Transcription
Blackstone is down 15%. Paula is down 25%. KKR is down 21%. Glenn, what's going on?
Glenn Shore, who covers some of the largest financial institutions on planet Earth.
"Secular growth stories in a market reaching all-time highs and they keep raising new money."
"And the stocks are down."
"Yeah."
"Why? What's going on?"
"There's a couple of things."
"So, if we're talking private credit, let's talk about Apollo. How are they doing? Apollo at the top of the list has helped the world understand that the superpower of asset management is long duration liabilities, not overnight funds at a bank."
"So let's talk about City, which is the best performing large bank stock in the bank universe this year. What does tokenization mean?"
"Now you have a digital wallet. It could make everything bulletproof on safety and soundness."
"When you bring up private equity and private credit, they go insane because they, you know, they say this is where it's going to happen. This is a disaster."
"Every bank said no turn in the credit cycle. The economy is resilient and the consumer is resilient. Every asset manager that manages these credits, same comments. And now you're going to tell us why."
[Music]
Hi, this is Steve Eisman and welcome to another episode of The Real Eyes Playbook. And today I'm interviewing a very old friend, Glenn Shore of Evercore, who covers some of the largest financial institutions on planet Earth, private equity, and asset managers. It's quite a broad coverage list. Kind of unusual for a sell-side analyst these days to be so broad, which is one of the reasons why you're here. I call your group the good, the bad, the ugly. But who's good and who's ugly sometimes slips around.
"No doubt."
"Bad is usually traditional asset managers. So, let's start with the ugly. This has been a very, very difficult year stock-wise for the alternatives. Blackstone is down 15%. Apollo is down 25%. KKR is down 21%. Owl is down 33%. Glenn, what's going on? This is unusual. In a bull market, historically, these stocks did very well. So, what's what's going on with these stocks?"
"Yeah. Particular growth stories in a market reaching all-time highs and they keep raising new money."
"And the stocks go down, right?"
"What's happening?"
"So that's there's a couple things. Uh."
"Repeat that again. Secular bull market."
"Secular growth story, secular growth story of these companies where they're every quarter when they report, they're raising more and more money."
"Across a broader range of categories."
"Granted, and the stocks are down."
"Yeah."
"Why? What's going on?"
"There's a couple of things. First of all, let's have a little perspective. 2023 and 2024 were unbelievable years for these stocks. KKR, I think, was up 80% last year and 30 or 40 the year before."
"Fair enough. Give some back when you start to question some of the growth drivers. Fair enough. We're in the question phase right now. Some questions were most recently, is this the beginning of a credit cycle? Uh, because if it's the beginning of the credit cycle,"
"That is a problem for managers that manage anything, let alone a lot of."
"Let alone companies that lend a lot."
"Correct. Now, the first thing I started saying to myself recently was like, all right, let me get this straight. You have some concerns about private credit or credit in general. We're going to shoot the credit or the private credit stocks, but Goldman Sachs can be $800 and high yield spreads can tighten every day. That doesn't make sense. One of those things has to give."
"Correct."
"Okay. So then you peel back that onion and I think you're starting to get through this earning season and you heard nothing."
"By the way, just to go, let me just interrupt for a second. High yield spread. So just for the viewers who don't know, is that the spread between high yield interest rates and treasury rates? And if it's, if it's very narrow, which is what it's been doing, that means people feel good about credit. So, basically, what you're saying is the high yield market is saying things are all good and these stocks, the way they're acting, are telling you bad stuff is happening. The two cannot both be true unless your worst fears were true, which is not the case, but unless you feel like the public credit markets take reasonable risks and you're not scared and the private markets are taking lots of risk and made big mistakes and they're in trouble."
"Okay."
"I think we've gotten past that fear, but maybe not for some people. But that was maybe the original thought. And what was comical about that is we had a couple of bankruptcies, fraud-produced bankruptcies, but some bankruptcies in like First Brands,"
"Right?"
"And those were broadly syndicated bank loans and they."
"So public credit, private credit."
"Correct."
"And they chose to shoot the private credit stocks. But so anyway, there's some people say private credit, they basically mean companies like Blackstone, Apollo, who are making loans, loans that don't trade."
"Correct."
"Okay."
"Correct."
"So at first, there were some thinking that the downturn in the stocks were a reflection on what people thought about the credits that they were underwriting."
"Well, and the credit cycle in general."
"Mh."
"Because even if it was just a run-of-the-mill normal credit cycle, these, the private loans being made in through direct lending by the Apollo and the Blackstones and Blue Owls and the Ares, they are loans being made to sub-investment grade companies with say five or six terms of leverage that now have higher interest rates. You could understand that if we were in a, a, a slower economic backdrop with tariffs messing with certain industries, there would be some credit problems along the way. And if we had a credit cycle, more levered companies would have more problems than less leverage by definition."
"By definition. But what's interesting about this bank earning season so far, and we've gotten through a good 75% of it, is"
"Every bank said no turn in the credit cycle. The economy is resilient and the consumer is resilient. Every asset manager that manages these credits, same comments. I just hosted a webinar with Moody's heads of private credit and they are good and they said we do not see a turn in the credit cycle. So that doesn't mean we don't come off really low loss levels for the last 17 years and have higher loss levels. And that's what maybe some people are freaking out about because if I told you 1% loss rates went to 2% loss rates, not the end of the world. Some people say not the end of the world. 2% no big deal. Other people could say, 'Oh my god, loss rates are doubling.' Right? So, so it's how far the loss rates."
"So, let's get just a little stock specific. Um, I'm your client. You're coming to visit me in my office and we're talking about this group. What are your two favorites in the group and why right now?"
"KKR, number one, simple answer. In in private equity land where there's been a delay of monetizations and some companies not able to return capital to their LPs as much as they'd like. The way KKR runs their business. They've been a consistent returner of capital, consistently exiting their private equity investments. They've had a 2x return of capital versus most of their peers in the industry. They have a ton of dry powder. Their ability to raise more money and put up good returns is great. So, one of the Achilles heels for the industry is not as bad an issue. As a matter of fact, this quarter."
"So, we'll just let's just press it so people understand. When you say lack of monetization, basically what you're saying, private equity buys companies, runs them for a while, levers them up, and then basically either tries to sell them or most of the time take them public. And the IPO markets have not been great until this year. So the monetization process has been extended."
"Clients have been upset. I'll put some numbers to it to make it make sense. Um, a normal big LPs, big pension plans, sovereign wealth funds, endowments, they give a huge check to these companies and say, 'Make me more money.'"
"'Make me money.'"
"'Make me more money.' And by the way, a good for the last 30 years, a good private equity fund would take money in, put it to work over the next three or four years, help the companies be better over the next three or four years, and then sell them those investments, monetize them over the three or four years following them. You'd get."
"Eight, seven to eight year period."
"Yeah, let's call it 10 on average."
"Okay. And they would, a good return would be two, two and a half times MOIC, multiple of invested capital. If you give me a billion dollars, I'll give you back two and a half billion in 10, 11 years."
"Okay."
"What's happened is interest rates went from basically 0 to 5% in 2022. That's why the market pulled back 20%. And then eventually went up. But but."
"What that meant was the M&A market half shut down for three years. The IPO market almost totally shut down for like three years. Here we are at three years later and we're still trying to sell some of those investments. Some investments were bought at too high a multiple. Some investments were bought with counting on rates staying zero forever. Any way you slice it, some of those investments are worth less than they paid and so they're sitting there. So that 10-year return of capital."
"Is now pushing 12 and 13. And so the age of."
"It's going to be 12 and 13 and and and everybody knows it."
"Yes. And half the portfolio."
"Industry has taken a hit."
"In terms of its its returns."
"Well, you think if you're an insurance company or a pension plan."
"And and you have to pay money out to your either insurance clients or your pensioners."
"You need cash flow."
"Right?"
"You model that stuff. The the private equity companies tell you, I'll give you money back in over the course of year seven, eight, nine, and money's not showing up, but you're still doing out. All of a sudden, you're overallocated to private equity. You have cash flow issues. Now you're mad at your manager and you say, 'Give me money back.' And they're like, 'We're trying. The market doesn't want to buy my stuff at the price I want to sell it.'"
"So, who's hurt you? Who do you think? So, you said KKR has done the best because they've been able to sell stuff. More normally, who do you think's taken the biggest hit here in terms of returns in amongst the big boys that you cover?"
"Well, I'll answer that, but what I'll tell you is is if there's two to three thousand private equity managers in the world, the some of the best 12 are the ones that got public, right? So, a lot of times public asset managers outperform the the average and not always, right? There's plenty of small managers, but when you look at the weighted average basis, some of the biggest managers."
"But amongst the big ones, who do you think's been hurt the most?"
"It ebbs and it flows. I would say that if you look at the multiples that some of the companies trade at, um, Carlyle had a period where their private equity returns were waning a little bit and their return of capital was hurting and that hurt their stock price. And now they've actually improved performance right about to the what I would call the Mendoza line. You know, these companies think two and 20 above an 8% hurdle. Meaning they'll charge, they don't charge 2% but they'll charge a base management fee. They'll charge, they'll get 20% of excess returns over a hurdle rate, usually in private equity, and it's 8%."
"Right?"
"So the client is more than happy if you outperform my 8%. I'll give you 20% of the profits above that over the course of the fund. And so some of their big funds are right at that hurdle rate. And that means."
"Carlyle."
"Who's below?"
"Um, actually, first of all, they manage a lot of funds and so it's hard. I don't think any of the public companies, the big public companies that are big in private equity have many, if any, funds below the hurdle rate. It's more of let's let's dial back. Why does anybody pay really high fees and lock up their liquidity for 10 years at a time with these private markets managers? Answer: non-correlated returns that are better than what's available in the public markets. For 30 years, the private markets industry was able to do that in private credit land. Despite whatever you're thinking in the headlines, they continue to outperform the public markets in credit land."
"In credit. In credit. In equity. Since interest rates went up in 2022, it's been impossible to beat the Mag 7 and their influence on the public markets, right?"
"So, private equity doesn't look like the best kid on the block right now."
"Yeah, but it depends what your time horizon. If you think Mag 7 will grow to the moon, just buy the Mag 7. You're good, right? If you if you want to keep doing it, just keep paying 60 times. It's fine. Private equity still holds a strong piece in the hearts and portfolios of big LPs like pension plans, sovereign wealth funds, and an increasingly piece."
"So, if we're talking private credit, let's talk about Apollo because Apollo is the king of private credit within the group. How are they doing?"
"They haven't reported yet. Just report tomorrow morning. Just so everybody knows, this is, um, we're doing this interview Monday, November 3rd in the afternoon and Apollo reports tomorrow. We have no inside information. We have no idea what's going to happen, but just tell us how you think they're doing."
"Okay, the the let's do the short and the long. In the short term, they've been, um, had disappointing spread-related earnings that they make from their."
"Private credit and their insurance company, right?"
"And that has been a function of rates have come down from their highs."
"Right."
"And credit spreads are really tight."
"Yeah."
"And the insurance industry, actually, thanks to them, has gotten smarter about how to manage their portfolios and there's more competition. So instead of putting up double-digit growth in like they hoped, they've been 5% this year. That's the disappointing side. Not the end of the world, but definitely not what people expected."
"Correct. Definitely not expect, correct."
"Now the reality is."
"They really have helped the world appreciate that the superpower of asset management is long duration liabilities. And that right, if someone, if insurance, if people take out insurance of any form, life insurance, say I hopefully will live 30 more years and I pay premiums and they invest that money."
"Mhm."
"They don't have to give me that money back until someday when I pass."
"Right."
"And so they have that use of that money for a long time. I think Apollo at the top of the list has helped the world understand the more interesting things you can finance with a long-duration balance sheet and that's everything in private credit land, but it's now increasingly data centers and digital infrastructure, um, and other long-dated projects that are best in the hands of a long-dated balance sheet, not overnight funds at a bank."
"Yes. And and so they've helped transform the private credit industry, not just making a direct loan to a private company. If Chuck-E-Cheese needs money, it's a private company."
"Um, they can borrow from a bank."
"But they're financing projects now."
"And now they're financing big projects, big solar and wind farms, big digital infrastructure, big power. And by the way, that's a, the regulator should like and want this. Think about why a bank, right, you taught me this, that why is a bank regulated? Because they have overnight funds for deposits."
"And they make long-term loans."
"And they make long-term loans and they do that on 10 times leverage. They should be regulated. Um, these a lot of these funds, if you have long-dated capital, you could make the same or shorter duration loans on a lot less leverage. That sounds better for the system. Like a lot better for the system. And so banks might want to lend to those companies instead of lending one loan at a time. And that's just I think that's just that's."
"You think Apollo was the stock that has done, not so, has gone down this year because of the spread income being punkish?"
"That is that is point number one."
"Right?"
"And point number two, to some degree, is if if we do have more credit losses, no one's talking about some company that manages fixed income mutual funds having problems."
"They're talking about Apollo."
"They talk about Apollo. Why? Because half their balance sheet is on their balance sheet. Right. Right. That insurance comes on their balance sheet. So first and foremost, less earnings. Second major."
"But you still like the group?"
"I do like the group. I believe in the power of long-duration liability. I believe in the diversifying component of private markets. I believe private markets are a way to build good, durable, diversified portfolios. And that's what the LP wants. And I believe in in pockets of private markets, you can create real alpha. So, just to conclude, I've had guests on this podcast who when you bring up private equity and private credit, they go insane because they, they, you know, they say this is where it's all, this is where it's going to happen. This is a disaster. And I keep saying, yeah, there's been a lot of growth, but there hasn't been any problems. So, you know, until there's a problem, there's no problem. How about this? 86% of companies in the US with 250 million or more of revenues are private. They can finance themselves in the private markets and stay private for a long period of time, if not forever, because of people like Apollo."
"Correct. And so if you want to get exposure to companies like Uber or OpenAI or other companies that are private and are private for a long time and grow, you either wait for them to be public at 80 billion or 100 billion valuations or you find private markets managers that can get you exposure and I believe in that over time."
"Okay, let's switch gears. Let's talk about the big boys. So, I'll go earning season was great. You know, everybody reported good numbers. The credit was fine. Um, I'm more interested in talking about some of the CEOs. So, let's talk about first, um, David Solomon, CEO of Goldman. So, what I like to say about David Solomon is peacock today, feather duster tomorrow, peacock again. So if we were to talk, if we were sitting here two years ago, his reputation was in the toilet because, well, you'll tell us why. And today everybody loves him. So let's start with why was his reputation in the toilet and what has he done since to restore the reputation?"
"Okay, I'll answer your question."
"And that was like front page news that his reputation was in the toilet."
"The press was loving it. Um, the Goldman Sachs was and still is the best, if not one of the two best investment banks on the planet."
"Morgan Stanley."
"And its investment banking and its trading platform are amazing and somehow they get amazing every year. But what I think the company, and by the way, this started a little bit before David took over, but he and he took it over."
"They took it on."
"Yeah. They decided if we continue to conquer the world of investment banking and and and trading, where else are there large pockets of fee pools that we think we can apply what we do best and risk manage, lend money, intermediate trade, and they decided the consumer business was one of those."
"Let me just pause you for a second. I also think the reason why they did this is the regulators didn't like their business and didn't like their business mix and so they were trying to develop something that would be like steady Eddie so that the regulators would like it and they found this consumer stuff. Go ahead."
"I say a lot of things about you."
"Yeah."
"All the time and one of them is you are the forest through the trees guy. My whole life and that is that is that is spot on. Right. Um, that I'm sure had some piece to it."
"I'm sure Lloyd Blankfein felt the regulators were breathing down his neck and he needed to do something."
"Yeah, they and there's nothing wrong with wanting. If you go."
"I'm not being critical. The regulators were breathing down his neck."
"Now, despite probably most of their partners and most of their shareholders saying."
"No, don't do that."
"They're like, great, we should do it. Um, so tell us what, tell everybody what they actually did because it's so interesting. It's like it's a real case study."
"I mean, part one was actually great."
"Y."
"Okay. They took on an online consumer deposit platform that gave them low-cost funding."
"They just raised deposits. That's it. That's what the original business was."
"Raise deposits."
"And instead of having wholesale funding, you could have some cheaper deposit funding. God bless."
"Right."
"Um, what you do with those deposits is is then."
"Another story. And so they started to grow a lending business."
"Um."
"And what kind of lending business?"
"To lend."
"What kind of lending business?"
"He asked with all the knowledge in his head."
"Uh."
"Please tell us."
"You know, lending to people that you might not want to lend to. In some cases."
"Priming, maybe was it installment loans?"
"Near prime installment loans, right? Like things, by the way, that that many consumer finance companies can run at good profits."
"Right?"
"But but definitely not mostly prime, definitely near prime and below prime and."
"Something Goldman Sachs has never done in its entire history."
"With all due respect, correct on the consumer side has done their entire lives. Only commercial on the commercial side. But there's a different money to non-investment grade companies, right?"
"So the joke I had about it was when you would speak to them about it, you know, like you'd say, you know, you're making consumer loans and it's a primy and I'm nervous about it. I think their response was basically something like, we're Goldman Sachs. We're really smart and we know what we're doing. And my response to that is there's a graveyard with tombstones of companies over the last 25 years who have literally said exactly the same thing."
"And you had zero price targets on all of them when you were a sell-sider. I remember. Um, okay. So, so fast forward. So, they started and they and they also did the, um, the Apple credit card."
"Which was by by the way, which was part of this whole broaden, um, broaden the platform and bring a more durable set of revenue to the firm so we can increase the floor of ROE. Like the concept is fine. It's the, the, the medium that they chose to do that with is not what the world wanted them to do it with, right? Uh, and so long story short is, is tried that for several years, sunk a bunch of money in and decided at some point, you know what, not working. Let's wind that down."
"Um, and David said something at one of the conferences that I completely agree with. He said, companies have to take some chances. Companies have to think about certain strategies and and not every single one of them is going to work. And when you decide it's not working, you can pull the plug and move on."
"Okay. So, they pulled the plug."
"Yeah."
"So, here's my question."
"Mhm."
"If you had to lodge, and we'll talk about David Solomon's reputation, how we restored it, but if you say to yourself, okay, we wanted to create a business that was more durable, so our ROE would be higher and less less volatile, and now we just got rid of it. So, it feels to me like we're back to where we were before this whole process started, which is fine. You know, it's an incredible investment bank, but you still have the same problem."
"Or don't you?"
"No, you do."
"You do."
"You do. You're you're you're cyclically exposed."
"Right."
"Right. Now, so what are they doing to address that?"
"I'd like to say it simply as they're trying to be an even better version of Goldman Sachs. And there are a couple things working in their favor or that make it a, a, a easier story to digest. There's still work to do. Trust, but the stock's not $800 just because we're in a good part of the M&A and IPO cycle, fingers crossed, come next quarter. They want to reduce the capital intensity of the firm. They want to continue to be great and invest in any of the white space across investment banking and trading that there are not already number one and two. And there, believe it or not, are some spaces to fill in there."
"But asset and wealth management is the key to this story. Reduce the capital intensity, which means sell off like the private equity that's on their balance sheet."
"Raise more capital. You know, they're one of the top 10 asset managers on the planet Earth and really good. They're just margins aren't good enough."
"You know, it's interesting as you say that if they had, um, 10 years ago."
"Not done this whole consumer thing, correct?"
"Had sold their positions in private equity and just raised a lot of funds, they'd be much farther along than where they are today."
"Don't shoot me, David, if you're watching this. But you know what we'd call them?"
"What?"
"Morgan Stanley."
"Right? We call them Morgan Stanley without the retail brokerage."
"I'm with you, right?"
"But but Morgan Stanley did an amazing job on on."
"Hats off to James Gorman. Unbelievable."
"Unbelievable."
"Unbelievable. And and that firm is now over half the company's asset wealth management."
"Right?"
"Um, and so."
"With a 23% ROE versus a 15% ROE right now."
"So back to your point, yeah, Goldman Sachs plans on being a lot bigger in asset and wealth management. Uh, in asset management, it's happening as we speak. Markets going up helps plenty, but is what it is. But then that that actually so that those assets compound with the market. They have many good products on that platform and they're half a great private markets manager. I mean, in private markets alone, like we just talked about Blackstone and Apollo and KKR, I mean, they're an excellent secondaries manager. They're an excellent private credit manager. They're half of a private equity manager and they have to build or buy their way."
"You took Goldman Sachs private equity, private credit business and measured it against a Blackstone or Apollo, where do you think they would rank more or less?"
"Um, they're that standalone business. So, so they're what they're missing is infrastructure and real estate."
"And they're pretty good in equity and really good in credit and secondaries. I mean, they're they're they're not like any of them. And and a lot of this was done on their balance sheet and less of a third-party business. So, they're transitioning to that. Okay."
"But but it's big. It's as big as like an Ares. Okay."
"They're they're large and they have to get more profitable."
"Uh, and they have to build out some of the silos that they don't have yet. And I think they should buy their way into if they can find partners to do that. And if not, do it organically. But let's switch gears."
"Yeah."
"BFA."
"So that stock has sort of, I mean, it's done okay this year, but it's kind of languished over the last couple of years. For viewers who don't know, why don't you tell them the the Silicon Valley like bet that Bank of America made? How is it hurt? How would it hurt them? And what do you think about the stock right now?"
"Because most people have already forgotten about this, but it's important to reflag it. They're earning five or 600 basis points less than the mighty JP Morgan in terms of return on equity."
"Correct."
"So just everybody knows, JP Morgan's return on equity this quarter was 20%. Morgan Stanley was 23."
"And Goldman, BFA, and Wells Fargo were all in the 15s."
"Correct."
"Okay. So you're saying there's 500 basis points difference right now between JP Morgan and Bank of America. And now you're going to tell us why."
"Yeah. So, I'm going to oversimplify it. There's many things that go into it. And it's hard to compare everybody to JP Morgan because JP Morgan is an beyond exceptional company. Yes, it is in every way and everything they do."
"So, it's tough. Um, so the answer is when interest rates were really low during COVID and a little bit after, and a little bit after, there was lots of deposit fight and and Bank of America and JP Morgan are excellent retail banks and they took in."
"So they took in tremendous amounts of deposit because people were scared to death. They took their money and they said, I'm going to give it to Bank of America and JP Morgan because I know it's safe."
"Correct. And even before that, they were also smartly building out their branches in in markets that they went crazy."
"But it went crazy. So they took in a ton of deposits."
"Right?"
"And rates were low."
"And every day you have to decide, well, what am I going to do? If I have two trillion deposits and one trillion of loans."
"Do you invest?"
"Can't make one trillion in loans overnight."
"Correct. Correct. And there's not been a lot of loan growth still."
"Right. Um, and so, you know, look, they're not alone. Some banks sat on their excess deposits because they thought investing in sub 2% loan securities was stupid. And."
"That was JP Morgan."
"Yeah. And some banks, BFA and others, plowed a ton of money into treasuries and agency securities with literally sub 2% interest rates. Well, that's what sunk Silicon Valley."
"And then lots of things."
"Lots of things. That was part of it."
"That was part I'm not saying Bank of America is going to, there's going to be a deposit on it, but that was part of what happened with Silicon Valley. How big was this? Was this, was this amount they put in long duration?"
"About $600 billion."
"600 billion."
"Yeah. Now, they got a lot of billions, but but that's a lot."
"And and and it, you know, you barbell it. Some of it's short duration, some of it's long duration. And so now interest rates go up from zero to 5%."
"And all those securities are less desirable."
"Not less desirable. You got negative. It's ne you have a negative spread on some of them."
"Yeah. Yeah. You go negative mark."
"Right."
"Right."
"They're trading below par. But but."
"You're still going to get your money back."
"You're going to get your money back. So, just to clarify, what it basically means is if they had done what JP Morgan did, which is just basically hold the money in very short-term securities, waited for rates to go up and then deployed it, Bank of America's return on equity today would be several hundred basis points higher."
"Yes."
"And they're stuck."
"Yep."
"With with these long duration, it's a slow grind. It'll take years to get work itself through. Now what's interesting about that right, and what this is the difference of picking a stock versus anything else is what makes markets is okay. Now, now we all know."
"Now we all know and the stock underperformed."
"And every day going forward."
"They have a better shot at growing their net interest income than just about any other."
"Because this stuff rolls off."
"Yeah, because the stuff rolls off and they're still a really good bank. They made a bad decision."
"But you know what? Everybody's entitled to make a mistake. They are."
"Yeah. So, you did a good job of pointing out Goldman's one mistake and BFA's one mistake."
"All right, let's switch gears again. So, let's talk about City, which is the best."
"There's more than one mistake."
"Yeah. Yes, which is the best performing large bank stock in the bank universe this year. The stock is up well over 40%."
"Half tip to CEO Jane Fraser."
"So let's let's spend a little time here. She, how many years ago did she become CEO?"
"Three."
"About then."
"Okay. So what has she done during those three years and what have been the results of that? So, let's walk people through because it's it's complicated."
"So, whatever is above the hat tip, I want to do the above the hat tip to Jane because if you asked me the day before she got the job, what do you think City should do? I would have said the worst thing they could do is give it to someone internal. Like, enough of this. This has been 15 years of mess. Let's get an outsider. And they brought in someone."
"To break some shells."
"Right. And she came in and broke whatever eggs she needed to break and make what she thought were the right long-term decisions and getting rid of hobbies and getting rid of places that they have. There's no such thing as a global consumer business with big synergies and where they had 100 countries with 2% market share. Who cares? Right. Like and made some really important decisions that I just didn't think an insider was going to be."
"So tell us some of the things that she did. She actually did. I mean, the one that really stands out for me is is exiting, you know, markets, consumer businesses like being a local bank in all these countries to where you had one and 2% market share."
"She exited."
"Exit hobby, losing money, just not worth it, not going to waste another hundred years trying to get to 4% share, right? So."
"So that frees up."
"That's crazy because."
"That was City's strategy for decades before Sandy Weill. That was their strategy."
"That's like Steve Eisman not having an opinion, right? Like."
"No, seriously. When I looked at City in the '90s, they had the, they were all over the world in retail banking in in, you know, Malaysia, Indonesia, where they had little market share. The interesting thing about the Goldman Sachs conversation to the City conversation is she went back and said, 'Who are we? What do clients, institutional, retail around the world look at us for? Let's focus on that. Let's get rid of everything else. Simplify the business, fix the systems, fix our relationship with the regulators.' That's a big piece of it. Um, and then focus on the businesses that matter most."
"And and roll with that. And that will improve our returns over time. And so."
"Okay, so now I'm going to be, I'm going to be a little critical. So, I think she's doing a great job. Um, so for those of you who don't know, until like yesterday, City was the only large-cap bank selling below book value, tangible book value. And the reason why it was selling below tangible book value is that its return on equity was like 7, 8%. And this quarter was close to 10. Another hat."
"Um, but here's my critique."
"Okay, so she's cleaned house. So now the question is, what's the house? And here's why I'm going to be a little critical. I'm curious what you think about this. So they, to me, there are four businesses now in City. One is what's called the treasury business, which is a global, basically payments business where you're the CFO of Nestle."
"Nestle, and you got to pay a bill somewhere in Indonesia or you got to send money to your division in Malaysia. You bank with City because City is all over the place. It's the biggest treasury, I think it's the biggest treasury business in the world, and that's what you do. It's a global payments business. It's a great business. Put that aside, and it's not a capital-intensive business. Then you have an investment bank, which is in my view, mediocre. It's not, it's certainly not top-tier. It's definitely at best second-tier. Um, you've got a large credit card business, but it's a credit card business that hasn't grown in 25 years. And you've got a retail branch system in the United States, which is basically New York, Florida, couple of other places, but."
"Six cities."
"But it's six cities in the entire good old United States of America. It's a subpar retail banking business. So you've got one good business and you've got three businesses which have been struggling in one way or another for years. You're Jane. A, do you accept my, do I."
"Let's play a game show. Do you accept my description of the company first? And number two, if you accept my description of the company and you were advising Jane Frasier, what would you tell her she needs to do and how to do it?"
"That's a tough one."
"The first one's easier. Third one much easier."
"The first one's easier. I would say they would add in, don't forget our private bank and wealth management business, which is you forgot because it's a little forgettable. Yeah, because it's small."
"But they want to grow it."
"They want to grow it. So, but everything else you said is fair game."
"Um, and that's the difference between picking companies and stocks because for years I have not recommended City on the basis of what you just said there. I can I can play capital markets with stronger capital markets companies."
"By the way, your your one of your competitors, Mike Mayo, if you woke Mike up at 3:00 in the morning, you said, 'Mike, wake up.' He said, 'I'm still recommending City.' That's what he, that's what he would do."
"Yes. Yes. Look, like I said, picking stock this, like you said, it's best performing stock this year."
"Yeah. The businesses can all improve. I mean, their their treasury and security services business, their global payments platform, all king aside, if you're Nestle and you got to finance cocoa receivables in 50 different countries, like how anybody, but there's not a question."
"Yeah, and they have 80 trading desks across the world in 80 countries and if you're a global FX player and you want to transact in FX, you're using City. Their FX, their rates, their local markets business, their emerging markets business, treasury, it's the other problem children. What do you."
"Correct. Look, you."
"This is where it gets hard, by the way. Cleaning house is gutsy."
"Yeah."
"Because there's tradition and you're and she, she's internal and she had, I'm sure it was bureaucratic warfare at its tip. Again, she did it great. Now."
"It's you got to actually improve operations."
"Yeah. And and they're they're doing the technology transformation side in conjunction with fixing their relationship with the regulators, making sure they don't send $900 million to the wrong bondholders anymore."
"You shouldn't do that."
"No. Um, so that stuff is happening in terms of growth. They've benefited, as all my companies have, from a great market backdrop. Think about this. Um, we've added in the last 10 years, we've added like $110 trillion dollars of market cap across equities and fixed income. Um, market volumes are up a lot."
"Um, and there's all this capital markets activity. So, rising tide definitely lifts a lot of boats and they've executed good enough on there to to participate. They've take they're in the process of taking out costs and fixing their systems. They're they're investing a little bit in trading and investment banking, right? They hired JP Morgan's head of the investment bank. He brought some people over with them."
"Right?"
"Wealth. They hired a team, um, that's good from other wealth management platforms. It's going to be hard to buy people or buy companies. They're not even probably allowed to buy anything without a mother may regulator."
"So, and in the, you have six cities in the retail bank, you can't buy, buy a bank. You can't open branches because you're managing expenses. We're at a very, very tough point in time of how do you grow? How do you compete? How do you compete in a retail bank against much bigger and diversified and better funded banks? How do you grow wealth without being able to buy a company and or buy people to grow your way? This is not, this issue about retail banking is not like an academic exercise where you just say, well, you don't have a great retail bank. There are real implications to this because you got a very large company with a subpar too small retail bank. It actually hurts the company's net interest margins by a lot."
"Yeah, no doubt about it. And might make you have to find wholesale funding or other funding than just core deposits. I mean, they get that through their wholesale business. Uh, and then even from a mix of business, they've made some progress in in banking and trading, but they're just trading alone is about a third of the company's profits."
"Right."
"Right. So then you also have to be cognizant of not letting the company be too lopsided and be too prone to cyclical, you know, changes. It's tough. It's tough sledding from here."
"Very tough sledding from here."
"Okay. Um, let's switch gear again. I I want to talk about asset management and I want to talk about tokenization and I'm going to get a little excited. Okay. So, number one, you're going to explain to everybody what tokenization means because I don't think there's one in two million people who can explain it in plain English. God willing, you're one of those people. And the second thing is, if I even understand what tokenization is, like I can understand someone arguing we're going to tokenize the rent rolls of that building there, which is not public. And so we're going to basically tokenize it, which is a basic basically way of saying we're going to take the cash flow and for every token you buy, you get some of the cash flow from a building that's not public. I'm all in on that. That I get. That's that's a different asset class that you don't have access to now. But they're talking about tokenizing stocks, tokenizing bonds. These are public markets. Like, like, you know, the other day I bought a stock. I'm a client of Schwab. This is not an advertisement, by the way. I go on the, I go on the Schwab system. I go to the stock. I put in how many shares it takes. This literally takes about 35 seconds. I press go and two seconds later, I own the stock. Tokenization does what? Like, can I add to that, please?"
"You could trade pre-market, pre-market right now. You can trade post-market right now."
"Right?"
"And any liquidity there? No."
"Even during the trading day when all the professionals are working, a huge chunk of the volume is taking place at the open and the close."
"And close."
"Right."
"So we need 24/7 global trading."
"Why?"
"Why?"
"Right. Now you can get into. Tell everybody what. Let's do a simple definition to for your understanding. What is tokenization?"
"I think I think you described it well. I think you can you can digitize what was long time ago a manual process. My first job was in the vault of Chase Manhattan Bank, right? Like you actually had."
"Papers."
"Papers, bond certificates."
"Um, so that went from there to DTC to electronic, but there was we went from T plus three settlement, trade date. It took three days for."
You to get to money. So if I sold you my IBM stock, it would clear three days. Three days I would get my money. Then we went to T+2. Then we went T+1. And so someday the world will take us to real time, immediate.
Now, what's interesting about that, right? And so, by the way, without needing any of the the the specifics, tokenization could just get you to a place where everything is real time. Okay. Now, you as a consumer don't care. I don't care. I know you don't care. And you that might be all we have to say, right? But all I care about is putting my order into Schwab and see it go through. Yeah. And it shows up on my screen. That's all I care about.
I I understand. Right now, I can trade, let's say, at one of the banks where I bank. I I can go in and out of my checking and my savings all day long. And if I want my money market cash, it's a separate brokerage account, and I have to call my adviser and have them move the money. Okay. That sucks. Tokenization might speed that up, right? And so tokenization can can theoretically speed up everything related to settlement. It could make everything bulletproof on on on safety and soundness. Okay.
So really, it's a the problem is what you're saying is a back office issue. What you're saying is that that tokenization for for stocks, bonds, and money market funds would dramatically improve the back office operation to make it faster. But that's not people think tokenization is something else that that it's like this. It's going to be this new sexy way to to buy stuff.
Well, well, let's there are a couple of things. One is you're correct. There's a clearing and settlement back office component. Mhm. Two, we can talk about what that means potentially for the future. Banks make money on float. Float is I have your money for a period of time before I give it to somebody else or back to you. Um, if you improve the technology and tokenization to do all that stuff, gives you [ __ ] Well, maybe you don't make as much money. That's possible. Possible. Possible. Um, and and then and then you can get into payments, right? Because banks, I don't know, you've been to the airport, how much did they charge you to change currency, right? A lot. 25% V. Well, this is where stable coins come in.
So, so technology, whether it be tokenization or stable coin, those things can eat at the the current payments and settlement landscapes, possibly banks are investing plenty. Um, you at the end of the day, all this stuff says, okay, you you say why? Well, some some some people in the younger generation, not just solely the younger generation, people doubted a place like Robin Hood or some of these digital wallets. Some of that was literally just about being able to access Bitcoin and other cryptos. But, but now you have a digital wallet. Um, you can you in a tokenized world, you can do everything right there on your phone or whatever your digital wallet you're using. Some of it is just evolving usage patterns. Some of it might be corporations wanting to access this cleaner set way of of settlement and and again have access to their money quicker in real time. Um,
Okay, let's change gears one more time. So I said at the beginning of the group was the good, the bad, and the ugly. So the ugly was private equity, but it'll come back. The good was the big boys, Goldman, Morgan Stanley who are doing great because the cycle is so strong. And the bad pretty consistently has been traditional asset managers leaving BlackRock aside which obviously is a fantastic company special within the group. Let's talk about what's going on for years now. By the way, the traditional asset managers was the first group that I picked up as a sell-side analyst in the 90s. Did you want ask me why? Because they were trading at 25 times earnings. That is not why. Why? The reason why I picked up coverage of the traditional asset managers was I was learning everything by myself. I barely knew how to model companies and I figured these are the easiest companies in the world to model. Even I can model them. So I picked up coverage of and then as I did research I said wow this is an incredible business. But the problem is back then basically what you would model was how much does the market go up every quarter? You'd have like a little percentage and then you would model flows. That would give you ending assets under management. Then you do average assets under management. You'd multiply it by the last quarter's percentages of average assets under management. Bada bing, you have the quarter. You could model that out for 30 years in two seconds. That's literally why I picked up coverage. So now the problem is you could model the market, but every quarter they lose assets. They they have outflows. So tell us what's going is there anything good going on in traditional asset management? Some talk to me.
By the way, you notice the first group I picked up in the late 90s which was what? The e-brokers. The second group though that I picked up was the asset managers. Um so what's interesting is is by the late 90s traditional asset managers traded 20 to 25 times earnings. And the reason is because they were growing 20 25%. And they were growing organically and they were growing organically not just the market they were gathering assets. And I'll tell you what because there is a correlary to what's going on today in private markets. But back then in the I remember what got me really excited when I started doing the research. In the mid 80s only 5% of US households owned a mutual fund. By the mid to late 90s, 50% of US households owned mutual funds. Okay. That's called a lot of organic growth, right? And that makes investors very happy and they pay big multiples for companies that can grow organically, right? Um, look at AI, right? So, so unfortunately I can speed up the history. Eventually, one of my favorite horrifying statistics, eventually there were more mutual funds than there were stocks. I remember that statistic. Crazy, right? Um now there's more ETFs than there are stocks too, right? What happened is because of that lots of competition. Um it was harder to produce above index returns, right? And at the same time, indexes took off technology. And I like describing it like this way because it's like any other industry in the world. Eventually technology comes for you and technology came in the form of an index fund and then eventually an ETF which in plain English allowed you to access index returns for a really low fee and much lower than a mutual fund. Much lower. So anywhere from 5 to 15 basis points. Depends where you access and what type but five you could pay five to 15 basis points. Never underperformed because you'd always be in line with the market versus versus what it started out as 60 basis points, then 50, then 40, then 30 for an actively managed fund, which unfortunately they're charging 30 basis points now at a mutual fund to actively manage your money. That's it. Wow. I mean, in the 30s is the average, but and falling. Wow. And unfortunately, the overwhelming majority of active managers weren't able to beat the index on a consistent basis. You might get it this year, you might not get it next year, right? And any five-year and 10-year, it's really hard. So for the last at least 10 years, the US mutual fund industry has lost about $300 billion a year of out year of outflows of outflows. And just by coincidence, net outflows or gross outflows, it's out of equity, it's net. It's it's money gone. Okay. And not by coincidence, the US act uh ETF industry has taken at least that much in maybe more.
So what's happened to the multiples of this group? It used to be a 25 times. Where are they now? Uh you know nine some get 10. Now I think they call that margin but called it multiple compression. Yeah. Yeah. People don't want to pay for beta meaning the market. Remember when you told us about your how you modeled you said how much is the market going to go up? How much are they going to grow organically times a fee rate and I get my revenue? Um, people are not going to pay any multiple because the market went up, right? Because they can get that in an ETF. Correct. What's interesting about that, by the way, that's hard to argue against. Very um except these strong long-term companies that have been around forever that are public, most of them, their assets do grow with time. And as much as you don't value that, the market goes up over time and some of these companies are managing one and two trillion dollars and are able to put up 30 something% margins. Um there is some operating leverage component but still people don't want to pay for beta, they want to pay for alpha, right? And it's harder to find. So these companies some similar to the rest of our discussion so far they they've all woken up at different times and realize that they have to evolve. Uh some have been at it for years and some have
Who's been at it the longest? I mean BlackRock BlackRock clearly but Leslie BlackRock aside the different animal. It's a different animal but let's and then I'll go next. They were early and in 2009 saw what just happened and some banks around the world needed money and they decided to pay a high multiple for BGI which is today's iShares ETF business. So that took vision, that took guts, it certainly did and it helped them transform. Before that they bought Malim from asset management from Mel when they were selling their asset manager. And so through a series of events they became this it right in one of one.
Okay, let's go let's go next level. It doesn't always work or sometimes it takes time. Invesco has been very hard at work for minimum 10 years maybe longer. at trying to build out and diversify the company into other asset classes. The the problem is is your backbook, right? Your old business that's decaying in that world we just talked about, it unfortunately is constantly decaying it decaying for everybody active equity unfortunately at the top of so um building a big they're the number four ETF business on the planet. They they bought up some of the smaller players around the world to get to the number four spot. uh they have an SMA platform. They built a a an asset management business outside the US and China which is an excellent local um markets business that grows a lot. Uh they now have active ETFs that they're layering. They have a partnership um w with some insurance companies like I mean it is you like Invesco. I I like how hard they've worked to make the company and they still have a backbook. They are now organically growing at a high rate. Um, you know, they they have the QQQ's which they were making no money on that. They're in the process of rewriting that contract to make money on. Uh it's it's it's it's finally starting to hum. But clearly the way you describe traditionals unfortunately they're still building digging out of their legacy build business and evolving the platform.
Okay. Um how's Franklin doing? You know next next next time we do this we can have that same conversation that you had about Jenny about Jane Fraser about Jenny Johnson. She's did a great job since taking over from her dad and her brother right um to helping that company evolve. They've used a lot of their capital and cash flow to start buying into the private markets businesses. It's working. Uh again, a back they've got that Western Asset Management scandal and yeah and unfortunately that hurt that hurt a lot. Uh and so they too are in the process of digging out from there. It's, you know, the the the common theme among this to to tie some of our previous comments together is is, you know, a lot of people gave Goldman heat for going down that consumer path, but what they were trying to do is see around corners and see where the world might be evolving and see where they could apply their their skills, right? And that I respect that the the traditional asset managers, many of them you could accuse of being fat and happy in the heydays and not seeing what was coming in in the business and not evolving quick enough, right?
I mean, how about this? How is it that Blackstone, KKR, Ares, Apollo, Blue, all these great companies have all these big broad private markets businesses? Not one of the traditional asset managers thought that might be a good thing to invest in. They separated that church and state and thought they'd be a part. And and again, if we had a hot tub time machine right now and we can go back 15, 20 years, you would have told him to get involved.
Okay, Glenn, as usual, thank you. That was very informative. Appreciate you for coming in. Really appreciate it. Thanks. Okay.
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This podcast is for informational purposes only and does not constitute investment advice. The hosts and guests may hold positions in stocks discussed. Opinions expressed are their own and not recommendations. Please do your own due diligence and consult a licensed financial advisor before making any investment decisions.
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