One of Superman’s greatest powers is his x-ray vision. Independent banking analyst Chris Whalen has similar skills when it comes to seeing through banks’ vaults and financial books.
You can hardly find anyone as well respected on Wall Street as Chris Whalen — and Chris has earned that reputation. In addition to his accurate and incredibly thorough analysis, Whalen follows Groucho Marx’s valuable advice, “Before I speak, I have something important to say.”
Therefore, you won’t see or hear Whalen babbling crap or echoing the lemmings as they follow one another over a cliff.
I had the pleasure of catching up with Chris to talk about his adventurous career in finance, the folly of Wall Street’s over-simplified ratings systems, why covering banks is like calculating the location of a particle in physics, and how a Groucho Marx quote guides his rigor.
Damien Hoffman: Chris, you’ve had a very adventurous career in finance. Tell me about your adventure.
Chris: I was brought up in a different household from most because my father, Richard Whalen, was a journalist. My mother corrected his spelling. He worked at Time Inc. and briefly at the Wall St. Journal with a guy named Robert Novack — whom we just lost. So I had the good fortune of following his career. That included moving to Washington DC and writing speeches for Richard Nixon.
I grew up in D.C., so my world was national politics and the Fed. People like Paul Volker, Alan Greenspan, and Arthur Burns would be at our house drinking bourbon, dining, and talking — doing what people did in the 60s and 70s. So that was my context.
I came out of Villanova in 1981 and worked on Capital Hill. Then I worked for the Heritage Foundation and Jack Kemp on the Hill — the Republican Conference Committee. That’s where I started to learn how to write for two great editors, Karl Pflock and Terri Hauser, who both also were hardcore libertarian conservatives.
Then I got a chance to go up to New York and work at the Federal Reserve in the management training program. That was my jumping point from DC to Wall St. After that program I went to work for Bear Stearns as a sales trader. I had a lot of fun there.
After Bear I worked with my father’s consulting firm, WIRES Ltd., that focused on trade and investments. We had a lot of big clients in the Far East. Then I started doing my own thing down under in Mexico because we were working on things related to NAFTA and Free Trade. Among other things, I published a newsletter called the Mexico Report until ‘97.
In ‘97 I moved from DC back to New York and did tech-industrial banking at Bear Stearns. I focused mostly on the financial buyer private equity community, but also got to try to make some big picture ideas work with Alan Schwartz, who is a tremendous banker. He didn’t deserve the way he got treated at the end of the Bear Stearns mess. I’m very hopeful that he’s going to come back. He can work as a banker in half a dozen industries and it’s really a talent to have that kind of flexibility.
Skipping ahead a bit, in 2003 I got a phone call from my current partner Dennis Santiago, whom I met as a banker at PruVolpe. He’s a great technologist and has built half a dozen major platforms on Wall Street for analyzing and displaying data. He had bended my ear about his latest project called Audit Integrity. I took a look at it – actually worked as a consultant on it for a few months. It was a good methodology but, unfortunately, you can’t boil down a fundamentals-based analysis because it’s going to be wrong very often. You’re going to have many false positives that will make the tool ineffective.
For example, when the flag is raised in the system, the question is, “What does the flag mean?” If you go through that iteration, which is what we go through for things such as our Bank Monitor sample, we are able to then approximate a score — but it’s still a very complex score. It is not a “yes/no” which is what Wall Street wants.
Damien: There are too many conditional variables to come up with one number in a snapshot and say, “This is it.”
Chris: That’s right. On the other hand, having the ability to crunch tons of variables in the platform is great. We get some interesting preliminary results.
I like to look at the context of the numbers, step back and say, “Where is this bank’s business model compared to the other banks?” Take Hudson City Savings Bank (NASDAQ:HCBK) for example. They are very different than the other banks — even the banks in their peer group and size range. They’re much less risky in a lot of ways that are very significant.
We said we’d stay positive on this name because they’re going to outperform everyone else. That’s the insight investors and risk managers want from analytics. You want the analytics to help you get there, but it’s never going to give you a 100% black or white answer. You have to understand what the numbers mean and the context. But there is also a judgmental factor you can’t teach to a computer. It’s moving. It’s dynamic. You can’t teach a computer that the last five years were crazy. You can say, “Yes, these are all anomalies and now we’re going into some more anomalies in the opposite direction.” But all the machine sees is the numbers and assesses them at face value.
So there is a judgmental part at interpreting all of these pretty analytics to try and finally come down to a judgement that offers something. We have a range for retail products. We have our index give a very objective view: “How did you do this quarter?” Basically, we look at five discreet factors that are all weighted equally. Then we get more subjective as we try to synthesize a CAMEL Rating — the framework regulators use for evaluating banks. We’ve got to decide which ones are important. The bottom line is you’re going to be much better off so long as you can remember the difference between objectivity and subjectivity in analysis.
What we see a lot of on TV and the news is just a general movement of prices — it’s not evidence of rational behavior. It is so funny when economists posit rational behavior in the financial market. I think for 50 years we’ve been moving away from rationality in the markets because we don’t focus on cash flow and the fundamentals of values. Instead, we look at stuff like, “To who can I sell this asset for more than I paid?” So, by definition we live in a speculative environment.
When you try to use fundamental analysis, you’ve always got to be aware of that speculative context. Look at financials. From March of this year until now we’ve had a 100+ percent rally in financials. Does that make any sense given the fundamentals? Absolutely not. You see this in other sectors as well. The momentum factor in markets today is fascinating. It’s much bigger than it’s ever been before.
Damien: Speaking about understanding the difference between types of analysis, does your diverse skill set play a role in keeping you cross-disciplinary in your approach?
Chris: A broader sampling of life’s experience is always a good thing. For example, I wasn’t a particularly good banker when I went back to Bear Stearns. I worked on fixed income and was also a bit older than most associates. But, fortunately, they gave me good tips and I worked on several deals. I also did a few at PruVolpe. That’s how you learn: the hands-on experience of diligence, talking to people, and researching financials. Those are all skills that take time to develop and to gain the confidence to use properly.
For example, if you’re an analyst, you learn how to tell little white lies if you can’t get access to the information you need. Some people stretch things too far. But working as an investigator in banking deals and as a channel researcher gave me forensic skills that I wouldn’t have learned about otherwise.
I’ve done a fair amount of work in consulting and litigation. So I’ve developed a niche of specialization with certain types of research, working with the public disclosure system, and tracking data that way. It helps.
Now, include my partner Dennis. He is a scientist and systems developer who knows how to query Edgar in amazing ways. That skill allows us to harvest data kids coming out of school just don’t know how to do. So there is a value to accumulating knowledge and skills you can’t get in formal settings.
It’s funny how people are skilled with technology when coming out of school, yet unskilled in the basics. They can use all the tools and program in different languages, but if you sit them in front of a terminal with a command prompt and ask them to build something from scratch, they can’t do it. Not all of them, but most.
Damien: As a researcher, how do you deal with barriers to disclosure?
Chris: Disclosure presents a lot of challenges outside the US because we are the only country in the world silly enough to believe in disclosure. Disclosure is not a universal thing. We can get hold of some data in some countries, but the quality level is iffy and the providence on the data is almost unknown. So, we end up working with private vendors. We have a friend in Vietnam of all places who gathers public and private company data throughout Asia. It’s a private service bureau model. There is no public mandate for disclosure in any of these countries.
Damien: How do your partners get the data if it isn’t mandated or disclosed?
Chris: Bilaterally with other banks. If they have business relations with the bank, they will exchange data confidentially.
It doesn’t help the analyst or the investor. As an analyst we are left with market price data. It’s all anybody really has. Then we have the US economic data which is a horror show — but everybody pretends it’s biblical text. This is why the data industry has focused on tools driven by market data instead of fundamentals. Issuers have no interest in transparency, but rather selling stocks and bonds.
That’s what you’ve got in most of the world: anecdotal news reporting. You don’t have the rigger of disclosure you have in the US. Even in Europe. Think about it: where do you go for bank data in Europe? There ain’t no place to go. I’ve been told there’s a not-so-secret secret — a non-public source for all the regulators. I’ve got to see if we can get them to give us some disclosure.
Damien: This leads to an interesting point. Your personal website has a very interesting quote from Groucho Marx, “Before I speak I have something important to say.” How do you know when you’ve done enough research to speak?
Chris: That’s a very good question. The first thing I do is assume the posture of the student. So long as you pay tribute to your sources and admit when you don’t know something, you’re all right.
I cringe when people describe me as an expert because it is very hard to be an expert in all of these banks — even the ones I actively cover. You can read everything, listen to all the calls, think deeply about them, and they can still surprise you!
I have to be qualified in my opinions. There’s no “absolute” anything. There isn’t an absolute distribution of possibilities on which you can run Monte Carlo situations and be confident because your possibilities are variables floating through space. You don’t quite know what they are, but you sort of do.
It’s like a classic physics problem. Where is the particle in space? The answer is I don’t know, but I think I kind of know where it’s going and how fast it’s going there … but I don’t quite know where it is in space right now. We don’t want to get into a trap of generalizing — which we all do because we want to say all companies are like, for example, this one is better than that one. That’s a narrative comparison. That’s dangerous.
Working with Dennis I’ve learned to use statistics very broadly the first time I look at a bank. I compare the bank to all banks because I want to know where it falls into possible ranges of business models. But when you’re a sell-side analyst — or especially investment banking — you tend to group banking peers very closely. In other words, they don’t look at the entire industry. They look only at a few peers and comps. That analysis is prejudiced because they are looking at only part of the industry group. However, if you keep those sources of distinction in mind, you can keep out of trouble.
Damien: Chris, you’ve clearly done better than keep out of trouble with your excellent analysis leading up to and through the financial crisis. We are proud to give you our Medal of Honor for Excellent Service and look forward to your future work.
Chris: Thank you, Damien. I am flattered. I look forward to staying in touch.