The Greek downfall is still in full swing as the voters are voicing their opinions, and soon they may arrive at a final decision to leave the Eurozone and all its glory.
Should Greece leave the union, the likelihood of excessive inflation on the drachma is all but law. But as daily withdrawal limits are still in place on ATMs, a not so well-known company is offering temporary cryptocurrency loans to be repaid in euro as the funds become available.
All the while, American community banks are joining with an unlikely partner to be a source for loan credit processing. Will the cons of LendingClub's (NYSE:LC) infancy restrict its potential earnings, or will partnering with community banks give pleasantly unexpected returns?
A full transcript follows the video.
Kristine Harjes: What now for Greece? This is Industry Focus.
Hi, everyone! Kristine Harjes here for The Motley Fool and you're listening to Industry Focus: Financials, where I am pleased to welcome back our senior banking specialist, John Maxfield. Hope everyone had a great, relaxing weekend and for all our American listeners; hope you had a fantastic Independence Day! Hope you got out there to celebrate and watch some fireworks, enjoy some good barbeque.
In the spirit of the summer gatherings we're going to do somewhat of a potluck episode today where we've got a couple different topics that we want to talk about. We're going to chat a little about community banks partnering with LendingClub and look ahead to earnings season. That will come up later in the episode. The first thing I'm bringing to the table is a follow up from our last Industry Focus: Financials episode where we talked about the Greek financial crisis.
John, fill us in. What's new here since we spoke last week?
John Maxfield: The big news right now is that the Greek voters went to the polls and they voted against further austerity measures in terms of whether or not Greece would go to the table and continue to negotiate on the bail out. That puts Greece in a situation where it's possible the other European creditors will step up to the plate and go back to negotiations.
It's hard to be able to predict the future, but the second option seems to be most likely. That consists of potentially leaving the Eurozone and going out on its own.
Harjes: If that were to happen -- and this is a question of opinion -- do you think that would represent a failure of the Eurozone?
Maxfield: That's a great question. The "at first blush" answer is "yes". This would represent a failure of the Eurozone because as Greece leaves it's the first part of the fracture of that union. However, I think if you look at it as a greater historical context it's probably evidence of how the Eurozone is actually working. What happened 70 years ago when there were disagreements? You had invasions and an enormous war.
In the 1870s you had the war between France and Germany, and before that you had the 30 year war, then the Napoleonic War, then the 100 years' war. I would personally say the fact that there's a disagreement and they are settling it in this way as opposed to driving tanks across borders is definitely an improvement.
Harjes: We'll take potential global financial meltdown over tanks.
Maxfield: That's right. It remains to be seen, of course, whether or not there will be a meltdown. Keep in mind Russia is in the midst of a severe economic downturn right now and that hasn't caused that much volatility in financial markets around the world right now. So it really remains to be seen what the impact will be of Greece if it does, in fact, leave the union.
Harjes: What sort of ripples have we seen already in markets?
Maxfield: Everybody's saying that Greece's potential exit is priced in. If you look at the S&P 500 today, after the referendum vote in Greece, it's only marginally down. It's down by 27 basis points, or 0.27%. It's a pretty normal day in the markets.
Harjes: Very nice. I guess on one hand you have Greece that's really small, but on the other hand it could be indicative of larger things.
Maxfield: Let me just add one more point about the "Greece" thing. You and I were talking about this a bit earlier today. When you think about the situation that Greece is in right now it has massive unemployment. I think it's around 20%. The economy has contracted by ¼ in real terms, or 25%. You're talking about a large scale economic depression along the same lines of what the United States experienced in the 1930s.
When you look at what the United States did in the '30s, we went through the new deal, had these huge public works projects and all these different things increasing the spending to get us out of this. Greece is being asked to effectively do the exact opposite. It certainly leads one to be sympathetic to Greece's plight right now. At least in my opinion.
Harjes: So you think the people are probably smart to vote no?
Maxfield: That's another question altogether because you have all these other situations. If Greece leaves they're going to have significant inflation. I can't imagine a situation where Greece going off the euro would not cause considerable inflation. So you have that element, but what it shows is Greece has been put into a really tough and unfair situation in terms of all this.
Harjes: So, continuing along the lines of currency, if you guys have listened to this show regularly enough -- and John, I know you know this -- I'm a bit of a coin fanatic. One of my favorite elements of this story to keep tabs on is the involvement of digital currency in this situation and could that come in and save the day. Greeks can't get euro in a meaningful quality out of ATMs right now. They have a daily withdrawal unit which is still at €60.
They can't purchase bitcoin with bank transfers either because of a freeze on these transactions, but it turns out there is this bitcoin competitor called Trestor Foundation and they're going to step in with their bitcoin rival currency called Trests and they will extend up to €2000 worth of Trests to Greeks that want to get it. In return, all they ask is you come in to one of their three locations and you sign a note promising to pay it back in euro once banks in the country reopen.
I find this whole situation absolutely fascinating. One of the interesting things about it is that Trestor pegged to the U.S. dollar. That means if the euro were to tank, the value of this currency would likely go up. Even more interestingly, the Trestor Foundation reported that merchants are actually beginning to accept Trests directly, taking euro out of the equation entirely. What do you think about all of that, John?
Maxfield: I don't even know. I wouldn't even know where to begin.
Harjes: It's crazy! I saw this story and I was like "No way!"
Maxfield: Yeah. To be honest with you, I don't know if that would be better or worse than a highly inflated Greek drachma. I just don't know what you would do with that currency.
Harjes: I don't think anyone really does.
Maxfield: But I'm a dinosaur.
Harjes: Still lots to talk about, so let's move on. Last week you sent me an article on community banks partnering with LendingClub. I thought that would be worth sharing with our listeners. First off, what's LendingClub all about? Let's have a little bit of background.
Maxfield: LendingClub is a lending marketplace. As opposed to a bank where you go to the bank and you get a loan, and the bank makes a loan, and puts that loan on its book; LendingClub introduces a third party. It puts investors who are looking for yields together with people who are looking for money to borrow.
LendingClub is kind of a liaison in that respect. What community banks are doing is going to LendingClub and saying "Look, LendingClub. Why don't you originate loans, and then we'll buy them from you on put those on our books?"
Harjes: What's the appeal of taking that route instead of just offering the loans directly?
Maxfield: The appeal to this route is, by outsourcing your loan origination process -- not all of it, but a certain portion of it -- you are saving on expenses because you'd have to be spending money to originate those loans. At the same time you're not foregoing the opportunity to create assets and invest in assets. So you're kind of getting the best of both worlds.
Harjes: What's the downside then? Is it riskier?
Maxfield: The downside -- and this is something that we don't know for sure until all this plays out, just like anything else -- when looking at it from an historical perspective, banks have traditionally and frequently gotten into trouble by outsourcing their credit origination process. If you look at the financial crisis and look at the big banks and mortgages they got in trouble with, a lot of those were created or originated by mortgage brokers that then sold the loans to the bank.
In many cases it wasn't the bank themselves that were originating those loans that turned toxic. Then if you go back another 20 years to the mid-1980s when we had this boom in the oil patch states, we had a small bank in Oklahoma named Penn Square Bank. They were originating loans to the oil producers and service providers and selling those loans to larger banks like Continental Illinois, Bank of America (NYSE:BAC), Seafirst Bank up in Washington, and Chase Manhattan in New York. Then all those loans went south.
The potential problem is, when you outsource your credit origination process you don't have the same type of control over the quality of the assets that are produced out of it.
Harjes: The other side of that equation is, LendingClub is pretty new, right? The banks have got to be more experienced at it.
Maxfield: That's exactly right. A lot of our banks go back 150 years, if not more. They've seen the credit cycle up and down multiple times. They understand you have to go into this process with humility, they understand a certain portion of loans will always go bad, regardless of how well you do your credit process; banks are just better at that whole credit origination process. They're not perfect by any stretch of the imagination, but they're better.
Whereas LendingClub is coming in, they're brand new, really confident in their abilities to use computers and machine learnings. It remains to be seen whether or not that confidence -- or in my position, I think it's over confidence -- will translate into higher levels of loan losses than what would be experienced by banks if they originated them themselves.
Harjes: From there we'll have to keep an eye out and see if there are other community banks that might take this same strategy. Before we sign off I wanted to point out that earnings are going to start coming out next Tuesday, July 14th. They'll be kicking off with Wells Fargo (NYSE:WFC), and J.P. Morgan (NYSE:JPM) on that day, then Bank of America, Citigroup (NYSE:C), and more to follow. John, what do you expect to see here?
Maxfield: The same thing we've been seeing for the past couple of years. Interest rates are still going to be compressing revenue, we're going to see expenses from compliance and regulatory stuff that are still going to be higher, you're going to see banks like Wells Fargo and J.P. Morgan probably getting double digit returns in equity; 10%, 12%, and 14%.
My guess for Bank of America and Citigroup is they're still going to be in that 4% or 5% in terms of return on equity. More of the same thing. Just watch for direction of expenses, direction of revenue, and also we're going to want to watch for if there's any guidance in terms of new legal cases and new investigations that could take big chunks out of revenue in the future.
Harjes: I'm sure we'll talk about all those updates and more once they come out. Stay tuned for future episodes. Folks, there you have it for today. Lots of interesting stuff to think about. Keep looking out for more news. John, thanks so much for being here and we'll talk to you all next week.
As always people on the program may have interests 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.