To break even from his 2011 loss of 32 percent, Berkowitz would need to make a return of 47 percent in 2012. While a high aspiration, Berkowitz does not seem inferior to the task. In 2000, the fund’s first year, he made a 46.5% while the S&P lost 9.1%. Back then, the fund had only $650 million under management, but had the same value-oriented approach and concentrated portfolio. The only descriptor it might not use anymore is “risk-averse.” The next closest he came was in 2009, when he returned 39%.
There is also the chance that Berkowitz could exceed his break-even point and make a sizable profit. For instance, Berkowitz has paid for his 105,012,095 shares of Bank of America an average of $14 per share. At the $5.50 share price it trades for today, he has lost approximately $893 million, and his holding would now be worth $578 approximately. If the stock merely doubled, he would have almost made back his investment, with approximately $1 billion. The last time Bank of America traded for $11 was just May of 2011. In January, it traded for triple the current stock price.
The Financial Select Sector SPDR Fund fell 18.5% for the year, compared to the S&P 500 which ended the year flat. What could happen next year to promote an upswing? According to the FDIC’s third-quarter banking profile (posted on Fairholme’s website), net income rose to $35.3 billion in the third quarter, a 48.6 percent increase from the third quarter 2010, making it the highest level for industry profits since second quarter 2007. It was also the ninth consecutive quarter of earnings improvements as bank’s see lower expenses for loan-loss provisions, which declined 47 percent from third quarter 2010, and 2.6 percent less than the previous quarter. Loan losses declined for the fifth straight quarter, and 39% year over year.
Other key economic data could affect the banks: jobless claims are down, pending home sales are up and housing starts jumped a seasonally adjusted 9.3 percent from October to November, and 24.3 percent from November 2010.
Dick Bove, banking analyst for Rochdale Securities, said on CNBC on Thursday the big negative on bank stocks could be perception. “People got such a shock in 2007 and 2008 when the banks really let them down, that people simply don’t believe anything one can say about banks at the present time,” he said. “However, every one of the key elements that one would look at to determine whether the banking industry is coming back strongly, are all positive.”
However, Vikram Pandit, CEO of Citigroup (C), Berkowitz’s fourth-largest holding, said in at a conference in December that the bank still faced an extremely challenging environment. “It’s a combination of market uncertainties, sustained economic weakness in the developed economies, and as well, the most substantial regulatory changes we’ve seen in our lifetime,” he said. “Needless to say, when you put all these three trends together, the competitive landscape is going to likely be very significantly affected for a number of years in the future.”
In the same presentation, he also acknowledged that the bank has struggled to significantly increase revenue, which has increased from $105.8 billion in 2008, to $108 billion in 2008, to $111.5 billion in 2010. It also improved each quarter of the three quarts of the year so far. Material improvement in credit quality, however, has driven their growth in net income. Most of their losses have stemmed from their Local Consumer Lending segment, whose largest asset is their U.S. home mortgage portfolio. In response, they are reducing mortgage risk by selling current and delinquent mortgages, and allocating $10 billion of loan loss reserves against the portfolio.
Berkowitz said that he paid about $32 per share for AIG (AIG), his largest holding, while the book value now is around $30. Today, the stock trades for $23 per share.
AIG is still paying large amounts of money to the government for a bailout it received in September 2008. It made six major payments in 2011, for a total of approximately $45 billion. It owes a remaining $8.4 billion, and the government still owns about 77 percent of the company, which may take a while to sell.
Berkowitz commented on the government’s stake in AIG in a September 2011 interview on WealthTrack: “There is a 77% overhang, a lot of investors won’t go near the stock until that overhang disappears, waiting for the government to get out, thinking that the government will make a very bad deal… at some point, not knowing exactly how the governments going to get out, and what’s going to happen to those shares, I have to look at the balance sheet of the company, the earnings power of the company, what I believe the company’s capable of and growing and what they’re doing, what they’re saying, and put it all together, the good, the bad, the ugly, look at the price the price that the company’s trading and make a decision as to whether or not this institution can be permanently killed, in which case is no, and whether or not at that price there’s a sufficient margin or safety to not lose any money any hopefully make a reasonable return for shareholders.”
Nonetheless, AIG generated cash flow of $16.6 billion in 2010, and $679 million in the trailing twelve months. The company’s overall financial situation still shows weaknesses. It saw declining revenue of $77 billion in 2010 from $96 billion in 2009, although earnings increased to $7.8 billion in 2010 from a loss of $10.9 billion in 2009, showing a profit for the first time since the credit crisis. On November 3, AIG authorized a repurchase of $1 billion of common stock.
Bruce Berkowitz has never had a position that suffered permanent loss of capital, or owned shares of a company that went bankrupt. If these signs of new economic growth continue into 2012, his thesis on currently troubled equities could gain far more credence and returns.