For many of you that have been with me for 5 years now, even prior to when T&T Capital Management (TTCM) was established, 2016 might feel a little bit like 2011. In 2011, a global bear market and severe U.S. correction coincided with fears that a collapse of European Sovereign Debt would lead to a recession worse than 2008. Stocks plummeted, including U.S. financial stocks, despite the fact that they hardly had any exposure to the weak European Sovereigns. Issues such as potential cross-defaults dominated the headlines and despite the fact that the fundamentals of the U.S. financial sector kept improving each quarter, the stocks dropped. This presented an absolutely amazing opportunity for us and for other investors that saw the situation clearly such as Bruce Berkowitz of Fairholme Funds and Warren Buffett, with his preferred stock and warrant investment in Bank of America. Keep in mind that while we were making investments in this sector, criticism was rampant. Barron’s magazine did an article touching on how Bruce Berkowitz had lost it that was similar to when the same magazine wrote that Buffett had lost his touch by not investing in the overvalued technology sector during the late 1990’s.
“To be blunt, Buffett, who turns 70 in 2000, is viewed by an increasing number of investors as too conservative, evenpassé. Buffett, Berkshire’s chairman and chief executive, may be the world’s greatest investor, but he hasn’t anticipated or capitalized on the boom in technology stocks in the past few years.“
Well Buffett thrived after the tech crash, despite a terrible U.S. stock market and Berkowitz and TTCM trounced the S&P 500 after 2011. Now here we are in January of 2016. Chinese growth is slowing. The 2nd largest economy in the world is shifting more towards a services-based economy as a opposed to a manufacturing and fixed asset-based economy. The rush to satiate China’s previous appetite for commodities caused a massive supply glut in key markets such as oil, iron ore and copper. This has driven prices down to levels that were once thought to be unfathomable. Once again, just like in 2011, market participants are overly dramatizing and miscalculating the big banks’ exposures to energy. Energy loans are about 2-3% of total loans for Citigroup and Bank of America for instance. Many of these 2% of loans are investment grade to large multinationals. Another significant chunk are to refiners who are benefiting from lower oil prices. Then lastly, just about all of these loans are asset backed, meaning that even in a bankruptcy they are unlikely to lose much, if anything. Make whatever assumptions you want about loan losses to energy, the banks would still be profitable barring a steep global recession, which I don’t believe is in the cards. Tough to lose money at 2/3rds to tangible book value.
Roughly 34% of loans are consumer mortgages. Credit cards are another big component. Lower gas prices are a huge benefit to consumers and while it is negative for countries like Russia and those in the Middle East, it is very positive for others like India and European nations. These lower prices provide consumers with the ability to better finance their credit expenditures such as mortgages, auto loans, and credit cards. Capital ratios and liquidity ratios have never been higher. The legacy litigation, which far exceed anyone’s estimates are mostly a thing of the past. These are the facts about the banks!
With that said, stocks like Citigroup and Bank of America are trading once again at fractions of tangible book value. In March, I expect both companies to pass the CCAR process with flying colors allowing additional returns to shareholders via stock buybacks and/or dividend enhancements. Costs are dramatically lower as is the risk profile of these companies. Gone are the massive off balance sheet exposures that killed the banks in 2008. This is by far and away the best investment opportunity I’ve seen since 2009. Not just with the banks but other companies like AGO and AIG. AIG is has a market cap less than $70 billion, which is a $30 billion discount to its shareholder equity. Over the next two years AIG is planning on returning $25 billion to shareholders’ via stock buybacks and dividends. That is a humongous catalyst. AGO is facing fears of Puerto Rico that are so dramatically overblown it isn’t funny. While market prognosticators forecasted losses on its most troubled credit PREPA at 50%, the bond insurers’ have already agreed to a deal with Puerto Rico where they won’t lose one red cent. I expect the news to get better and better as the year moves on despite lots of contrary noise.
This is what investing is all about, buying something that is worth far more than the current price, but understanding that volatility is inevitable. Many times I’m asked, why do we concentrate our positions? My response, why in the world would you put the same amount of money in your 20th best idea as your 1st best idea? I cannot envision a scenario where these particular investments do not succeed. Does that mean this is the bottom, no, but I’d bet we are pretty darn close on them. While being concentrated may cause more volatility during a market panic, it also creates the potential for dramatically outsized returns in the recovery. I could not be more confident that this will once again be the case. Patience is key, but 6 months or a year from now, I believe we all will be wishing we could have bought more at current prices. Below is the great video from 2011. Smart investing advice doesn’t go obsolete.