Whitney Tilson and Glenn Tongue, Managing Partners of T2 Partners and the Tilson Mutual Funds, recently finished their speech at the Value Investing Congress, entitled An Update on the Mortgage Crisis and a Discussion of Wells Fargo. The following are our notes from the presentation.
Investment Idea: Long Wells Fargo (NYSE:WFC)
- Whitney and Glenn were short WFC at $30/share and covered around $10/share. They are now long. The idea is not as attractive as it was two weeks ago.
- WFC net income spread was 4.8% and could be seen as a competitive “moat.” The combined earnings power (normalized) of WFC/Wachovia is $3.55 to $4.26/share.
- Bull case: $4.00/share in earnings power. This implies a $40-$50 stock price at 10-12x earnings. Enormous yield spreads. Wachovia portfolio already significantly marked down. Buffett recently touted the stock and said he would have been willing to put 100% of his net worth in WFC when it was trading at lower levels earlier in the year.
- Potential risks: Wells Fargo has a minimal amount of tangible equity to absorb losses—Glenn and Whitney think they have no tangible equity (which makes them cautious). They expect losses to be between $47 billion and $120 billion in the future. They have provisions in the low $20 billion range right now.
Other Opportunities for Long Investing
- Blue-chips: Coca-Cola (NYSE:KO), McDonald’s (NYSE:MCD), Wal-Mart (NYSE:WMT), Altria (NYSE:MO), ExxonMobil (NYSE:XOM), Johnson and Johnson (NYSE:JNJ), and Microsoft (NASDAQ:MSFT).
- Out-of-favor blue-chips: Berkshire Hathaway (NYSE:BRK.A), Wells Fargo (WFC), American Express (NYSE:AXP), Target (NYSE:TGT).
- Balance sheet plays: EchoStar (NASDAQ:SATS), dELiA’s (NASDAQ:DLIA).
- Turnarounds: Wendy’s (NASDAQ:WEN), Winn-Dixie (NASDAQ:WINN), Huntsman (NYSE:HUN), Crosstex (XTXI), and Resource America (NASDAQ:REXI).
- Special situations: Contango Oil and Gas (NYSEMKT:MCF).
- Mispriced "options": General Growth Properties (GGWPQ.PK), TravelCenters of America (NYSE:TA), Ambassadors International (AMIE), Borders Group (BGP) and PhotoChannel Networks (OTC:PNWIF).
Mortgage Market Analysis and Outlook
- About two-thirds of homes have mortgages. Of those homes, 56% are owned or guaranteed by the two government sponsored enterprises (Fannie Mae, Freddie Mac). There was a surge of toxic mortgages over the past ten years. The wave of resets from subprime loans is mostly behind us.
- What is ahead of us? Alt-A = $2.4 trillion category (much larger than subprime—known as "liars loans"). Alt-A mortgages and their resets are mostly ahead of us. Alt-A delinquencies by vintage show the collapse in lending standards in 2006 and 2007. About $750 billion of Option ARMS were written in 2007 and three-fourths were written in the four housing bubble states. Option ARMs are beginning to soar.Delinquencies on jumbo prime mortgages are soaring. This is the next big wave to hit California. Delinquencies on prime mortgages are beginning to soar.
- HELOCs and home equity loans were also popular during the bubble. This is a $1 trillion market. Of the $1trillion loans, only $200 billion were securitized—so much of this is still on many of the banks' books. 30% of all cars purchased in CA in 2007 were purchased with HELOCs.
- Housing outlook: Existing homes sales are falling and foreclosures are rising, leading to a surge in inventories. Whitney says there’s a huge amount of "shadow inventory" on banks' books. The current month’s supply numbers greatly understate the severity of the housing environment.
- Foreclosure filings have increased dramatically. Foreclosures in March rose 48%, y-y and 17% sequentially. RealtyTrac estimates that over 1.5 million bank-owned properties are on the market, representing around a third of all properties for sale in the U.S.
- Home prices are in a freefall. Whitney uses the Case/Shiller national index to gauge home prices.
- Whitney said that home prices need to fall another 5-10% to approach the long term trend line. He says the real danger is not returning to trend, but overshooting the trend line. Home prices in California have already overshot the trend line.
- Outlook for housing prices: Prices are down about 30%; "trend" would be down about 40%. Prices could go down 45-50%, and it will take another year or so to get there.
- Total estimated financial sector losses will be about $3.8 trillion. Institutions have been able to raise capital to mostly keep up with write downs, but this is not likely to continue.
About the Speakers
Whitney R. Tilson is the Founder and a Managing Partner of T2 Partners LLC, which manages three private investment partnerships and the Tilson Mutual Funds. He is Co-Editor-in-Chief of Value Investor Insight. Tilson has been a guest on Lou Dobbs Moneyline and Wall $treet Week, has been profiled by the Wall Street Journal and is a regular columnist for Financial Times. He is the Co-Founder and Chairman of the Value Investing Congress.
Glenn H. Tongue is a Managing Partner of T2 Partners LLC and the Tilson Mutual Funds. Mr. Tongue spent 17 years on Wall Street, most recently as an investment banker at UBS, where he was a Managing Director and Head of Acquisition Finance. Before UBS, Mr. Tongue was at DLJ for 13 years, the last three of which he served as the President of NYSE-listed DLJdirect. Prior to that he was a Managing Director in the Investment Bank at DLJ, where he worked on over 100 transactions aggregating more than $40 billion.
Disclosure: No positions.