Obviously, my first thoughts on this subject were biased on two fronts. First, I immediately gave credit to Paulson for being able to deftly trade in and out of positions and subsequently make money based on the extreme volatility we have seen. Second, since I am personally so bearish on regional and money center banks, especially after their incredible runs, I automatically assumed that a man who had made so much money being short financials was equally as pessimistic on the sector. However, aside from a short paragraph discussing his purchase of Regions Financial (RF) in the Bloomberg article, what I and most of the headlines missed is that as of the end of Q2 Paulson was quite long the US banking sector. Check out the table below to see what I am talking about:
|Paulson and Co.||Q1 à Q2|
|Position||Ticker||Shares Owned||Bought (Sold)|
|Bank of America||BAC||167,990,464||167,990,464|
|Capital One Financial||COF||17,000,000||17,000,000|
|Fifth Third Bancorp||FITB||5,000,000||5,000,000|
|First Horizon National||FHN||3,000,000||3,000,000|
|JP Morgan Chase||JPM||7,000,000||7,000,000|
|Marshall and Ilsley||MI||12,000,000||12,000,000|
|Peoples United Financial||PBCT||2,750,000||0|
*Although Paulson also owns shares of Goldman Sachs (GS), I do not consider GS to be a similar type of bank despite being classified as a bank holding company
My initial reaction to the fact that Paulson had taken a stake in some of the most troubled regional banks along with money center banks BAC and JPMorgan (JPM) was: “Wow, what am I missing about this sector?” I mean look at RF for example. As Karl Denninger pointed out this morning, the company disclosed in its footnotes that on a mark to market basis its loans (as of June 30th) were worth $22.8B less than the balance sheet said they were. That’s in comparison to $18.7B in shareholder’s equity. Correct me if I am wrong. I know my math skills aren’t top notch, but that sounds like a $4B hole to me!
I have to admit I was perplexed. I saw Paulson speak recently in New York and the way he explained his strategy to short the RMBS market through buying credit default swaps on subprime-linked CDOs (just nod if you don’t understand—it’s not that important) was brilliant. He figured out that only 5% of the underlying loans would have to go bad for the tranches he had insurance against to be wiped out. Then he risked an insignificant amount (you read that right: he didn’t even have to bet the house) of his capital and due to the asymmetric nature of and levered payouts on CDS he literally made billions. Then he followed up a ridiculous year in 2007 by shorting the investment banks that he knew had written CDS contracts on the dodgy CDOs and who were holding a lot of subprime securities on their balance sheets. So simple but yet so brilliant. And yes, he made billions more in 2008.
So what gives now? He seemed to understand to some degree the toxic balance sheets of the banks last year. What does he think is different about the ones he owns now? Unless he has used the time since the end of Q2 to reduce his position sizes or eliminate his stakes in these banks (there have yet to be any filings that indicate as much---see below), at first glance it appeared that Paulson may genuinely be bullish about the prospects for these banks, even at the current price levels. I still didn’t believe it myself so I thought I would compare the prices at the end of Q2 to the current prices to see if I could craft a scenario in which he had sold on recent strength.
|> Stock Price||> Stock Price|
|Position||> Ticker||> 6/30/2009||> 8/13/2009||> % Change|
|Bank of America||BAC||$13.20||$17.00||28.79%|
|Capital One Financial||COF||$21.88||$35.30||61.33%|
|Fifth Third Bancorp||FITB||$7.10||$10.84||52.68%|
|First Horizon National||FHN||$12.00||$13.60||13.33%|
|JP Morgan Chase||JPM||$34.11||$42.90||25.77%|
|Marshall and Ilsley||MI||$4.80||$7.32||52.50%|
|Peoples United Financial||PBCT||$15.07||$17.00||12.81%|
Well, isn’t that interesting? Even if Paulson did not buy these stocks at their 52 week lows, he still could have realized significant appreciation just in the last 45 days. Remember these increases have occurred in less than a month and a half so even if he bought the last day of Q2 the returns are enormous on an annualized basis. You can only imagine how well he has done if he bought in April or May. So, with the lag between reporting and filing and the potentially stale nature of the June 30 th data, he very well could be out of all of these positions. But wouldn’t he have had to file with the SEC indicating that he had sold out of a material position? Intuitively you would say no because he had not filed a 13D on any of them. But I thought I would check just to make sure.
|Position||Ticker||Shares Owned||Total Shares Outstanding||% Total|
|Bank of America||BAC||167,990,464||8,650,000,000||1.94%|
|Capital One Financial||COF||17,000,000||449,000,000||3.79%|
|Fifth Third Bancorp||FITB||5,000,000||795,310,000||0.63%|
|First Horizon National||FHN||3,000,000||215,210,000||1.39%|
|JP Morgan Chase||JPM||7,000,000||3,920,000,000||0.18%|
|Marshall and Ilsley||MI||12,000,000||368,100,000||3.26%|
|Peoples United Financial||PBCT||2,750,000||332,970,000||0.83%|
*Share data from Yahoo Finance
Looks like he is safely under the 5% threshold on all of these companies. This means that he could have sold out of these positions at anytime over the last 45 days without any official notification to the market.
So, what can we take from all of this? Nothing concrete obviously. What we do know is that even after some of these stocks had run up from their low points in Q1 Paulson decided to invest in them. I should mention that as of the end of Q2 he owned 2M shares of the Proshares Ultra Short Financials (SKF), ostensibly as a hedge against his bank positions. He also may have been short other banks as hedges or in pair trades. Most importantly, there is no way to know whether he thought the long term fundamentals were good or if he was betting that the government’s attempts to recapitalize the banks and backstop liabilities would help push share prices up. But, in either case, if he held on long enough it looks like it turned out to be a very profitable decision (at least on paper).
My final thought is that it would be foolish to assume that just because he accumulated such large positions as of the end of Q2 that he is still long these stocks and is bullish on the sector as a whole. As I keep pointing out, these companies still face economic circumstances that include a weak and highly indebted consumer, continuing declines in housing prices, never-ending foreclosures, and an impending commercial real estate crisis. So, before you go and start advising everyone you know to buy shares of the US banks because Paulson has suddenly turned long term bullish on them, remember that he has proven to be smart enough to make billions of dollars in some of the most difficult markets investors have seen for decades. Just that fact should indicate to you that he just might be sly enough to know when to get out and even be willing to turn around and go short when the time is right.
(Disclosure: Long SKF)
About the author:
My name is Ben C. and I am 2nd year MBA candidate at the Anderson School of Business at the University of California- Los Angeles. I have a BS in Economics from the Wharton School of Business at the University of Pennsylvania. Before coming to Anderson I worked as a generalist equity research analyst for Right Wall Capital, a long-short equity hedge fund located in New York City. Prior to working at Right Wall I worked as an analyst at Blue Ram Capital, another long-short equity hedge fund located in Rye Brook, NY. This past summer, I worked for West Coast Asset Management as a research analyst. West Coast, which was co-founded by Kinko’s founder Paul Orfalea, is run by well-known value investors Lance Helfert and Atticus Lowe.