Bank Earnings and Square’s New Debit Card

Jason Moser: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market each day. It’s Monday, January 28th, which means we’re talking Financials. I’m your host, Jason Moser.
Joining me in the studio via Skype, as usual, we’re always happy to have him here, Certified Financial Planner, Matt Frankel. Matt, how’s it going? Matt Frankel: Pretty good. It’s been an interesting Monday. Moser: [laughs] Yeah. Care to share just a little bit of that with our listeners? I don’t want to overstep my bounds here, but as a parent, I was feeling for you. Frankel: [laughs] Well, my three-year-old daughter at her preschool class, she tripped over the stool for the toilet and wound up whacking her head on it.

Whenever that happens, whenever it’s a head injury, they have to have a parent come in and take a look. So, we’re recording this a little bit later than usual, but she’s totally fine. She was running around giggling. Other than a little bit of a goose egg on her forehead, you wouldn’t even know anything happened. Moser: Yeah, I’ve gone through that once or five times with my kids growing up.

Bank Earnings

I appreciate that they have that policy. It doesn’t make it any easier. Big shout-out to Austin for being so flexible to change his schedule, as well, so we’re able to get you guys the show. Speaking of the show, we’ve got a
big one today. We’re going to talk about the latest in the developments with Synchrony and Walmart. It looks like Square has a new business debit card. We’ve got a listener e-mail to get to. We’ll tap into Twitter. We’ll give you One to Watch. We’re going to begin the week with the winners and losers so far this earnings season with the big banks. Matt, we’d talked about a lot of these big banks a couple of weeks ago.

Bank of America

We were looking at some of the opportunities and the challenges in the quarter they’re reporting. You’ve gone through these releases, you’ve seen some of the winners, you’ve seen some of the losers. Tell our listeners what you found. Frankel: For the most part, there weren’t too many big surprises. Banks, as a rule, are a generally predictable industry, especially commercial banks. Having said that, there were a couple that stood out. Bank of America was, I think, the best out of the big four banks.
They just keep improving and keep getting better and better. They’re really doing a good job of putting their pre-financial crisis self well in the rearview mirror. If I’d told you in, say, 2010, 2011, that Bank of America was going to be probably the best-looking out of the big four banks, you would have told me I was crazy. Moser: I know I would have. Just a year ago, it seemed like Brian Moynihan and Bank of America were stepping in something new on a daily basis. Now, it seems like they’ve
passed that torch on to Wells Fargo, huh? Frankel: Right. And a few years ago, if I had told you that anyone but Wells Fargo was the best-run bank out of the big four, you would have called me crazy. Times have certainly changed in that regard.

Lending and investing revenue

The biggest surprise in my mind to earnings were the two big investment banks, which are generally less easy to predict. So, if there’s a surprise, a lot of times that’s where you’re going to find it. Goldman Sachs had a blowout quarter. Goldman had been one of the worst-performing bank stocks because of the drama related to the Malaysia bond fund gone bad. That’s still definitely an overhang on the stock, which is why it’s trading for significantly less than book value. But the bank, its earnings were excellent. Lending and investing revenue, which includes the Marcus division, was up by 56% year over year. That’s huge, and Marcus is still a very small component of the business. They just announced recently at the Money20/20 conference I was at that they’re expanding into wealth management. They’ve already expanded into personal loans and savings products for Main Street, so now this will bring even more people into their ecosystem. Historically, Goldman’s been a wealth manager for the 0.01%, so this is really opening new doors for them.

Avenues (mortgages, auto loans, insurance products, checking accounts)

It’s been successful so far, plain and simple. They made their first personal loan, just for example, in October 2016. Two years later, they hit $4 billion in personal loans, which is a drop in the bucket in terms of a big bank but is quicker than Lending Club even got to that level. It’s impressive growth so far, and tons more room to grow. CEO David Solomon at a recent presentation said that possible avenues include mortgages, auto loans, insurance products, checking accounts offered online that pay nice interest rates. There’s a ton of room to expand this. I’ve said it before, but I don’t think the market appreciates what a big force in commercial banking Goldman Sachs could become. It’s got a phenomenal brand name and it doesn’t have any of that legacy infrastructure that weighs on profits that any of the other big banks have.

It doesn’t have branches or anything like that. It has this great opportunity to grow, and it’s really been reflected in their earnings. On the other side of the aisle, Morgan Stanley, their fourth quarter was a big disappointment. It was a standout, one, because bank earnings generally were good. Everyone pretty much beat earnings estimates, beat revenue estimates. Morgan Stanley did not. They missed on both the top and bottom line

Trading revenue

Trading revenue was particularly weak. Morgan Stanley’s fixed income trading was down 30%. I think Goldman’s and a few of the others’ were down 18%. So, while trading revenue was pretty weak across the board, it was weaker than peers, which is always a bad sign. If a certain metric is generally terrible and equally terrible, it’s not necessarily a bad sign for a company;
but when you’re underperforming your peers, that’s when you want to watch out. That’s what happened with Morgan Stanley. Wealth management business missed expectations, as well. All in all, it just was not a great quarter. When you miss on the top and bottom lines, there’s usually a reason for it. There was, it’s their trading.

Like I said, that’s the most unpredictable part of banking, in my opinion, is trading revenue. Don’t read too much into one quarter’s trading revenue. But all in all, Morgan Stanley was the disappointment, and Goldman Sachs was the winner. Over the past couple of weeks since earnings, you’ve seen a lot of price divergence between the two. Moser: Sure. Really quick, going back to Goldman Sachs for a second, it made me think of something I’d like to get your opinion on. Do you feel like Goldman Sachs, given the move to open up their lending to a bigger audience, pursuing Main Street, given Goldman Sachs’ reputation, the brand, the aspirational, maybe, nature of that brand from your everyday Main-Streeter, do you think there’s a parallel with what they’re doing with what American Express had to do a little while back in opening their product suite up to more customers, taking that brand that they’ve had, that they’ve done so well over so long nurturing, a bit of an aspirational brand, opening that up to more clients with more products?

Goldman Sachs And American Express credit card

Do you feel like Goldman Sachs benefits from that kind of boost at all? Frankel: Sure. That’s actually a great comparison! Moser: Why, thank you! Frankel: For those who aren’t familiar, American Express was a credit card for rich people up until a decade ago or something.
Moser: Exactly! I feel like most people on Main Street probably feel like, “Oh, forget about
Goldman Sachs, that’s just for rich people.” But apparently, not so anymore, right? Frankel: Right.

And now, anybody with $20 can walk into a Walmart and get a prepaid
Amex card. That’s the extreme end of their product line, but they’ve become a credit card company for Main Street. They still have their high-end products. And in my opinion, they’re the best in the business at high-end credit cards. The Amex Platinum is, in my opinion, the best credit card product on the market. It’s in my wallet right now. But, they’ve done a great job of opening their business up. It’s leveraging their brand name. Goldman Sachs actually has, in my mind, a unique advantage over peers. Not just the brand name. Bank of America, Wells Fargo, these are all good brand names, too. But, they hall have this big legacy branch infrastructure overhanging their heads. Pretty much all of them are reducing their branch count over the past few years and continue to do so because it’s really eating into their costs and eating into their ability to be competitive.

If you see Goldman Sachs right now, their Marcus savings account pays 2.25%. Bank of America and Wells Fargo pay about 0.1%. And the reason that they can afford to do that is because they’re not paying all these costs associated with branches. Not just the physical buildings, but paper costs, employment costs. There’s a ton of costs involved in opening a branch, and Goldman doesn’t have to worry about any of that.

That, I think, is going to be even more of a competitive advantage than its brand name. Hill: Earnings season is just getting underway. I’m sure we have more banks coming, but it’s definitely been an interesting few weeks thus far. Let’s take a look at this. Back in November, Matt, we took a listener question from @BTCapital12 on Twitter. There was a situation brewing with Synchrony and Walmart and litigation that the massive retailer was threatening.

Matt, I’ll let you take a little bit of a victory lap here. I’m going to go ahead and hand it to you. Explain away. Frankel: Thank you for giving me my I-told-you-so moment. In the middle of last year, over the summer, Walmart announced they were dropping Synchrony as their co-branding partner.
Big account. I liken this to, using another Amex comparison, when Amex lost Costco. It’s to that magnitude.

Walmart and Sam’s Club company Having different credit card products

It’s a big deal to them. But the real drama came a little bit later. One, as everyone knows, Walmart and Sam’s Club are the same company, but they’re two different credit card products, in terms of Synchrony’s line of products. There was a big question mark as to what this meant for their Sam’s Club business, which is also a huge part of Synchrony’s business. Do they keep that? Does that go to Capital One, where Walmart’s going? Two, Walmart announced that they were suing Synchrony for $800 million related to losses on their credit card portfolio.

They said Synchrony didn’t do a good job of analyzing credit risk, and there were bigger losses than expected, and they weren’t making as much money as a result. That was a big question overhanging. I forget my exact words, but I said that it was somewhat of a negotiation tactic, because Synchrony had to decide whether it wanted to keep the Walmart loan portfolio, sell it to Capital One or somebody else. There were a few things that needed to happen before the relationship could be completely dissolved. Just recently this was also a big surprise of earnings season — not only did Synchrony have a great quarter, but they pretty much said the two things investors really, really wanted to hear: that they’re keeping the Sam’s Club business, the Sam’s Club credit card will remain a Synchrony product. That’s a big deal. And, even bigger, Walmart is completely dropping its lawsuit against Synchrony. An $800 million weight off their shoulders is a very nice late Christmas present for Synchrony investors.

The market hates uncertainty. Uncertainty has been lifted in regard to the litigation risk. Sam’s Club is still a Synchrony product, so the hit they took from the Walmart loss is now just confined to their Walmart product. This is a big win for Synchrony shareholders, which we’re seeing reflected in the share price, but Synchrony still trades for very cheap multiple. They’re a very economically-sensitive business. Store credit card default rates tend to really move with recessions and things like that. But their profit margin is so great that it would literally take another Great Recession to really put them in the red. So, I think the market’s fears in that regard are overblown. We just got some great relief. The business did really, really well this past quarter and this past year. I still love Synchrony as a stock. Shareholders who listened to me last year got handsomely rewarded this past week. Moser: Hey, now, everybody! I wish I would have shut up about it and bought some myself.

Square Debit Card

Last week, the company just released another product to their merchants. This time, it’s a business debit card, they’re calling it Square Card. It’s going to help businesses manage their cash flow by essentially eliminating the time between making the sale and having the funds available. Really, what we’ve seen, as cash becomes a smaller portion of the money that’s being spent, not only here domestically but globally, a lot of this boils down to time and making the funds available. The quicker you can do that, the better off you’re going to be.

These tech companies are able to build out pretty robust risk profiles that allow them to do that. I thought that it was pretty interesting. This partnership is actually with MasterCard.  Square’s definitely trying to build its ecosystem. The thing that I found the most interesting is that this card offers Square sellers instant access to their money. If, say, a coffee shop uses Square to accept payments. If somebody swipes for a $5 cup of coffee, that $5 is instantly available to the seller through this debit card.

They can either spend the money anywhere MasterCard is accepted or access it through an ATM. That’s instantly available, which is a big deal. But the thing that really stuck out to me is that Square is offering users of this card a 2.75% discount at any other Square seller. They’re incentivizing their own merchants to use other Square sellers to keep the money in the family. That’s really a unique way to strengthen the ecosystem. I think “unique” is my key word when it comes to Square. Like you said, they’re in the news seemingly almost every week with some new product, new offering, whatever. All of the things they’re using to strengthen their ecosystem are really unique, meaning that no one else is doing this. I don’t think the PayPal credit card gives you a discount for using another seller that accepts PayPal, just to name one example. Visa doesn’t give you a discount for using your card anywhere else Visa’s accepted, for example. It’s a really unique and innovative way to strengthen their ecosystem. Read also about Target Red Card Review.

Bank Earnings and Square’s New Debit Card

Competitive risk is everybody’s biggest concern when it comes to the Square. Is PayPal going to steal their market share? Is somebody else going to come up with a cost-effective way for small businesses to accept credit cards? What’s to prevent that from taking Square’s business? And the answer is, things like this are what’s going to prevent it from taking Square’s business. I love this product. I think it’s a lot more significant than the market is giving it credit for right now.

Innovating and brings new products

I was only half-kidding when I said it seems like Square’s in the business of not sitting still. In this space, in the payments space as a tech company like that, you need to be innovating and bringing new products to market at a rapid pace. It certainly seems like they’re doing that. Furthermore, it seems like they’re doing it well. It seems like they’re bringing products that people really like.

It seems like this is a company that’s just continuing to do what we’ve hoped it would do. I suspect that shareholders like us and our listeners feel pretty good about the fact that we all own shares today.

 Retail investors advantages over fund managers

Remember, being truly diversified means there’s always something doing badly, so don’t freak out about it. That’s the whole point of being diversified. If you have enough diversification in your portfolio, there’s always going to be something that’s missing the mark. But when you’re well-diversified, you don’t care because you have other winners to pull up the slack there.

No. 1, we’re not under pressure from anyone to do something clever on a day-to-day basis.
No. 2, we have a much longer time horizon because our livelihood doesn’t hinge on quarter-to-quarter results.” I think that is very well said. That’s very much in line with how we invest here at the Fool and what we try to talk about all the time on our shows. A good point there, and I wanted to make sure to shine a light on those two tweets because I liked them. Frankel: I think the second one might have actually been from Peter Lynch under an alias. Moser: Ah, that’s possible! There’s a lot of good stuff that Lynch left out there for us, for sure.

Use Of Zelle

We wanted to jump in here. There’s an e-mail that we received while we were away. Basically, he’s asking us about Zelle. This was the situation. “My wife was going to someone for a birthday party with her friend. She owes money to the one that got it all set up. Her friend requested that she Venmo her the funds.” His immediate response was, “Hey, just use Zelle,” because
his wife wasn’t using Venmo. Long story short, she used Zelle to transfer the funds. No fees, easy to do. You don’t have to download another app. “Can you speak to how Zelle can affect the War on Cash basket?” It was a good question. I think it’s something worth noting, anybody who has a bank account with Wells or Bank of America or any of the big banks probably has access to Zelle.

I know I’m a Bank of America account holder and I have access to Zelle. Now, with that said, I’ve never used it. His question keys in on something that’s worth noting, my initial response to that is that while Zelle is something out there, it’s a nice value-add for people who have those accounts, When you look at companies like PayPal and Square and the services. They offer like Venmo and Xoom and what not, those are services that are being built more for the younger users in mind who are coming up into the banking world as they’re growing up. I look at my kids, for example, at 14 and 12.5 years old. They’re a little bit more of that Venmo target vs. something like Zelle is with a Bank of America account. That’s not to say that Zelle is not a threat. I think Zelle absolutely is going to continue
to hold its own. But, it’s a very big market opportunity, and I don’t think Zelle is something that necessarily threatens smaller companies like PayPal or Square. I do think it probably keeps them on their toes.

What do you think about it,? I think the one thing to keep in mind is just how many resources the people behind Zelle have. If you’re not familiar, Zelle is a project that was funded by a bunch of the big banks all together. The banks that funded Zelle have something like, $4 trillion or $5 trillion in assets, a ton of resources at their disposal.

Square and Venmo As first movers

I think Square is an extremely innovative company, same could be said for PayPal, with Cash and Venmo. Not that it’s a threat to Square or Venmo, but it has to keep them on their toes. You think Square is a big company? Square is tiny compared to these banks, same with PayPal.
So, it’s a question of resources in my mind, when it comes to how much you have to worry about a certain competitive threat. Square and Venmo were the first movers. Venmo, especially, was the first mover there. But I think they still should strive to innovate and one-up the banks and beat them at their own game because the banks have a lot of resources they could throw at building competitive infrastructure if they really wanted to. Moser: Yeah, you’re right.

Banks do have a lot of resources there that they can do a lot of things with. That always makes me go back to that idea that, just because a company has the resources doesn’t necessarily mean they can execute. You have to be able to actually execute with the resources that you have. I think Zelle is something that’s here to stay.

PayPal and MasterCard Executives

We were actually reading through an article here earlier in regard to PayPal and MasterCard executives. Who are talking about this space and seeing it as such a great time for collaboration with all of these parties involved, big and small. They have opportunities to bring new products and relationships to market for banking customers of all ages. It’s interesting when you see the executives from companies like PayPal and MasterCard
saying that. Those are obviously two very big and important companies that are doing a lot on their own out there. When you discuss about the opportunity to collaborate and do more, they’re certainly not viewing this as a zero-sum game. They’re not viewing this as win or lose.

This is something where it’s a big enough market opportunity that there
are a lot of different ways these companies can all succeed. I think that’s ultimately the way we look at it. We’ve discussed before, certainly, about the war on cash. I could have probably thrown five more companies in that basket if I wanted, I just drew the line at four. Anyways, a very good question from Petey in Utah. We enjoyed having the chance to talk about it a little bit. Thanks, Petey from Utah for e-mailing us that question! And, hey, listeners out there. Earnings season really kicking in now here, shouldn’t be very hard to find something to keep on your radar for the coming week.

What’s your One to Watch? Now that the big banks have already
reported. I’m looking at a smaller one, Axos Financial, AX, which a lot of our listeners know better as BofI or Bank of Internet. They report tomorrow. Their stock has really underperformed the sector recently. A lot of questions about whether they’re going to be able to maintain profitability and all their competitive advantages going forward.

I’m looking at their earnings report to see how they’re doing growth-wise, what their plans coming up are. I know they’ve made a few big acquisitions like a Nationwide financials deposit portfolio. How they’re planning on implementing that. It’s going to be a really interesting earnings report to watch because the stock has gotten so much cheaper lately. I’m a
shareholder and I wouldn’t be opposed to adding more if I get some really good growth figures from the company when I see it tomorrow. So, that’s what I’m watching this week. and what’s the ticker?

Apple company

Well, I’m going to be focusing on a little company called Apple, AAPL. Apple earnings are also out tomorrow, Tuesday, after the market closes. With all of the noise about iPhones and missing iPhone targets and whatnot, it seems to me to be missing the mark a little bit. Listen, as iPhones get better, they should last longer, so I’m not sure what everybody is so upset about this for. I think that with a company that’s focusing on moving more towards Services revenue, one of those avenues, one of those drivers,
is going to be Apple Pay. I’d love to hear more about Apple Pay on the call.

My hope is that going forward, we will hear more about Apple Pay, particularly as we see this move towards cashless gaining traction. That’s going to be what I’m focusing on with Apple earnings tomorrow. I think that’s going to do it for us this week. As always, it’s great talking with you! I’m glad we were able to make this happen today. It’s been a while since I’ve been on this end. Just a quick reminder for our listeners, I wanted to let you know that we have an interview with Ameris Bancorp CEO Dennis Zember that will be hitting next week’s show. We’re going to drop part one of the interview on next week’s show, then we’ll drop part two of this interview on the following week’s show. Listeners would know Ameris Bancorp, it’s a company I’ve talked about a lot. It’s one where I have a lot of optimism in what they’re doing. Dennis and I spoke for a little bit about the things that they’re doing.

He told some stories about the financial crisis. A really fun interview, I think you’ll get a lot out of it. Look for part one of that interview to drop next week, and then part two the following week. As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don’t buy or sell stocks based solely on what you hear.

Please follow and like us: