44 - Investing in Bank Stocks (WFC, CFR, ALLY, DFS)

Mental Models discussed in this podcast:

• Credit
• Leverage

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Show Outline: Bank Investing

The full show notes for this episode are available at https://www.diyinvesting.org/Episode44

Four Types of Banks for discussion:

• Wells Fargo (WFC) - National and Global Bank (ROE about 13%)
• Frost Bank (CFR) - Regional bank focused solely on Texas (ROE about 13%)
• Ally Bank (ALLY) - Online-only bank (ROE about 12%)
• Discover Financial (DFS) - Niche bank focused on credit cards (ROE about 26%)

The Business Model of Credit Card Companies

• Take in deposits and then make loans on those deposits
• A highly leveraged business model
  • Leverage is your enemy
  • Leverage is your friend
• Two ways to make money:
  • Bring in deposits at low cost
  • Make loans at high returns

Quality of the business:

• Driven by two factors:
  • Deposit retention
  • Cost of deposits
• Infinite durability - there will always be a need for banking services
• High switching costs

Potential Threats

• The high number of competitors
• Low-interest rates
• Competition on rates paid for deposits
• Liquidity crisis - see 2009 financial crisis
• Making bad loans - see 2009 financial crisis
• Too much leverage - see 2009 financial crisis

Summary

Investing in banks is an attractive proposition. However, banks also come with major risks. Even your most average bank operates at a very high rate of leverage. Leverage can be both a curse and a blessing. Unfortunately, you will have to do your research on each individual bank to determine how their leverage is being used.