My gut tells me that we have a big investment opportunity today in American banks. The problem is that my brain tells me that there is no way I have the expertise to figure out exactly what is on the balance sheet of these entities.
I’ve never been convinced that people inside banks are fully aware of the real risk that lies in their assets. I mean how many loans get underwritten by branches that are supervised by some guy who will never even meet the executives who run the bank? A bank is only as good as its internal controls on its underwriting standards. And internal controls are only as good as the people using them. And we all know what people are capable of. These are huge institutions that rely on the effectiveness of their systems. That frightens me.
However. While I can’t really drill into those assets to the level I would like. A person could always take a basket approach to such a contrarian investment if you believe that an entire sector is likely wildly undervalued. It reduces the risk of betting too much on one bad seed, and allows exposure to the simple premise that banks will survive and generally are in pretty good shape.
I saw this article and interview with Dick Bove and I have to admit it made a lot of sense to me:
The stock market is "simply flipping out" by selling off American banks, but the drop in their European counterparts is justified, Richard Bove told CNBC Thursday.
The selling in U.S. banks is "ridiculous," the Rochdale Securities banking analyst said on a day when the Dow Jones Industrial Average is down about 4 percent.
"Take a look at Bank of America (BAC) bonds today, it’s flat. If you look at Goldman Sachs (GS) bonds today, they’re actually up a little bit. So the bond market is telling you that there isn’t a risk in the American system. The stock market is simply flipping out," he said.
But the selling in European banks is justified because of the continued uncertainty. He said these banks "have to give these countries that can’t repay their debt three to five years of [a] debt-free period. They don’t pay their principal back and you cut their interest rates at the same point in time. As a result, that gives them a chance to build up some cash flow to improve their economies."
But he also wants European banks to be forced to "write these loans down to what the true value is. We can’t tell if tomorrow morning Greece wakes up and says, 'We’re going to be just like Argentina. We’re not going to pay you back ever.' Then banks will have to write this back down. So these banks have got to write down their assets to real value."
Finally, "You need a strong group of central banks — China, the U.S., Europe — to put together a pool of money that can be accessed by the banks to rebuild their capital."
Here is the video:
Rather than try and wade in here myself and buy a basket of banks, I think the smart move is to enlist the services of a proven financial sector investor to do it for me. And what I’m thinking is that buying into the Fairholme Fund, or buying stocks that mimic the Fairholme Fund’s huge exposure to the financial sector is a terrific strategy.
These were the main holdings of Fairholme as of their last semi-annual report:
Top Ten Holdings
Berkshire Hathaway (BRK.A) 7.2%
AIA Group 6.7%
Sears Holding Corp (SHLD) 6.4%
Bank of America Corp (BAC) 5.7%
Brookfield Asset Management (BAM) 5.6%
Goldman Sachs (GS) 5.5%
Citigroup (C) 5.5%
Morgan Stanley (MS) 5.3%
Regions Financial (RF) 5.3%
Total of Top Ten Holdings 71.2%
Buying now we are certainly getting a big discount from the price Fairholme paid. I’d suggest buying the stocks directly might be the better strategy as Fairholme is likely going to be struggling with redemptions for some time which could impact its performance to some degree.
Another alternative is to simply follow Buffett and Prem Watsa and buy the higher quality banks such as Wells Fargo. It is hard to imagine that with Buffett’s 20-plus years as a major shareholder that he doesn’t have a good feel for everything about WFC. And he is still buying today.