The Big Banks Report Earnings and We Dig In

In this podcast, Motley Fool analysts Deidre Woollard and Jason Moser discuss:

• Bank of America's strong quarter.
• BNY Mellon's move to hold crypto for its clients.
• Why banks are pumping up their loan-loss reserves. 

Elsewhere, advertising tech stocks have been hurt, but actual spend is holding up. Motely Fool producer Ricky Mulvey and Motley Fool analyst Asit Sharma look at the ad landscape, as well as one smaller player with a strong balance sheet.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on Oct. 17, 2022.

Ricky Mulvey: Earnings season is back. We're taking a look at Bank of America's latest quarter and the future of adtech. You're listening to Motley Fool Money.

Deidre Woollard: I'm Deidre Woollard sitting in for Chris Hill and I'm joined by Motley Fool senior analyst Jason Moser. Hi, Jason.

Jason Moser: Hey, how are you?

Deidre Woollard: I'm doing good and Bank of America is doing pretty good, too. They announced earnings today, they beat earnings estimates even though profit was down. Banks like BofA, Wells Fargo, JPMorgan, they're all getting this boost from higher interest rate income even as deposits are slowing down. Are higher interest rates a good news, bad news situation for banks?

Jason Moser: Yeah, I think that's probably a fair way to put it. I would say, it probably favors more good news than bad. You look at banks that are maybe a little bit more levered to mortgage lending and maybe that drives up a little bit as rates go up. But generally speaking, we've been hoping to see this at some point or another with banks as interest rates continue to rise. We see ultimately the net interest income numbers for these banks this quarter really taking off and net interest income, for those unfamiliar with it, it's the difference ultimately between the revenue generated from a bank's interest-bearing assets and the expenses associated with paying on the interest-bearing liabilities. Ultimately as rates go up, we should see banks making a little bit more money in that net interest income. If you look at Bank of America, that net interest income was up 24% for the quarter. JPMorgan net interest income was up 34%, Wells Fargo up 36%. Definitely, a nice thing to see even though you probably you don't like seeing your adjustable rate mortgage tick up, I'm sure, but I think that probably speaks to the merits of getting it 30-year fixed mortgage. But yeah, I think probably more good news than bad.

Deidre Woollard: One of the things that I noticed about the earnings was that the consumer is still spending, it's slowing, but it's still strong. But banks are really preparing for the worst. They're pumping up their loss reserves. What does that mean and is there a possibility that it could be too much? Can they overprepare?

Jason Moser: I don't think they can overprepare. Banks are obviously a very heavily regulated industry and they have to keep a close eye on this always. We always, every quarter we see either they're pumping up those reserves or they're releasing those reserves. Ultimately that loan-loss provision, it's just something that banks set aside for potential uncollected loans and payments. It covers nonperforming loans, customer bankruptcies, things like that. We always say you want to prepare yourself for a rainy day. This is the banks' version of preparing themselves for a potential rainy day. And definitely we've seen a lot of these banks setting aside a bit more as opposed to releasing money recently, if you look at Bank of America, their net reserve build was 378 million.

That was versus a net reserve release of 1.1 billion a year ago. JPMorgan, another bank that increased that reserve, they built up 808 million versus a release of 2.1 billion a year ago. Then Wells, they also, they added 784 million to their loan-loss reserves. It is something when you see banks doing this, it impacts earnings. When we see them setting this money aside, that is a little bit of a headwind to earnings. Conversely, when we see them releasing that money, that can be a little bit of a tailwind. It's something that just plays out quarter-to-quarter and year-to-year.

In ultimately, you look for those tailwinds when you feel like they've got that money set aside if economic conditions are starting to improve. When they start setting that money aside, that when they start building that reserve, it can be a little bit of a clue as to what they see coming down the pike. It feels like to me they anticipate potentially a challenging situation here in the coming quarters, we hear a lot of talk about recession potentially hitting in 2023. A lot of people would argue that we're already in a recession now. I think it's one of those things that you expect to see it with banks, whether they are reserving or releasing. But the fact that they're reserving does give us a little bit of a clue that maybe they see some challenges on the horizon.

Deidre Woollard: Those challenges are things like consumers that may be defaulting on their credit cards or things like that.

Jason Moser: Yeah. When you look at recessionary times, obviously, coupled with inflationary times, the consumer is really in a pinch right now and credit card balances are at historic high levels. Consumer savings rate, the personal savings rate is around 3.5%, which is historically a very low level. It's a consumer right now that's a little bit of a challenging spot. The banks are saying, "Hey, things might get worse before they get better and we may have some loans out there that ultimately won't get paid. We need to put this money aside to make sure that we that we have our businesses in order and we're meeting those capital ratios that the regulators expect to see."

Deidre Woollard: Jason, you're famous for talking about the war on cash. Bank of America saw 44% more Zelle transactions than checks written. Are we also in the midst of a war on checks and which fintech companies are going to be the beneficiaries of that?

Jason Moser: I hate having to write checks personally. Every once a while you got to do it. But we're seeing more and more now that's becoming an old way of doing business. I think you see the obvious suspects to me, you got PayPal and Block. They're going to keep winning from this trend. I think you've got with PayPal obviously they also have Venmo. You see a lot of money moving between PayPal Venmo and Square Cash app. Those are the obvious winners. At Visa and Mastercard, I think do a wonderful job of finding positions in this value chain to help continue moving money around. They have partnerships, obviously with companies like a Block and PayPal. They'll benefit as well. I think maybe some names that folks might not be as familiar with. You look at a company like Marqeta, which is ultimately a cloud-based API platform that helps companies, they are a modern card-issuing company.

They have big customers like DoorDash and Uber. They help these companies build their own personalized payment programs for their workforces. We recently saw a neat new relationship Marqueta forged with Uber and I believe it's Mastercard. But again, I think that is another company that continues to benefit from more money moving digitally and then another one that focuses more on the enterprise level. If you look at a company like Bill.com, they're hoping to digitize and automate the back-office financial operations for small and midsize businesses. Taking the paper out of doing the business and making it more electronic. Well, I think that those are some companies that should continue to benefit for some time to come. I will add to that, all of those companies I just mentioned, I actually own shares in all of them myself. I'm sticking by what I say here. I'm a big believer in all of those businesses.

Deidre Woollard: That's war on cash basket at work.

Jason Moser: We're expanding the basket, Deidre, we're expanding the basket.

Deidre Woollard: Well, speaking of expanding and financials, BNY Mellon, they've recently announced that they're going to start holding crypto for clients. How much should we think about this as a potential game-changer? Are we going to see more uses of crypto? Is it finally going to become practical in some way versus just a trading mechanism?

Jason Moser: I'm still not sold on crypto as a medium of exchange and we've been having, that's really the question we've had to answer for so long, is it a store of value, is it a medium of exchange, is it something else entirely? It feels like it's a difficult argument to make that it is a medium of exchange. Most people just aren't using crypto to buy things. It doesn't seem like it's really an effective store of value these days. A lot of folks were arguing that it was a nice hedge against inflation, it doesn't seem to be playing out that way. Now it's not to say there's not a future for crypto. Obviously, it is here to stay in the purposes that it serves, I think will evolve over time.

But I think this is ultimately a good thing for crypto enthusiasts in that it adds credibility to the space. I think of Bank of New York Mellon. One of the oldest banks still out there exists. One of the most important banks in our banking system, one of the big eight they say, "This is something that adds credibility to the space." To me, we'll likely see more banks dabbling in this as time goes on. But ultimately, I think it's a fairly low-risk way for Mellon to bring crypto into their world. Learn more about its use cases. Ultimately, like I said, I think it just adds credibility in this space which is ultimately, I think what crypto enthusiasts want.

Deidre Woollard: Absolutely. Crypto enthusiasts, yes. We'll have to see about the rest of us. 

Jason Moser: Yeah. I would not call myself a crypto enthusiast, I'm a little bit more of a skeptic. But hey, listen, like I said, it's a space that continues to evolve and it's here to stay. I think we're just, we're going to find some use cases as time goes on right now. Still just just just not very clear.

Deidre Woollard: Yeah, I would agree with that. Really appreciate your time today.

Jason Moser: Oh, my pleasure, thanks for having me.

Deidre Woollard: Some advertising tech companies have been cut in half. Actual advertising spend isn't slowing down like you might think. Ricky Mulvey has more.

Ricky Mulvey: Advertising spend isn't slowing down as much as you might think but the adtech disruptors sure are beaten down. Joining us now, Motley Fool senior analyst and contributing learner Asit Sharma. Asit, good to see you as always.

Asit Sharma: Ricky, my friend, good to see you today.

Ricky Mulvey: I'm excited for this topic because there might be some opportunity, we'll find out. We might be in a recession vibe session, whatever you want to call it. But according to some studies, ad spending is slowing down a little bit but still growing. The World Federation of advertisers found that 29% of major advertisers are slowing spend next year, but a similar amount are increasing their spend. A different study from a company called MarTech found that 77% of chief marketing officers expect to increase their spend next year and the media agency called Magna Global expects that overall ad spend will still increase by about 5% in 2023. Asit, I just threw a lot of data at you, is any of it meaningful to you?

Asit Sharma: I mean, yes, Ricky, it's meaningful in that it's so confusing, right?

Ricky Mulvey: Yeah.

Asit Sharma: Are people cutting back or they spending more? I will say like in general, when the business climate withers, companies start to pull back on their variable costs so the ones they can immediately curtail without having too much of process change. Across a lot of industries, whenever you get a palpable decrease in demand, it makes sense to cut the variable cost of marketing and advertising. You don't want to overspend past some equilibrium demand level. When you see a high-inflation, high interest rate environment, marketing and advertising budgets are some of the first to get squeezed. Now, why this picture is mixed has something to do with advertising efficacy, which I'm going to return to in a bit here as you have a very interesting quote to discuss in a moment about this.

Ricky Mulvey: Well, we got two teases thrown in, but you said why companies would, it make sense that the common knowledge company, we're uncertain about the future economic climate, we're going to slow down on hiring. But it does seem that a lot of these major public companies are very hesitant to slow down on advertising spend.

Asit Sharma: I think this is because publicly traded companies have a finer needle to thread in an environment like this, they have to meet investor expectations. If you're a growth company and you have to show your investors that you're growing even in a difficult time, you're very loath to cut that marketing advertising budget, because you don't want to mess up even though some of that spend might be over that demand level that I was talking about. If you're a mature company, you want to meet those earnings-per-share targets. You don't want to miss on earnings days, so you will second-guess pulling back on those particular variables, spend line items on your income statement because you're juggling the idea of maybe having an effective spend or ineffective spend versus investor angst and anger if you really miss. You might lean toward keeping that marketing budget in place. Maybe even increasing a bit if you can cut another cost somewhere else and still hit the earnings per share that investors want to see.

Ricky Mulvey: From what the advertisers are seeing, the ad buyers are looking for something a lot more measurable so maybe you'll see a little less brand spend. The Trade Desk's chief financial officer, Blake Grayson, said in the latest earnings call quote, while the macro environment has created some uncertainty and we're not immune to it, we continue to gain more share as more and more advertisers seek efficiency and measurable results in their ad spend particularly connected TV. There's two questions with this. I think there's a larger conversation about connected TV and how much of an opportunity there really is there. But the first question is, why do you think the Trade Desk is able to see so much more efficiency than other advertising platforms?

Asit Sharma: I think for The Trade Desk, they're realizing the fruit of much investment over the past several years. Part of the answer is in your quote above, they're doing very well in connected TV. They offer this 3, 2, 1, they offer this capability to a wide array of multinational companies and that's an advantage over an internet walled garden like [Alphabet's] Google. Part of it is just this, it's a big part of the industry and they've been playing in it for a long time. The second, I would say is their UID 2.0, so this is the company's answer to cookies. It's a technology that ensures more privacy to the end user. Trade Desk has led a consortium of other players in the industry to develop the technology and there's some evidence and it's fledgling evidence. Take this with a grain of salt, that UID 2.0, actually provide some pretty robust analytics back to the companies that decide to use it.

There's a business case that's extending beyond just privacy and offering a competitor to cookies, which Google keeps saying they're going to do away with. They keep pushing back the date in which they're finally going to kill cookies. The third thing that I will say about the Trade Desk is they have developed a really good analytics platform. It's called Solimar, and this helps you measure your spend a little bit better. Ricky, as you point out, spend should be measurable. If you can show a company that through using our platform, you're going to get a higher return on your advertising dollars, then that is a case during an inflationary periods to keep that business and actually to have some marketing dollars that companies may spend in non-measurable endeavors like brand promotion, piling to programmatic advertising where they can prove back to their CFOs that there's some results on this money.

Ricky Mulvey: I am curious if the opportunity in connected TV is a little overrated though, because it's not like ad inventory is sold out right now. If you watch something like ESPN+, it's frequent that during the commercial breaks, you're just seeing the banner headline that we're in a commercial break, we'll return in a few minutes. My first thought is, boy, I bet the Disney Company would like to sell that space and then the second is, you're going to see even more inventory open up when Netflix introduces its ad tier and does more space create more opportunity or is this a case where the greenfield might be a little too large?

Asit Sharma: I mean, this is one of the questions of the day. It's something that I, not being this absolute expert in the industry often wonder, how much is the demand out there for connected TV? It certainly has been a growth vehicle for so many companies in this newish industry but at what point do we reach this imbalance between supply and demand? I've had that same experience I'm sure many listeners have. For me, it's usually during the NCAA tournament where I'll buy a subscription to ESPN 2 and then cancel it after the tournament's over. But yeah, I mean, you're sitting there seems like ages waiting for the activity to pick back up doesn't someone want that space? Now, I should say that part of this evolving relationship between The Trade Desk and Disney is supposed to answer that question. They're supposed to be putting more ads up on their various streaming properties, so we'll see. But at some point I think we will see the industry hit this happy medium. We're going to see more connected TV ads. I'm not sure it will ever reach that space where it's similar to normal TV in the real world.

Ricky Mulvey: I think one question is how local businesses are able to take up the connected TV opportunity. At least for me, I'm not seeing a ton of local car dealerships advertising in that space and it might be an education question, it might be a cost question, but it's something I'm watching. While The Trade Desk is buying ads, you got two smaller players on the sell side, both are also beat up this year. Magnite down about 61% and the other is PubMatic. As you're looking at these sell-side providers, which is what you're selling the ad space on behalf publishers, what are the key differences for investors to know?

Asit Sharma: Well, Magnite is a player that I think most listeners will be more familiar with. They've been around longer. They were the Rubicon Project, became Magnite. They've grown a lot through mergers and acquisition, Ricky, played very well in the connected TV space. One of the characteristics that I like about Magnite is that they are good at supply path optimization, so that means just reducing the number of intermediaries or middlemen in a sell-side equation so you have more direct from the publisher as inventory to the platform, to the buyers. PubMatic is a smaller company that has been around for quite a while now.

The key difference between PubMatic and Magnite is that PubMatic invests in its own infrastructure. They own most of their own servers and they built this specialized global cloud infrastructure to serve publishers. They do this extremely well and I will say, as well as Magnite does supply path optimization, PubMatic's even doing that a little better. I think that they are really making a case for publishers just to deal directly with them and they're helping those publishers roll up their own supply chain ad inventory streams. The final difference between the two, I think, is PubMatic just has superior financial characteristics.

The CEO and CFO, in fact, the entire management team of PubMatic has always wanted to run a profitable company so they have positive operating cash flow. They do invest a lot of money in their servers so cash flow could be better but it's growing. But you look at the margins, these two companies, PubMatic has gross margins around 72% versus 54% for Magnite. PubMatic has a positive operating margin of 22%, Ricky, and Magnite typically loses money in operations. It's got a negative operating margin of 13%. That is a big differentiator between these two companies. Both still have a lot of growth ahead but I sort of like PubMatic for its platform, how sophisticated it is, its relationships with publishers, and the fact that it makes money.

Ricky Mulvey: Asit Sharma, always appreciate getting together with you.

Asit Sharma: Thanks so much, Ricky, this was a lot of fun. 

Deidre Woollard: 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. I'm Deidre Woollard. Thanks for listening. We'll see you again tomorrow.