After a month of pre-recorded shows, Industry Focus: Financials is live again!
In this week's episode, Jordan Wathen catches Gaby Lapera (and the listeners) up on October's finance news. Find out what's been happening with Wells Fargo's (WFC -1.04%) fraudulent accounts scandal, and why it's so surprising that CEO John Stumpf has stepped down; why BlackRock (BLK -1.06%) and Charles Schwab (SCHW 0.70%) ramped up their index fund fee game; how money market fund rules have changed and what it'll mean for businesses everywhere in a few months; and why the FDIC is encouraging new banks to start up by employing new, looser regulations.
A full transcript follows the video.
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This podcast was recorded on Nov. 7, 2016.
Gaby Lapera: Hello, everyone! Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. You're listening to the Financials edition, taped today on Monday, November 7th, 2016. Just so you guys know, that means that today is the day before election day. If you're listening to this on Monday or Tuesday, and there's still time, please go and vote. My name is Gaby Lapera, and joining me on Skype is Jordan Wathen, one of our top analysts at The Motley Fool. Hey, Jordan! How's it going?
Jordan Wathen: It's going alright. It's good to see you back in the United States!
Lapera: I'm so happy to be home! It was a great trip, but there's something to be said about being home and being able to eavesdrop on people on the Metro, and being able to brush my teeth with water from the faucet. Such exciting things! [laughs] Anyway. I've been gone for a month, just in case you somehow missed it through all of the pre-recorded podcasts that we did, and I haven't really checked the news, because it's not really a vacation if you check the news. So, Jordan has graciously agreed to fill me in on some of the financials news that I missed while traveling. Follow along to learn what I missed, and maybe what you potentially missed over the last month.
I was thinking maybe we could start with a story we were following really closely before I left, but I don't know anything about right now, which is the Wells Fargo story. As you guys might remember -- I hope you remember, I don't know, the new cycle is so short these days -- Wells Fargo was accused, and it was eventually proven correct, that they had opened a bunch of fake accounts. They were being investigated, they had to pay a bunch of fines, John Stumpf, the CEO, was required to stand up in front of the Senate Banking Committee, in front of Elizabeth Warren, and he got absolutely roasted. Totally watch that footage if you haven't yet, even though it's totally a month old now. What's happened with Wells Fargo since I left?
Wathen: I think the big story with Wells Fargo is that John Stumpf's career actually came to an end over the fraudulent accounts scandal at Wells Fargo. To recap, they opened 2 million accounts for people who never said they wanted them, and now, John Stumpf, finally, after some push and shove, he exited on October 12th and stepped down as CEO of Wells Fargo.
Lapera: This is really wild. John Stumpf has been the CEO of Wells Fargo since 2007. Before all this happened, people thought he was an incredible CEO and an incredible leader. And here we are, 2016, and he has to step down because his company has been up to things that they really shouldn't have been.
Wathen: Right. If you go back and read any book on the financial crisis, and look at what happened during the bailouts, John Stumpf basically said, "Wells Fargo is on solid ground, we don't need your bailout money, I don't even know why you're bothering me and bringing me here." Wells Fargo really was, they were perhaps better off than any other bank. Really, his legacy could have been that he successfully guided Wells Fargo through the worst financial crisis since the Great Depression. Now, basically, his name gets tarnished with this whole scandal.
Lapera: Yeah. And it's really interesting to me, because at the beginning of this scandal, it didn't seem like he had a great grasp of how seriously everyone was taking it. Like, I don't know if you've seen any of the footage of him talking about it really early on, but he didn't even seem like he was going to stop down or apologize, and Carrie Tolstedt was going to get a ton of money and stock options. So, it's really interesting to see how things have shifted. I wonder what happened that caused him to be like, "You know what? I'm stepping down."
Wathen: I think it's the pressure. This is one of those things that -- during the financial crisis, every bank was in trouble. They all underwrote terrible loans, they all lost billions of dollars on these loans. But right now, it's just Wells Fargo. It's just Wells Fargo that you're hearing about with these account scandals. And the numbers they've put out this quarter have indicated that there's at least been some kind of change in the sales process, because they noted that checking account opens were down 25% year over year in September, and credit card applications were down 20% year over year in September, also. It's probably two things. The consumers are wary of Wells Fargo to some extent. And there's probably a very obvious change in sales practices. People are no longer getting accounts they didn't necessarily request.
Lapera: Yeah, it's going to be interesting to see what happens to Wells Fargo long term. I'm not going to make a call right now, because I literally just got back, so I haven't looked at anything they put out. But you better believe we're definitely going to do a show on it later on, probably this quarter.
Let's move on to something else you mentioned to me before the show. Apparently, The Wall Street Journal put out an article about index investing.
Wathen: Right. The Wall Street Journal basically turned October into a discussion on index investing, and basically the rise of passive investing. It was over a course of a series of articles that basically detail how passive funds are pretty much the only investment funds anymore that are bringing in money on a net basis. So, money is leaving funds that are actively managed to be invested in index funds. Obviously, this rise has been super important for the financial industry. Active investors are probably under more pressure now than they ever have been to generate results, to go beyond, or beat, or exceed their index.
Lapera: This is actually a really timely story, because we talked about this on a podcast while I was gone, about active management vs. index tracking. One of the biggest players in this space is BlackRock. I know, you said they said some pretty extreme things post this Wall Street Journal article.
Wathen: Right. What's happened, basically, there's an ongoing fee war in passive funds. Just to get down to the very basics, there's no difference between index funds. If an index fund tracks the S&P 500, it just tracks the S&P 500. So, the best fund to invest in is the one that can do [that] the least expensively, that charges the lowest fees to investors who do it. Basically, BlackRock is engaging in an all-out fee war now. They came out and reduced fees on 15 of their exchange-traded funds, which have about $220 billion in assets, so it's a huge pool of assets. And some of the big cuts were to their S&P 500 ETF, trades under the ticker IBB. They cut that fee almost in half, from seven basis points to four basis points. They cut their fees on an aggregate bond ETF, which is basically a total bond market -- it basically tries to design a portfolio so that it looks like the bond market as a whole -- they cut that fee from eight basis points to five basis points. And then, after this, interestingly enough, an executive at BlackRock went to Bloomberg and said, "Our plan, basically, is to make our S&P 500 ETF the biggest in the world." Basically, in no uncertain terms, he's saying, "We're going to compete on fees and make sure this is the biggest." And then, of course, you can't have a fee cut without someone else coming in. Charles Schwab followed it up. And because BlackRock actually matched their pricing on their bond ETF, they cut theirs by 1 basis point, so it'll be four basis points instead of five, just so they can be the cheapest.
Lapera: That's incredible. I feel like, potentially, Vanguard might end up having a run for their money.
The other thing that made news while I was gone, according to Jordan -- this is not the most exciting news, but we feel as if we should cover it -- is that the money market fund rules have changed.
Wathen: [laughs] Yeah, it's not the most exciting news; it's not supposed to be. If you own a money market fund, you might have gotten a letter. Basically, what happened was, the government changed the rules on money market funds so that if they invest in private securities -- so, debt issued by companies -- they have to mark, basically, their assets to market. If they invest in government bonds, they can basically keep their $1 share price that they know and love. What's happened as a result of this is that all this money, billions upon billions of dollars, has gone into government bonds that used to be invested in corporate bonds. So now, corporations are spending more than they ever have to borrow short-term money. It's created an inefficiency in the market, at least for the short term.
Lapera: Yeah. So, although this sounds boring on the surface, it will be interesting to see how this shakes out long term for companies, because they've basically been cut off from a cheap source of short-term funding. So, we're going to see how they react to that. But that's something that's going to become more apparent in months from now. Right now, it's kind of a boring story.
Wathen: Right, it's a boring story. It's good news for bank earnings, because LIBOR, which is the index for short-term interest rates, has gone up, so floating rate loans that are based on that index have produced more interest income than they otherwise would have. So, that kind of gave you a little pop in bank earnings.
Lapera: Yeah, which is the most exciting news. I guess, if you're listening to this podcast, bank earnings must be exciting to you. [laughs] That kind of brings us to our last news item, which is, the FDIC says they want new banks.
Wathen: Yeah, it's almost hard to believe. The FDIC, in April, they came out and said, "We're going to make it easier to start a new bank by reducing the regulatory scrutiny that you get on a new bank from seven years to three years." Basically, when a new bank starts, the FDIC scrutinizes them a little heavier than they otherwise would for seven years. Now, that's down to three years. So, they're making it a little bit easier. Really, it's important because there haven't been many new banks in the United States. The only one I can find is called Bank of Bird-In-Hand, which is based out in Amish country, Pennsylvania.
Lapera: That doesn't sound real.
Wathen: That's the only bank since 2010 to start up.
Lapera: Oh my gosh. First of all, that bank doesn't sound real. I don't think I would put money in there. That is not an official recommendation, mind you, because I'm just a podcast host. But I don't know, a bird in the hand is better than two in the bush, I'm not sure how I feel about that. [laughs] Second of all, the FDIC wanting more banks, I think listeners would probably ask themselves why. Besides creating more competition, one of the things that happened post-financial crisis is that a lot of really big banks left small communities, so a lot of smaller communities have been underserved by the bigger banks. There are a couple of smaller regional banks that have taken advantage of this because, one, the bigger banks left small communities, they moved in and were like, "We're here! We'll take all your deposits and make you loans!" But in general, smaller communities are underserved by larger banks.
Wathen: Right. This is a multidecade trend. Before the show, I went and looked it up. If you go back to the early 1980s, there were 14,000 banks in the United States. As if the second quarter of 2016, there were only 5,200 commercial banks -- roughly one-third as many. And then, obviously, of course, the number of banks doesn't really matter if you live in a place where the larger banks aren't serving. What happens in a lot of cases -- and I'm just going to use this as an example -- New York Community Bank (NYCB 3.95%) is obviously based out of New York, but they actually have branches in Florida, Arizona, and Ohio. They take deposits in those areas, but they don't make many loans in those areas. They're mostly making loans in New York City -- I think it's greater than 90% of their loans are in New York City. So what happens is, they're taking deposits in the cities, but they're not making loans to the residents of those cities. And obviously, the FDIC and bank regulators as a whole would like to see more community banks that are focused on these smaller areas.
Lapera: Yeah. We'll see how this shakes out. Maybe we'll start reporting to you about new banks soon. This brings us to the end of our news segment. Jordan, is there anything else you'd like to say?
Wathen: No, that's it. I think October was fairly boring. You missed a good month.
Lapera: That's good. [laughs] I think no news is good news in the banking sector, because I feel like the only news we ever get is bad news.
Lapera: Listeners, if you feel like there's something else I need to know, please drop me a line at [email protected]. I will definitely respond to you. And, I'm sorry to everyone who emailed me while I was gone. I will respond to you within the next few days.
I just wanted to take a moment, I was talking to Chris Hill before the show, and he mentioned that people might like to hear about my trip. Here's a quick top three summation of my trip. If you really want to hear more, you can also email me at [email protected]. Weirdest thing I saw was Window of the World. This is an amusement park in Shenzhen in China. Most Mainland Chinese are never going to be able to leave China, so they've set up this crazy park that has all the wonders of the world, according to the Chinese, miniaturized and stuffed into a park. So, they have an Eiffel Tower and an Arc de Triomphe and a Blue Mosque. They also have an Americaland, which was bizarre to visit, because they have a scale model of the White House, and overlooking that is Mount Rushmore. I don't know if that was for comedic effect, or if they're not 100% on their grasp of American geography or what. But it was definitely a really interesting thing to see.
The most dangerous thing I did while on my trip was crossing the street in Hanoi. I strongly encourage you to look up YouTube videos of it. It's terrifying. But, once I accepted my death, my inevitable demise and inconsequential place in the universe, it was totally fine. The most incredible place I visited were the temples around Siem Reap. Beng Mealea was my favorite. Super beautiful. If you can ever make it to Cambodia, I strongly encourage you to do so.
For those of you guys keeping track at home, you'll remember that I am a vomiter. I puke all the time. In case you're wondering, I only vomited twice on this trip, which is an incredible feat for me. And only one of those times was food-related. In other news, it turns out that taking two pills of Dramamine makes me pass out and drool on people. So, I will not be doing that again. Also, I need to buy stock in whatever company makes Dramamine.
OK, that brings me to the end of my summary about my trip. I feel like I've just for you all to look at my vacation pictures, and I'm so sorry about that. As usual, people on the program may have interests in the stocks that they talk about, and The Motley Fool may have recommendations for or against, so don't buy or sell anything based solely on what you hear. Again, contact us at [email protected], or by tweeting us @MFIndustryFocus. Thanks to Austin Morgan! I totally missed you, buddy! And thank you to everyone else for joining us. Everyone, have a great week!