3 Key Takeaways From Jamie Dimon's Annual Letter

Next to Warren Buffett, nobody's annual letters to shareholders are as closely watched as those of JPMorgan Chase (JPM 0.49%) CEO Jamie Dimon. Dimon tackled many topics in his recent 66-page letter, but we focused on his commentary on fintech, bank regulations, and working in offices. In this week's installment of Industry Focus: Financials, host Jason Moser and Fool.com contributor Matt Frankel, CFP, discuss what Dimon said and what it could mean to investors.

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This video was recorded on April 12, 2021.

Jason Moser: It's Monday, April 12th, I'm your host, Jason Moser. On today's financial show, we're going to dig into some of the takeaways from Jamie Dimon's recent letter to shareholders. And believe it or not, folks, but earnings-palooza is upon us. Big banks as always will lead the way. We'll take a look at what investors should be watching for in these upcoming earnings reports. Joining me as always is certified financial planner and apparently monster-truck rally guy, Matt Frankel. Matt, how is it going?

Matt Frankel: Pretty good. It seems like earnings season just wrapped up, doesn't it?

Moser: It does. It does, but I think [laughs] Emily Flippen said something that was just very, very on point last week for Motley Fool Money, and I can't remember if it was on the show or if it was in the conversation afterwards, but she said something to the extent of just: Time is meaningless. [laughs]. It's possible to even really wrap your head around time anymore it feels like because yes, it does feel like earnings-palooza just wrapped up, but here we are, it's upon us.

Frankel: That's somewhat true in the second quarter, because I don't know if a lot of people are familiar with this, but the fourth-quarter earnings are always reported along with year-end earnings, so they take a little while longer.

Moser: Right. Yeah.

Frankel: I mean, one company that we follow a lot, Boston Omaha, just reported their first-quarter earnings last week, I believe. [laughs] I mean their fourth-quarter earnings, and now the first quarter is already over.

Moser: Yes. We are already in the second quarter, good thing to remember there. Current quarter is the second quarter. Well, Matt, let's go and kick off this week's show with something I feel I've been looking forward to talking with you about, because I was able to read through this last week. JPMorgan CEO Jamie Dimon published his letter to shareholders. I would put his letter in a small group of letters that I think all investors really should consider reading. I mean, I think you look at letters from folks like Buffett at Berkshire Hathaway, Jeff Bezos with Amazon. I think Mark Hill's letter to shareholders. Tom Gayner's is always a fun one to read as well. JPMorgan, Jamie Dimon, he left no stone unturned this year, it seemed. This was a very in-depth missive, but really helpful from a number of different angles. I mean, you can take this in whatever direction you want, Matt, but we really wanted to try to pull three main takeaways from this letter for investors. I will go ahead and let you take it from here, but let's talk. What were some of the takeaways from this letter that you feel like matter for investors?

Frankel: Well, you weren't kidding that he covered a lot in this letter. [laughs] I mean, you said you sat and read it, read the whole thing this weekend. Did you get the hardcover or the softcover edition of this book?

Moser: [laughs] I was thinking about trying to put it on my Kindle, but then I ended up just reading [laughs] on my computer screen.

Frankel: It's quite a way. It was 66 pages. Just to put that in context, Buffett's letter was about 20 pages, and more than a half of it was just general financial discussions about the business. This is a long letter. He really left no stone unturned. The point is, it was tough to narrow down just three things to talk about. He gave me quite a challenge with that one.

Moser: [laughs] It's fair.

Frankel: So I think the biggest takeaway from our point of view is his thoughts about fintech. Basically, he pointed out that over the past 10, 20 years, fintech has just become such a disruptive force in the financial industry. Just to name a couple of things he said, private credit -- meaning the credit, loans, and things like that, that happened outside the banking system -- have gone from $7.6 trillion in 2000 to $18.4 trillion in 2020. That's well over doubled. All these fintech lenders, they're making personal loans, and you can get an auto loan without going through a bank now, and things like that. The market cap of public and private fintech companies is roughly $800 billion right now.

Moser: Wow.

Frankel: It was a negligible amount in 2010, just 10 years ago, 10 years before the end of last year. It was negligible, like it was listed as zero [laughs] in the letter. So this is good and bad. Dimon views this as an enormous competitive threat to banks, and he should. He absolutely should. I mean, how much business do you think banks have lost because of companies like Lending Club?

Moser: Quite a margin. It's got even worse.

Frankel: Or SoFi, or Square, or PayPal. I mean, Square Capital, the business lending side of the business. Square is, now they are banks. They've just recently become a bank, but they weren't. They made billions of dollars of loans without a banking charter. And that took money away from banks like JPMorgan. So Dimon views this as a negative trend in a way. Take that with a solid grain of salt. He's somewhat biased.

Moser: Negative for whom? [laughs].

Frankel: Right. But he's trying to say that it's negative for the market and the economy and the consumer. The traditional banking system, especially large banks, uses more-stable sources of credit. As I mentioned earlier, he was CEO of JPMorgan Chase during the financial crisis. During a time like that, who was loaning money to consumers? Credit definitely dried up a little bit, but the big banks were still making loans. I mean, my parents bought a house in 2009, and had no trouble getting the mortgage. They went with a big bank to do it. The entire credit cycle, there's a history of just big banks being the providers of credit to the market. You can really especially make that case now that after the financial crisis, banks are required to maintain such high capital levels and really take care to be able to survive any type of recession. I mentioned during COVID, there was another level of stress test that was applied to the banks to see how they would deal with it.

Moser: Yeah, absolutely.

Frankel: If you remember that in a really adverse scenario. Fintechs aren't subject to that. Who's to say that? I mean, PayPal and Square are their own little animals. But one of these start-up lenders are the fintechs that are just getting into the growth mode. Who's to say that they would survive a terrible downturn?

Moser: I think you make a really good point there. One more thing, if you recall, in the letter, he put out this chart that compared banks versus fintech and nonbanks, and he was comparing the regulatory requirements. I wanted to get into that with you a little bit, because on the one hand, a lot of the services and companies that are being born from this fintech movement are really encouraging. This is a really amazing time from a number of different perspectives. It's opening up all sorts of different avenues in the world of finance, particularly for consumers that we haven't seen really ever. If you think about a lot of these fintechs, you look at Square, you look at PayPal. Let's take PayPal, for example. PayPal being a company -- they partner with a financial institution. They partner with Synchrony Bank, for example, in order to be able to underwrite lending in certain cases and whatnot. Square, like you said, until they actually got their bank charter. That was a little bit of a different animal altogether. But the idea is basically that when you are a bank, you'll be holding the capital regulations, capital ratios that just simply don't exist for fintechs and nonbanks. 

I would recommend anyone just to take a look at that chart in that letter, because it's just food for thought. I think it can help shape the conversation of how you feel like this space may evolve in the coming years. Because while I love the convenience in the innovation from a lot of these fintechs, I also ask myself the questions, if we run into some protracted downturn, these fintech companies, they really don't have any of these regulatory requirements they have to worry about. There's no liquidity requirements, there's no real operational risk, capital right there, they don't have the same capital requirements, less costly regulations. It just makes you wonder. There is a place in the world for banks that fintechs and nonbanks can't really fully fill. They can't fill that void that banks are currently filling here.

Frankel: We'll get to the regulation side in a second, because that's actually my second takeaway from the letter. But having said that, you mentioned the capital requirements for traditional banks really make them more-transparent, safer providers of credit, I guess you'd say from the market standpoint. It's also worth mentioning that in recent times, it's been really easy for hot start-ups to raise money. Look at SoFi. SoFi is going public through a SPAC merger and raised billions of dollars in the process.

Moser: Yeah.

Frankel: That really helps some of these businesses compete, and really provides them the capital to make loans and things like that. They just acquired a bank, SoFi, and were able to pump $700 million of their own capital into it to boost it up. It's been really easy to raise money. A lot of these fintechs are not profitable. In a downturn, it will not be as easy to raise money. We mentioned last week when we were talking about why the SPAC boom has dried up. That at some point investors' appetite for speculation starts to run out. That's especially true if the economy takes a turn for the worse. 

Another thing that Jamie Dimon said, this wasn't one of my big takeaways, but that inflation is very possible, and a series of rapid interest-rate increases often leads to a recession. In a recession, the fintech industry wouldn't nearly be as stable as it is right now.

I'm not saying that all these companies we're just talking about would fail in a recession or anything to that effect, but they wouldn't necessarily be as great providers of credit to the system as traditional banks would be.

Moser: Yeah. That stability just isn't there. It's neither right nor wrong, it just is. They live in two different worlds right now, and I think that's what shapes that conversation. That's what makes that conversation I think so enlightening for investors where you think about how that future may look. Is it one being replaced by the other, or are we ultimately looking at a future of partnerships, I wonder.

Frankel: Right. It's a good question. One that I don't have the answer to it; Jamie Dimon doesn't really, either. The regulation thing I wanted to pivot to because that's really the other side of the equation. Fintechs have a clear advantage over traditional banks when it comes to regulation right now. If you don't have a banking charter, there's certain things that you don't have to do.

Jamie Dimon in his letter, he made a table with 11 different disadvantages banks have compared to these fintechs. Just to name a few, I'm not going to read the entire chart, but banks have to buy FDIC insurance to protect depositors. I think you mentioned that you're a Wells Fargo customer, if I'm remembering that right.

Moser: No. We're Bank of America.

Frankel: Bank of America. That's right. With Bank of America, let's just say they went out of business tomorrow, the money in your savings account is fine. Because they have FDIC insurance. FDIC insurance cost JPMorgan $12 billion over the last decade. That's something a fintech doesn't have to have: high capital requirements even on deposits. To get that capital, banks are paying interest on it. Fintechs don't have those capital requirements, they are set by whatever their business dictates A lot of liquidity requirements, they have to keep a certain amount of liquid assets on hand. The last thing any bank wants or the banking system wants is people not being able to get their deposits. If you have $1 million in your bank account, you need to be able to walk into a bank and withdraw $1 million in cash if you want to. The banking system needs to support that. Not that that's a good idea as your financial planner -- don't do that. But it needs to be a possibility, otherwise that leads to a panic. A big cause of the panic of '29 was people couldn't get their money out of banks quickly enough.

Moser: That's right.

Frankel: The big run on the banks. Just regulatory compliance costs that the banks have. I could go on; there's a ton of these listed here. But if you add up all these costs that JPMorgan said they've had that fintechs don't, you're talking just back-of-the-napkin calculation. You're looking at $50 billion of costs that they've had over the past decade that a fintech would not have.

Moser: That's significant.

Frankel: That's very significant. What Jamie Dimon says is that we need to really level the playing field. Not that fintech innovations shouldn't be encouraged. He absolutely thinks they should be encouraged. We need innovation, we need better ways to move money around and better ways to lend. That's a big part of a lot of our investment thesis that we say here when we talk about our favorite fintech companies, that's a big part of it, is that we need this stuff. But, the big banks shouldn't be at that much of a disadvantage. We should be encouraging fintech innovation from all sides, including from the traditional banks, is his point of view.

Moser: Yeah. It really makes you wonder how much, [laughs] I don't know if there was any history behind this or not, but how much they must regret not making at least a couple of shrewd acquisitions earlier on in the game to be a little bit more ahead. I think most of us would agree with JPMorgan, one of the top-performing banks out there. That's a bank with a stellar reputation, not only as a bank but related from an investor's point of view as well. You imagine, had they been able to make a meaningful acquisition, bought Square three years ago or four years ago, something like that, to really add to that toolbox, to add some of that tech ammunition. It could put them in a little bit of a different place. But back to your point, though, real quick: It's not fintech is a bad thing and it's not fair. It's like you have to recognize that the banks have something that the fintechs don't, and the fintechs have something that the banks don't. There's a lot to be said for the stability in the banking system, thanks to that regulatory environment, thanks to those capital requirements. That's not just lip service, those are real services. Even if consumers don't think about that on a daily basis, that's something real, it exists, and it also is not free. 

Frankel: Well, it sounds like we have a case of great minds think alike here, because here's a quote from Jamie Dimon: "We have mentioned that our highest and best use of capital is to expand our businesses, and we would prefer to make great acquisitions instead of buying back stock."

Moser: Well...

Frankel: Given how much money that JPMorgan in a normal year spends on buying back stock, you're talking in the tens of billions of dollars. I agree with you that they're kind of late to the party. They probably should have acquired Square or something like that back in 2012, 2013 when they could have done it for nothing. Because a lot of very smart acquisitions were made during that time frame. But unfortunately, most of the big banks missed out on that, in my opinion.

Moser: Yeah. Look at something like the Plaid, Visa trying to acquire Plaid; that deal was shut down. But it makes you wonder why wouldn't a big bank be looking at, hey, maybe that's an opportunity, but maybe those same antitrust concerns keep them on the sideline. I don't know.

Frankel: Maybe. One of the companies we talked about, I think, is it nCino that does the bank operating system software?

Moser: Yeah. The bank operating system software.

Frankel: Instead of paying hundreds of thousands of dollars to this company to provide you with an operating system, why not acquire it, and then provide it to other banks as well? [laughs] I don't get why there haven't been more acquisitions in the fintech side of traditional banking. We've seen a great deal of [merger & acquisition] activity between banks like BB&T and SunTrust.

Some other brokerages have acquired one another in the past few years. But none of the big banks seem to really be thinking outside the box when it comes to acquisitions. It sounds like Jamie Dimon is starting to realize that that was bad thinking.

Moser: Yeah. Well, better late than never. Maybe there's still the opportunity to get in there and make a meaningful deal, something with a big splash.

Frankel: Pivoting to the last takeaway, and this is kind of a selfish one for me just because I have been saying since last March. People are going to work in offices again. [laughs] I don't know about Fool HQ. I don't want to go down that rabbit hole right now. Selfishly, I'd love it if the building could be open one day a month, so I could come visit. I'll just put that bug in people's ear out here. [laughs] But Jamie Dimon seems to be a believer that office work is better. I'm not talking about the branches. Obviously there are some aspects of branch-based banking that cannot be done remotely. I'm talking about the office workers, the people who work in their Wall Street offices. He said the bank is still planning to build a brand-new headquarters in Manhattan. That's obviously a big investment. He said there are a bunch of weaknesses from the work-from-home approach, including bringing new employees into the mix. He said it's really tough to train somebody and just kind of bring him into the office culture if they've never been to the office.

Moser: Yeah. Absolutely.

Frankel: He cited, and quote, "Spontaneous learning and creativity," I wanted to get that quote right, [laughs] "that comes from being around your colleagues." There have been years when half the interesting projects I've gotten to work on at The Motley Fool came from a conversation I had when I was visiting the office and someone said, "Hey, what do you think of this?" Just that spontaneous nature of collaboration. No one's going to have a spontaneous Zoom call. How many times have I spontaneously called you via Zoom over the past year?

Moser: I can't think of one. [laughs]

Frankel: Right. He's got a point there: the spontaneous creativity. I would go beyond that even and say that, if you're new in your career, you want to see and be seen by your colleagues and your bosses and things like that. That's really tough to do if you're working remotely.

Moser: Yeah. Well, that old "out of sight, out of mind," and before, it certainly would be understood if you were worried about being a remote worker that you weren't being seen. Now, it seems like maybe that is going to be the norm for some folks. I will say, I fully agree with him. I think we're going to get to a point sometime here in the next year or two years, whenever, maybe it materializes differently for different companies, but I think we may get to a point where actually physically working together is seen as a competitive advantage again. I agree with it totally. Remote work is fine for stuff that is just automatic and repetitive tasks, things like that. If you just got a job where buttons need to be hit and you just got to do this and that and you just got a routine. But as far as collaboration and learning, remote work is just awful for that. It just doesn't work. At least that's my experience over the last year. I talked to a lot of folks in the investing profession that find remote work to be not good for learning and collaboration as well. I think you and I are on the same page there. 

To me, I think he makes a lot of sense there. I think it's why we're seeing companies like Microsoft and Alphabet going ahead and accelerating going back to the office now, because clearly we're at a place where vaccines continue to roll out, the risk is being mitigated each and every day. Reed Hastings, another CEO, has been very clear with his thoughts on this as well. I tend to agree. I think being able to work remotely is a nice thing to have, it's a nice thing to be able to do. But if you're in a job that requires collaboration, ideas, developing ideas from the ground up, remote work is just very stifling in that regard. I suspect he's on to something there.

Frankel: Yes. To be fair, I'm a believer in the hybrid work model.

Moser: Yeah. I'm with you. I think the hybrid makes sense. I think honestly, that's what a lot of places had before this started. Maybe not to the extent, maybe that hybrid didn't tilt so far over to the virtual side. I know a lot of places had that option going into...

Frankel: I know for a fact that The Motley Fool, if you had to work from home for a day, it wasn't a big deal.

Moser: It was absolutely normal.

Frankel: Yes. Zoom could be productive, being remote can be productive, just as productive as being in the office. You can even make the argument that it's more so in certain ways, because you're saving your commute and things like that. What did it take you to get to and from the office each day?

Moser: [laughs] There's no drive, that's for sure.

Frankel: That's time you could spend getting work done.

Moser: True, but by the same token, that drive was often spent listening to podcasts or something where I was learning. And that was unencumbered [laughs] time, 20, 25, 30 minutes on the road where I could actually listen to something and learn, which is a little bit different when you are in a house full of all sorts of things going on.

Frankel: I really think the market has been surprised at how many CEOs, David Solomon from Goldman Sachs is another one who has mentioned that he wants people in the office. I think the market has been surprised, especially when it comes to these tech companies, at how eager CEOs are to get people back in the office, not necessarily all the time. I doubt Google is going to make people work in the office all the time. That's just not what they are about anyway.

Moser: Yeah. Who knows how they implement it fully? But yeah, I did get your point. I think the idea is being together more than not.

Frankel: These are companies that really place value on collaboration, which I think is really the X factor there. I think that's a positive catalyst for some of the office real estate companies I follow.

Moser: I can imagine. We should probably do a whole show just on REITs here and talk about the death of the office has been greatly exaggerated.

Frankel: If only someone had been saying that [laughs] all along.

Moser: I bet you, we could probably scroll back and find a podcast or two there.

Frankel: [laughs] Those are my biggest takeaways out of the letter. Like I said, it was 66 pages, so if I miss something you found really important, don't hold it too much against me, [laughs] but it's a good read. It's on JPMorgan's website, if you are interested. It's definitely worth a read if you have the time.

Moser: Yeah. Good read indeed. I appreciate you digging into it for us. Before we wrap up the show, Matt, earnings-palooza, believe it or not, it's here. Wednesday we have two reports from JPMorgan and Wells Fargo, then on Thursday we have Citi and Bank of America. Take this however you want to take it, but what are some of the things you'll be paying attention to this go-round for earnings season? I guess also, I'm going to put you on the spot here in regard to Wells Fargo, just because that is your pick for 2021. Loyal listeners know that is your financial stock for 2021. But what's piquing your interest here for this earnings season?

Frankel: Well, it's worth mentioning that there's a lot that we're not going to learn. We mentioned in the last show, I believe it was, that banks aren't going to be allowed to reimplement their buybacks or increase dividends till at least June. You're not going to get news on that front. I don't even think you're really going to get any commentary on possible sizes of buybacks until after the stress test happens this year. That's something that you're probably not going to get this time. Wells Fargo is not going to raise their dividend back up, I wouldn't count on that. But interest rates have started to rise, as every tech investor has noticed as a downward catalyst.

Moser: The rotation is real.

Frankel: Right. Interest rates have started to rise. It started to trickle down to consumer interest rates somewhat. For example, mortgage rates are no longer at their all-time lows; they are going up a little bit. Benchmark interest rates are still at record lows. The federal funds rate is still at zero, and most banks are still paying next to zero on deposits, so I'm curious to see if this is starting to trickle into an increase in the banks' net interest margin. That's one thing I'm looking at. I'm thinking that they could possibly surprise the upside when it comes to interest margin.

Moser: Hey, now.

Frankel: [laughs] I'm also curious to see how all that volatility in the first quarter -- I mentioned interest rates started to rise, tech stocks went crazy to the downside for a while. Interest rates were going all over the place for a little while. I'm curious to see how that translated into trading revenue at a lot of the big investment banking firms, especially. I know Goldman Sachs reports sometime this week as well. I want to say it's also Wednesday. JPMorgan has a big investment banking division, Bank of America does. That won't affect Wells Fargo so much, but I'm curious to see how that translates into trading revenue because volatility tends to create a spike in trading revenue and also investment banking revenue. The IPO market was as hot as ever in the first quarter.

Moser: Yeah, that's a good point. Made a lot of delays there that started trickling through, didn't they?

Frankel: How many SPACs went public?

Moser: Oh, my word.

Frankel: All of those are IPOs. They pay investment banking fees that's to be underwritten. I want to see how that SPAC boom led to investment banking fees. I think this is going to be a quarter where the investment banks are the stars, but I think that later in the year, we're going to see really the savings and loans like the small banks we mentioned last week, and Wells Fargo, which is primarily a lending operation -- I think those are going to have a great second half of the year, I'd say, after the stress tests come out, they're allowed to buy back stock and interest rates start to normalize, and they can finally make some money from lending again, because when interest rates are almost zero, it's not a great time to be in a business that lends money.

Moser: No, it is not.

Frankel: I'm expecting default rates to stay low. The stimulus bills that were passed, unemployment insurance is extended through I think September. The PPP opened a second round, businesses have access to capital now. So I'm not expecting loan default rates to be any higher than they have been, so I think we're going to see a good quarter in banking. I think the investment banks are the ones that could surprise the upside.

Moser: Well, we look forward to digging in, but until then, Matt, I think that's going to do it for us this week. I appreciate you taking the time, as always, to enlighten our listeners and hey, enlighten me, too. You said some stuff that I didn't know.

Frankel: There we go. You said some stuff I didn't know, too.

Moser: Well, that's the goal, right? [laughs] We walk out of here learning from each other, and that's always a good thing. But again, thanks. I look forward to doing it again next week as always. Remember folks, you can always reach out to us on Twitter @MFindustryfocus or you can drop us an email at [email protected]. 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. Thanks as always to Tim Sparks for putting the show together for us. For Matt Frankel, I'm Jason Moser. Thanks for listening and we'll see you next week.