Tue, 1 May 2012
Better credit metrics, low valuations, improved capital and liquidity, and consolidation in the industry should yield better profitability for banks, says Dodge & Cox manager Charles Pohl.
Laura Lallos: Hello, I'm Laura Lallos, one of the analysts here at Morningstar.
Dodge & Cox is known as good old-fashioned value investors, and also known for its very strong team of portfolio managers. And today I'm pleased that we have with us two of those managers, Charles Pohl and Diana Strandberg.
Diana Strandberg: Good to see you.
Charles Pohl: Thank you.
Lallos: Value investing opportunities often come where there is uncertainty, and one area that faces a lot of uncertainty right now is financials. That's an area where you are overweighted. Can you talk about what gives you confidence in the sector that is amid so much uncertainty right now?
Pohl: Well, in the domestic area, we were roughly market weighted at the end of the second quarter of last year. And then we went to the fall, and we saw some real opportunities created by the concerns in Europe to add to those positions at very attractive valuations.
But we also see some interesting things going on on the fundamental side in terms of ... and this is true both in the U.S. and it's also true in Western Europe ... significantly improved capital ratios, significantly improved liquidity. We see a declining inflow of nonperforming loans, declining credit losses, so you've really passed the peak of that cycle.
So, the credit situation is improving, low valuations, improved capital, improved liquidity, and a consolidation in the industry that we think will yield better profitability, better competitive position for the surviving players going forward over time.
So, all of those things came together and, we think, have created some interesting opportunities.
Strandberg: Our positioning in the international portfolio deliberately, where we've gotten the valuation opportunity, we are seeing the same things as you mentioned, Charles, around improved capital ratios and more stable sources of funding for the banks. We have deliberately positioned the portfolio and been adding to areas outside of the eurozone, where the central banks are, for example, to Barclays and HSBC, where you have the Bank of England as your central bank, to Credit Suisse in Switzerland, where we can see more flexibility in terms of the ability to be a backstop and a willingness to be a backstop to the financial system, but also from a monetary policy point of view, having currencies that can adjust if adjustments need to be made, and where we were getting the same sorts of very deeply discounted valuations.
So that's been a deliberate and nuanced change in the international fund.
Lallos: On the domestic side, Wells Fargo is the largest holding [in Dodge & Cox Stock], and that's a company that certainly exemplifies the consolidation trend, for example. Can you talk about the opportunities there?
Pohl: We have a very large position in Wells Fargo. It's a terrific franchise, excellent management team over time. And one of the more interesting things, I think, today about that company is that they are really two companies, Wells Fargo and BofA, which is also in the portfolio, that have true nationwide footprints of branches across the United States. And you look forward over time, the ability of other companies, maybe with the exception of JPMorgan, to develop a footprint like that is going to be quite limited by the reluctance of the regulators to allow other very large institutions to be created.
And so that creates some opportunities for the longer term in terms of being able to spread a lot of their costs over a bigger customer base, in terms of people moving from one geography to another, being able to stay with the same financial institutions, so reducing churn, or reducing costs, that way. I think that it opens up some interesting opportunities for them.
And then in the mortgage area, they have been able to very substantially over the last five years increase their market shares as a lot of the more marginal competitors have been driven out of the business, and then also [Wells Fargo's] very opportunistic acquisition of Wachovia at a very attractive price during the financial crisis.