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Fairholme Focused Income Fund Buys Financials: BAC, C

August 03, 2011 | About:
Fairholme Focused Income Fund is managed by Bruce Berkowitz, one of the best investors among the newer generation. Voted as the Domestic-Stock Fund Manager of the Decade in 2009, Berkowitz is known for his relatively concentrated portfolio. He holds a relatively small number of companies, believing that the more diversified the portfolio, the more likely that the performance will be average. He targets deeply undervalued stocks with proficient management and strong free cash flow. His Fairholme Focused Income Fund seeks current income, other forms of cash distributions, and capital preservation. To meet these objectives, the fund invests in a focused portfolio of cash distributing securities and has the flexibility to invest in numerous different securities, including corporate debt securities, government debt securities, bank loans, convertible bonds, and equity securities. The fund follows Fairholme's focused, multi-sector, value-based approach. According to its second quarter portfolio update, Fairholme Focused Income Fund's biggest moves included new positions in Bank of America (BAC) and Citigroup (C).

Bank of America Corp. (BAC)

Fairholme Focused Income Fund purchased 2,160,000 shares of Bank of America for an average price of $11.82, impacting its portfolio by 17.57%. The price has since fallen 27%. Bank of America is one of the world's largest financial institutions, serving individual consumers, small- and middle-market businesses and large corporations with a full range of banking, investing, asset management and other financial and risk management products and services.

According to Bank of America's second quarter report, the company reported a net loss of $8.8 billion for the quarter, compared with a gain of $3.1 billion for the same period last year. However, excluding certain mortgage-related items and other selected items, net income was $3.7 billion for the quarter. The reported loss was largely a result of the recently announced agreement to resolve nearly all of the legacy Countrywide-issued residential mortgage-backed securitization repurchase exposures and other mortgage-related costs. These were partially offset by lower credit costs, gains from the sale of non-core assets and debt securities, improved sales and trading revenues, and higher asset management fees and investment banking fees.

Total revenue, net of interest expense, was down 54% year-over-year and 50% quarter-over-quarter to $13.5 billion, largely due to $14.0 billion of representations and warranties provision recorded in connection with the agreement to resolve the legacy Countrywide-issued residential mortgage-backed securitization repurchase exposures and other mortgage-related costs. Excluding these items, revenue, net of interest expense, was $26.5 billion. Net interest income decreased 13% year-over-year to $11.5 billion as a result of lower consumer loan balances and lower yields. Noninterest income was reported at $2.0 billion, down 88% over last year. However, excluding the mortgage-related items, noninterest income would have been $15 billion for the quarter, up 2% over last quarter though still down 6.7% over last year.

Among the company's operational highlights, total average deposit balances were up $44 billion, or 4%, over last year and up $13 billion, or 1%, over last quarter to $1.04 trillion. The number of net new consumer and small business checking accounts was positive for the second consecutive quarter, indicating the company's focus on improved consumer relations. The company's balance sheet continued to improve with risk-weighted assets declining $41 billion and global excess liquidity increasing $16 billion over last quarter. Provision for credit losses declined 60% over last year, reflecting improved credit quality across most consumer and commercial portfolios. Nonperforming loans, leases, and foreclosed properties ratio continued to decline to 3.22%, improving over both last quarter and last year. Tangible book value per share improved from $12.14 last year to $12.65 this year, though this is down from last quarter's $13.21 per share.

Along their different business segments, Global Card Services reported net income of $2.0 billion, up $1.2 billion over last year as a $3.3 billion decline in credit losses more than offset a $1.4 billion decline in revenue. The lower revenue was a result of a drop in net interest income from lower average loans and yields while the lower credit losses reflect improving economic conditions and continued expectations of improved delinquency trends. Global Banking and Markets also improved over last year's net income of $898 million to $1.56 billion, with record investment banking fees of $1.6 billion, the highest since the acquisition of Merrill Lynch.

In his investing thesis on Bank of America in June, Berkowitz indicated his confidence in the company. On Bank of America's CEO Brian Moynihan, he indicated his support, stating "I like Brian Moynihan... He’s ahead of the curve. He actually lowered late fees. Without being recognized, he’s taking all the right steps for consumers. He’s working out the mortgages." He also noted that Bank of America will soon leave behind the traces of its bad loans from 2007 and 2008 and instead enjoy the benefits of their great loans in 2009 and 2010. On their underlying business, he noted that "Balance sheet’s great. The reserves are unbelievable."

Bank of America has a market cap of $96 billion. It has a P/S ratio of .7, below its historical average, and a P/B ratio of .5, also below its historical average. The stock is currently trading for roughly $9.50, near its 52-week low of $9.32.

On 8/3/2011, Bank of America announced that it has hired Anne Clarke Wolff from JPMorgan Chase & Co. to work as co-head of global corporate banking. Wolff will split responsibilities with Joel Van Dusen to oversee Bank of America's global corporate banking operations worldwide. This continues Bank of America's strategy of expanding its corporate and investment banking operations beyond the United States since buying Merrill Lynch in 2008.

It has been reported that Bank of America has held settlement negotiations with some states over home foreclosures separately from talks with a larger group of state and federal officials. The proposed deal would "give the bank liability releases from state and federal claims over its mortgage practices in exchange for reducing loan principals to help struggling homeowners."

Citigroup, Inc. (C)

Fairholme Focused Income Fund purchased 383,000 shares of Citigroup for an average price of $44.21, impacting its portfolio by 10.91%. The price has since fallen 16%. Citigroup, Inc., a global financial services company, provides consumers, corporations, governments, and institutions with a range of financial products and services.

According to Citigroup's second quarter report, net revenues decreased 7% year-over-year from $22.1 billion to $20.6 billion. Citicorp revenues were roughly flat compared to last year at $16.3 billion. Citi Holdings revenues declined 18% year-over-year to $4.0 billion, largely a result of a 34% decline in assets to $308 billion. Corporate/Other revenues fell $400 million due to lower revenues from investment yields. However, significant improvements in the cost of credit lowered expenses, as total cost of credit in the quarter fell 49% to $3.4 billion. This was driven by a 35% decline in net credit losses and a $2.0 billion release of credit reserves. Operating expenses grew 9% to $12.9 billion to partially offset the decreased credit costs. Overall, the company reported net income of $3.3 billion, improving by 24% over last year's $2.7 billion and 11% over last quarter's $3.0 billion. Book value per share grew 13% over last year to $60.34, and tangible book value per share grew 16% to $48.75.

Among Citicorp's different business fronts, International Regional Consumer Banking revenues increased 12% year-over-year to $4.8 billion, but this was offset by a 9% decline in North America Regional Consumer Revenues to $3.4 billion. By contrast, net income in international RCB declined 15% to $922 million, while North America RCB net income increased by $632 million to $684 million. This was a result of lower credit reserve releases internationally and higher releases in North America. Transaction Services revenues grew 6% to $2.7 billion due to strong service products in emerging markets, but net income fell 6% to $868 million as a result of an 18% increase in expenses. Securities and Banking revenues fell 8% to $5.5 billion due to the ongoing macro environment that led to lower customer activity levels, and net income declined 29% to $1.2 billion.

Citigroup has a market cap of $108 billion. The stock trades with a P/E ratio of 11.3, slightly below its nine-year average. Its P/S ratio is 1.3, also below its nine-year average though higher than its recent average. Its P/B ratio is 0.6, again below its nine-year average though higher than its recent average.

On 8/3/2011, Citi announced that it had appointed Steve Yang as head of Greater China credit sales, joining from JP Morgan where he was co-head of structured credit syndication.

On 8/3/2011, it was reported that bids for EMI could fetch more than $4 billion, allowing Citigroup to recoup about three-quarters of the money it lent to the private equity buyout of the company in 2007.

This is part of GuruFocus Real Time Picks report, which reports the stock trades of Gurus within the last few days. For more information, go to Real Time Picks.

Rating: 2.8/5 (11 votes)


Noblepaladin - 6 years ago    Report SPAM
This is very interesting as BAC and C are not exactly "income" stocks at the moment.
AlbertaSunwapta - 6 years ago    Report SPAM
They'd better be watching out for the investor redemption boogyman. As GMO and First Pacific have highlighted, being rational, reasonable and right doesn't appease unit holders only concerned with short term returns.

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