Chess, bank funding, opportunity
Chess, bank funding, opportunity
is there something here??? Crouching deposits, hidden losses
Above is the final position from “A Queen for the King” featured in “My 60 Memorable Games” and other media. White resigns this position, as capturing black’s queen leads to checkmate in 1, and with any other continuation completely lost for white. It’s a beautiful and remarkable position that was achieved by a counterintuitive move (to most)- a queen sacrifice is rarely seriously considered by amateurs in all but the rarest of cases. Black cleanly calculated and made this move with dramatic consideration; what’s more, this was not a mismatch of skill as both players were grandmasters.
How did black make this brilliancy? He simply didn’t eliminate it as a possibility. Buffett and Munger drew this comparison from chess to investments:
“WARREN BUFFETT: Yeah, we don’t consider many stupid things. You know, we get rid of them fast.
And in fact, people get irritated with us, because they’ll call us, and when they’re in the middle of the first sentence, we’ll just tell them “forget it.” You know, and we don’t — we can see it coming.
And, you know, that’s the way, actually, the mind works. There was a great article in The New Yorker magazine 30 years ago or so — little more than that. It was when the Fischer-Spassky chess matches were going on. And it got into this speculation of would the humans be able to take on computers in chess.
And, you know, here were these computers doing hundreds of thousands of calculations a second. And they said, “How can the human mind, when all you’re really looking at is the future, you know, the results from various moves in the future, how can a human mind deal with a computer that’s thinking it at speeds that are unbelievable?”
And of course, they examined the subject some. And a mind, like — well, in fact, all minds, but some much better than others — but a Fischer or Spassky, essentially, was eliminating about 99.99 percent of the possibilities without even thinking about it.
So it wasn’t that they could outthink the computer in terms of speed, but they had this ability in what you might call grouping, or exclusion, where, essentially, they just got right down to the few possibilities out of the zillions of possibilities that really had any chance of success.
And getting rid of the nonsense, I mean, just figuring that, you know, people start calling you and say, “I’ve got this great, wonderful idea.” Don’t spend 10 minutes, you know, once you know in the first sentence that it isn’t a great, wonderful idea.
Don’t be polite, go through the whole process. And Charlie and I pretty good at that. We can hang up very fast, right? (Laughter)
CHARLIE MUNGER: Well, there you have it. All you’ve got to do is go at it in the way that Vasily Smyslov did when he was the world champion, and — of chess — and just do the same thing in investments.”
Identifying a queen sacrifice is the best analogy I can draw to investments:
1.) Identify something optically counterintuitive and come to the conclusion there’s something worth calculating. (“is there something here?”)
2.) Calculate cleanly while giving respect to your opponents calculation ability (they might have mapped it out before you did!). Allow for every possible outcome & assume your opponent calculated that out too- it always comes down to calculation.
3.) Have conviction and play out the line. Analyze afterward.
Financials- SCHW, FRC, and RILY (long)
These past two weeks (and this weekend) have created potential opportunity. Funding desks at regional banks across the country are watching in horror as deposits flow from their costless checking accounts to money market mutual funds, G-SIFI checking accounts, gold, bitcoin, stablecoins(?) and under mattresses. Short, costless money exists no longer. This was especially problematic for undercapitalized banks and created the solvency problems observed today.
I knew the FRC business well as a brand: bank high net worth individuals and do a good job and they’ll give you all of their business (including deposits above $250K!). Give them a 2.6% 30-year fixed jumbo mortgage and they’ll give you their investments to manage; simple, classic cross-selling at a retail bank with an emphasis on customer service. The culture, the growth, the commitment to avoiding market-making and the eventual drama it creates. FRC had a great brand and a great business model.
But it didn’t matter at all- panicked rich people, who stare at their screens all day, saw the collapse of the share price, and the rest was history. Not to mention the price of solvency: either you run the loan book upside down (where funding costs>interest received on the loans a/k/a negative carry) or liquidate assets en masse, where the price of liquidity would be certain to create insolvency.
I point out FRC as a case study in “there’s nothing to do here”. I knew the business as high quality, deserving a high multiple, a franchise with brand loyalty, and it evaporated. It’s a lesson in “facts change, change your mind” and the fickle nature of brand loyalty in banking or any other commodity business. It mattered, until it didn’t matter, and now it doesn’t matter and can’t matter. FRC is a run-off book without a franchise- one that is deeply in the hole.
SCHW is another “is there something to do here?” case, but markedly less dramatic. I don’t think SCHW is insolvent as there’s no book to run-off, but it’s an interesting case study. SCHW longs would trumpet, in the age of ZIRP, the massive cash balances SCHW customers would keep. This was a coded way of showing equity holders that if short rates ever came back, SCHW’s sticky customer base and low deposit beta would allow them to earn the interest on their customer’s cash and pocket the spread like checking accounts. A simple, intuitive thesis.
What if the complete opposite was true? What if funding your book with client cash at 0% lead to massive run risk? Clients knew about this grift and made their plans to move cash when short rates went higher. Maybe this gets exacerbated in the face of other banks being run or simply the SCHW stock price cratering. Either way, chicken or egg, SCHW is hurting and the price of funding has skyrocketed. Money goes where its treated best.
Incidentally, RILY’s funding costs, outside of securities lending and borrowing for their brokerage business, are almost entirely termed out and fixed rate debt. Staggered maturities through 2028 in RILY’s baby bonds give flexibility to RILY’s CFO for optimizing capital structure, including debt repurchase or simply paying debt as it comes due with proceeds from RILY’s principal securities portfolio. I intend to do a more fulsome update post on RILY, including the harebrained SNCR offer, for another post. I am certainly a fan of their capital structure, I am certainly in love with the profitability of their investment bank, but it remains to be seen how well their principal book and operating businesses will hold up in the coming environment.