Consider investing in large, well-managed banks, which have benefited from post-crisis regulations and industry consolidation. J.P. Morgan (JPM) stands out as a core holding due to its proven risk management and dominant market position. In contrast, be cautious with Bank of America (BAC), as its significant unrealized bond losses are expected to be a drag on future earnings. Another major growth opportunity is the private credit market, which has expanded as traditional banks pulled back on lending. To gain exposure to this trend, consider a leader in the space like Apollo (APO).

The Banking & Financial Sector

• The sector is much safer now than before the 2008 Global Financial Crisis (GFC). Post-crisis reforms, like the Dodd-Frank Act, forced large banks to massively reduce their leverage and take on less risk.
  • For example, Citigroup's (C) leverage was reduced from 35-to-1 before the crisis to around 10-to-1 after.
• An "unforeseen consequence" of these regulations is that the big got bigger. Stricter compliance and technology costs are easier for large banks to absorb, allowing them to take market share from smaller competitors.
  • J.P. Morgan's (JPM) deposit share grew from 7.4% in 2008 to over 12% today.
• The recent failure of Silicon Valley Bank (SIVB) was not a systemic issue but a unique case of a concentrated business model and poor risk management. It highlighted how smaller banks were not subject to the same strict liquidity rules as the largest banks.
• The regulatory environment is expected to become more favorable for banks.
  • The new Vice Chair of Financial Supervision at the Fed, Michelle Bowman, is seen as more friendly to banks than her predecessors.
  • Stress tests are expected to become more lenient, and compliance costs may be reduced.

Takeaways

• Bullish Outlook: The speaker has a positive outlook on bank fundamentals for the next few years, citing a strong economy, improving loan growth, and a stable credit cycle.
• Regulatory Tailwinds: A less strict regulatory environment could improve profitability for the sector.
• M&A Potential: The speaker believes more bank mergers are needed for mid-size banks to compete on technology spending. A potential change in administration could lead to a "kinder view of M&A," which would benefit investment banks that advise on these deals.
• Focus on Large Banks: The largest banks have proven to be the most resilient and have benefited from consolidation. They are better equipped to handle the high costs of technology and compliance.

J.P. Morgan (JPM)

• The firm was mentioned as the inventor of the Credit Default Swap (CDS), a key derivative in the 2008 crisis.
• During the crisis, JPM acquired the failing investment bank Bear Stearns for $2 per share with the help of a government guarantee.
• In the low-interest-rate environment during COVID, JPM was highlighted as a bank that prudently decided not to "chase yield" by buying long-term bonds, which protected it from the large unrealized losses that other banks later faced when rates rose.
• The company is a prime example of the "big get bigger" theme, having grown its deposit market share from 7.4% in 2008 to over 12% today.

Takeaways

• Prudent Risk Management: The discussion positions JPM as a well-managed institution that has demonstrated strong risk controls, particularly in avoiding the duration risk that impacted other banks.
• Market Leader: As a dominant player that has successfully navigated crises and benefited from industry consolidation, it represents a core holding for investors seeking exposure to the largest and most stable US banks.

Bank of America (BAC)

• During the 2008 crisis, Bank of America acquired Merrill Lynch in a government-facilitated merger.
• Unlike JPM, BAC did decide to "surf the curve" during the low-rate COVID period, buying long-term bonds to improve its earnings.
• As a result of this decision, the company now holds approximately $100 billion in unrealized losses on these bonds now that interest rates have risen.
• However, this is described as an "earnings problem, not a solvency problem." Because BAC is a very large bank with a highly diversified deposit base, it is not being forced to sell these bonds at a loss to meet customer withdrawals (unlike what happened to Silicon Valley Bank).

Takeaways

• Earnings Headwind: The $100 billion in unrealized losses will likely weigh on the company's net interest margin and overall earnings for years to come as the low-yielding bonds mature.
• Stability is Not in Question: Despite the large paper losses, the speaker emphasizes that the bank is not at risk of failure. Its massive, diversified deposit base provides stability. This highlights the difference in risk between the largest "too big to fail" banks and smaller, more concentrated institutions.

Private Credit (featuring Apollo)

• The growth of private credit is described as a major "unforeseen consequence" of the post-2008 banking regulations.
• As traditional banks were forced to de-risk and made fewer types of loans, private capital firms stepped in to fill the financing gap.
• Apollo (APO) is specifically mentioned as an example of a firm that has seen "explosive growth" by creating funds dedicated to making these private loans.

Takeaways

• Major Growth Theme: The shift of lending from the regulated public banking system to the unregulated private market is a significant trend. This presents an investment opportunity in firms that are leaders in the private credit space.
• Unregulated Risk: The speaker notes a key risk factor: this entire area of finance is largely unregulated. While no significant problems have emerged yet, some critics believe the "next crisis" could originate here. The speaker's take is, "We will just have to wait and see." Investors should be aware of the potential for future issues stemming from a lack of oversight.