Buffett Buys Into Big Banks

by: John M. Mason

In the last half of 2018, Warren Buffett invested a lot of money in some of the largest banks in the United States.

Mr. Buffett likes to buy into stocks that are out-of-favor, and large commercial banks seemed to fit the bill in 2018; but, Mr. Buffett likes to invest in future performance.

The changing nature of the banking industry lends itself to this last criteria as the large banks move dramatically into building scale through technological innovation.

Warren Buffett Doubles Down on Big Banks….” So reads the headlines of the article written by Katherine Chiglinsky and Ben Foldy in Bloomberg LP today.

Buffett, as is well known, likes to buy when companies are out-of-favor. In the last part of 2018, this certainly was the scenario. For example, the S&P 500 Financials Index fell by 14 percent in the fourth quarter. One has to go back seven years to find a quarter that was worse.

But, there may have been something else going on in the master investor’s mind.

Mr. Buffett and team might have been sniffing the winds and got some idea that it might be a time for some of the larger banks in the industry, regional banks, to get together for reasons that have to do with the future structure of the industry.

Ms. Chiglinsky and Mr. Foldy report:

“Warren Buffett’s Berkshire Hathaway Inc. took advantage of a plunge in bank stocks to pile even further into his bet on financials….”

“Berkshire spent the last half of the year snapping up more shares of banks and insurers, moves that made the company a major shareholder in four of the five largest U.S. banks. The Omaha, Nebraska-based conglomerate boosted its stake in JPMorgan Chase & Co. and Bank of America Corp. in the last three months of the year.”

“Berkshire also boosted its stakes in regional lenders, including PNC Financial Services Group Inc. and U.S. Bancorp. That could be a bet on consolidation in the industry, as this month’s announced merger between SunTrust Banks Inc. and BB&T Corp. has led to speculation that more deals are coming.”

This last paragraph captures some of what I have been trying to say concerning the banking industry going forward. As I wrote last week, SunTrust Banks and BB&T have indicated that the major driving force behind their effort to consolidate the two banks is the spread of information technology in the financial industry.

Finally, it appears as if the banking industry has reached a tipping point in its movement into 21st century technology. And, the leaders at both SunTrust and BB&T point to this factor in their discussions of the combination.

The reign of information technology in the banking industry is here.

For example, the banks say that they will achieve $1.6 billion through the consolidation of the two banks. These savings will be funneled into “technology and innovation.”

The banks feel that they have a lot of catching up to do. For example, in 2018, BB&T had a technology budget that only totaled $1.1 billion. In 2018, Bank of America reported that it had a technology budget of around $10.0 billion.

And, what is the game here?

The name of the game in the information technology world is “scale.”

We have seen how this has played out in the giant tech firms. Well, now we are seeing this movement playing itself out in the banking industry. And, the movement is taking place in the largest commercial banks. And, there is no question about it, scale is the name of the game.

As of September 30, 2018, the largest five domestically chartered commercial banks in the industry controlled around 50 percent of the assets in the banking industry. The next 20 largest domestically chartered banks controlled 20 percent of the assets. So the smallest banks, about 4,450 controlled only 30 percent of banking industry assets.

The game in the banking industry that Mr. Buffett appears to be playing is the taking advantage of the consolidation and shrinking of the banks still in existence.

This play at this time, it seems to me, is not about the best-run banks with the highest return on shareholder’s equity.

The play is about the restructuring of the industry and which banks are going to dominate over the next five- to ten-years.

On June 30, 1990 there were 12,343 commercial banks in the industry. On June 30, 2000, there were 8,315 banks. On June 30, 2007, just before the Great Recession there were 7,279 banks. And, on September 30, 2018 there were only 4,774 banks around.

Do you sense a trend here?

Reaching the tipping point in terms of the movement into greater consolidation for boosting scale through the use of technology, this can only continue over the next five- to ten-years.

Who are the best of the big banks? Who has the leadership to innovate and create the “new” financial system? Who is going to survive and prosper in this environment?

Is this the game that Mr. Buffett is now playing?

If it isn’t, Mr. Buffett’s strategy is certainly very close to the one that I would suggest for this time period.

And, this is not a short-run play in my mind. It is a long-term strategy in the sense that it is based upon one’s estimate of who are going to be the leaders in the building of “scale” in the commercial banking industry and who will be the survivors.

The short-run play? Well that will have to do with what regional banks, like SunTrust and BB&T are going to get together and how will these transactions result in short-term gains in for shareholders. This is a game that doesn’t promise good size returns that can be earned consistently.

Mr. Buffett plays for the longer-run. I like to think that I play for the longer-run.

To me, one of the most important games in town is the future of the financial industry and that future depends upon the use of information technology. And, the use of information technology involves scale. The winners here are going to be the large organizations that innovate and change and bring us into the new world of platforms and networks, built upon intellectual capital.

I think, for whatever reason Mr. Buffett is making his investments, he is currently on the right track.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.