Bruce Berkowitz on Financials
Bruce on WealthTrack? No, I still find it too familiar to call him Bruce even though most bloggers do so. OK let’s try again: Mr Bruce Berkowitz manager of the decade on Wealthtrack? Nah, too formal. One more time: Bruce Berkowitz on WealthTrack
Coming back to his roots and sharing the lessons of the S&L crisis for today’s environment. His thesis for Wells Fargo in the 1990s is something to read time and again side by side with Peter Lynch’s account. Below the fold, an excerpt of his views on banks but all the interview is worth seeing.Vodpod videos no longer available.
BRUCE BERKOWITZ: There are two parts to the investment equation. There’s sort of what you give and what you get. So we’ll start out with what you get. We’ve had this most extreme period in the financial history of the United States. Some say we came very close to another Depression. And the U.S. government and its agencies just did a great job of pulling us away from that cliff. And, for the last couple of years, companies have gone through tremendous stress, the financials. But today, their balance sheets are stronger than ever, their earnings power, their pre-tax, pre-provisioning power is stronger than ever. And, you have to think about loans and the life of loans. You know, most loans go for between two and five years, whether it’s an individual loan, commercial. So there’s been this two-year stress period of burning through all these bad loans. And at the same time, they’ve had these two years of good loans, because they’re in very stressful periods. That’s normally when they put on their best loans.
So, the financial system came to the brink. U.S. Treasury, New York Fed, Congress did amazing job. I mean, with hindsight, you know, you could criticize a little here and there. But they did an amazing job. Now it’s up to private enterprise to take it over from here. And traditionally, that’s going to be our banks and our brokers leading the way on this nascent recovery. And there are going to be fits, and there are going to be starts. But again, the balance sheets are strong; the potential earnings power is used. They’ve battled hard, and it’s a trite saying, but whatever doesn’t kill you makes you stronger is quite true. And for those financial institutions still standing, and the ones we’ve invested in, will get through this period and move on to a more normal earnings period.
CONSUELO MACK: So, what’s the biggest risk that you’re taking, in having this sort of a concentration in these companies that have been through the grinder?
BRUCE BERKOWITZ: Well, the biggest risk would be the correlation risk, that they all don’t do well. Which would mean, you know, a severe double dip in the entire financial system of the United States, totally melts down, malfunctions, no longer exists. So, it’s hard to see that.
But, on the other hand, when you take a look at our fund today, one-sixth of the fund now is cash equivalent. Another one-sixth of the fund is in fixed income securities. So, we’re only two-thirds invested. So we have billions of dollars of cash ready to take advantage of whatever further stresses may come our way. And, you know, we’re right. And then, as I was mentioning to you, the other part of the equation is what you give. And by “most hated,” I meant that the financial institutions are not very popular today, given what’s happened in the past couple of years, and their price reflects it. So, we’re paying a pessimistic price for institutions that are essential to the country, and that will lead us, as they usually do, out of the recession.
CONSUELO MACK: Some of your competitors, including Don Yachtman, of the Yachtman Funds, who has a terrific track record as well, you know, recently told me that he doesn’t understand what you’re doing because he feels that financials are black boxes. That, in fact, you can’t possibly know what Citigroup’s loan portfolio really looks like. And that, he feels that you’re taking a tremendous amount of risk that is kind of contrary to what your prior practices have been. You don’t think they’re black boxes? I mean, you actually think that you know what Citigroup owns and what its debts are?
BRUCE BERKOWITZ: It’s our belief that enough time has gone by now, as I’ve said, that you’ve had the vintages, the various loans for a given year. You start to see, you know, the bad parts, the delinquent loans. You get to see the cash yields on the bad debt. You know, one thing that’s nice about getting older is that you start to see certain cycles before, and this is very reminiscent of ’91, ’92, when people thought Wells Fargo was going to go under because of commercial real estate. Citigroup, again. And, it’s perverse psychology. You’ve had so much strain in the system, so many balance sheets; individuals have been hurt, that it’s just very hard to look at them in a positive way.
But, with time, you start to see the patterns and the recovery, and you also have to give credit to the regulators, to the auditors, to the executives, to the oversight committees of the Congress. I mean, these institutions have been studied in the last two years. They’re under a microscope. Every element has been studied. And when you’re in stress mode, and when your institutions are shrinking, it’s very difficult to hide bad news. Everything comes out in shrink mode. But the good news is, when you’re shrinking, cash flows build up. You’re able to pay off the bad debts, and you’re able to fight another day. And, you see it now with the institutions.
CONSUELO MACK: Bruce Berkowitz and the Fairholme Fund’s rule number one is don’t lose money. And then, rule number two and number three is pay attention to rule number one. So, given the current strategy that you’re following, in the Fairholme Fund, are you still adhering to the rule number one and two and three, of don’t lose money?
BRUCE BERKOWITZ: We believe we are. At the prices that we’re paying for securities, we just don’t see the downside. We don’t see death, we don’t see bankruptcy, we don’t see significant losses. In the case of the banks, we’ve been buying below book values. We’ve been buying single-digit earnings yields. I mean, at some point, the banks will start to have a more normal earnings period.
It’s amazing, when you think of a Bank of America and all of the organizations they have merged with over time, including Merrill Lynch and MBNA, it’s tremendous. The amount of value and wealth is just tremendous in a Bank of America and in fact, it’s essential to the rebuilding of the country’s balance sheet. And so is Morgan Stanley and Goldman Sachs, and Citigroup and Regions Financial and CIT. All the companies that we purchased during their stressful periods.
CONSUELO MACK: So, Bruce, what would convince you to sell? I mean, is it going to be a price decision with some of these companies?
BRUCE BERKOWITZ: It’s going to be a price decision.
CONSUELO MACK: It is a price decision.
BRUCE BERKOWITZ: It’s going to. It’s just so cheap, relative to what you’re getting. And eventually, if we’re right in our understanding and we don’t have that dreaded double dip, going back into the Great Depression, then there’ll be a more normalized earning period. And then, that’ll be a tough part to determine, at what point our investments start to equate to T-bill type returns.
CONSUELO MACK: And so, when you look at, you know, a Citigroup, for instance. Let’s just take them one at a time. I mean, it’s value now. Do you think that there’s still a lot of value left?
BRUCE BERKOWITZ: Yes. Citigroup has the ability to earn a dollar a share, which would put it at $10, let’s just say. And you compare it to where it’s trading today, four. Under four.
CONSUELO MACK: And Bank of America, again, same?
BRUCE BERKOWITZ: All the same.