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By John Coumarianos | 06-24-2010 01:29 PM

Gensler: European Banks Still Too Risky

European banks were too stingy when raising capital, leaving them exposed to future downturns, says T. Rowe Price Global Stock fund's Rob Gensler

Securities mentioned in this video
PRGSX T. Rowe Price Global Stock

John Coumarianos: Last question, I wanted to talk financials a little bit with you. It looked like you recently added Bank of America, and I wanted to get your assessment about how their problems are shaping up and why you picked that one over say Wells or maybe some slightly smaller one like U.S. Bancorp?

Rob Gensler: Well, Wells and U.S. Banc are great names. They're just not cheap, okay. I'm a big tangible book fan, when it comes to financials. Not book, but tangible book, because that's the fact, that's what they can actually earn.

Wells Fargo, where is it now 27-ish, 25, 28. I lose track because I don't own it at all, but their book value, tangible books are only 12 or 13, so it's over two times tangible book. USB is a little – United Bancorp, a little bit cheaper, they are great institutions. I actually mistakenly sold Wells Fargo too early, like 16.

Bank of America, why did I buy, and look I didn't own it at 2 to 15, so I'm a bit of a dope that way maybe, but reality is at 2, it was a solvency trade. Will it go bankrupt? I didn't want to make the bet, would it go bankrupt. And I didn't even buy it until they did this huge capital raise. And when they did the huge capital raise, the bankruptcy risk, the balance sheet risk is basically off the table and now the risk and the opportunity is what's the earnings power, okay, and what's the fundamental valuation?

Bank of America has about $12 in tangible book. At $15, it's about 1.25 times tangible book, okay. That's a lot cheaper. And I fundamentally believe the earnings power is circa 15% return on equity on tangible, and that it will accrete its book value. So if I do a three-year price target – I know that's long out and some investors don't bother, but three years from now the book value is probably about 40% to 50% higher.

So, it goes from 12% to 17% or 18% and if it actually only trades a book value, I'm going to make some money. Well that's sort of my downside. Well, what's my upside? What if it trades at 1.5 times book because it's actually – we're passed the regulatory reform or passed the credit cycle and the earnings power is a lot lower, because what these things all had earnings power on tangible book of 25% before; on tangible, not on rate.

So, I'm reducing the earnings power but saying why I am worried? I could make between 10% or 20% to maybe 50%, 60%, 70%, no, it's a three year, kind of, I think. But I didn't even layout a scenario, where I lose money. Well, could I lose money? It could meander. I could have opportunity costs.

I think it's a powerful story. It's not a growth story, it's not really growing. It's about normalizing the earnings and getting it really cheap for a fabulous franchise.

Coumarianos: Which is trading so cheap…

Gensler: For a very good franchise, but I'll take – compare that to Citibank, it's trading a lot cheaper. I'm like, there's a lot of wood to chop there and that one could still go, could. I'm not predicting it, could still go horribly wrong. I'm not looking in financials to own names that I think have wide dispersion that have a lot of – oh, I can make a lot, but I could lose a lot.

I'm looking for – it's we own in Intesa Sanpaolo, which is the largest bank in Italy. It's the most boring bank I have ever met in the world and that's good. In a bank, I want boring, okay. They trade at 0.75 times tangible book, 0.8 times because of all the Southern Europe issues going on.

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