Yet Another Value Podcast - Net Interest's Marc Rubinstein on $COF and if Silicon Valley Bank has fundamentally changed banking

Episode Date: June 9, 2023

Marc Rubinstein, Founder and Editor of the Net Interest Newsletter, is back on the Yet Another Value Podcast to have a wide-ranging discussion digging into Marc's thoughts on the current state of banks, financial sector, as well as dissecting his article on what makes Capital One $COF interesting. For more information about Marc Rubinstein, please visit: https://www.netinterest.co/ Article on Capital One: https://www.netinterest.co/p/capital-one-buffetts-latest-banking Article on Charles Schwab: https://www.netinterest.co/p/vivat-charles-schwab Chapters: [0:00] Introduction + Episode sponsor: Stream by Alphasense [1:50] Overall thoughts on what's going on in the financial space [5:15] Banks are balance sheets [9:23] Why is tangible book value good? Why can't we go to half of tangible book value for a long time? [13:47] Activism in community banks [16:50] Wave of bank consolidation coming? [19:06] Advantages in small banks [22:32] History of Capital One $COF and what makes them interesting [33:33] Marc's thoughts on the bank failure reports and has the way banking works fundamentally changed? [42:11] Why isn't $COF not interested in buying regional banks anymore? [48:58] Buffet attracted to the online side of or is he actually attracted to the diversified, consumer-focused nature of these banks? [51:39] Does Capital One have a technology / marketing advantage versus other people? [58:06] What does the future look like for Charles Schwab $SCHW? [1:05:39] Current valuation of $SCHW [1:07:36] Earnings issue, not liquidity issue [1:09:27] Are we underestimating how profitable banks will be coming out of this banking crisis? Today's episode is sponsored by: Stream by Alphasense Are traditional expert calls in the investment world becoming obsolete? According to Stream, they are, and you can access primary research easily and efficiently through their platform. With Stream, you'll have the right insights at your fingertips to make the best investment decisions. They offer a vast library of over 26,000 expert transcripts, powered by AI search technology. Plus, they provide competitive rates on expert call services, and you can even have an experienced buy-side analyst conduct the calls for you. But that's not all. Stream also provides the ability to engage with experts 1-on-1 and get your calls transcribed free-of-charge—all for 40% less than you would pay for 20 calls in a traditional expert network model. So, if you're looking to optimize your research process and increase ROI on investment research spend, Stream has the solution for you. Head over to their website at streamrg.com to learn more. Thanks for listening, and we'll catch you next time. For more information: https://www.streamrg.com/

Are traditional expert calls in the investment world becoming obsolete? According to Stream, they are, and you can access primary research easily and efficiently through their platform. With Stream, you'll have the right insights at your fingertips to make the best investment decisions. They offer a vast library of over 26,000 expert transcripts powered by AI search technology. Plus, they provide competitive rates on expert call services, and you can even have an experienced by side analysts conduct the calls for you. But that's not all. Stream also provides the ability to engage with experts one-on-one and get your calls transcribed free of charge, all for 40% less

than you would pay for 20 calls and a traditional expert network model. So if you're looking to optimize your research process and increase ROI on investment research spend, Stream has the solution for you. Head over to their website at streamrg.com to learn more. Thanks for listening, and we'll catch you next time. All right, hello, welcome to yet another value podcast. I'm your host, Andrew Walker. And if you like this podcast, it would mean a lot if you could rate, subscribe, follow, review, wherever you're watching or listening to it. With me today, I'm happy to have on for the second time because, Mark, I think you were one of the first eight guests that had on the podcast. I didn't look at the exact number, but like way back when

we were getting started. But for the second time, Mark Rubenstein, Mark is the founder, writer of Netinterest.com, which is very much in the mindset right now. Mark, how's it going? Right, Andrew. Pleasure to be back. Hey, well, really happy to have you back. Let me start this podcast the way I do every podcast. Just a quick disclaimer to remind everyone, nothing on this podcast is investing advice. That's always true. But I think our goal today was to talk about a lot of companies in the financial space. So people should remember, if we're talking about a lot of companies, even risk here, right? Lots of companies. Please do your own work. Things are going really quickly in the financial sector right now. So it's all the financial advisor. This isn't financial

advice. And Mark, the reason, kind of the reason I reached out was you had this incredible piece, which I'll link to this in the show notes covering Capital One about two weeks ago, which I think is a really interesting company at its own right. But then you've also written about Charles Schwab is another really interesting company. And you've just been at the center of the hurricane that's hitting the financial landscape right now. So I'll pause there. We can talk Capital One. I want to talk Schwab a little bit.

But just overall, what are your thoughts we're talking here, June 6th? What are your thoughts overall of what's going on in the financial landscape? I think, I think, so banks, it's interesting, people are going back to trying to understand what there are various points in the cycle where people have to re-learn what a bank actually is. A bank is, it's a shape-shifting entity. But there are times when it projects growth, there are times when it projects value, there are times when it projects a bond-like instrument. We forget that, and I wrote a piece a few weeks ago, which makes the point that a bank is less a business and more a balance sheet, that the best way, the best mental model for thinking about a bank in good times and in bad, especially in good times, is that it's a balance sheet. It's a collection, it's a portfolio of assets, funded by some mix of funding. instruments, which may be deposits. The trick of deposits is that they look like their long term, and the bank is structured to exploit that long-term nature of deposits.

But we've known throughout history, and we're reminded again in March, that that's not always the case. And that the simple bank case is really interesting, because more than most banks, Silicon Valley was seen as a business. Actually, more than Silicon Valley, First Republic, was embraced by investors. I would have discussions with investors historically who would look at First Republic with a very different lens from the kind of balance sheet mental model that I would employ. This is the best business, phenomenal customer service, a whole narrative around that.

And the stock was trading in a big premium. to tangible bulk value to reflect that and how quickly that can change. And I suppose just to answer the question, that's just by way of background, we're now three months on, but we never actually got over the financial crisis, 15 years on. Banks never globally got back to the kind of valuation multiples that they were trading at prior to that. muscle memory is very long and here we are again. So fortunately for investors who have the ability to be opportunistic and unfortunately for

executives within the industry, the market has a very long memory and it can take a long time for these things to recover. Look, you hate so many things that I want to talk about because we're here to talk about Capital One, and I'm just typing notes on the screen. I've got seven follow-up questions to everything you just said. So let me start with a few. So you and I were talking before, you know, I think anybody who's been reading what I've been putting out in yet another value blog or I'm working on a letter for my investors, like I'm really interested in the banks right now. And I'm more look at banks, as you said, the quote I had was you said banks are balance sheets. And I look at banks as banks are balance sheets, right? Like, yes, you can pay more than tangible book value for him. Like, you know, if you think it's going to earn good REs, you can pay 1.2 or 1.4. But one of the things I was surprised by is you look at some of these banks that exploded. And a month before they explode, they're valued at Silicon Valley banks valued at what like 3.7 times. They're unadjusted book, right?

Or they're before incorporating the health and maturity securities that actually took them to infinity times book. First Republic's at three times. Silvergate, if I remember correctly, is at like 10 times book value, right? Because they're a growing crypto bank. And I don't think anybody is paying 10 times, wants to pay 10 days a week. But my question to you is, can you pay, you know, real franchise value for any bank? Or is the right answer always to be looking at banks as banks are balance sheets?

I can pay a little more than tangible book. I can pay a little bit less. But I can never pay more than 2x because they are balance sheets. There's not really a franchise there. Yeah, I guess, look, you can pay. So you can plug that gap by thinking about sustainable return on equity, the extent to which a bank is able to generate a sustainable, return of equity in excess of its cost of equity that will justify a premium to book value.

Jamie Diamond always a go-to analyst in the banking industry. Every year writes a very lucid shareholder letter and he talks about valuation. He is the best, it's the best lesson in how to value a bank is his shareholder letter. He talks about valuation being anchored to tangible book value. And that his goal, he's the best lesson in how to value. is for growth in tangible book value, but nevertheless, it is, in his view, the anchor. Every time I've seen a bank, there's a great example here in the UK where I'm based. I'm going back 20 years. It was the biggest bank in the world at one stage in terms of market cap.

It was Lloyd's Bank, traded a big premium to tangible book value, and it suffered in the financial crisis. Whenever city groups, another example, didn't trade at such a premium to book value, but it was one of the biggest banks in the world at one stage. And there's just a cyclical component to it, driven by, driven by, driven by a number of factors, kind of mean reversion in terms of asset prices, but also kind of complacency sets in. You know, when I've studied banks in the past, frequently, one of a whole series of mental models when trying to understand them, we've spoken about one. Another one is that the same crisis, banks are prone to crises for various reasons, but it's never the same consecutive crisis. Often it's diametrically opposite. Yeah. So the one we've been experiencing recently was it was driven.

It was interest rate driven rather than credit driven. It was driven by retail deposits rather than wholesale funding, diametrically opposite to the Playbook from 2008. And you can roll that forward. Often the bank that has had the most successful crisis will then be prone to a slip-up in the next crisis. Maybe it's management complacency. Maybe it's simply that the regulators aren't focused on its business mix. But that tends to be the case and no bank is immune.

For both First Republic and Silicon Valley Bank, I haven't looked recently, but I would bet good money that their loan losses were better than 90% of their competitors, right? Now, part of that is because First Republic was funding super prime creditors with under market interest. rates, right? But again, a lot of, especially in March, a lot of the investors I would talk to, they would say, oh, you know, I don't know, banks are black boxes, I can't look at their balance sheet. How do you mark these? And I say, I hear you. Yes, we can't go in and know the details of every loan, but I think you're applying a 2008 mindset where you would see these banks that had AAA securities on their balance sheet that turned out to be worth zero. And that's why they blew

up. And that is not what happened here. You know, the marks were accurate. You could look, I remember January, you could look at Silicon Valley's bank. And I've got a tweet from February. I can time say somebody wants. You can see, hey, held some maturity securities. They're worth less than the entire shareholder equity of this bank, right? And it was just a trust game that depositor was never pulled. They'd never have to sell and they could realize those. And that trust game ran out. So yeah, I'm with you. It's so diametric. Let me ask one more. You said a lot of the banks never got over the financial prices, which is certainly true. One thing, this is going into a completely different direction, But one thing a lot of investors have asked me about the banks is, hey, I get it.

A lot of banks are trading at or below tangible book value right now, you know, adjusted on adjusted however you want to do it. Historically, that's been attractive in the U.S. But if I go over to Europe, there's a bunch of banks that have traded for half of book value for years. Japan, there's a bunch of banks that have traded for under book value for 30 years. And a lot of people have asked me, hey, why do we know the zombie bank issue, right? It's kind of a zombie bank that they just stumble along for years, never create shareholder value,

but they never go bankrupts, they don't cross a car. Why aren't these, we about to have a lot of banks that kind of just become zombie banks? Why is tangible book good? Why can't we go to half of tangible book for a long time? So the premise is right. Again, as you know, I'm based in Europe. I've looked at European banks extensively over the years. Right now, about two-thirds of European banks trade in a discount to tangible book.

And even prior to March, the majority traded at a discount to tangible book value. Now, there's a number of reasons for that, principally profitability, right? But there's a number of underlying reasons for that. One is that the large, it's kind of a breach of corporate finance theory that if any asset trades at a discount to its liquidation value, then it should be liquidated, right? Then private equity would come in and liquidate the assets. And I guess the friction here arises because private equity is in many, cases excluded from participating in this sector because of certainly in the u.s and in europe bank

holding company legislation and restrictions over who can own a bank but also the costs and we're seeing this to a degree with credit swiss if it's a large some distinguishing here between the large banks and the smaller kind of regional immunity banks but the large banks the you know it's kind of I think of it like it's kind of the Hotel California effect. It's very easy to get into some of these businesses that add to complexity that fuel the overall balance sheet size, but it's very difficult to get out. And, you know, you look at, I look at, say, Deutsche Bank's balance sheet and it's the same, frankly, for J.P. Morgan and Citigroup, is a great example.

The new CEO, Jane Fraser, has been in her position for two years now. She's been articulating a simplification agenda. And again, we're 15 years after the financial crisis, and she's still trying to simplify the business. It takes a long time to sell off those assets, spin off businesses, and they've just been stymied from a sale of the business in Mexico. It takes a long time. So just the notion, so it tries to get a discount to book, fine, but capturing.

that discount, even the bank itself, and certainly this sector is a graveyard for activists, very difficult for an activist to go in and try and close that discount because of the complexity involved in some of the businesses. Can I just show, I 100% agree with you, but I do think there is one thing where something like Citigroup or UBS or something, hey, it's very difficult as an activist to get, you know, these are $100 billion plus companies, very difficult as an activist to get a size where you can even like really shake the, you know, kind of shake the company up there. But I think the second thing I'd say is, you know, in the U.S., one of the, like a lot of the companies I'm looking at are

the banks, they're, they're regionals, the community banks. And there is the question, is the book value right? If it trades at five in the book, values 10, and it turns out, you know, they've got $8 per share of losses on the books or something. That's a different story. But I do think there is something like, and you can tell me if I don't think they, Europe or Japan have these small community banks that are kind of publicly traded. I don't think they're as open to, you mentioned activism. I think activism at small banks actually can be quite successful because you go in, you've got a little small bank with, you know, the community deposits. It's got some loans. Very easy to diligence, especially for a buyer. And if you're the

buyer, if it's a little town, all the buyers and all the towns next to you are really, you know, that's a very acquisitive deal. So it's very easy to go in with activism. It's a simple sale playbook. And I just don't think, like, I think people think of Europe. And yeah, UBS, Credit Suisse, as you mentioned, those are very difficult to do this because there's not, there's one buyer, if any, it takes the government blessing. It's crazy complex. But if it's community bank of new Canaan, pretty easy to go in and sell that to community bank of old Canaan down the street. Well, that's a good point. You're right. The U.S. is unique here. It's a happy hunting ground for bank investors. There are 4,000, 4,000 banks in the U.S. It's a capital, intensive

industry, and so therefore, they tend to be public rather than privately owned, although there are credit unions, there's another 5,000 credit unions as well, and we don't have that. There are many more banks in the US, absolutely, per pop, per GDP, than in any other country in the world. So that's absolutely clear, and that can be an opportunity for investors and for activists. You're absolutely right. And now, a quick word from our sponsor. Are traditional expert calls in the investment world becoming obsolete?

According to Stream, they are. And you can access primary research easily and efficiently through their platform. With Stream, you'll have the right insights at your fingertips to make the best investment decisions. They offer a vast library of over 26,000 expert transcripts powered by AI search technology. Plus, they provide competitive rates on expert call services, and you can even have an experienced by-side analysts conduct the calls for you. But that's not all. Stream also provides the ability to engage with experts one-on-one and get your calls transcribed free of charge, all for 40% less than you would pay for 20 calls and a traditional expert network model. So if you're looking to optimize your research process

and increase ROI on investment research spend, Stream has the solution for you. Head over to their website at streamrg.com to learn more. Thanks for listening and we'll catch you next time. Do you think we see a wave of kind of bank consolidation, not in the BP Morgan and city groups region, but probably the regional's and the smaller players, do you think we see a wave of consolidation on the heels of this? Because we were already seen a little bit of it earlier, you know, a few banks I follow that there were emerging stuff. But I do wonder just you probably get regulatory burden going up.

Regular burden is already very high in the U.S. It probably goes up on the heels of this. The tech spend, you know, one of the things that was killing community banks is they're at versus we're in an online world. It's the thing that killed Silicon Valley Bank, right? You could do $40 billion of deposits polls in two hours if you needed to. But the tech spend everything that's going up. And that does favor the larger players.

I just, I wonder if this is the last round. We really see a wave of consolidation on the heels of this. Yeah, look, we're seeing it anyway. We're seeing consistently since the mid-19, consistently since 1985, we've seen steady decline in the number of banks in the US. We've seen consolidation. And whenever there's a crisis, it's an opportunity for a large bank, J.P. Morgan, whether it was Washington Mutual in 2008, First Republic now, to just push the envelope a little bit and get just that little bit bigger. I think it's inevitable for all the reasons you say. However, you know, our mutual friend, Bernard Hobart has written some analysis, actually, where he looked at donors to Congress people.

And the community banking lobby is a very successful, very relatively aggressive lobby. And we saw this actually when Janet Yellen was grilled on the hill. The extent to which the preservation of community banks, smaller banks, is so important culturally to much of much of America. So that may not change. But in the middle piece, we've seen it. We've seen, you know, SunTrust, BBT. Really bad timing that the First Horizon deal was called off as this crisis was playing out. I was listening. First Horizon is having an investor day right now. I was listening to it up until we started recording the podcast.

You mentioned the Byrne writing about the strength of the lobbying for the small banks. The small banks have a lot of disadvantages, right? J.P. Morgan has national marketing. They can probably hire the best bankers. they can really leverage the tech spend over a much bigger asset base, which is massive for tech spend. But you know what? The small banks have one huge, huge advantage. And that's regulatory, right? Where, A, their regulatory burden for making loans, compliance, all that, I believe is much lower.

But even ignoring all that, just the capital cost, right? The crazy thing about J.P. Morgan is they run about a 20% return on equity with capital. And they hold common equity as a percent of assets that's probably double what a bank a quarter, 10% of their size does. So, you know, if I'm a $200 million, $200 million bank, I probably can maybe get a 15 to 16% return on equity if I'm pretty good. I think that's what the good ones do. JP Morgan gets a 20% return on equity and they hold double the amount of capital.

So their return on assets is actually, you know, probably three times as high as a community bank. It's just crazy how good they are. Yeah, no, that's right. They, they're told me to 17. I mean, this is a point. Bitcoin Morgan had their own investor day a few weeks ago, and this point was made. They're targeting 17% return on tangible.

Their capital ratios are materially higher because they have to hold four and a half percent against risk-weighted assets just for being big and complex. And they subsidize the system, ultimately, because in addition, the big banks are taking on more of the FDIC deposit insurance assessments relative to the, regard, just on an ongoing basis, in addition, they're taking on more of the special assessment linked to the recent losses FDIC has suffered. Kind of a miss, there's a misnomer out there really about, kind of, I mean, clearly the FDIC, there's this notion of bailout and the FDIC.

The FDIC is an industry, the FDIC is backstopped by the federal government, but on a day-to-day basis is an industry cooperative unit that is that is that is funded by the industry and therefore deposit insurance which benefits smaller banks more than the bigger banks because they're not too big to fail is heavily heavily subsidized by the bigger banks now again it comes back to the point about the degree to which this structure is embedded within American culture And now, Jamie Darwin can't complain about it. It's funny, I had never, it makes complete logical sense, but I never really thought of that, right? Like, FDIC, I just always thought about it, oh, it benefits everyone, but you saw in March, right?

If you were pulling money, if you were desperate and you were going crazy, where was the, the two places, the three places you could park money is J.P. Morgan, it was Wells Fargo and it was city. Because, A, they're huge and they're safe, but you also knew they had the implicit back, the implicit backstop of the government, right? The government is not going to let those guys fail. It's going to, if city goes under and unsecured depositors, take 97% on the dollar. It destroys the economy. So you're fine. But because of that, like FDIC insurance, whatever, it's probably whatever for them, right? Whereas a community bank, if you didn't have FDIC insurance there, no one would keep money there.

They'd all be at JPMorgan. So JPMorgan pays in the system and it benefits someone else. Let me turn to Capital One real quick. So again, the reason I reached out Capital One, which I think is just an absolutely fascinating company. Again, you did a great write-up on their history there. At this point, they're the third-largest card issuer. They get started in the 80s and 90s. They kind of figure out a loophole for getting better returns on credit cards.

Now the third-largest card issue, they started going into banks. And there's a lot of stuff I want to talk about them because I find them a fascinating company. But I'll turn over to you. Do you want to quickly go through the history of Capital One and what makes them so interesting? It's interesting. You're right. I look at a lot of fintech companies, financial technology, and there's nothing new. under the sun capital one was arguable which i guess you know technology is as old as time so

which was the first financial technology company i don't know but the bank of america introducing the credit card in the 50s or maybe people were doing stuff before then i don't know probably yeah i mean visas visas are good uh uh uh could visa could be one the capital one they changed they they they so capital one changed the way to credit credit card business was what was run. It was so successful that it has many copycats all around the world in various emerging markets, India, in Brazil, in Russia. They, they, so they launched a credit card in a slightly differentiated way,

used direct mail in order to market it, differentiated on price, which was the innovation. but then run into problems in the early 20 years ago, ran into problems in the early 2000s, comes back a little bit to what we were saying earlier that no two crises repeat consecutively. And actually, if you can go back through the modern era, you can almost alternate between wholesale funding and retail funding crises.

In 20 years ago, you had a wholesale funding crisis that caused many subprime lending, actually to fail, but caused Capital One, which at the time didn't have a deposit franchise. It was funding its credit card receivables, either via securitizations, all via warehouse lines also. And actually, like a lot of fintechs today, grew too quickly, grew its balance sheet and grew its business more quickly than its compliance function, arguably, again, like many fintechs, many high growth financials in the market today. And that caused a market scare.

Wholesale funding costs, actually, they ultimately ramped, but before that wholesale funding just disappeared completely. They were able to navigate that, but they came out the CEO, who's the longest-serving financial company CEO globally, probably with the exception of Warren Buffett, if you regard Bokshar as a financial company, but globally, rich Fairbank is longer serving CEO of any financial company globally. You've founded that company. And he came back, he came out of that with the idea that actually they need to turn into a bank

in order to raise deposit funding. All of the benefits of deposit funding were just spoken about. That's something he wanted. And so 2005, 2006, he brought a pair of banks and just changed the whole business mix. One of the banks he bought was Hibernia, which I'm from New Orleans. My dad worked for Ibernia. And when they bought out, that's how he retired. So I've been familiar with Capital One for a long, long time.

And actually, Capital One, I remember specifically, they were set to close on like a Monday. And the Thursday before Hurricane Katrina hits New Orleans. And Hibernia might have been bankrupt. I mean, I don't know. I was in high school. I wasn't analyzing bank balance sheets. But Capital One restruck the deal, but they did close it. And I think that was probably good for all of the New Orleans economy.

And again, it's just, it's crazy how one little deal, if Capital One decides to claim MAE. Maybe I would have done in the merger R back then. But, you know, it's just crazy how things swift. There's one thing I did want to say there before we go back to Calvin one. You mentioned, hey, back in the 2000s, they learned, hey, we grew too fast for our systems. And I just want to go back to the crisis we're having right now. it is funny. The old adage is there's nothing worse than a fast growing financial. And everyone's heard it. I always equated it to, hey, when you're a fast growing financial, you know, you make a loan today and it doesn't come back to haunt you for normally three or five years. Right. So you're a fast growing financial. Maybe you're making all these loans and the problems in your book, you don't discover them for three years. And actually, if you grow fast enough, it might not be five or seven years because you grow so fast that, you know, year one's problem loans, you don't even notice them in the context of your balance sheet by year four because. you've made so many more. That's always been the adage, but it just struck me, struck me,

Silicon Valley Bank, First Republic. They were fast growing banks, but the risk was on, they grew too fast on the deposit side, and especially Silicon Valley Banks, appears to have grown too fast for its internal tech systems, risk management functions, everything. So just another thing on the fast growing bank adage. Yeah, that's right. And it's fascinating. You talked over about a black box, about bank being a black box. What's useful for the outside analyst of the sex? when a bank runs into difficulties is the material that is then published after the fact. And so, you know, the bank doesn't have to go bust for that to happen. You know, we got a great insight into J.P. Morgan's Treasury operation in the aftermath of the

London Whale grading loss in 2012. The bank commissioned a inquiry, which is publicly available on its website, and gives you real insight into what it goes on. inside the bank's treasury business. The same credit Swiss, obviously the bank now is no more, but in 2021, when they suffered that loss on our Kegos, they commissioned a law firm to make an investigation into what went wrong and that gave phenomenal insight into how a prime brokerage operation works or should work.

And to your point, right now we've had FDIC and the Fed file reports on post-Norton reports, on Silicon Valley and signature bank and they're just fascinating reading. You know, your point about tech is a really good one. Turns out, you know, we all thought Silicon Valley Bank by definition was probably likely to be good at tech. Turns out, turns out, according to supervisors, their tech actually wasn't that good. And they were, they were reprimanded for it prior to their ultimate collapse. thing that came up, again, to your point about kind of misjudging risk, if you like, is

the duration of deposits. They had an assumption, they modeled an assumption, duration of deposits, which ultimately their risk profile breached their limits. So they change the model. They change the input rather than change, rather than make a business decision. I have made this point before, maybe on this podcast, maybe talk to, I cannot believe when you look at Silicon Valley Bank, off the top of my head, $80 billion of deposits at December 31st. Of that $80 billion, we now know somewhere between $6 to $8 billion, so 10% was Circle, if I'm remembering correctly, was just a circle had $8 billion in uninsured deposits at Silicon Valley Bank. And then on top of that, Roku, if I remember correctly, has somewhere between $500 million to $750 million in uninsured

deposits just sitting at Silicon Valley Bank. And it just blows my mind that Silicon Valley Bank could look at this and say, hey, let's just round it up. Call it 10% of our deposit base is uninsured deposit from one customer who three years ago wasn't even here. Right. Like we don't know. The feds, we're talking June 6th. The feds just sued Coinbase today, which I believe point base gets tons of revenue from a circle. But we don't even know if this is illegal product, security. We don't know how the future is going to evolve. And they just thought, oh, cool, 10%. Like you would have thought, at least you matched that with extremely short-term, absolute liquid. And no, they just parked it all in deposits. Absolutely crazy to me. Can I ask a question on that? You can comment

on that, or I can do a quick follow-up on that. Yeah, no. So the only thing I would add to that is it's almost like the kind of amnesia effect here, which is that, you know, Silicon Valley was trading and a premium to book value. Everyone thought it was fine until it wasn't. And after the fact, we then learn a lot more, some of which is public. I mean, you know, you You know, the uninsured deposit number was public. The fair value of the health and maturity securities was public. These were nuggets of information that were available to any analyst, any investor, any customer. But none of which is public, you know, the idea that they weren't good attack,

the idea that they were changing their risk models, the idea of signature bank that management just kind of wasn't returning supervisor's calls. The way it works, this is probably true globally, but it's embedded within law in the US, is they call it confidential supervisory information. By the law, it's confidential. You know, you would think, you know, this is superior to any kind of SEC requirement to disclose anything to investors, that regulators know stuff that investors are not allowed to know. And once you see this, it comes back to why these things may be traded at a discounted

a book. Once you see this, once you, you know, you kind of wonder, hang on, if that was the case of Silicon Valley Bank, that's the case of Citibank, that's the case of Credit Suisse. What's going on at, what's going on at JP Morgan? What's going on at Capital One? You know, I don't know. Regulators know, I don't know. One of the best arguments, and I think anybody who's read my writing is I think banks are really attractive right now, but one of the best arguments is a year ago, if we had had this conversation, you and I, if we talked about First Republic, if we talked about Silicon Valley, we might have debated valuation. We probably would have focused on valuation. If we believe the depository was

real, we would have never, I don't think in a million years, we would have thought they would be at zeros. And we both would have been like, these are two of the best banks out there. These are two of the best banks out there. I don't think either of us would have been talking about their risk culture or internal issues with their technology. No, just wouldn't have come up. We would have been talking about the quality of franchises. The argument is, hey, yeah, you can go buy stuff for Tangible Book right now. But if you had seen, as you said, if you had seen what the regulars were saying about Silicon Valley Bank, you wouldn't pay tangible book.

Would you have paid a fraction? Maybe, but maybe not, you know, like, yeah. Let me, we were talking about the internal reports before, right? And you mentioned Silicon Valley Bank. I think we've done on them a lot. You read the report. And I've kind of only gone in so I can't claim to him super dove into it. But you read the report and you're like, oh, my God, these guys were just way out over their skis of this.

Is there anything else? us you kind of learn from reading this round of the bank failure reports? Well, so the other point is, and it's not an original point particularly, is this notion, the question is, has something changed, something fundamentally changed in the way banking works. And, and, you know, it's not original observation. People have been making it since 10th of March, but this was fast. This was, this was fast. And even when we look at growing concerns like Pac West, the degree of attrition of deposits is like nothing that has happened before.

You know, I was short when I ran a financials fund many, many years ago, I was short at Washington Mutual kind of December 2006. It took a long time to play out. And actually, there were three rounds of, and again, And this wasn't the reason why I was short. I was short on traditional kind of asset quality concerns. But again, one thing we've discovered after the fact is there were three separate rounds of, there were three runs. There wasn't a single bank run.

There were three discrete runs on the bank. When IndyMac failed and then there were three discrete bank runs, which had been, would have been well, which had been documented. And each of them, even in aggregate, were smaller than obviously what we've seen recently. So just, you know, the kind of duration. So I would say, it's not an original point, but the duration of deposits,

we just have to re, we have to re-mort that, recast that. As you, 2006, 2008, I mean, I think there was online banking, but people weren't really using it. It probably wasn't the speed. You know, if you wanted to do a bank run, you see the line, it's the line of people outside the street. and yeah, the line of people outside the street can induce fear, but guess what? You can't pull a billion dollars with a line of people outside the street, right?

Because human tellers have to like literally write every individual check and they have to go deposit them. In this case, as you said, I mean, basically every deposit left Silicon Valley Bank within 24 hours. Like nobody was prepared for that. A lot of people, I mean, look, if we're going forward, the bank CEOs are prepared to address this, right? Every bank CEO now has, hey, here's our liquidity, here's how we're ready. we have 100% of our deposit base in cash on the balance sheet or whatever, right? They've got all those. I do think it is an interesting question.

Regulators are going to have to wrap with this. Hey, every deposit in the bank can leave within 24 hours. How do you run a bank where a bank's business model is, the simplest is borrow short, lend long. How do you borrow short when a bad headline? I think the short seller reports are crazy, but short sellers can gang up and say this bank's terrible. And, you know, if you're a depositor, if the short sellers, if,

If there's a 1% chance, they're right, that's a disaster. If there's a 99% they're wrong, cool. You've got to worry about the 1% they're right. Pull now. Pull now. Come back later if you can. So if you're a bank regulator or your bank, how do you think about that going forward? It's just, look, so I would have a more optimistic spin is as follows, which is, I guess,

the bad case is, you know, why is anyone, the bad case is the mid-market funds at, let's say, five percent, why is anyone bothering with a bank? But the reason is not everyone, it doesn't mean all boil down to rate. There's a convenience factor as well. There's, you know, a deposit, it's kind of a bundle of features. Rate is one of them. Instant liquidity is another. Convenience is another, a relationship with the bank manager, with the bank is, is another, you know, that was put into a bad light, again, coming back to. Silicon Valley. This idea, if you want a loan, you have to retain funds on deposit with us. It was kind of seen a bit badly. Various politicians asked questions of the bank, but it's acceptable.

You know, it's funny that Silicon, because every bank I would listen to, they would say, hey, you know, if you were one of the people who pulled, you know, we remember that. We look at a wholesome, a wholesome relationship when we make loans. So if you put all your deposits, we're probably not going to be there for your line of credit. We're probably not going to be there for your next loan because we need a wholesome relationship to do all this type of job. So that's exactly right. So that's fine, lots of features.

So deposits aren't going to go to zero. You know, this idea that deposits I'm going to go to zero. But we've got different types of deposits. And actually, there are a framework already a liquidity coverage ratio, which looks at different types of not just insured and uninsured, but different types. of deposits, operational deposits, non-operational deposits, household deposits, and then whether they're insured or uninsured, all different spectrum of deposits, which have different risk factors and ultimately different durations.

And actually, the evidence is that most of those buckets behaved, most of the deposit contraction has come, if you look at Bank of America, Wells Fargo, as a segment their deposits, it's coming out of wealth management. I mean, Charles Schwab. Yeah. Oh, I've got some questions on Charles Schwab on here. Yeah, you did a great article on them too, yeah. Yeah, it's coming out of Ralph management because, which makes sense, because if we think about the features that their customers rate, um, it's coming out of wealth management, because look, a wealth management account is a broker's account, right? You and I, $100,000, we're saving that to grow, we're investing into the stock market. We want to grow it.

If we have $5,000 of cash there, it's to buy stuff opportunistically in the future. It's not to, you know, write checks for our household expenses or for rent. It's, we're really thinking of that as investment. So if things get hairy, A, we need that $5,000 can get up and B, we're already thinking about growing that. So why not shift it from a cash that earns nothing to a money market fund or a short term bond or something like that? Like it makes all the sense in the world, whereas you're checking account, again, which you're writing your rent, you're getting your deposits in, you're using to pay your utilities. You're not really thinking about, hey, I need to maximize my interest rates on that. Maybe it's suboptimal, but all sorts of human behavior is

suboptimal. So it does make sense to me that the wealth management sweeps is where most of it would be because that's where it's most agree. That's where you're really looking to get your best return. Exactly. And so outside of that, credit Swiss is a great example because Credit Suisse was a slow burn. Unlike Silicon Valley, Credit Suisse was suffered its first, maybe a bit more about Russia's Mutual. There was a series of runs. The first one was in October of 22, six months before it went first. When the internet discovered CDS charts and said, hey, Credit Suisse CDS went from 20 to 100. And yeah, that's a big increase. But it's also, this is a thin market. A hundred isn't that big in the grand scheme of a CDS. But first run.

Yeah. Well, exactly. But if you look at those classifications of deposit types, the risk was where the risk was identified. The risk was in uninsured wealth management type of deposits. So the framework is there for an outsider to understand this risk. And companies will be more transparent about it, but deposits aren't going to zero. No, you know, the other thing I think people miss is deposits, people probably think about deposits like you and me themselves. They think about their deposits, what they're getting. A lot of these, as you said, are operational deposits, right?

It's GE has an account that they used to pay hundreds of thousands of people on their payroll, that they used to pay hundreds of thousands of vendors. And you can correct me if I'm wrong, but I believe an operational deposit, like the A, it's definitely a zero percent checking account. And B, you can't just sweep money in and out to money market funds. Like you need to have that money in there to fund your daily operations. And those are like kind of the golden ticket for banks. And, you know, that's what a bank franchise is really built on that and the under $200,000,000.

But that's really where the banks build their franchise on. And those just can't sweep over to a money market. Tell me if I'm wrong. Yeah, that's right. That's right. That's right. That's right. Let's see.

Turning back to Capital One. So, of course, we talk about Capital One and we're talking about everything else. But I do want to start with Capital One. So, you know, let's just fast forward today, right? Capital One in the past, they are a credit card issuer. They figure out some tricks. They're very technology driven, as you said. If we fast forward today, they bought some banks and their basis.

business, their basic business model is we use the bank side to fund, mainly the card issuer side. They have other businesses, but now they're the third largest card issuers, card issuance is over 50% of their business. And if you're doing credit cards at 18% interest rates and funding with zero percent deposits, it's actually a pretty nice business. I want to ask you a few questions about them. Hey, they were at a conference recently and someone asked them, hey, you guys in the past

have bought regional banks to fund your business. Regional banks have been smashed. Would you be interested in buying a regional bank now? And they said no, we're out of the buying regional bank business. We see value elsewhere. And we could go a lot of places with that discussion, but I just want to ask, why aren't the issues in buying regional banks anymore? Yeah, I guess we're there, right?

So if you look at the balance sheet now, they have 350 billion deposits. Their last banking acquisition was ING direct, which wasn't a regional bank, but it brought in, gave them what they wanted it was online it was online deposits build them so 300 billion deposits they got a bit less than 300 billion dollars of loans so so they so it's the right they skewed appropriately in the current environment between deposits and loans and first republic was the other way around first republic was it was it was the other way around so um and i think what they realized i think what they've realized through this you know because they're deposits were up in the first quarter. Actually, there was a Wall Street Journal article about

this this week. We're talking on the 6th of June. It was Monday, the 5th of June, was a Wall Street journal article, making the point that two banks whose deposits were up in the first quarter through the turmoil in the middle to the end of March were ally and Capital One. Well, let me just jump in there because this is where I was trying to drive the conversation, right. Allied and Capital One have gone, not branchless because Capital One does have branches and they've tried, experimented with the Capital One little cafes and everything. They still have the Legacy Ibernia bridges. But Allies branchless, Capital One is largely online. It does strike me that both of these businesses that try to do largely online to attract their depositors,

so that involves lots of marketing, very slick online technology. It does strike me that Buffett owns, I think Berkshire owns a significant piece of Alice. and they just bought a significant piece of Capital One in Q1. And my question is, you know, is Buffett seen where the Puck's going, right? Capital One and Ally, online focused banks, that's where the Puck is going. They look, very clearly, they, they, the Puck's been wearing now for 20 years, right? Interestingly, the antithesis of that argument was a bank called Pomerulous Bank shares, which was pronounced by TD.

Yep. Vernon Hill, I'm told he ends the biggest house in New Jersey, was the founder and chairman of commerce bank shares. CBAH was its tickery. He sold it in 2008 to TD. He then came to the UK and set at Metro Bank in the UK. And his thesis was that was to do really nice branches, that really, really nice branches, and to compete with the internet banks by paying less,

but all in, if you include the OPEX of sustaining that branch network, all in, the cost would be similar. And I think, I mean, it's difficult now to actually disentangle within TD. and it's difficult in TD whether that strategy still persists. But I think he's lost. I think he's lost that argument. I think I probably would agree with you. But I would say, CD, we mentioned at the top of the First Horizon Investor Day. TD tried to buy them at the start of 2022 for what worked out to about two and a half times tangible book value.

Right. So that deal fell through for reasons unrelated to First Horizon. but I would look at that deal and say, as recently as early 2022, TD looked at their bank branching model and said, yeah, we want to lean into having branch coverage. Because their argument was you put First Horizon's branches with our branches and it fits like a glove, right? It fills in all the little spots that we don't have. Let me ask a different question.

I mean, you both. Again, one of the red flags, we're speaking about fast-grown financial being a red flag. Another red flag that I often look at is who's at the top of those best buy tables. Who's offering the highest deposit rate? Yep. Because inevitably, or maybe it's like the wine list in a menu, you go for the second, you go for the second cheapest. And maybe, you know, if you're one or two on the, maybe if you're two on the best buy table,

you are in need of deposit funding and that's a red flag. And actually, a lot of the cases, why the card was. there in Germany. There was a company called Green Sill private company owned a German bank that went bankrupt in the UK in 2020. They were up there. Often along these failures you will find have been desperate for deposit funding and they've been up there. So you kind of, you know, you need loyalty. The hot money isn't the best money. That's the hot, right? And you can do hot money, right? Like Andy Beale made a fortune in the global financial crisis getting hot money on the deposit side because his advantage was

he was buying assets for a song. But if you're a bank that's always trying to fund with hot money, you're going to, you know, you're the highest payer. You've got the highest cost. It is interesting. Alli and Capital One, I can't remember which, but I was reading their call yesterday. And when they said, look, go go look up our CD prices. Are we higher than the branch down the street? Yeah, probably because the branch down the street has to fund all the overhead costs of having the branch down the street. So we're higher than them, but we're probably like the 80th percentile of height. We're not the absolute top tier. Here's the hottest money. And we still attract people because we've got a good brand. So we pay more than the lowest, but we pay less than

the highest. And that's probably the right spot speed. Let me ask a different question about Buffett's investment in Ally and Capital One. So one way to look at it is, hey, these guys are largely online and that's where the puck's going. And that's probably right. But the other way to look at it is, hey, Ally and Capital One, to my knowledge, are the most consumer-focused banks, right? The The vast majority of their loan book is for Capital One credit cards and for Ally and then secondarily Capital One auto loans, right? So it's this huge diversified pool of consumer bucks. You go into a consumer recession. Maybe that's bad. Maybe they're over reserved. Who knows, whatever? We can talk about that. But it does strike me, you know, versus a every person

I talk to worries when they invest in a bank. It's all commercial real estate and it's all downtown skyscraper loans that are empty and going to zero. That's not the case. But, you know, if I looked at a first horizon or one of these other regionals, a lot of the book is commercial real estate and they can be chunk your loans. It's a little bit harder, whereas if you look at a credit card book with 10 million loans in it, like you actually can play statistics with that, even from the outside, you can kind of statistics. Do you think, so I want to ask you there, is Buffett attracted to the online side or is he actually attracted to the diversified consumer focus nature of these banks? Well, you can see that Capital One is a good test case

because you can see that. There'd been running with consumer credit card portfolio for 40 years. And it's been fairly predictable. It's been fairly predictable. The correlation with whether it's unemployment or the rate of change of unemployment has been very good. The transparency as an outsider through securitized 30-day delinquencies, rates is very, very high. So you get an early look into how the portfolio is... Which they publish every month, if I'm...

Publish every month, middle of the month, 15th of the month. The flip side is where they've had problems, they've had these kind of funky acquired portfolios. They have had problems lending to lending taxi medallions in New York. That was a business they inherited from Norfolk. They had problems in oil and gas, an oil and gas. portfolio when there was a energy crisis in 2015 out of hibernia. They right now, also North Fork, they've got a new commercial new estate portfolio, which clearly there are a question marks around. And yet, through all of these cycles that have affected specific sectors, specific geographies,

the consumer, the very diversified consumer credit card portfolio is kind of performed fine. Another question on Capital One. So again, I've talked to lots of investors, and I've talked to a few who are I consider Barry Sharp who were interested in Capital One, even before Buffett bought it, right? We can all just follow Buffett's investments, and we probably shouldn't because they've all. I've like Apple and Occidental over the past couple of years, just the man is over 90. He's, you know, the bet he might have made the most profit anyone's ever made in an investment off of Apple.

It's just unbelievable. But even before Buffett bought Capital One, they were interested in Capital One. And there were lots of reasons, right? So I think they were going to extract to the consumer focus. Capital One's returns on equity, if you look over time, have been fantastic. All through 2022, the market starts selling them off because of worries about the consumer and the worries about auto. But one thing that I have heard is a lot of people like Capital One because because of their online nature, maybe because they're still founder led, they think that they've got a massive tech advantage. And I just wanted to ask you, and I can give some anecdotes that.

But I want to ask you, do you think Capital One does have like a tech, maybe marketing as well, tech marketing advantage versus. other people? Or is that a little bit of Capital One spin coming out, do you think? Yeah, I don't know. It's difficult to go. Marketing, yes. Marketing is kind of in their DNA. They've always been good at that. Tech, they were the first, they were one of the first banks to go into the cloud. That's part of what they say. And Capital One gives a thing where they're like, hey, five years ago, if we had a $50 million bucket of loans that we realized was underperman expectation, we'd have to cut that whole $50 million out. But now because we're cloud-enabled, we can look at that 50 million and say, oh, it's actually

like the 10 million that we're lending to people who are named Mark with the C instead of Mark with the K, that's where it's going bad. So we'll cut that 10 million out. We can keep the other 40 million, which actually have good economics. And they've talked about other examples like that. But then the flip side is they're big, right, and they're old now. So there's a technical debt issue, possibly. The example of you gave was interesting because I was talking to an ex-head of Barclays in the UK,

ex-CEa of Barclays in the UK, not that long ago, who left Barclays and now is involved in Fintag. And he says a lot of the time the issue is the quality of the data. So, you know, maybe in some registers I am Mark with a K because it's misspelled. In others, I'm Mark with a C. And there was I'm Mr. M. In others, maybe it's a joint account with my wife. And the bank, the systems aren't table to recognize that it's all the same person, all the same risk. So that's an issue. I can't answer that. You mentioned tech debt. Another argument I've heard for Capital One is because they were one of the first of the clouds and because they have done acquisitions, but probably not as many massive acquisitions as some of the argument is they've got less tech debt than other

companies. You know, you think about a JP Morgan just this year. They buy First Republic and they're going to have a huge integration, and they buy WAMU, and they've got the, like, all these companies are a mismatch of multiple companies. And those integrations, they're never just always flipped onto one system. You build systems on top of each other and creates this massive tech debt. And his argument was Capital One has much less tech debt than all of their peers. Do you believe that or do you think that might be a little over? Again, I don't know because I haven't been inside looking at the tech.

What I would say, and it is a feature that's common to both JPMorgan and Capital One, is that profitability is really important because if you've got the first, free cash flow to invest back in tech, then it's a huge competitive advantage over an unprofitable bank. And again, to something we were talking about earlier, to a smaller bank, if you've got both the profitability and the scale to maintain, you know, Jacob Morgan in their investor day gave some very detailed disclosures on their tech spend. I can't remember the numbers off the top of my head, but a big chunk of it, 50% of it, with maintenance. And then 50% of it was investment.

Go ahead. And that's a big, you know, it's a big burden for an unprofitable smaller bank. So, you know, certainly just that ability to get 18% off credit cards, even though clearly the credit costs are higher. The average, the return on assets at Capital One are sufficient to drive profitability, to drive free cash flow to invest in tech. I remember. I think it was before the pandemic. It might have been just after, but I remember it was an article in the Wall Street Journal, I think. It was a community. It was talking about the death of community banks and how this tech debt we're talking about really catches up to them because, you know, J.P. Morgan's mobile app. It doesn't have problem. Sure. But it's probably much better than your local, your local banks. Because if your bank manages a billion dollars of assets, they don't even have the budget to go and develop a really functional app. And there was just a quote from it was like the CEO of the local bank. And he was like, like, yeah, I do most of my banking with Bank of America because their app is so easy. And it just always stuck with me. Because again, people who read my writing, people know I've said it. I'm really interested in the bank sector right now. And I look at all these banks. And you know, the answer might

just be, hey, why go by the local community bank for 90% of book value when Capital One probably trades for 1.1 times book value. But guess what? As we said with the Buffett, they are skating to where the puck is going, right? They have enough to invest in their technology. They're going to take all that share. Yeah, you're paying a little bit more for book value, but maybe you want to pay up a slight amount for a bank that's proven. They can do 20% ROEs-ish, and they've got the tech spend, and they're already depressed a little bit because they're making lots of tech spend and marketing investment and everything. Yeah. And now, a quick word from our sponsor. Are traditional expert calls in the investment world becoming obsolete? According to Stream,

they are. And you can access primary research easily and efficiently through their platform. With Stream, you'll have the right insights at your fingertips to make the best investment decisions. They offer a vast library of over 26,000 expert transcripts, powered by AI search technology. Plus, they provide competitive rates on expert call services, and you can even have an experienced by-side analysts conduct the calls for you. But that's not all. Stream also provides the ability to engage with experts one-on-one and get your calls transcribed free of charge,

all for 40% less than you would pay for 20 calls in a traditional expert network model. So, if you're looking to optimize your research process and increase ROI on investment research spend, Stream has the solution for you. Head over to their website at streamrg.com to learn more. Thanks for listening and we'll catch you next time. Let's see. We have gone through a lot. I do just want to ask Charles Schwab, because I'm just fascinated by this company and what's

happened with them. You had a great write-up again. I'll include that in the show notes. Charles Schwab, fascinating history. Just as we sit here today, for those who don't know, Charles Schwab had the issue. Mark mentioned earlier, they started a bank to fund their business. It went great. Then all of a sudden, everybody pulled everything from the cash sweeps. And now Charles Schwab's kind of in flux. They were using the bank to fund the whole business because they went to zero on trading and all

this sort of stuff. What do you think the future looks like for Charles Schwab? Is this a one-time thing or do they really need to reevaluate a lot of their business model? Yeah, look, I think that would be, I think they'll be fine. So firstly, any kind of liquidity, maybe three things to talk about. One is liquidity, two is solvency, and then three is kind of business mix. On liquidity, they are fine. They've got sufficient liquidity, be it cash directly on the balance sheet, or access to cash from the federal home loan banks, or the ability to sell some of their securities portfolio that would any event mature within a year and therefore trades close to part in order to satisfy any kind of extreme deposit outflow scenario.

So that's fine. The company has given a lot of disclosure around that. the cost though of and they call it cash sorting the process through which customers switch out of bank deposits into money market funds and Schwab unlike other banks kind of sits in the gatekeeper to that so unlike other banks gets the benefit of as the custodian of the money market fund as the salesperson of the money market fund gets some of the benefit from that switch. That's small, though, right? You don't get a lot for someone in a money market. Yes, it's normal. It's an earnings drag very, very clearly, because the earnings benefit of being, of invested,

of being in the earnings benefit of using those deposits where very little in the rate of interest is being paid in order to fund a securities portfolio, which, is underwater but is still generating a few percentage points is much higher than the kind of few basis points they'll get from selling a mutual fund but they keep the customer they keep the customer the customer is not going you know it's not like one of those banks where the customer the customer hasn't got they've kept the customer so there's the sum value there's some value in that um but it will cost them because right now um you know wholesale funds are priced at about five percent, whether it's federal home loan banks, or whether it's the new facility, which

I don't think Schwab has tapped yet, but the new facility, the bank, a BTFP program that was launched by the Fed on the day Silicon Valley Bank went under. So they've got access to, but it's expensive. So it's going to be a drag on their earnings. That much is clear. I think we clearly underestimated cash sorting. Actually, most of it already happened last year. They came into this year, and every month of this year, cash sorting has declined. It accelerated in March as a result of the factors we've spoken about, the kind of crisis that ensued there. But it's eventually spoken about before.

And then the problem is the one that many, the sample size is very small of rising rate environments. They've got 20, what, 2018, 2019. And then before that, we've got to go back to kind of pre-crisis. Sample size is very small. You know, their bank is relatively new. So, and I guess it's natural to go to the most recent period because that's the most consistent with customers' kind of mentality and with the technology that we have available today, i.e. the ability to see what money market rates are and do switches and so on. So they went

back to that. They underestimated the impact, but not a liquidity issue, a bit of an earnings issue. Where there is the question is this point about solvency because they, because they are, they, they, they, they, this is a brokerage business with a bank hacked on. The bank is regulated. But it's not regulated as a too big to fail bank. It's not, you know, there are various, there are four categories of bank category one, two, three, four. One of the issues with Silicon Valley was that it was transitioning from one category to another and a lot kind of got lost in that process. But they don't have to, they don't have to include their available for sale mark to market as a negative. to the extent it's a loss against their capital. And if that changes, then they'll take a capital.

I just tell our listeners what they mean. So if you buy $10 of bonds available for, if you buy them available for sale versus health to maturity, $10, and they go to five. If you buy them held to maturity, you keep marking them at 10 on your book on your balance sheet. When you report your book value, you say, hey, our book value is $10 per share, right? If they go from 10 to five and they're available for sale, you report your book value as $5. So investors will see your book value as $5. But for regulatory capital purposes, you still report and available for sale as $10. So what Mark's referring to, and I'll do the numbers from memory, so they might be slightly

off. But Charles Schwab reports 9% set 1 as their capital ratio. But if they're available for sale were marked at their actual value, not their kind of cost, I think it would be under 4%, which would be well beneath a well-capitalized bank. So they would be maybe not getting seized, but they'd need some pretty serious capital injections in some ways, shape, form. Yeah, that's right. I think the numbers are seven, the tier one leverage ratio, end of March, of 7.1%. But if you're baking real realised losses, the kind of $5 on that, $10, to your example, you're down to 3.2%, which is below 4%.

But it's a very cash, but the Fed will give them runway. The market might not. You know, we've seen in Europe, certainly, when there's a transition event, the market goes to fully loaded capital ratios very, very early. But it's very cash generative business, very capital generative business. The brokerage business isn't very capital intensive. So, you know, there are some margin loans, but it's not very capital intensive. So very cash generative business.

So they can generate that very quickly. It's a cash generative business. And the other point that all these banks like to make is, hey, the AOCI, so the different between the seven and three or seven and nine percent or whatever from your cost for available for sale, that accretes really quickly, right? Every quarter that takes by, you get closer to those bonds paying off at par, so you accrete some of that back, and that starts to accrete quicker and quicker over time.

I guess the one thing with Schwab, and we could talk a hundred different ways. Again, Mark did a really fascinating interview that involved, I didn't realize Bank of America bought Schwab, and then Charles Schwab bought him back from Bank of America in one of the first private equity buyouts that involved cash flows, not asset management. It's a really fascinating thing. The one thing I get with Schwab and you can just like market psychology me is the stock prices call it $55 per share as you and I are talking. And, you know, it's down 33% so far this year. And I thought like, hey, this is a good business. We can sort through all these different issues. You've got the bank and the broker. So in a disastrous scenario, we can talk about

splitoffs and all this sort of stuff. I was like, this is going to be super cheap. And I just go look at it. And I see $2,0.22 earnings per share, $3.90 per share. $2.21, $3.25 per share. And just look at it. I'm like, that doesn't look like a distressed bank to me. Like it seems like a bank, they've hair cutted. Yeah, there's going to be lower earnings going forward, but it's nowhere near distress to me, especially, you know, two months ago, people to me were talking about, is it going to make it?

And the stock still trades at, call it 13 times, 14 times EPS. I'm like, it doesn't look like there's distress to me has been my big issue. Tell me if I'm missing something or you can say, hey, a little outside of my wheelhouse here. No, I think, I think you're right. I think the market, I think this is a degree of. I hate to say efficiency in the market, but I think the kind of it's going to be okay case, they're going to ride through it. It's an earnings issue rather than a liquidity issue or a solvency issue is the consensus,

and that's being reflected. There'll be a short-term earnings hit. I don't know if that's 33% and therefore, you know, maybe it hasn't even been derated. Maybe its stock price simply reflects the downgrade in short-term earnings. I don't know, but, you know, Schwab's going to be around and the TD deal is still going to generate synergies and everything's fine. Yeah, yeah. No, and it's interesting you mentioned earnings issue, not liquidity issue. I think, I'm surprised it took this.

In March and April, I could not buy financial stocks because I thought there was real solvency issues. We didn't know how bad the deposits, pull-outs got. Then all the banks reported earnings in April. And I stopped being worried about solvency once all these banks came out and said, hey, we lost two or three percent of our deposits when Silicon Valley Bank bailed. But it stopped right after that, right? But then the market freaked out in late April, early May, as First Republic went down and everything. And I feel like it started really pricing insolvency issues in May. And as you and are speaking, again, it's June 6th. I think the market's just starting to transition from, hey, these banks are going to be okay. You know, the KRE, the regional bank index is probably at 20 percent over the past. week and a half or so. I think we're transitioning from it's no longer liquidity worry or solvency worry anymore. Now we're starting to worry about, hey, what do the earnings look like going forward? I don't know if you want to comment on that or anything. Yeah, that's right. I think that's right. I think that's right. I think that's right. I think, um, yeah, there are other questions

which mean that maybe peak multiple won't be as high as prior peaks, some of which we've talked about, just the notion that we have to think about what the duration of deposits is once again, the idea that governments can just step in, you know, as a shareholder, and there is an argument that, and actually Buffett kind of decries this argument, but there is an argument that one doesn't own banks, one rents them, you know, maybe the cyclical aspect, maybe even Buffett would agree, given what happened to Wells Fargo. I don't know. That's another one. The reason I didn't invest in banks for a long time was for years. Everyone would say Wells Fargo is the best culture and it turned out for multiple years,

they actually had the worst culture. Last question on banks, because you generous with your time, we're running right now, I do think the market's transition to an earning story. And yes, we're going to have a consumer. We're probably going to have a recession coming at some point in the next year or two. Yes, regulatory burden is probably going up. Maybe we get some capital exchanges. But I do wonder if the earning story is actually people have it wrong, right?

First Republic and Silicon Valley Bank are gone. And they were probably taking the super prime creditors by wildly mispricing risk, right? You've had two of the top 20 banks in the world go away. We're going to have probably increased regulatory, specifically capital requirements going for it. I wonder if people are actually underestimating how profitable banks will be coming out of the hills of this, right? Like banks retrenching, I wonder if you're actually going to see loan spreads getting really juicy

and banks actually, you know, two years from now, we look back and say, oh, there ROEs were actually a little inflated for the next couple years because the environment kind of got, people priced the environment for much worse than it was. Yeah, it could be, it could be, you know, and there's an opacity, the lack of understanding in how banks work, you know, this idea that banks have to pay, the idea that there's sort of wrong with a bank paying to depositors below what the market rate is, that's how banks get paid. You know, they don't send you an invoice once a month. You know, you don't have a subscription contract with the bank, you pay by taking a below market rate on your deposits.

All the more so, since various fees in the aftermath of Dodd-Frank, various fees, late fees, for example, overdraft fees, all of these have been heavily regulated. All the more reason for banks to, you know, they call it deposit beta, for that to be a relatively, low number. Now, competition, competition will change that. Competition for deposits will change that going forward. The one thing you haven't mentioned, which could be really interesting for the sector, which is that if the Fed, so the biggest, the disintermediation threat to the sector overall is the Fed. The Fed, the RRP, which the Fed offers money market funds, is a disruptive threat, to bank deposits. And various bankers, led inevitably by Jamie Diamond, at JP Morgan, have questioned why

the RRP rate has to be fixed so high. And one thing the Fed didn't do in March or subsequently in May after First Republic has changed that. But it's something that could happen. And if that happens, it kind of reduces the disruptive threat. that the Fed poses through the RRP to the banking system and therefore deposits will flow because, you know, deposits, because money market funds, by the way, aren't themselves a threat to deposits because the money market, because it will just, it stays in the banking system.

Yep. The only way out of the banking system is into the Fed through the RRP. So any legislative, well, it wouldn't be legislative, any regulatory change there could be something to look out for. That could be, that could be a positive. no completely makes sense man there was so much more to talk about it's just a super interesting question but look you've got it net interest it's just been on fire the past couple months obviously the financial sector has been interesting but the Schwab piece the capital one's piece you had the piece on

jp morgan's invest today i'm sure i'm for many more because i've only got those three pieces pulled up but it's just on fire so i'll include links to all those in the show notes uh mark this been great thanks so much for coming on and we'll have to do a follow-up quicker than we got this one on thanks Sandra. It was a pleasure. A quick disclaimer. Nothing on this podcast should be considered an investment advice. Guests or the host may have positions in any of the stocks mentioned during this podcast. Please do your own work and consult a financial advisor. Thanks.