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Tracking the consumer evolution of financial services

Archive for the ‘Profitability’ Category

Expedia takes a hard line with American Airlines (AA) | why this is critical for the next phase of ecommerce – UPDATED

This is a good thing.  The problem with much of ecommerce is that it places a nice usable front end on to existing infrastructure.  It does not necessarily remove intermediate steps and costs and usually adds a layer of cost.  Online banking is the perfect example.  That is the root of consumer frustration that online should be cheaper but is not.

Expedia stops selling American Airlines tickets |

American Airlines and its online partners have struggled for months to agree terms as their contracts expire. American wants to pay the sites less and has pushed them to connect directly with its own computers rather than using intermediaries called global distribution systems.

As you may know the travel industry all use a couple of intermediaries, with Sabre being one of the largest.   So when your travel agent looks up a flight for you they are looking at Sabre, not AA United or BA.  Why should Expedia connect to Sabre too?  Sabre take a commission.  If Expedia uses Sabre then the only potential saving for Expedia is the cost of a travel agent.  It does not lever the competitive capability of Expedia.  By suggesting the removal Sabre Expedia places themselves in direct competition with Sabre.  (Taking that further, travel agents could always link through Expedia in the future, but thats a different point.)

By integrating direct to AA, Expedia can properly lever AA’s information and do the same with the inevitable other airlines as they come on board too so as not to lose competitive advantage.

They key though is elimination of the transaction cost inflicted by Sabre.  This is the real value in ecommerce – elimination of middleman costs and infrastructure that was built based on human front ends, in this case travel agents.

Relevance to Bankwatch:

This is why I see BankSimple as a good idea but really a first step, and little different than say a PC Financial or mbanx (both Canadian – one alive, one gone).  It has taken Expedia years to build up the customer loyalty and volume to be able to take a strong stance with AA.  Can AA and the other airlines afford to not fall into place with Expedia will be the question for 2011.  Clout is one way to get inside an old industry.

Banks have their Sabres throughout in terms of independent payment networks, ATM networks, cheque clearing, EFT /ECH networks, credit card networks.  How can the BankSimples and other new entrants get past those and disintermediate and eliminate the real costs that layer on to become bank services charges.

UPDATE; 3rd Jan, 2011

There are always two sides to every story.  This from the WSJ indicates that it is AA who pulled themselves from Expedia.  The reason is partly  the same as above, ie to remove Sabre from the transaction, but also to remove Expedia too, and thus retain the commission for themselves.  WSJ speculate the idea is to get out of the cycle of competing on price, and introduce competition on features such as wifi.

Time will tell if they can retain market share this way.  At a minimum it will mean an enhanced internet service from AA and the logic above will stand, which is to remove middlemen costs that were built to support pre internet sales distribution.

Further update: Barrons takes my tack and has quotes to support it.  Maybe WSJ missed this one.

A story and a theme to follow with interest.

Written by Colin Henderson

January 2, 2011 at 22:03

The fragility of the banking system – the final 2 days in the life of Wachovia in 2008

There is a statement today …

Statement of John Corston, Acting Deputy Director, Complex Financial Institution Branch, Division of Supervision and Consumer Protection, Federal Deposit Insurance Corporation on Systemically Important Institutions and the Issue of "Too Big To Fail"

that contains some very interesting facts, and side from he bureaucratic commentary there is a real sense of incredulity that this is how big banks are managed.

The overall message is excruciating detail is one of rationalising insufficient regulatory oversight existed to permit the FDIC to adequately monitor the situation.  It describes the nature of onsite examiners at FI’s with greater that $10 Bn in assets (news to me) and how they were able to determine in 2008 with limited information that Wachovia was deteriorating do to increased bad debts but also doubts about derivatives which were being traded not as a hedge but for house benefit.

No surprises so far, and sounds like a regulator.  Then despite the bureaucracy no sooner than 11 + days before the demise of Wachovia, FDIC got excited that there was a problem despite earlier warnings.

In early September 2008, the FDIC became increasingly concerned with the liquidity condition of Wachovia. During the week of September 15th, following the Lehman bankruptcy, Wachovia experienced significant deposit outflows totaling approximately $8.3 billion, representing a mix of deposit types, but primarily large commercial accounts. On September 23rd, senior executives and staff of the FDIC met to discuss our elevated concerns with the institution, specifically noting liquidity concerns including considerable contingent funding risk and increasingly negative market views on the firm. The institution’s marginal and weakening financial condition made it vulnerable to this negative market perception.

This is the point where the detective work goes from years to minutes in detail.  Early September 2008, FDIC met with Wachovia executive regarding ‘elevated concerns’.

Liquidity pressures on Wachovia increased the evening of September 25th when two regular Wachovia counterparties declined to lend to the firm.2 Since the institution was a net seller of Federal Funds this signal was not viewed by the OCC as a catastrophic development. As discussed in the next section, the failure of WaMu was announced late in the evening on September 25th. As of the morning of Friday, September 26, the OCC indicated to the FDIC that Wachovia’s liquidity position remained manageable. During the day, however, market acceptance of Wachovia’s liabilities ceased as the company’s stock plunged, credit default swap spreads widened sharply, and many counterparties advised that they would require collateralization on any transactions with the bank.

So now over a 2 day period from Sept 23rd to Sept 25th Wachovia encounters counterparties to their commercial paper that will no longer lend to Wachovia, yet the OCC (Treasury) signaled all remains well.

Wachovia’s situation worsened as deposit outflows on Friday (26th) accelerated to approximately $5.7 billion, $1.1 billion in asset-back commercial paper and tri-party repurchase agreements could not be rolled over, and $3.2 billion in contingent funding was required on Variable Rate Demand Notes.

Then the final kicker.

On the morning of September 26th, before U.S. financial markets opened for the day, the FDIC Board approved both the systemic risk exception and the acquisition of Wachovia by Citigroup. This proposed acquisition included government assistance in the form of an asset guaranty on a portion of Wachovia’s assets in exchange for $12 billion in Citigroup preferred stock and warrants. The terms of the asset guaranty called for Citigroup to absorb the first $42 billion in losses on a $312 billion segment of Wachovia’s assets with the FDIC covering any additional losses above that amount.

… …

In the end, the Citigroup transaction was superseded by an unassisted bid by Wells Fargo to acquire Wachovia that was announced on Friday, October 3rd.

Relevance to Bankwatch:

The moral of this saga is the speed that a bank can disappear.  On September 23rd FDIC determined Wachovia was in serious trouble and September 26th Wachovia’s fate was sealed.  The speed of this is astounding and certainly speaks to the inability of the system to determine earlier that a problem was brewing.  But the FDIC already ranked Wachovia as being in trouble earlier in September (“FDIC became increasingly concerned with the liquidity condition”).  Surely some earlier activity could have occurred, especially since even this blog knew there was a systemic mortgage problem 18 months before Sept 2008!

For me this really speaks to the fragility of the banking system and the banks.  It also speaks to the lack of teeth that the regulators have, or are willing to exercise.  Its an obvious fact that banks operate at the convenience of government.  No legitimate enterprise could otherwise operate with debt to equity of 20 :1 +/- and survive. This occurs by virtue of the money markets and direct connection with the central bank who effectively manage the liquidity positions of banks. 

So long as that is the system there must be better co-ordination of information with the regulator so that banks are kept honest and do not get into the kind of house trading that made Wachovia a high risk market maker rather than a market participant.  This participation is high risk market activity not associated with basic banking is why Wachovia deserved to disappear.  The flip side is that banks create sufficient capital depth that they can operate independently.

Written by Colin Henderson

September 1, 2010 at 21:40

FDIC report on US Banks’ financial profitability confirm dire circumstances

These graphs extracted from the latest US FDIC quarterly report display the long term impact of the crisis on the US Banks. Their predicament has a much earlier lead time, and a suggests a far longer expected period for improvement to anything close to pre 2008 results.

People are in retrenching mode, and the consumer confidence and asset values that drove banking business volumes until 2007 are not returning in the near future, depsite the stock market growth which has occurred in 2009.

Loan losses remain 400% higher than the 2001/ 2007 period. when related to Operating Revenue.

Relevance to Bankwatch:

Banks have a double whammy of covering loan losses that continue to grow, and lack of new business growth on the retail banking side to help grow out of those losses.

Written by Colin Henderson

November 24, 2009 at 13:45

Posted in Profitability

Mullenweg’s Safe Bank Could not just Survive but it could Prosper

When Matt wrote his post the other day about starting a bank it got me thinking about the effect of what he is saying relative to profitability when we introduce a policy to be safe and carry capital reserves of 2 – 3 times more than todays banks.


– demand deposits = demand loans

– GIC (CD) = Mortgages

– incremental investment in higher returning mortgages is funded from cash

safe bank

Relevance to Bankwatch:

  • A $4 increase in gross profit results in a 15% higher Return on Equity when a lower capital ratio of 10% is accepted.  Note the stock market values ROE over absolute profits.
  • the increase in gross profit is not so much in absolute dollars, especially when we consider the additional risk taken on
  • the relative risk of Regular Bank is exponentially higher with $200 more in loans and $200 less in equity – thats a $400 differential
  • a 12% ($84) loan write down in Safe Bank is absorbed within the $300 capital, leaving them still at a substantial 24% capital ratio versus original 30%.
  • a 12% ($100) write down in Regular Bank eliminates their capital and requires FDIC takeover – THEY ARE GONE!

The basic question then is whether the Regular Bank can make up the absolute dollar shortfall relative to Regular Bank of $4 (20% of Regular Bank gross) by efficient operations, less /no branches etc.

A 20% improvement seems doeable.

This simplistic model is deliberately just that – simple.  It does suggest though that there is an opportunity to consider a different model that will still satisfy shareholders, but also satisfy common sense and a more conservative risk profile.  Which Bank will step up to this model?

Thoughts and critiques from the Basel experts welcome.  Note I ignored cost of capital for this exercise.

Alos here is the spreadsheet.  safe bank Note:  download, save, and change name to safe bank.xls – then you can open in Excel or OpenOffice.

Written by Colin Henderson

August 31, 2009 at 23:51

The Productivity Gap is closing in on Banks’ | Branches will be next

FT reports on a new Bain report concerning RoE at Banks, and the unliklihood that Banks’ can regain previous RoE levels.

This fits with the theme here of no more business as usual, post crisis. The spreads in this low interest enviroment are simply not high enough to accomodate spreads like we saw over the late 90’s and early 2000’s. Furthermore and separate from the spread issue, the growth in credit will not be there either because consumers are unwinding unwieldly debt levels that are now disproportionate to asset levels.

The course banks must follow is rejuvenated product suites, and of course reduction of cost base, which is why Bain leapt right to branches.

Banks’ may need to close a third of branches’ | FT

Business consultancy group Bain concludes that UK retail banks face a tough future in which their return on equity (RoE) could be 50 per cent lower than pre-recession peaks.

Bain said that over the past two decades, leading UK retail banks have posted RoE – profit divided by equity – averaging 24 per cent and are unlikely to see those levels again.

Written by Colin Henderson

August 17, 2009 at 20:27

The Dangers of Thin Value

Umaiar defines thin value as a mirage that will eventually evaporate. it is value that has no point nor reason, other than generate revenue for the corporation. The landmark example he offers is ARPU, or Average Rrevenue per Customer in the telco business. The 15 second instructional wait time in front of every voice mail is worth $620 million to one telco is one example he offers. The sole purpose of the 15 seconds is to generate revenue, notwithstanding claims that it is for the benefit of the user.

The Value Every Business Needs to Create Now
| Harvard: Umair Haque Edge Economy

Profit through economic harm to others results in what I’ve termed “thin value.” Thin value is an economic illusion: profit that is economically meaningless, because it leaves others worse off, or, at best, no one better off. When you have to spend an extra 30 seconds for no reason, mobile operators win — but you lose time, money, and productivity. Mobile networks’ marginal profits are simply counterbalanced by your marginal losses. That marginal profit doesn’t reflect, often, the creation of authentic, meaningful value.

He goes on to refer to other examples of thin value, and its the last that interests me here.

Thin value is what the zombieconomy creates. The healthcare industry profits, but Americans get poor healthcare. Automakers fought tooth and nail against making sustainably powered cars. Manufacturers of all stripes stay mum about environmental costs. Clothing companies can’t break up with sweatshop labour. The clearest example of thin value, is, of course, banks: they invested our national wealth in assets that turned out to be literally worthless.

That got me to thinking what examples of thin value in retail banking are – value that has no direct correlation to benefit received.

  • no interest on the first $ xx
  • chequing accounts vs savings accounts
  • credit card interest
  • credit card terms
  • overdraft fees

The list can go on. The theme I see in the thin value concept is this: there is no direct attributable consumer benefit associated with the cost paid out. Everyone accepts there is a value expected for their financial services, and the thin/ thick value approach focusses on the relationship between the cost and the benefit.

Thin value suggests that the operator cannot rationalise the value they are creating, therefore must use back door methods to bring in revenue in other ways.

Relevance to Bankwatch:

Here is Umair speaking on the concept some more. The concept is scary for corporations, because it means that business is not going back to the way it was before. It is all to easy to assume that the crisis is easing and recovery means going back to business as usual.

But this is not going to be business as usual, as i have talked about previously here [consumer mindsets] and here [Enter the Zombie Banks]. Consumers are more self aware than ever, and more aware of switching opportunities through bank and non bank designed tools to perform self assessments online. Services such as Wesabe exemplify.

How will your bank redesign services to demonstrate thick value?

Written by Colin Henderson

August 1, 2009 at 09:26

“We’ve already blown past the worst-case scenario on unemployment” | repeat stress tests

As banks rush to repay TARP money, driven by the desire to remove government control rather than any reflection of improved financial standing, here is a sobering statement from Elizabeth Warren.  Just as GM didn’t ‘get it’ in terms of the world will look like on the other side of this recession, many banks appear to have similar blinders.  Instead of arguing that they are not in bad shape and that they are secure, why not make changes now that display the recognition that the future is not going to be anything like the past.  I say again, and blame the politicians for the use of the word recovery – recovery does not mean a return to 2007.

Repeat stress tests right now | MSNBC

The Congressionally-appointed panel overseeing the Troubled Asset Relief Program (TARP) recommends running again the stress tests on US banks, as economic conditions have worsened, its chair, Harvard University professor Elizabeth Warren, told CNBC Tuesday.

“We actually make recommendations to do it all over again right now,” Warren told “Squawk Box.”

“We’ve already blown past the worst-case scenario on unemployment,” she added.

Yahoo Japan notes the expected repayment of $68 Bn from 10 banks.

金融不安後退 大手10社公的資金返済へ

6月10日1時53分配信 産経新聞

Reported by Nobuyo Henderson

Written by Colin Henderson

June 9, 2009 at 12:24

Posted in Profitability

Tagged with , , ,

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