Who Leads the Asset Gatherers? | SCHW, MS, GS, AMP, RJF & SF

July 5, 2024 | Premium Service | Happy July fourth! In this edition of The Institutional Risk Analyst, we return to look at Charles Schwab (SCHW) and the other asset gatherers, including Morgan Stanley (MS), Goldman Sachs (GS), Ameriprise Financial (AMP), Raymond James (RJF) and Stifel Financial (SF).

We generally use several groupings to describe commercial banks: Lender Banks, Universal Banks, Consumer Lenders and Asset Gatherers.  We used to think about fintech banks or even crypto banks. With the fall of Silvergate Signature Bank, FTX and others, and now the Fed settlement, maybe we will forget that one for now ("Silvergate, Reverse RPs and the Theology of Prosperity").

Despite the resurgence of bitcoin prices earlier this year, the willingness of institutional investors to risk capital on coin-related ventures remains weak and highly variable one day to the next. The aftermath of the various ETFs and other fund vehicles seems to be first and foremost a liquidity event for incumbents, but now with far less robust volumes than many hoped.

There are a number of crypto ventures we've seen in the past year, including one with a full-blown banking license in Bermuda, yet capital seems to be strangely reluctant to commit. Perhaps investors fear that any prophylaxis devised by counsel will prove inadequate to prevent contagion a la FTX.

None of the companies profiled in this note are taking positions in foreign banks acting for global counterparties as a payments platform focused on coins. Ever resourceful, GS did start a crypto trading effort in 2021. The table below shows the rank of these stocks in the WGA Bank Top 50 Index for Q1 2024. 

As of the end of June 2024, the WGA Bank Top 50 Index was up more than 14.5% vs 9.5% for the Invesco KBW Bank ETF (KBWB).  The WGA Bank Top 10 Index was up more than 15% during this same period. If you want more information about licensing the WGA Bank Top Indices, please email info@rcwhalen.com 

Like the rest of the industry, SCHW reached a peak just short of $80 per share in mid-May and has given ground ever since.  This large cap bank stock is still up 30% over the past year, but this is less than half of the gains seen by recent sector leaders such as Western Alliance (WAL), which is up 75% over the last 12 months but is still trading at just 1.25x book value.

Many of the names in the top 25 banks measured by 1 year total returns are trading at or about 1x book value.  Call this normal. The larger banks led the way in January and February, but today the top 25 names in terms of total return include many smaller stocks.

WAL is up due to, among other reasons, the prospect of lower interest rates. Attentive readers of The IRA know that mortgage rates need to fall about 200 bp before we start to see significant purchase and refinance volumes. WAL's big connection with residential mortgage is a function of the purchase of AmeriHome mortgage from Apollo Global (APO) portfolio company and balance sheet Athene in 2021.

The other big question mark on WAL and other banks with mortgage exposure, is whether the historically wide spreads of mortgage-backed securities over US Treasury debt are likely to narrow anytime soon. Or to put it another way on MBS spreads, will mortgage spreads come back in without more QE from the Fed? Are spreads today around +140-150 bp or more to the Treasury yield curve now the new normal ex-QE? Nobody really wants to talk about this. 

We added Ameriprise Financial (AMP) to the group this quarter and that change has certainly added a new benchmark in terms of equity returns. Over the past five years, AMP has outperformed the group by a considerable margin, delivering a total return to shareholders approaching 200%. 

Source: Google Finance

AMP is a $45 billion market cap bank holding company from Minneapolis with over $1 trillion in assets under management and another $400 billion in assets under administration. It  offers financial planning products and services, chum for the fish if you will. The core products include wealth management, asset management, insurance, annuities, and estate planning. As of year-end 2023, more than 80% of the company's revenue came from wealth management. Many of the firm’s comps are non-bank giants such as Black Rock (BLK) and Apollo Global Management (APO). 

As you might imagine, the credit profile of AMP is good, below Raymond James and the perennial leader in terms of credit losses at Goldman Sachs. Now more than a year since disposing of the loss-leading retail assets of Marcus, GS continues to report very high levels of credit loss compared to other asset gatherers and even compared with some of the largest universal banks. 

Source: FFIEC

A net loss rate of 62 bp vs average assets for Goldman Sachs is 2x Peer Group 1 and higher than the same metrics for JPMorgan (JPM) and Bank of America (BAC).  As discussed below, the gross spread on loans for GS is over 11% as of Q1 2024. Recalling the old credit rating breakpoints from S&P, this suggests that the clients of the House of Goldman are decidely subprime and are about a “B” universe.

AAA:  1 bp

AA:  4 bp

A:  12 bp

BBB:  50 bp

BB:  300 bp

B:  1,100 bp

CCC:  2,800 bp

Default:  10,000 bp

A net loss rate of 62 bp at Goldman Sachs is closer to a “BB” bond equivalent. More importantly, these credit losses are coming not from the retail value trap known as Marcus, but the institutional side of the house, one reason why the gross spread is 2x JPM and WFC. 

The type of secured lending that Goldman Sachs puts on the books is a good bit more risky than the same type of prime and warehouse lending business at JPMorgan. This is mostly a function of the clientele, who tend to be more volatile than the customers of Jamie Dimon. Think about GS pricing loans against mortgage servicing assets vs JPM, which has a cost of funds half that of Goldman. Same with MS, Nomura (NMR) and other large dealers. With the debacle at New York Community Bank (NYCB) in Q1 2024, JPM pretty much owns the high end of secured finance, while GS, MS et al fight over the scraps.

After credit losses, we move next to the gross spread on loans and leases. These banks don’t tend to make a lot of loans, but the pricing of their loans says a lot about the business model. Notice in the chart below that AMP is right behind GS in terms of gross spread at 8% and well-above the other banks in the group.  SCHW and RJF are tied for number 3 and just above the average for Peer Group 1.  A bit over 25% of total assets at SCHW is held in loans, but the loss rates are near zero.  Notice that the gross spread on loans at MS fell in Q1 2024.

Source: FFIEC

After credit and the yield on loans, another part of the analysis is the return on securities. In Q1 2024, SCHW has a very low yield on its investment securities at 2%. This implies a discount from par in excess of 20 points.  However, SCHW has among the lowest interest expense in the industry at 1.5% of total assets at Q1 2024. Thus while the yield on the book is low, so is the funding cost.  The yield on securities for SCHW is ugly disclosure, but not fatal by any means.

Yet SCHW no longer has the lowest cost of funds in our Asset Gatherers group. AMP has a cost of funds that is just one third that of SCHW at 51 bp.  And AMP has a yield on its securities book of almost 5% or 200 bp above the average for Peer Group 1. Obviously we do not need to teach the folks at AMP about duration. Note that GS and then MS have the highest funding costs in the group and also have average yields on their securities books well-below their funding costs. Fortunately, fee income is most of revenue for both firms.

Source: FFIEC

Finally we look at net income and, again, the results hold some surprises. Earning assets at SCHW equal almost 90% of total assets, but at AMP only 37% of total assets generate interest income.  There is a 4:1 ratio between AMP’s non-interest fee income and interest earnings. Only RJF has a similar operating profile. Indeed, if we look at the group, AMP, RJF and SF perform far better than do the larger firms such as GS, SCHW and Morgan Stanley.

Source: FFIEC

Although GS and MS are part of our asset gatherers group, both of these banks also share many attributes of the universal banks. The major difference is funding costs, because neither GS nor MS have a substantial retail deposit base. Thus while AMP, SCHW, RJF and SF focus mostly on advisory business for their revenue, MS and GS also focus on trading, investment banking and also lending to institutional customers.

MS, for example, has the largest derivative position on Wall Street and GS is a close second. Indeed, the pattern of the derivatives positions of the two firms suggests a high degree of correlation. Most of these exposures are related to interest rates, but the sheer size of the derivatives books of the two largest dealers is reason for concern. The point is that MS and GS have one foot in the world of asset management, but the bigger foot in trading and capital markets. But it seems pretty clear from the LT stock performance that AMP is stock to beat among the Asset Gatherers.

Source: FFIEC

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