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Why is Buffett bullish on BAC but bearish on other financials?


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I still don't really understand why Buffett is bullish on BAC while selling off his other financial holdings, like WFC.

Also Munger has quite some money in his personal portfolio invested in BAC, as well as Li Lu.

Especially Li Lu, he is someone who, I think, aims for quite high returns and in my view right now BAC isn't one that is going to return more then 10% per year.

 

Could someone give me more clarification about this or refer me to an article or a comment in CoBF?

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I was listening to a podcast recently - Focused Compounding - talking about banks - this episode in fact:

https://focusedcompounding.libsyn.com/website/how-is-a-bank-like-a-railroad-and-other-crazy-ideas-geoff-has-about-investing-in-efficiency-driven-businesses-0

 

Unlike, say, restaurants, Banks tend to survive even if they're fairly poorly run.

 

Some will have poor cost-control but still manage to charge a sufficient interest margin between their borrowing cost (e.g. deposit rate) and their lending rate (e.g. loan rates) and maintain sufficient client relationships that few customers will shop around and actually switch.  In the case of inefficient small local banks they might earn lower returns than putting their capital in an index fund but they can still keep running and paying the staff and the CEO can still be the guy at the country club who runs a bank and there's nothing forcing them to up their game.

 

Other operators will fanatically cut costs from the non-customer-facing side and anything that doesn't benefit the clients or add efficiency to their systems. There are some interesting examples in that podcast.

 

I wonder if Buffett, Munger and Li have determined that BAC is pretty much the low-cost operator among the big banks with a relentless focus on efficiency, much like GEICO is to car insurance. I think there's a lot of admiration for what Brian Moynihan is delivering at BAC. There's admiration for Jamie Dimon too, but I think the investment banking side of JPM is too big for Berkshire to go huge.

 

In the podcast episode Geoff Gannon was talking about the effects of an ultra-low interest rate environment (made even lower by COVID-19) and whether that would squeeze the interest margin available to the less efficient operators in the industry, while the likes of BAC, able to make massive IT investments spread across millions of clients, would be able to maintain their profitability and possibly win new business better than their competitors and may even be able to make cheap acquisitions of banks with lower efficiency and make efficiency improvements post acquisition.

 

I'm not sure that is the case for BAC versus the likes of WFC, but I think it's a line of reasoning to consider if investing in banks, especially having such an extreme environment as we're seeing now, with the possibility of even negative interest rates looming.

 

Perhaps someone has more insight into it. I'm not in the US, I'm no longer a direct investor in BAC (just via my BRK exposure) and my experience with US banks is limited to a few interactions with Wells Fargo, so I don't want to express an opinion.

 

Another option is that WFC was seen as one of those situations where they decided they'd seen enough rats coming through the kitchen door to worry that the kitchen was infested and get out perhaps before the new CEO does a load of big bath write-downs. Maybe there's concern that unauthorized account opening scandal is just the first example of a culture of poorly-aligned incentives encouraging illegal behavior or maybe the response to it has not been decisive enough to satisfy Buffett.

 

We'll know for sure by Monday whether Berkshire's 13F and their holdings in New England Asset Management's 13F included any remaining shares of WFC at 30th Sep. My suspicion is that they had sold the whole WFC stake by mid August, judging by the rate of sales in Q2. I imagine we'll see the Berkshire filing on Saturday and might have to wait until Monday to see NEAM's filing based on the last time the 45-day deadline fell on a weekend.

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I am not familiar with NEAM and their relationship to Berkshire. It appears that it is 75% owned by General Re. Are the funds they manage similarly invested for Berkshire? Could you provide any more infor or direct me to where I could learn more? Thank you.

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I am not familiar with NEAM and their relationship to Berkshire. It appears that it is 75% owned by General Re. Are the funds they manage similarly invested for Berkshire? Could you provide any more infor or direct me to where I could learn more? Thank you.

 

If you search “neam” on this site, you’ll find a few threads with great info.

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I think Buffett has always tried to earn the best in class banks rather than the turnarounds. Even with BAC he initially bought the warrants and only exercised them when their turnaround was well underway and they were in great shape.

 

So Buffett selling WFC just indicates they have a lot of problems. You can probably make a lot of money if they fix their problems. But it doesn't have the certainty Buffett craves.

 

I can't really guess his revised thinking on JPM especially as a year or two he was saying he was dumb not to buy it sooner and set out his thesis quite persuasively:

 

"A business that earns 15% or 16% or 17% on net tangible equity, that’s incredible in a world of 3% bonds. I mean, just imagine that you had a deposit account with JPMorgan that they made a mistake and they gave you 15% on it. And they couldn’t redeem it. What would you sell that account for? You wouldn’t sell it for 100 cents on the dollar. You wouldn’t sell it for 200 cents on the dollar. You wouldn’t even sell it for 300 cents on the dollar. You have an FDIC-guaranteed instrument that would now be at 300 cents on the dollar. If it was 15% on equity, you’d be earning 5% on it, which is way better than Treasuries. Now, if on top of that, your deposit allows you to let your interest compound to some extent, now, that instrument becomes even worth way more. Because if you have an instrument that could compound at 15% for 10 years and use the added capital, that’s worth way more than three times tangible equity at current interest rates, way more.”

 

So do not know really what changed for him.

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The total share of financials in the Berkshire portfolio has grown a lot in recent years, & untill the pandemic hit, to an outsized part of the total portfolio value. [We have to remember the AXP position here, which also carries a lot of deferred taxes]. When the world and the outlook suddenly changes to look extremely dim and uncertain, and one wants to reduce the total exposure to financials, perhaps for that reason alone, you have to pick, and something has get the boot out of the boat.

 

- - - o 0 o - - -

 

A belated welcome to you here on CoBF, Arski! [ : - ) ]

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I was listening to a podcast recently - Focused Compounding - talking about banks - this episode in fact:

https://focusedcompounding.libsyn.com/website/how-is-a-bank-like-a-railroad-and-other-crazy-ideas-geoff-has-about-investing-in-efficiency-driven-businesses-0

 

Unlike, say, restaurants, Banks tend to survive even if they're fairly poorly run.

 

Some will have poor cost-control but still manage to charge a sufficient interest margin between their borrowing cost (e.g. deposit rate) and their lending rate (e.g. loan rates) and maintain sufficient client relationships that few customers will shop around and actually switch.  In the case of inefficient small local banks they might earn lower returns than putting their capital in an index fund but they can still keep running and paying the staff and the CEO can still be the guy at the country club who runs a bank and there's nothing forcing them to up their game.

 

Other operators will fanatically cut costs from the non-customer-facing side and anything that doesn't benefit the clients or add efficiency to their systems. There are some interesting examples in that podcast.

 

I wonder if Buffett, Munger and Li have determined that BAC is pretty much the low-cost operator among the big banks with a relentless focus on efficiency, much like GEICO is to car insurance. I think there's a lot of admiration for what Brian Moynihan is delivering at BAC. There's admiration for Jamie Dimon too, but I think the investment banking side of JPM is too big for Berkshire to go huge.

 

In the podcast episode Geoff Gannon was talking about the effects of an ultra-low interest rate environment (made even lower by COVID-19) and whether that would squeeze the interest margin available to the less efficient operators in the industry, while the likes of BAC, able to make massive IT investments spread across millions of clients, would be able to maintain their profitability and possibly win new business better than their competitors and may even be able to make cheap acquisitions of banks with lower efficiency and make efficiency improvements post acquisition.

 

I'm not sure that is the case for BAC versus the likes of WFC, but I think it's a line of reasoning to consider if investing in banks, especially having such an extreme environment as we're seeing now, with the possibility of even negative interest rates looming.

 

Perhaps someone has more insight into it. I'm not in the US, I'm no longer a direct investor in BAC (just via my BRK exposure) and my experience with US banks is limited to a few interactions with Wells Fargo, so I don't want to express an opinion.

 

Another option is that WFC was seen as one of those situations where they decided they'd seen enough rats coming through the kitchen door to worry that the kitchen was infested and get out perhaps before the new CEO does a load of big bath write-downs. Maybe there's concern that unauthorized account opening scandal is just the first example of a culture of poorly-aligned incentives encouraging illegal behavior or maybe the response to it has not been decisive enough to satisfy Buffett.

 

We'll know for sure by Monday whether Berkshire's 13F and their holdings in New England Asset Management's 13F included any remaining shares of WFC at 30th Sep. My suspicion is that they had sold the whole WFC stake by mid August, judging by the rate of sales in Q2. I imagine we'll see the Berkshire filing on Saturday and might have to wait until Monday to see NEAM's filing based on the last time the 45-day deadline fell on a weekend.

Thank you, that clarifies something.

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The short answer... Not all banks are created equally.

 

Slightly longer answer.... JPM is materially different from Citi, just like BNYM is different from USB or BAC. They have different sources of revenue even if you were to just look at loans, the composition of loans varies across all big banks. During stressful economic times, certain loan exposures will keep banks insulated while others will struggle more.  I won't speak for Buffet as he is a lot smarter than I am, but I don't think the relationship between Buffet's view on the Financial Services industry and his individual financial holdings are perfectly correlated. He has also held most of these banks for a very long time so his return on capital has been tremendous. He will realize large embedded capital gains if he were to sell out of all banks just because he didn't like the short term outlook of financials.  I do think buffet believes that banks are long-term compounders so it may just be that if he wants to lower his exposure he sells his least favorite in the sector while maintaining the rest.

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I still don't really understand why Buffett is bullish on BAC while selling off his other financial holdings, like WFC.

Also Munger has quite some money in his personal portfolio invested in BAC, as well as Li Lu.

Especially Li Lu, he is someone who, I think, aims for quite high returns and in my view right now BAC isn't one that is going to return more then 10% per year.

 

Could someone give me more clarification about this or refer me to an article or a comment in CoBF?

 

I doubt it's all that complicated.  WFC is a crummy bank with a history of fraud and BAC is a big, safe bank that will probably give a positive return.  Buffett doesn't have a lot of options, especially with banks large enough to invest in size.  MTB, is too small, JPM has too much key man risk, CITI is garbage, GS/MS have very different business models, he's at the regulator limit for AXP, V/MA are too expensive... etc. That leaves BAC.

 

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