Motley Fool Money - Big Banks Sure Are Quiet These Days

Episode Date: March 13, 2023

Regulators seized another bank over the weekend, as the federal government came up with a plan to use money from a fund paid into by U.S. banks to make SVB's depositors whole again. (0:21) Jason Moser discusses: - Signature Bank failing and shares of First Republic Bank falling 60%. - Why "bailout" is probably not the right word to describe what's happening - How big banks like JPMorgan Chase and Bank of America are gaining strength simply by going about their business (11:20) We're celebrating our own version of "March Madness" by having analysts face off, bracket-style, as they go head-to-head over which stock is a better buy. Jim Gillies and Jim Mueller kick off the week with a biotech software company and a well-known real estate broker. Companies discussed: SIVB, SBNY, FRC, SCHW, BAC, JPM, SDGR, RMAX Host: Chris Hill Guests: Jason Moser, Jim Gillies, Jim Mueller Producer: Ricky Mulvey Engineers: Dan Boyd, Kyle Carruthers Learn more about your ad choices. Visit megaphone.fm/adchoices

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Hey, thanks for having me. So I said this on Friday's show. The situation is fluid. It continues to be that way. And for anyone who missed it on Friday, you, me and Matt Argusinger talked about Silicon Valley Bank, the possibility that by Sunday night, Silicon Valley Bank could, by then, be the property of another bank. That is not the case. What is the case is that signature bank, which is a commercial bank based in New York,

has also been seized by regulators. Shares of First Republic Bank, which is based in California, are down 60 percent, as you and I are chatting on Monday afternoon. And at one point today, shares of Charles Schwab, just plugging along. I don't want to use the word boring, but I can't think of it. Just boring old short, I like Charles Schwab. But at one point, Charles Schwab was down 20% the same thing. Retirement plans were through Charles Schwab, right? Right.

Right. Which sort of got me wondering, like, wait, what's happening at Charles Schwab that has this? So there's a lot going on here. Where do you want to start? Well, I mean, I think this is all just a really good reminder of the psychology that is in play when something like this happens, right? I mean, when you talk about Silicon Valley Bank, I mean, in simplest terms, I mean, this was a failure of bank leadership that ultimately resulted in a bank run, right?

I mean, the bank put itself in a precarious position with its investments. Clients started withdrawing funds at a more precipitous rate. Word got out. There might be some capital issues, and it just feeds on itself. I mean, the regulators had no choice, but really to get in there and shut it down. I mean, the big question, I mean, there are a lot of questions over the weekend. I mean, one of the big questions was, is this something indicative of something more systemic throughout the entire banking system?

And I think most of us felt like it probably was not. And I think the main reason was just because of the nature of Silicon Valley Bank and the clients that it serves, right? I mean, its clients are generally companies that keep very large balances. well, well beyond a $250,000 FDIC insurance limit. And further, I mean, these are companies where they're not only keeping part of their balance sheets, but they're also running their day-to-day operations to keep the business running, which includes, of course, payroll.

You don't see companies meeting the payroll, then employees don't get paid. And now you start to see the second and third order impacts from a problem like this. And so I think it made a lot of sense. for regulators to view this as an urgent situation. I mean, it sounded like they were trying to go a few different ways with a solution there. It was very interesting to see that they didn't really have any bidders, so they had to kind of get creative with a solution. And I think ultimately the solution is a good one.

I mean, of course, it's going to be politicized, and you're going to have fundamentalists from both sides of the aisle, arguing their cases. Granted, I think that's more philosophical and theoretical in nature. This is the real world. We have to come up with real world solutions. solutions, longer term consequences be damned, right? We can deal with those another time. But like they say, the patient's bleeding out, you've only got so much time. Solving the problem doesn't help if you let the patient bleed out first.

And so they really, they stanched the bleeding, and I think it makes a lot of sense. I mean, I think it's important, too, to remember, like you're going to hear the phrase bailout, bandied about, I think, a good bit with this. And I would be careful using that term. I think that, I mean, this is not something that bails out shareholders. This is not something that bails out executives. I mean, their fate is sealed, right? This is something that is protecting depositors who really, at the end of the day, we're just looking for a place to put their money to run their businesses. And so I think it's going to be interesting to see how this shapes sort of that deposit

landscape going forward and how we view banks in our financial system here in the United States. I mean, it does feel like banking has really become a utility. And I don't know. that we should blame folks for just wanting to deposit their money. So it does feel like we'll see a shift in how that risk is perceived going forward in these new facilities that the regulators are developing to protect, not only the institutions, but the depositors as well. So a lot going on for sure. Still plenty, I'm sure, to unfold. But it does look like they got ahead of this to prevent what could have been a wider spread contagion. And to be clear, the most of the money that's being used to reimburse the depositors would come from a fund that has already been

established that is paid into by U.S. banks. So, I mean, I won't speak for anyone else. When I hear the term bailout in the past, one of the places my brain automatically goes is like, oh, they're going to, this is going to be taxpayer money. They're going to write a check from the federal government, and it's going to be taxpayer money, it'll be added to that sort of thing. This is not that situation. So to your point about let's be careful with using that word, I think that's well taken. As I said on Friday, somewhere on the spectrum of outcomes for Silicon Valley Bank was a larger bank steps in and buys them. I suppose technically that's still a possibility, although the big banks have been very quiet for the most part.

I'm wondering, since this is an industry that you and Matt Frankel used to talk about every week on the industry focus podcast, what you see when you look at the big banks right now, because one of the things I'm wondering is, are the big banks simply by virtue of sitting quiet? Are they strengthening their position? Are they just very quietly making it obvious? this, hey, you know what you're not going to have a problem with? If you bank with J.P. Morgan Chase or Bank of America, you're not going to have this problem.

Yeah. Yeah, well, I mean, it's a very fair question. I mean, that would be a criticism. I think a lot of folks would have in regard to what's going on. And in regard to the solution is that ultimately it makes the rich richer. It makes the strong stronger. And there certainly is something to that, right? I mean, we saw over the weekend, right? The news in regard to First Republic Bank out there in California, $15 billion bank, well-capitalized, regional bank. They even felt the need to get out in front of this and notified their account holders and shareholders that they were well-capitalized. This was something that was not impacting them. The technology-related

deposits representally 4 percent of their total deposits. And yet, even that, that's, you know, didn't do it, right? We saw lines over the weekend of folks wanting to get their money out of First Republic, and that in turn led them to then shore up capital from not only the Fed, but from one of the big banks, right? J.P. Morgan helped infuse some capital into First Republic, more or less to just make sure, right? And so that communicates a message where, on the one hand, First Republic is putting out an 8K saying, hey, don't worry about us. We're fine. And then at the same time, they're raising money just to make sure. So it does create a conflicting message, which makes you wonder. So I think that's going to be something going forward. I think that's one of the reasons why figuring out a longer-term reasonable solution to this makes so much sense.

Because at the end of the day, right, we're to a point where deposits, I mean, you can't really be blamed for wanting to deposit your money, right? I mean, deposits, that's now more or less just a utility, right? I mean, you're not going to just keep your money in a coffee can under your bed or bury in your backyard. I mean, you've got to deposit your money somewhere. And for many of these businesses, I mean, you want to split up your $250,000 among however many banks. I mean, it becomes not very practical.

And so I think at the end of the day, this will give the banks, small, medium, and large an opportunity to participate on at least somewhat of a level playing field because those deposits will essentially be protected. Now, it does, it does, we have to see ultimately how this facility works out, right? I mean, we saw that the regulators produce this facility. So going forward, banks who run into this situation where they see a run and they need to shore up some capital to make sure, even if it's through no fault of their own, right, they had the opportunity to participate, to participate in this lending facility to keep their finances short, it remains to be seen whether that ultimately works or not. But in theory, that should help keep these banks a little bit more

a level playing field as far as depositors are concerned. And that will be good. But right now, it certainly does make it look like, you know, the rich get richer and the strong do get stronger. That's not a surprise. Banking is certainly not the only industry that deals with that type of dynamic. But again, I mean, this is going to be something I have a feeling we're going to be discussing. We're going to be talking about this, I think, for the rest of the year. I was just about to say that. And I was also going to add, I have a feeling by the end of the week, we're going to hear from Jamie Diamond. Oh, yeah. Yeah. Yeah, absolutely. I mean, it's going to with Jamie talks. People listen. Jason Moza. Thanks so much for being here. Thank you.

March Madness starts this week. And even if you're not a fan of college basketball, basketball, don't worry. We've got our own tournament with eight analysts facing off against each other, pitching a stock that they believe is a better buy than the other analyst stock. Today, in the first of our quarterfinal matchups, Ricky Mulvey referees a debate between Jim Gillies and Jim Mueller. Which stock is a better buy? A biotech software company or a well-known real estate broker? This segment was recorded during the morning show on the Motley Fool's live video stream, which is available to members of any Motley Fool service. Kicking off the first round of March Madness, the Motley Fool Money, world champion stock

competition. Jim Mueller, five to six minutes is yours. I'm going to go on mute and listen in. The company I'm going to pick is one I own myself and one that is an active options recommendation. It is Schrodinger. It's on the NASDAQ under ticker S-D-G-R. And it is It is, and you might think of it as appropriate, given my biochem background, but I've never, ever recommended or, and have not invested in biotech for years and years and years. It is a biotech company, but not your general run-of-the-milled biotech company. No, this is actually, if they didn't do biotech, they'd actually be profitable and cash flow positive.

It started off as a software company, so it has four ways to make money, software sales being the first one. It's a software company that has developed a way to predict how molecules interact with each other down at the molecule-to-molecule scale using physics and a whole bunch of x-ray crystallography and NMR imaging that have been developed over the years. And what they're doing is being able to use a computer, an algorithm, or an AI, to predict how the molecules interact and therefore how drugs can, finding the best molecule that could act as a drug against a particular target.

And what you want with a good drug is you want high specificity. That is the drug molecule will bind only to its target and not to anything else, so fewer side effects. And you want strong binding, and so they use this algorithm, their software, to find candidates that will do that. And what this does for drug discovery companies is cut down several years out of the decades-long process of finding a drug. But it's all at the front end, the discovery phrase.

So instead of screening in a laboratory, hundreds and hundreds of molecules, they can screen on computer thousands and thousands of molecules to find the best one. And then they build it. And then they go through the process of making sure it works the way they think it does, starting up the clinical trials, the phase one, phase two, phase three trials, and so forth. So that long part of actually trying out the drug first in the lab and then with actually humans hasn't changed, but it's the front end. And that's a fairly expensive portion of the drug discovery process that companies are willing

to pay to shorten. And that's how Schrodinger got its start. And they had a couple of successes early on, got a couple of drugs all the way through FDA approval with one of the... other partners, Adios, and they have since then since collaborated with many of their customers. So they sell the software, they've collaborated with many of their customers, and currently they have nine different drugs in their collaboration program in clinical trials, three of which are in phase two, the other six are in phase one.

So we're in the slow part of that portion. So that's the second way they make money. As those molecules, as those drugs meet certain milestones, such as those drugs, such as a getting in being approved by the FDA or passing phase one or passing phase two they get paid last year they got paid about 45 million dollars from those kinds of milestones this year they expect to double that so their third way of getting paid money is by partnering by buying actually investing in some of their partners and so as that company becomes more valuable with a successful drug they get

that their portion of that values that's three that's their third way the fourth way is the prize itself finding their own drugs and being able to get them through this process and start selling them to the market or licensing out to a big drug maker, a big pharmaceutical. They have several of their own drugs now, just entering clinical trials. They've got one in phase one, and they have identified another that they've just identified last quarter, and they're putting it together, getting data ready to apply to the FDA to be allowed to use to the phase one trials. So drug discovery is very, very expensive, and most

the time companies like this get invested in by other companies, and they get money from that, and they sell debt, and all this other stuff. Schrodinger is funding itself from its own software sales and from the drug milestone payments that it receives. And so they burned about $112 million off their cash balance last year. At that rate, they have about four, four and a half years worth of cash on the sheets, on the balance sheet. But this year, they're expecting to get about 90 million instead of 45 million, about 90 million in drug discovery milestone revenue. And so that increases the length of term. They're going to only burn, if all else remains the same, they're only going to burn about 80 million instead of 112 million off their cash. And so they're

extending their lifetime as a cash burning company at this point. So it's a, a, a bet on the future, a bet on software being able to lead to better molecules that lead to better drugs and getting them through the FDA process. And so it's a long-term bet on that. And so the share price, I think, is attractive at this point. It was as high as 110 shortly after they became public in February 2020. It's since fallen down into the mid-20s. It was down as low as the teens at the end of last year, but it's recovered quite a bit since then. Five, six minutes on a high-level software company without talking about artificial intelligence. Look at that.

I mentioned it. I said AI. But AI is just computer software algorithms working together. That's all it is when you come right down to it. Yeah, that's not as fun. All right. Jim Gillies coming with his stock. Five, six minutes is yours.

Sure. Okay. So I am coming at it from almost pretty much the opposite end of the market, as my esteemed colleague is, he's coming for high tech and brainiac performance. And I'm going, you know what? I'm going to look at companies that are, well, some of the things I like to say are run towards fires, which is a variation of say, contrarian thinking. I want to run towards fires. I want to buy businesses that are on fire. My take on it is because we want to do, this is a long-term contest, right? We're not just fighting over March Madness. We're looking

for stocks, outperforming for the long term. And so for that perspective, I hold the view that long-term performers, your best long-term performers, come from low prices paid during pessimistic times, either for the market itself or for the stock itself. And this is a company that has a pessimistic market. And that company is not as cool and sexy as Schrodinger. It just makes money, which is different than Schrodinger as well. It is Remax the Real Estate People.

Remax is a franchisor of real estate and mortgage brokerages. They have about 143, 144,000 agents under them, roughly 60 percent in North America, the rest international. What's interesting about Remax is it is not a traditional business. They are selling, they like to sell franchises. And I like franchise businesses because they are, you know, I sell someone else a concept. I get a royalty from them. They get the operational risk. What is not to like? I call them check-cashing machines. I sell you my concept and branding operational know-how systems. Franchisees sends a percentage of their gross revenue back to me as royalties, in addition to paying regular franchise and regular marketing fees.

So that means remax gets to hold onto a high-margin growing revenue stream for them to deploy. And one of the interesting things about Remax, and I'm going to share my screen in the middle of this, if that's okay. This is a history of Remax's transactions per agent at their largest brokerages. You can see they're typically in the 16 to 17 plus transactions per year per agent, these large brokerages, compared to a number that goes between seven and eight for their competitors. And this has been a longstanding trend. Why is that? There's something different happening, right? When your average competitor, the average

agents do about seven and a half times transactions a year, and you're doing 10 more than that, what's going on. And this is the secret sauce for Remax. It's how the commissions are split, okay? Traditional brokerage, the broker takes 20 to 30 percent of the commission. So when you pay a fee to sell your house, one third of that, say, goes to the brokerage, two-thirds stays with the agent. And then, of course, they have to split it with the other agents. whatever. Remax has a more agent favorable mix. The agent keeps 95% of the commission. And Remax, the brokerage, takes 5%. And so that leads to a phenomenon where the best agents, people really good at selling, they migrate to Remax banners because I'm betting on

myself, I get to keep more of my money. And that's a very powerful incentive. I get to keep more of the money, I go out and shoot and kill and bring it home, I get to keep more. That's fantastic. The way that Remax the company offsets that more favorable mix to the commissions, setting up their people who are causing their money to do better, the way they do that is there's annual dues paid per agent by the brokerage. There is a fixed fees per agent. There's our broker fees, which is that 5% of take, franchise sales and monthly fees for their mortgage office. So, you know, look, there's no tag days for remit. Max, but there's a not easy to replicate secret sauce that brings the best agents under their banner.

So why did I say an industry on fire? Well, a year ago, real estate, real estate was great. Everyone, we don't build enough houses. Homebuilders are going to the moon. Then central banks said, hey, interest rates are too low, started jamming them straight up. And that has quashed house prices. It's quashed sales. The entire real estate market has kind of washed out.

Anyone who's a redfin owner could attest to that or a Zillow owner. And so I'm looking for a company into the space that's blown out. I'm getting cat calls from Mueller here. I'm looking for companies in the space that are going to do better on a cash flow basis because they can weather the problem. So here's Remax today. Hopefully you bought into what I've said here. Remax today is pretty much at its lowest share price of all time since it's a

since its 2013 IPO, aside from the down draft and the pandemic, which was kind of weird for everyone. But what do we have in Remax today? We have a company. Oh, and by the way, the insiders, the founders still own 40 percent. It's a dual share class structure. They own 40 percent. The two members, it's the husband and wife team.

The husband's CEO for years, took zero in compensation because he just gets dividends. Same deal with the wife. They're both on the board today. zero compensation. Something about foolish founders. We like, I don't know. You can insert it here. But the company today, if you adjust for the outside ownership, or the 40% ownership by the insiders, you have an enterprise value about $890 million. They have about $448 million debt, $109 million cash. And enterprise value, like I said, $890 million. That is about, I estimate this company can do about $70 to $75 million a year in free cash flow. That means the stock is trading at about 12,

12 and a half times free cash flow. That free cash flow number is going to be going up over time as they sell more franchises and more motto mortgage franchises. I should say the motto mortgage brokerage, which is a Naysa thing within them, but 230 outlets going to go to a thousand over the next decade. That is currently a cash suck. It's going to be a cash contributor in the future. But I say, you know, for 12 times cash flow and a depressed industry, I am willing to do this all day long with a recognizable brand, because here's the thing. We know Schrodinger, and I don't mean to pick on Schrodinger, but Schrodinger has got, you

know, there's a great deal of uncertainty of what drugs are going to work, right? I mean, that's the whole schick of biotech, what is going to work. I'm not smart enough to figure that out, okay? But here's what I do know. I do know people are going to be selling more and more and more houses. people need to move. There will be household formations. I am going to bet on a much, much, much more sure thing. And that's pretty reasonable price. Oh, and by the way, you get 5% dividend yield to wait. So with that long-windedly, I yield my time.

Jim Gillies. Thank you. Jim Mueller. Thank you. We'll reveal the winner next week during the semifinals again. That was recorded during the morning show on Motley Fool Live, which if you're a member of any Motley Fool service, You can watch on tomorrow's show, Tim Byers goes up against San Mateo. As always, people on the program may have interest in the stocks they talk about, and the Motley Fool may have formal recommendations for or against. So, don't buy ourselves stocks based solely on what you hear. I'm Chris Hill.

Thanks for listening. We'll see you tomorrow.