If you've ever tried to seriously dig into the balance sheets of any of the nation's largest banks, chances are, you wound up more than a little bit puzzled about what their real asset values are. Line items covering things like derivatives portfolios, collateralized debt obligations, and other Wall Street jargon are obfuscating multibillion-dollar portions of those trillion-dollar balance sheets.
We've looked too, and in most cases, we don't have a clue what those numbers truly represent. That's why Gaby Lapera and Tim Hanson recommend finding banks where simplicity and personal responsibility still rule the day. In this segment from the Motley Fool's Industry Focus: Financials podcast, they explain how smaller banks operate with more skin in the game, more transparent portfolios, and ultimately, why their management teams can take greater personal responsibility for the bank's success than their megasized competitors.
A transcript follows the video.
This podcast was recorded on March 14, 2016.
Gaby Lapera: The other thing that I thought was really interesting that you said was [about] knowing what's actually in these portfolios. I recently watched The Big Short, which was maybe the most stressful movie for me of all time, even though I knew how it was going to end. I feel like that's how people in 1996 watched Titanic. That's how it felt watching this movie. One of the things, the collateralized debt obligations ... say that three times fast.
Tim Hanson: CDOs.
Lapera: CDOs. A lot of people have no idea what's actually in them. That was one of the premises of the movie: that these people had these giant portfolios and no one actually knew what was inside any of them.
Hanson: There are so many messed up things about that situation with regards to the financial industry. You had myriad businesses whose jobs were [to be] originators. What does an originator do with a loan? It simply makes the loan, and then sells the responsibility of the loan to somebody else. In many of those cases, the people buying it would pick those loans apart and sell different portions of them. Really, what was left over from a financial-product standpoint bore little to no resemblance to what had been created in the first place. The person creating the loan downstream could not care less about what ended up happening to it upstream. It's a volume play at that point, and that's where you end up getting so many poorly written, underwritten loans.
One of the things about community banks is they are community banks, which means that their lending footprints tend to be in the region or area that they're doing their business. If you want to go back to Burke & Herbert (NASDAQOTH: BHRB) here in Alexandria, the bulk of their business is being done in Northern Virginia with Northern Virginia homeowners, Northern Virginia businesses, so on and so forth. Generally speaking, when they originate a loan, they're much more likely to keep it on their own books. The incentive is there for them to only originate loans that will remain money good for the lifetime of the loan. That level of personal responsibility is something that I think you find in smaller financial institutions that has sort of been lost as financial institutions have become too big to fail, so to speak.
Lapera: That's such a great answer, I'm just so impressed. Thank you so much!