Bruce Berkowitz on the Exceptional Value in the Financial Sector
Bruce Berkowitz is the founder and manager of the $20 billion Miami-based Fairholme Fund, which last year celebrated its tenth anniversary. Along with Charles Fernandez, he runs the fund’s portfolio management team. Mr. Berkowitz was named the US stock-fund manager of the year for 2009 and the US stock-fund manager of the decade 2001-2010 by Morningstar. We interviewed him on February 16.
In last year’s interview, you said that one should never play Russian roulette no matter how good the odds, but given the dependence of the financial system now on government support both here and abroad, aren't you playing Russian roulette with approximately 80% of the Fairholme Fund’s holdings in the financial sector?
We stayed away until we thought the Russian roulette element was over. The Russian roulette part was at the initial stage of the financial crisis, before the government became involved. That part ended once it was clear that capital would be given to the banks and what the objectives of the Fed and the Treasury were, and once enough time went by. By enough time, I'm referring to the further seasoning of potential bad loans, most of which originated in the 2007-2008 period.
At that time, you no longer could kill the companies, but there was still a question as to how much they could make in a more normal time. You really can't kill all of them or you would kill the entire economy.
So if Bank of America was required to return to mark-to-market accounting, would that change your investment opinion of their common stock?
They have had significant mark-to-market accounting changes, which have represented tens of billions of dollars. For real estate loans, the bank rules are quite specific as to how they have to be treated if they are not accruing. In other words, if someone stops paying you then you have an issue; it needs to be marked to the market.
Loans created and underwritten since 2009, or even at the very tail end of 2008, are good loans, well documented, with better credit quality, better yields, and better fees. You have this digestive period of bad loans, and at the same time you have the ingestion of good loans. You have a sense about how long it takes, with a given year of issuance, for a loan to burn off, the average length of a loan, and what the probabilities are when loans go bad.
What I'm getting at is enough time has gone by for seasoning. The banks have better balance sheets than I can remember.
Let me ask another question along the lines of the real estate lending. When you purchased your positions in banking stocks, did you anticipate the legal issues regarding foreclosures? Do the recent court rulings impact your appraisal of the value of those businesses?
I did not expect it to be as big an issue as it is. I did understand the nature of no-doc loans, liar loans and so on. The market values of banks and institutions that supposedly got involved in this have been more than adequately marked down for such potential liabilities. You are starting to see their true exposure now, based upon settlements with Freddie Mac and Fannie Mae, settlements beginning with MBIA, and every quarter in the footnotes and 10-Qs of the banks.