Vox Rationalis

Analyzing the U.S.'s Four Largest Banks

"Secondly I have grouped the 4 together for a number of reasons. Many investors like to invest in ETF's like the XLF and KBE and the 4 holdings are 37% of the XLF and 33% of the KBE."

If this was the reason you grouped these, why did you instead mention only the S&P 500 in your article? No mention whatsoever of why these should be grouped. But let's break this down a little further - current holdings of XLF:

1 JPMorgan Chase & Co. 12.61%
2 Bank of America Corp. 9.57%
3 Wells Fargo & Co. 9.32%
4 Goldman Sachs Group Inc. 6.48%
5 Citigroup Inc. 3.87%
6 U.S. Bancorp 3.35%

So why no GS, which makes up a much higher portion of the XLF? Or more importantly, why C at all, since its losses dramatically pull down all of your numbers while accounting for over 10% of the group's market cap?

"Now if you go to Value Lines 2010 estimates for the four banks and take out Citigroup from the picture you get a ROIC for the remaining 3 of 2.4% compared to 2.1% for the four, so the other three still do not inspire."

Wow. I hadn't even read to the end of your article: "I want to see at least 20% ROIC (return on invested capital) before I even think about investing a dime in any enterprise." You really have a complete lack of understanding about how banks work, and should have known better than to provide any advice without more study.

A banker is an intermediary who directs capital to where it can be put to good use. Take this function away, as you suggest by limiting banks to their deposits only (which, by the way, are borrowed funds with a different name), and capital no longer moves as efficiently, the cost of doing business increases, and economic activity and growth decline.

And so, since banks operate on the margin, that their returns are lower than other businesses is not just intuitively obvious to the casual observer, but NECESSARILY so. Dramatically simplifying, banks MUST be low-return businesses or other businesses couldn't afford to borrow money.

As an example, consider Hudson City Bankcorp, which Forbes named the Best-Managed Bank of the Year for both 2007 and 2008. Here are the ROIC figures, according to their annual report:

2007: 1.03%
2008: 1.27%

The big three banks have ROIC of 2.4%, much higher than the Best-Managed Bank in America, and you think they're dramatically too low? If your 20% were really a good yardstick for banks, do you think HCBK would be thought of so highly? I ran a screen just for giggles. Of the 38 large-cap banks (<$8B), only one -- Banco Bradesco -- had a ROIC higher than 10%, coming in at 11.4%. Most of the Canadian banks - which have been sailing through the trouble unscathed - run between 5% and 10% ROIC.

Banking is all about leverage and risk; if there were no risk, there would be no reason to limit the amount of money a bank borrows and then lends -- no need to limit leverage. Of course, risk is inherent in any borrowing, and the recent industry failure to manage risk is a big part of what we're all dealing with now. Do I want a banker who takes no risk? Of course not, because my returns as an investor or depositor would be surely reflect this risk intolerance. I want a banker who properly assesses risk. We pay for the banker's ability to assess and manage risk in a leveraged environment - not ROIC.

"So it seems from [2010 loan loss reserve estimates] that JPM might have a lot more bad loans on the books then the others and that C's situation may not be as bad as people think."

Man, this is just ignorance - you should follow the banks for a while before spouting advice on them. WFC has taken HUGE amounts of heat among analysts for not increasing its loan reserves more (WFC insists it is generating sufficient cash to cover its losses without adding to reserves). Citi really hasn't had to increase reserves as much as it should, because it's mostly government-owned anyway and needs every productive dollar it can get. Taking JPM's higher number as an indicator that it has more losses is just plain stupid - it could just as easily, and in fact far more likely, indicate that JPM is a more conservative operator.

Apologize to the nice people for wasting their time. DISCLOSURE: long WFC, BAC.

Analyzing the U.S.'s Four Largest Banks

Sorry, but there are big problems here. First off, source your data.

The clearest logical problem is the impact on the "analysis" of grouping these companies together. This only makes sense if one is considering buying the group as a basket. Strikes me that very few would consider this, and so it makes no sense to group them for any analysis; comparing them would be more useful.
JPM and WFC, by most accounts, are very well-run, and have done a much better job managing risk than most banks. BAC's purchases put very much it in a category of its own.

And as for C - does it make any sense whatsoever to group C with ANY other company? What happens to your numbers if you pull C from the discussion?

Buffett's Big Surprise: Sage of Omaha Was in Favor of Bailouts

"It's hard to disagree with that straightforward conclusion as to the motivation behind the sage's self-serving rhetoric."

And obviously, those who post articles on seekingalpha.com (myself included) are raging egomaniacs motivated purely by the euphoria of foisting our names in front of others. What? There are other possible motivations? Ones that don't serve to enrich our egos?

More than one possible answer to a question. It must boggle your mind.

What's Buffett's Ideology?

Social Media wrote:

> Why doesn't he share BRK profits with his shareholders? what is point
> of value if one cannot enjoy the cash out of it?

Simple. By not paying dividends, Berkshire allows shareholders to take all of their taxable gains at the time of their choosing, which can be greatly beneficial. Or to allow greatly appreciated shares to pass through their estates, which reduces the tax on gains to ZERO.

Few shareholders would argue that BRK's profits haven't benefited them, since their holdings have appreciated 1014% since 1/12/1990 (the oldest number on Yahoo), or a bit more than twice what the S&P 500's returned during that time.

What's Buffett's Ideology?

Dividend Tree wrote:

> Vox Rationalis,
> All the points that you quoted and responded, doesn't that point
> towards shrewd business acumen ? And not value investing alone as
> one may read all over the place! Thanks for you comments though !

I think you probably needed to provide your definitions of "value investing" and "business acumen." I believe Buffett would be the first to tell you, he is a capital allocator. He lets the business people run the businesses. So from that standpoint, his business acumen is unknown - he lets the experts take care of that.

What's Buffett's Ideology?

"Are these examples of value investing within derivatives domain?"

Yes!

"...during 4Q2008 and/or 1Q2009 BRK offloaded significant position of his holdings in landmark US companies. Buffett is using BRK’s cash to invest in instruments which are not available to general public. Remember his preferred share at fixed 10% interest rate both in Goldman Sachs and GE!"

These two are not unrelated. Buffett had an opportunity to exchange blue chip equity holdings with low dividends into blue chip equity holdings with high dividends. Who wouldn't do this?

"So Buffett is taking advantage of huge cash and public stature to step on common shareholder dividends of less than 5%?"

Wait, you're complaining about Buffett making such an investment? Do you think that every investment option should be available to every investor?

"Or does this mean there are no value investment opportunities even with markets down by more than 50%?"

If you think Buffett and/or BRK wasn't buying in early March, well, I think you're foolish.

"Since he is not investing in common shares, does this mean there is no value in traditional US markets?"

1. You don't know what he is investing in personally, nor do you have any better knowledge about what BRK's been doing than the rest of us.

2. Near the November bottom he was putting large amounts of cash to work in GS and GE. Since then he's taken advantage of opportunities due to the failing of credit markets. Is there really any need to question whether these investments presented great value?

Does this mean there's no value in equities? Of course not. It means there were better opportunities in the credit markets. If I could have loaned money to Harley Davidson at 17%, I would have.

Recession Hits Omaha: Moody's Downgrades Berkshire Hathaway

"The rating cut is specifically related to the decline in profitability coming out of Berkshire’s worst year since Buffett took over in 1965."

No. Moody's indicated that the primary rationale was the reduced capital cushion caused primarily due to falling stock prices. It then indicated that reduced earnings was a contributing factor. But look closer at the earnings. Comparing 2007 to 2008, earnings fell from $13.2 billion to $5 billion. Of the "lost" $8.2 billion, more than $6 billion were paper mark-to-market losses on derivatives, including $5 billion on the infamous equity index puts. The difference in the two years in investment gains was $6 billion, primarily due to the large gain BRK took in 2007 on its PetroChina investment. From these two entries, it looks like the decline in profitability was due completely to the declining equity markets, which (don't tell the bears) is quite unlikely to repeat its performance this year.

Luckily, there's another easily obtained metric we can use to compare: operating cash flow, where the drop from 2007 to 2008 was 10.34%. For comparison, operating cash flow was 10.36% HIGHER in 2008 than in 2006.

"At Ockham, we have BRK-B as Overvalued currently..."

Really? Overvalued? Pretty bold, considering it's trading at just under 1.3x book and under 1.9x tangible book, both of which are toward the low end of historical measures.

"...as the famed company’s earning are expected to slip in 2009."

Well, I guess you're talking about operating earnings since the lowest estimate I've seen puts the bottom line number about 40% higher than last year. More importantly: do you always base your valuations on a single year's earnings?

Even the 'Oracle of Omaha' Makes Mistakes

"Buffett and his company, Berkshire Hathaway (BRK.A), haven’t been able to avoid the credit problems that most of the financial industry has already encountered."

Really? BRK has had trouble getting financing? Or are you saying they've had borrowers defaulting?

"Berkshire is down over 40% from its 52 week high, and has lost $11.6 billion in net worth."

I guess you mean book value. As of 12/31/08. Quite a bit more than that by now, with some $9 billion of equity losses YTD, don't you think?

"...it’s now questionable whether this blue chip company can keep its luster and demonstrate the strength and leadership that it has shown for decades."

I'd probably dispute this statement, if it had any meaning whatsoever.

"This past month, credit issues have been the biggest concern for Berkshire Hathaway."

Please, provide any evidence to support this notion. What gives you the idea that BRK is concerned in the least?

"Standard and Poor’s did affirm Berkshire’s rating of AAA, but will continue monitoring the company giving them approximately one year to raise capital in order to ensure stability."

This is absurd, if by "raise capital" you mean the ordinarily understood definition, or for that matter anything other than "continue operating without any modification." S&P says nothing about BRK needing to raise equity capital.

"I feel that Berkshire is solid from a credit perspective..."

I'm sure my relief is echoed by all BRK holders.

"This appears unfair and has had a negative impact on the stock value of Berkshire."

Another unsupportable notion. Do you seriously think that credit bureau downgrades have had ANY impact on BRK? Where's your evidence?

"Additional reason for concern is that the price for Berkshire credit swaps has increased significantly. These swaps are essentially insurance on Berkshires liabilities, and the rise in price emphasizes a need for Berkshire to stabilize its finances. High swap prices insinuate a higher possibility of Berkshire defaulting on its debt obligations."

Complete misunderstanding, though this one is pretty common. As discussed here: seekingalpha.com/artic..., the best reason I've seen for the broad CDS price is due to the fact that holders of BRK's long-date market puts have no other insurance options. Usually, buyers of such contracts are able to hold collateral to cover potential losses, but this is not the case with the BRK puts. So these holders buy CDS to provide insurance for the next five years as part of a longer-term risk management strategy. There's no other logical explanation I have read.

"In response to credit issues, Berkshire Finance sold $750 million in three year notes that will yield 282 basis points above the treasury rate. This sale was originally meant to be for $400 million, but Berkshire decided to increase the transaction this past Thursday."

"In response to 'credit issues'"? You didn't even read any of the press articles about this, did you? "Net proceeds from the sale will go to Vanderbilt Mortgage & Finance Inc., a unit of Berkshire’s Clayton Homes Inc., which makes manufactured housing, according to documents obtained by Bloomberg News. Vanderbilt provides loans to buyers of homes sold by Clayton." (www.bloomberg.com/apps...). So a mortgage lender borrowed money so that it could then lend it at higher rates. Shocking! I wonder if anybody's ever done anything like this before?

"Buffett also recently announced that some of his company’s financial troubles pertain to the rising price of capital..."

I defy you to cite a single instance of Buffett referring to BRK as having "financial troubles."

"The outcome of Buffett’s $5 billion investment in Goldman Sachs' (GS) is yet to be seen. At first glance, it appeared to be a bad decision, as Goldman dropped to $52 a share, deeming the ability to strike at $115 useless... The warrants do not expire until 2013, so there is still ample time to allow Goldman Sachs' to rise even further in price. The 10% dividend on these preferred shares is a bonus that could help Berkshire solidify these shares in the future."

Again, you show a complete lack of understanding. This investment was in preferred equity, which boosted GS' capitalization ratios while paying BRK a hefty 10% dividend. BRK's investment didn't decline in value with the common, because the BRK shares are not traded, and are only redeemable for a 10% premium. Because the preferred investment also cannot appreciate with the common, the warrants are included to provide sharing in the potential upside.

"His current objective is to secure capital at a competitive rate compared to those who are receiving aid from our government."

Again, says what source? BRK will, AS ALWAYS, raise capital when it has a suitable investment opportunity that for which debt financing makes sense.

The writer should be ashamed to have published such an "analysis."

Buffettology: Book Represents Buffett's Approach to Investing

"Similarly, rather than invest in the vehicles of communication (cable, radio, and newspapers), better to buy the advertising agencies..."

This is kind of amusing, considering that BRK's 20% ownership of The Washington Post has been one of the most successful investments of Buffett's career, despite WPO's 63% decline from its all-time high.

The Real Reason Behind Berkshire's Exploding CDS Spreads

David Clayton wrote:

> @BS Detector: The idea of reverse-engineering the Berkshire index
> puts intrigues me. Have you made any progress, or would you mind
> if I put an article together on it?

I haven't done anything with it. Have at it.

Explaining the Berkshire Share Price

paultaut wrote:

> BS Detector: The voting aspect is popular and unlikely to be removed.

Agreed. I think SA has likely seen an increase in traffic directly attributable to the voting function. Since traffic drives ad revenue, there's no way they will/should kill it. This doesn't mean it can't be improved, and I've emailed them with suggestions. I have no idea whether my ideas fell upon deaf ears, if the development aspects are too daunting, if revamping is in the works, or if they're taking their time so that Voting 2.0 has little left to improve, understanding that there's no way to make it perfect.

> You probably won't believe me but I have given you an "up" occasionally,

I have no reason to doubt this.

> ...that I don't understand why there are so many negative votes.

Simple - I piss people off. And reaching -500 or -600 or -700 only takes one committed person (such as b****.* AKA p********d, who has used those and additional accounts to systematically "thumbs down" me - though I think he's not the only one).
[usernames disguised so that perhaps Seeking Alpha will allow this post to stand]

>Would you pay an annual fee to read the Articles posted?

Not today. This is the central question facing all media. With august print publications such as the Seattle P-I and perhaps the SF Chronicle biting the dust in the face of free competition online and on TV, how long can it last? Will we end up with Google news and a few hangers-on? Can anybody else survive if content is free?

> This comment is addressed specifically to you. How long do you think
> it will take for a couple of posters to give it a Con?

No idea. If your detractor(s) is clever, he won't do it, since that would make it appear more likely to have been me. For my ratings, much depends on whether my detractors are on vacation or not, since they seem to have nothing else to do while at the computer.

> just because we differ, doesn't mean I do not learn from the exchanges I help to create.

Peace. I'll still pound you for incorrect assertions of facts, and you should still pound me for being an ass.

Peace just the same.

Explaining the Berkshire Share Price

paultaut wrote:

> Do you actually believe that the number of votes you give whether
> Pro, Con or total cannot be tracked? That who is using the website
> at any given time, cannot be pinpointed?

Of course not. What did I write that might have given you that impression?

> Take Friday the 13th(I lost about 80 votes with the exact same situation
> as you describe, none of my recent comments had more than a couple
> of negatives)

That's not the first time that my identifying a systematic self-voter has been followed up by somebody (not me, though I'm well aware I can't prove it) providing thumbs-down systematically.

> Its pretty simple, the system is being altered or haven't you noticed.
> Fairly soon those that trash just for the sake of trashing will be
> identified. They have no place on SeekingAlpha.

What makes you think Seeking Alpha would "identify" anybody? I've urged them to scrub the voting, but I see no reason to suspect anything's in the works.

The Real Reason Behind Berkshire's Exploding CDS Spreads

Nicholas Waltner wrote:

> Technically, one derives the zero-coupon curve to price options at
> each date in the future. I didn't bother doing this, as the curve
> is fairly flat past 10 years and hence is about the same at the coupon
> curve.

It seems to me that the risk-free rate has to be a short-term rate, that rates include risk based on duration. Unless risk-free doesn't necessarily mean risk-free.

> but index yields have gone up a lot - but who knows what the final
> dividend yield will be owing to all of the cuts.

It has to be lower. S&P dividend rates haven't been anything close to this high in 20 years.

The Real Reason Behind Berkshire's Exploding CDS Spreads

Mr. Waltner:

No time at the moment, I'll be back to this tomorrow, but:

1. I don't recall the yearly exposure numbers, but that's a good data point for determining the average purchase point each year. I think we need to make an assumption as well about the blend of the four indexes involved, but I haven't done any work to make a logical suggestion for that.

2. Your 90.8% of the December 2007 S&P close of 1468 puts it at 1333 (not 1384 - please verify your number), which is if I remember correctly rather close to the number he used in an example in this year's letter. I think the odds are good that this number was not a random choice, but was chosen to make his example reasonably close to the real situation.

3. Premium was I believe $4.9B as of YE08. It think it was $4.5B at YE07.

4. I'll need to bone up on option pricing a bit before I can have anything close to a considered opinion on the rest, though one thing jumps at me - the interest rate. First is a nit, as I recall U.S. Treasuries are generally used as the proxy for a risk-free investment rather than LIBOR. Secondly though, I think it's reasonable to think that the recent flight-to-quality has driven yields on Treasuries artificially and unsustainably low; at YE the 10-year was at something like 2.25%, while in the years leading up to October is was rarely below 3.5%. Does B-S specify a selection methodology here? Does it even differentiate based on the time period, that longer-dated options should use a different rate than shorter-dated options? I think I know where you got your number, and I'd guess that Buffett got his by looking at a longer-term, less panic-driven sample. Are both methods legit according to B-S?

Can you reverse-engineer his other assumptions?

Also, I'd like to see your numbers again based on current levels (S&P at 750, 10-year T at ~3%).

BTW, I'm one who likes data, so more detail is always better for me personally. But to save my many detractors from having to look at ever more words, links for the details are are fine with me.

Is Berkshire a Long Run Buy?

"There surely must be a premium in the shares simply because of Buffett’s reputation. That could come out of the price. Moreover, Berkshire appears to be an extension of Buffett: It’s been his show."

Two points.

Decomposing BRK can provide support for both the undervalued and overvalued positions. My feeling is that on a price to tangible book value basis, it doesn't look cheap, but on a cash flow basis it does.

I think the net Buffett effect right now on the stock is very close to zero. Buffett's age and succession questions present risks, and I think the market is in effect overvaluing risk premiums due to heightened risk aversion, and many share prices are discounted more than is appropriate. This is countered by the undisputable Buffett premium, but right now I think the net Buffett effect is as low as it's been since 2000.

I'm long BRK.