While the first 2 months of 2016 were quite terrible, markets are clearly starting to loosen up. This is very good news for the big banks’ that rely on companies issuing equity and debt as part of their investment banking operations. There is no doubt that first quarter earnings will be bad compared to robust results at the same time last year, but this fact is more than priced in to the prices of these stocks. Today both Bank of America and J.P. Morgan announced that they have added to their stock buyback programs. They are limited to what they can do until the Federal Reserve reviews their CCAR plans in June but fortunately, due to their robust capital ratios, they are able to buy back some stock before then.
Stock buybacks at massive discounts to book value in the case of Bank of America and Citigroup is the easiest way to grow intrinsic value per share. It is akin to buying dollar bills for 60 cents and the best part is that the value of the dollar bill keeps growing. Bank prices reflect a reasonably severe recession, which is not in the cards in the short-term in my opinion. Economic data has been better than expected but it is and has been obvious that economic growth is weak. This is nothing new, nor is the fact that interest rates are low, which pressures net interest margins.
Financial stocks offer some of the best value and lowest risk as defined by the risk of permanent losses of capital that we have seen in quite some time. While Mr. Market has punished them severely since the beginning of 2016 unfairly in my opinion, this has allowed us to buy more stock and sell lucrative puts. We also have sold long-term calls way out of the money, which basically manufactures a sizeable dividend while we wait for the stocks to appreciate. Barring a significant deterioration in the economy, I suspect that the CCAR results in June will be a catalyst as Citigroup and Bank of America might be able to buy back between 5-8% of their current market capitalizations due to excess capital. This will materially enhance book value per share and earnings per share. This is really the same thing that made AIG such a successful investment for us over the years. The company was overly-capitalized and bought back stock at huge discounts to tangible book value per share, causing tangible book value per share to grow at an accelerated rate. The same story is taking place in all of our major financial stock positions, and ultimately the market will reflect these value-enhancing initiatives. Thank you very much and as always if you have any questions, please don’t hesitate to contact me at 805-886-8140.