get for your stock today the best available guess of what the price will be in the future. Obviously no one quite believes that. 

Rates markets.

Many mortgages in Spain, Portugal and Italy are indexed to Euribor, sometimes Euribor minus a spread, and so with Euribor rates being low or negative some borrowers are getting paid interest on their mortgages. I feel like there are two takeaways here:

  • Monetary policy works! "With the economy in such a bad state, these monthly savings are more than welcomed," says a Portuguese real-estate agent. Everyone should have a floating-rate mortgage.
  • Banks are sort of dumb. Santander gave a client a loan in 2005 at a rate of Euribor minus 1.1 percent, but the client "claimed that Spain’s largest bank inappropriately established a floor on his mortgage in 2013 and therefore owed him money." Put the floor in when you make the loan! If the floor is very out-of-the-money at the time of the loan, hey, that's no problem. But if you write a contract that could theoretically require you to pay your borrower interest, and you don't want to do that, maybe take the time to write down the words saying you don't have to.

Elsewhere in rate product, Pimco is selling Treasuries, October 15 remains a mystery, and investors remain scarred by it. (Also worried about liquidity, of course.) Dan Davies, on the other hand, points out that the once-in-three-billion-years shock of last October 15 is hard to find on a chart, which maybe means that it's not that important. And here is Ben Bernanke on the term premium

Compensation accounting.

This is a pleasing accounting story: Jarden Corp. gave its CEO a grant of $73.9 million in restricted shares that are "improbable" to vest "because the underlying performance criteria -- annual net sales of $10.5 billion and adjusted earnings-per-share of $4 by Dec. 31, 2018 -- are unlikely to be achieved." So the company valued them at zero for compensation expensing purposes. "It does not strike me as best practice," says a consultant, and an analyst thinks that the performance targets are actually "very reasonable." But the interesting point is that if you give your CEO options that are far out-of-the-money -- so that they only pay off if he achieves highly aspirational performance goals -- then everyone would agree that those options have a value and that you have to expense them. The Black-Scholes formula tells you how to value an option, even an out-of-the-money one, and so you go value it and say "this unlikely-to-pay-off option on $74 million of stock is worth $10 million" or whatever it is. The restricted shares are conceptually the same thing, but since they don't have the form of an option their valuation is not a capital-markets pricing exercise but rather an accountant valuation exercise, and accountants are much more susceptible than the markets are to arguments like "this probably won't pay off so it's worth zero." Which is an obviously terrible argument. I mean lottery tickets probably won't pay off and yet they're not free.

Activism.

One stereotype of short-term-oriented activist investors is that they try to get immediate cash returns to shareholders at the expense of cutting wages and making workers' lives worse, so I'm okay with this "Hedge Clippers" protest at the 13D Monitor Active-Passive Investor Summit yesterday, in which the (labor) activist group demanded living wages at Darden Restaurants, where (hedge fund) activist Starboard Value recently won a proxy fight. Even though:

But they chanted, somewhat incongruously, “Show me 15, Bill Ackman,” referring to the group’s $15 an hour wage goal. Ackman, another hedge fund manager, does not own a stake in Darden. 

And:

Ironically, the protestors interrupted a panel at the Active-Investor Summit on how companies can defend themselves against shareholder activists. On the panel were public relations guru Joele Frank, who runs her own firm, and lawyer David Katz of Wachtell Lipton Rosen & Katz.

So the anti-activist activists interrupted the anti-activist panel at the activist conference. Elsewhere at the conference, Bill Ackman announced that senior executives at Herbalife are hiring their own criminal defense lawyers, which he thinks is a big deal, though the company denies it.

Sheila Bair's book is out.

I guess if you were trying to mobilize public opinion against bankers you might, what, accuse them of killing puppies? That's the route that the former head of the Federal Deposit Insurance Corporation is taking:

Her latest book on the financial crisis, The Bullies of Wall Street, which comes out on Tuesday, is aimed at a younger audience. The book is a young adult novel/explainer of what happened during the financial crisis, how it may have affected teens, and how U.S. officials responded. In the following excerpt, Bair, tells the story of Matt, a fictional teen who is facing the fact that his beloved dog Attila will have to be put to sleep because his family is about to lose their house to foreclosure.

Oh. Don't worry, I've read ahead, the dog is okay. He goes to live on a farm. No, really, that is actually what happens in the book.

Things happen.

Snoop Dogg is investing in an on-demand pot delivery company. Greece is threatening to default again. "A financial system that relies on an early warning indicator of imminent financial collapse seems destined to fail." Because of REITs and inversions, "a record 54 companies in the Standard & Poor’s 500 Index of leading U.S. firms are now at least partially exempt from the corporate income tax." Bain Capital, the preferred private equity firm for governors of Massachusetts. "Why Deutsche Bank is not Goldman Sachs, by Morgan Stanley." General Electric is losing tax breaks by giving up GE Capital. Tyler Cowen on General Electric and Dodd-Frank; my view is that moving commercial lending to deposit-funded bank-regulated banks probably should be viewed as a Dodd-Frank victory. David Zaring on "The SEC's 700 Page Long Song of Itself." Polish 'Prince' Challenges Nigel Farage To Duel. Are You A Disruptor? Human composting. Man Goes on Divorce Court to Accuse Girlfriend of Having Orgy with Wu-Tang Clan.

If you'd like to get Money Stuff in handy e-mail form, right in your inbox, please subscribe at this link. Thanks!

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Matt Levine at mlevine51@bloomberg.net

To contact the editor on this story:
Zara Kessler at zkessler@bloomberg.net