Check out Oddball Stocks for details of a book about investing in banks in the works that Nate Tobik is co-authoring. A sample chapter (about whether bank stocks are risky) is available there for download. I enjoyed it and highlighted the following, which supports a couple of key points the authors make in the chapter about investment opportunities with banks:
In 2012, a rogue trader (nicknamed by the media as the “London Whale”) at JP Morgan caused a loss of $6.2b. JP Morgan was able to absorb this loss and move forward without an impact to their business. Consider that of the 6,279 banks in existence in the US at the end of Q3 2015 only 177 had more than $6b in total assets. The London Whale made three bad trades that in the aggregate lost more money than 97% of the banks in the US hold in assets on their balance sheets.
Separately, the Heard of the Street section of the WSJ is often a good source of interesting statistics and commentary. For example, in the Thursday 3/10 edition, Aaron Back describes how banks have been preparing for higher rates by classifying more and more (debt) securities to “held to maturity” instead of “available for sale.” The so-called big four U.S. banks’ held-to-maturity holdings have increased from under 5% in 2011 to approaching 20% by year end 2015. Interest rates, however, at least presently, have not reciprocated. It sounds like a little FIFO, LIFO shifting. Very interesting to think about the various implications and juxtapositions of capital cushions / distressed debt levels / whether oil and gas companies will further tap credit lines / potential broader slowdown in CRE / health of auto loan and lease payments / student loan repayments and loan securitization/syndication and etc.
There is excess capacity in too many areas (and not just commodities). Reinsurance, for example. Retail real estate spinoff dreams, for another (the Sears and Macy’s locations I’ve seen are fairly typical in their feeling quite dated and needing serious renovations while leaving me scratching my head about who would actually want to lease or own stores other than Amazon). Not to mention consumer electronics, which is one area where it’s easy to understand how Japan (a longtime investment focus of mine) has struggled to remain relevant on a global scale: far too much domestic capacity where intense competition and me-tooism hurts profit margins, not to mention the overall glut when including global capacity from companies in China, South Korea and Taiwan, making meaningful differentiation near impossible and commodifying nearly everything. Perhaps almost the same can be said about investing in Banks in Japan. And even the global investment banks leading up to 2008 and for many the ongoing struggles today.
There’s a sort of natural Batesian mimicry in business and investing with one too many geniuses (and unfocused/undisciplined companies) masquerading as value-creators while in fact serving as a drag, ultimately, on pricing power and profit margins for the industry (and securities markets) at large. In some ways, consumers may benefit (and especially some patient and disciplined value investors) as prices come down, although there is often plenty of collateral damage or negative externalities by association.
Let me end by saying I like Nate’s approach with the smaller banks and oddball companies among which we are more likely to find simplicity (e.g. balance sheets), focus (one core or a limited number of profit drivers) and less competition (e.g. more attractive market valuation at time of purchase or accumulation). I haven’t commented about my newsletter in awhile — suffice it to say the rather obscure Japanese smaller caps are necessitating the aforementioned patience and discipline, which I believe is now essentially a matter of arbitraging time to realize value. I hasten to add however, as a I said recently to a friend, that opportunity cost may prove to be a bitch in some cases!