John Hempton on What's Ailing Bank Stocks

Tracy Alloway (0:06)

Hello, Odd Lots listeners, it's Tracy Alloway. Before we get to today's show, I have a bit of news. It's something I'm really excited about. Odd Lots is hosting its first ever live event on Thursday, September 19th in New York City. Join me and Joe Weisenthal as we host an all-star lineup of guests to talk about everything from white collar fraud to sovereign debt and much, much more. This will be a group of new Odd Lots guests plus a few old favorites. We'll also have live finance-themed music as well as drinks and just overall great conversation.

Details of the lineup are going to come out very soon, so keep listening to Odd Lots to learn how to sign up to see us live on Thursday, September 19th in NYC. Joe and I both hope to see you there.

Hello, and welcome to another episode of the Odd Lots Podcast. I'm Tracy Alloway. My co-host, Joe Weisenthal, is away this week.

I happen to be on a work trip to Australia. I've never been before, it's fascinating. I have big plans to meet a koala. But beyond that, I also happen to be in the country for a momentous historic occasion, which is the benchmark Australian bond yield dipping below 1% for the first time. I was also there when the Reserve Bank of New Zealand opted to cut rates by 50 basis points, which was something that shocked the market. Just a couple hours later, we had rate cuts from the Central Bank of India and also the Central Bank of Thailand as well. So, clearly, we are in another cycle of fresh monetary easing, and along with these lower yields and interest rates around the world come lower bank stocks. Bank valuations are trading at historic lows, partly because of concern about banks' ability to make profits on lending when rates are this low. And who better to talk about all of this than John Hempton of Bronte Capital, someone who's been writing about the financial markets for a very long time on his blog and also invests in them through a long and short hedge fund.

John, it's so nice to meet you in person finally.

John Hempton (2:38)

Thank you. I'm a little bit in awe of that requirement to speak about it generally because I like to speak about these things rather specifically.

I started my career in financial markets as a bank analyst. So once upon a time, I read more or less every bank account for every major bank in the world. And along the way, I decided that they were largely not very good businesses.

There are exceptions. There are extremely good oligopolies in some countries, Canada, Australia, Scandinavia. There are a few banks that have large captive businesses that should be very cheap to run. The trust banks come out. But as a general rule, most banks are not very good businesses, but they mask themselves as pretty good businesses most of the time.

Tracy Alloway (3:27)

How do they do that?

John Hempton (3:28)

Well, firstly, they're very powerful because they have access to large amounts of money.

And being powerful means that you just get a lot of press. Journalists seem to be too interested in bankers. The world seems to be too interested in bankers. The second reason is that you can deceive yourself for a very long time running a bank. Banks are quintessentially estimate machines. And thirdly, every now and again, they really are very profitable. We're looking at the moment at banks across the world, except in the United States, basically at 30 year low. A lot of the European banks, and it's not just Deutsche, 30 year lows. If you look at Sock Gen, it's at a 30 year low. If you look at Credit Agricole, UBS, the English banks, they're all at 30 year lows. And I live in a world of extremely expensive stocks. And so suddenly, I feel like I want to be a bank analyst again, just because, you know, these things look cheap.

So I've been puzzling myself a bit about bank margins for a while. Now, I'm going to lead you back to an article that was appeared in The Economist on January 15, 1998 And the article is just comical when you read it now, it's called The Lloyd's Money Machine. And at the time, Lloyd's TSB, as it then was, was the 35th biggest bank in the world by asset and the biggest bank in the world by market cap. Ten years later, Lloyd's was essentially UK government property. But this was, it wasn't ordinary profitable, it was ferociously profitable. To pick an example, if you look at the banks in the world at the moment and do say revenue to risk weighted assets, you see the Japanese banks at the lowest end and revenue is sub one percent of risk weighted assets. Then there are the German and Italian banks and the English banks get up to about two and a bit percent. And the English banks are in the order that you would expect with Royal Bank of Scotland being the thinnest and Barclays being the fattest margin. And the margin actually just matches the stock prices.