Tom Brown founded Second Curve Capital in 2000. The New York based hedge fund invests exclusively in the financial sector. Prior to founding Second Curve, Brown was working for Julian Robertson. He was in charge of the North American financial services group at Tiger Management. Brown has also worked as a banking analyst for many years and has won various awards. Under Brown’s management, Second Curve returned an average of 20% annually, net of fees, since inception, versus about 4% for the S&P financials index.
In this article, we are going to discuss in detail a few positions in Brown’s latest 13F portfolio and decide whether it makes sense for investors to follow his investments.
Brown has a tilt towards small-cap stocks. All companies in his latest portfolio have market caps of below $2 billion. The only two positions in his 13F portfolio at the end of 2011 with a $1+ billion market cap are Synovus Financial Corp (SNV) and Sterling Financial Corp (STSA).
Brown increased his SNV stakes by 30% over the fourth quarter last year. As of December 31, 2011, his fund had over $6 million invested in this position. Some other hedge fund managers were also bullish about SNV. At the end of 2011, there were 19 hedge funds with SNV positions in their 13F portfolios. Ken Griffin’s Citadel Investment Group more than doubled its SNV stakes over the fourth quarter. It had $34 million invested in SNV at the end of last year. Bill Miller’s Legg Mason Capital Management and Glenn Russell Dubin’s Highbridge Capital Management also both had over $10 million invested in SNV.
SNV’s revenue for the fourth quarter of 2011 fell by 11.9% compared with the same quarter a year ago. But the declining revenue did not hurt SNV’s bottom line as its earnings are improving. The company reported net income of $27.36 million for the fourth quarter of last year, versus a net loss of $165.57 million for the same period in 2010. Its fourth-quarter 2011 EPS was $0.01, higher than the -$0.23 a year earlier. SNV has a high level of nonperforming loans and relatively small allowance coverage for such loans. The nonperforming loans account for 4.21% of the total loans of the company, higher than its peers. But the allowance for loan losses was $536.5 million at the end of 2011, only 63.4% of nonperforming loans, lower than peers. On the other hand, the credit quality of SNV is improving. It has lower net charge-offs in the fourth quarter of 2011 and its new nonperforming loans are also declining. The company also has high capital levels, which we believe are sufficient to cover possible future losses. The company’s average deposit rate is 0.82% for the fourth quarter, more than the average of its peers. SNV is expected to make $0.10 per share in 2012 and $0.19 per share in 2013. Analysts also expect SNV’s earnings to grow at 8.75% per year in the next couple of years. So, SNV’s P/E ratio for 2013 is 10.42, versus 10.63 for another Mid-Atlantic bank BB&T Corporation (BBT).
Sterling Financial Corp (STSA) is another financial stock with relatively large market cap in Brown’s latest portfolio. Brown had $6.3 million invested in this position at the end of 2011. A few other hedge funds also held STSA. For instance, Jim Simons’ Renaissance Technologies and Israel Englander’s Millennium Management both opened new STSA positions during the fourth quarter. STSA reported strong earnings growth for the fourth quarter of 2011. It made $0.63 per share during the recent quarter, versus a loss for the same quarter a year earlier. STSA also demonstrated a pattern of positive EPS growth over the past couple of years and we believe this growth trend will continue in the future. STSA is expected to make $1.44 per share in 2012 and its earnings are expected to be $1.55 per share in 2013. STSA’s forward P/E ratio is about 14. The number is relatively low compared with the market, but we still like mega-cap financial stocks which have much lower forward P/E ratios. For example, Wells Fargo & Co (WFC) has a forward P/E ratio of about 10 and Bank of America Corp (BAC)’s forward P/E ratio is around 11. Just a few months ago Bank of America’s forward P/E ratio was less than 7.
Tom Brown has a strong track record but we believe this is the time to buy large-cap financials that are still trading at attractive forward P/E ratios.