Noahs' Arc 2023 Q1 Newsletter
Guns & Grains, Holding to Maturity
Welcome to our first newsletter of 2023 – we’ll be talking about banks (how could we not?) and circling back to something that we think is being ignored: the war in Ukraine.
No aspect of this material is intended to provide, or should be construed as providing, any investment, tax or other financial related advice of any kind. You should not consider any content herein or any subsequent services provided to be a substitute for professional financial advice. If you choose to engage in transactions based on the content herein, then such decision and transactions and any consequences flowing therefrom are your sole responsibility. Noahs’ Arc does not provide tailored investment advice to any person directly, indirectly, implicitly, or in any manner whatsoever.
Executive Summary
Holding to Maturity – In the aftermath of the Silicon Valley Bank collapse, we discuss how our financial holdings have held up.
Guns & Grains – A Tale of 2 Wars – The ground war isn’t the only thing being fought by Russia and Ukraine… we examine the war for votes in the UN.
The Next Stage – With graduation on the horizon, we’re thrilled to enter the next stage of life: with the wind at our backs, we’ll be heading towards the future aboard the Arc.
Holding to Maturity
Company financial information not cited was sourced from 10k’s
Noahs’ Arc is, and will continue to be, long banks. Of course, we do not believe that these particular banks are anything like Silicon Valley Bank (SVB), Signature, or Credit Suisse. After spending copious amounts of time over the last 3 weeks channel checking ourselves, we’ve decided to take the downturn as a buying opportunity. Here’s why:
One of our banks, Jeffries, is largely an Investment Bank not focused on deposits, meaning this crisis is not a direct issue. The other two, Stifel (SF) and Raymond James (RJF), do have exposure to deposits. To explain why we are buying more rather than panic selling, a postmortem on SVB is helpful.
Banks are able to classify assets as “Held to Maturity” (HTM). The name explains the intentions of the assets – if it is a bond expiring in 30 years, and a bank marks it HTM, the bond should not be sold for its entire duration; rather, the bank is signaling that it intends to receive the principal repayment at the end of 30 years.
When an asset is HTM (rather than “Held for Sale”), the bank does not have to mark down the value of the asset in response to rising interest rates. If that 30 year bond had an interest rate of 1%, but now interest rates on a 30 year note are 5%, that original bond is inherently worth less than it was. If the asset is HTM, banks do not have to report this mark down on their balance sheet. This becomes a problem if many of the assets are marked as HTM; it’s even more of a problem if those assets are 30 year mortgages rather than treasuries, seeing as mortgage rates have increased more than treasuries have, leading to even further markdowns.
For SVB’s part, 80% of the bank’s assets were HTM. Additionally, over 85% of deposits were above FDIC insurance at the bank. These two factors, coupled with rising rates and slowing venture funding causing fewer inflows to the bank, really created quite the perfect storm for SVB. All of the necessary ingredients for a bank run were there, including the presence of one billionaire with enough sway over the Valley to set off the dynamite.
So, what of our banks?
RJF has no assets HTM, meaning all of its losses on longer term debt are accounted for on the balance sheets. Additionally, the bank is now offering a cash sweep program that nets up to $50mm in FDIC insurance, reducing the risk of a bank run.
SF does have about $.25B in unrecorded losses on its HTM portfolio, but we view this as a reasonable number and their use of HTM (about 20% of assets) as responsible, especially given their over $2B in cash on the books. Moreover, its Asset Protection Plan includes more robust insurance than FDIC and SIPC with over $1m in cash covered on each account and up to $150mm in securities.
In short, both banks have much better liquidity and reserves than SVB. We have been upping our positions accordingly.
Guns & Grains – A Tale of 2 Wars
It's been a little over a year now since the war in Ukraine began, wreaking havoc on the Eastern European country and adding further chaos to global supply chains, particularly related to food. Noah and I wrote extensively last June about the effects this war is having on inflation (updated stats show the scary reality: food shortages and instances of global hunger are at their highest in decades). Our thesis is that volatile, non-core CPI (like food & energy) is at risk. While this part of CPI has since thankfully slipped in deflation, our concerns remain.
In our view, there are two wars going on:
The first is the literal boots on the ground war. This is a war with a single objective in the eyes of the Ukrainians: recapture any and all territory Russia has taken from them since the invasion of Crimea in 2014. This is the war that Ukraine is winning, with much of the lost territory over the last year recovered; they are now preparing for a widely anticipated spring offensive to try to capture more land as soon as temperatures in Eastern Europe warm up (rumors are this occurs in early May. Note this timeline, this is key for later). Russia is rumored to have started their spring offensive early, to little success.
The second, and we believe more important war, is the war over fertilizer and grains. This war matters for Ukraine, and unfortunately, it is one they are losing.
Since the war in Ukraine broke out last February, much of the world has been suffering from grain and fertilizer shortages, which have led to political instability in some 3rd world countries. For a while, there was little governments could do with massive quantities of grain stuck in Ukraine.
Last summer, Turkey brokered a deal with Russia and Ukraine to allow grain and fertilizer to continue flowing; with sanctions on Russian banks, this was a big deal. Agricultural prices relaxed. But Ukraine, in some ways, has struggled to export, allowing Russia to buy influence with its commodities. If countries depend on Russia for grain and fertilizer, how could they vote against Russia to help Ukraine in the war?
They can’t. They’re stuck. This was evidenced a month ago at a UN vote when a resolution to push Russia to leave Ukraine faced strong resistance due to African countries abstaining or voting no on the motion, almost half of which receive aid from Russia. Russia has been instrumental in helping them reduce price increases for food and grain in their local currencies.
In the West, (the United States and Europe), there are tight supplies right now for grain and food; generally, there are no food shortages here. Most western farmers are low on fertilizer, but are intentionally waiting for prices to continue falling up until they need to plant their crops around May. This is an inherent risk. The US and Europe are net importers of fertilizer from places like Russia. We make more of it than some countries that have suffered over the past year, but we are still dependent on imports to grow our crops.
Our concerns are the following: Ukraine is likely going to launch its much anticipated spring offensive in early May. Last Saturday, Russia and Ukraine extended their grain deal for an uncertain amount of time. Ukraine said it was for 120 days, but Russia said it was only 60 days (conditional on the US lifting sanctions; we won’t). Ukraine looks to be the favorite to make substantial gains in this ground war when they push their offensive, and we believe Russia will respond by pulling the rug – we’re afraid they’ll cancel the grain deal.
This is not certain, but if it happens, it will have an enormous impact on global crop prices; Western farmers are most at risk with their low fertilizer stores.
However, since Russia is already providing food aid to its “allies,” their struggle will be somewhat muted. Their goal is to have a tailored impact on crop prices in the west, putting pressure on us to loosen our support for Ukraine. This could especially be the case when farmers are forced to buy fertilizer last minute at sky-rocketing prices, making it too expensive to use and diminishing western crop yields.
Russia knows that without the western aid of bullets and tanks, winning the war in Ukraine is extremely feasible. Ukraine is winning the ground war (and Russia knows it; they just recently announced a desperate recruitment drive for 400,000 more soldiers), but losing the one that matters, with support in other countries for aid falling as Russia works to inflict food inflation pressures.
Public opinion for the war is wearing thin in the west as well, with support dropping in the United States and the number of people saying we are sending too much military aid to Ukraine approaching the proportion of people that argue we are sending the right amount.
In our opinion, current US fertilizer and grain markets are not considering this risk. While we hope the war does not escalate (and Russia doesn’t resort to crimping food supplies), we recognize the asymmetry and non-zero chance of it.
The Next Stage
Noah and I are rounding out our last month of being college students…. we’re not sure where the time went, but it's been an experience we wouldn’t trade for anything.
We plan on running Noahs’ Arc and Ultima, the AI investment research side of the business, from Ann Arbor once we graduate. We figured that since this is where it all started, why not stay here for another year for good measure?
As always, we appreciate your feedback and attention as we publish these newsletter. Creating something in a vacuum is dangerous, and frankly, boring.
We appreciate the support you’ve given so far.
Cheers,
Noah & Noah
No aspect of this material is intended to provide, or should be construed as providing, any investment, tax or other financial related advice of any kind. You should not consider any content herein or any subsequent services provided to be a substitute for professional financial advice. If you choose to engage in transactions based on the content herein, then such decision and transactions and any consequences flowing therefrom are your sole responsibility. Noahs’ Arc does not provide tailored investment advice to any person directly, indirectly, implicitly, or in any manner whatsoever.