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Gensler: European Banks Still Too Risky

John Coumarianos

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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Coumarianos: How hard is it to wrap your arms around what tangible book is when you look at the financial, how much do you have to go loan by loan and say okay…?

Gensler: You're right. That's really what you should do but we can't, I mean, they don't give us that information at all. But obviously, you take out all the goodwill and all the amortization. And so you do a rough cut, I mean for all the corporate disclosure, companies still only tell you what they want to. So you raised a good point, but I really do take it. Let's take the tangible and let's –what you can put to productive use in a balance sheet.

We own a bunch of financials, especially in developed world financials about 13% of the strategy, 14% right now. And they're all trading between below tangible book and maybe 1.25 times tangible book and the book values are accreting.

Coumarianos: Yeah.

Gensler: Okay, between 5% and 15% to 20%, and some of that book value accretion is just write-backs of reserves that are going to start because the credit cycle is getting better. And we know the earnings power is impaired, but the book value is accreting and they're trading cheap enough that if nothing else happens I'll make a bit of money, not a lot, but a bit. But if we get the valuations back to call it 1.5 times tangible and higher tangible, it's not a bad game.

Coumarianos: So, do the Europeans banks look attractive?

Gensler: No. Intesa we own, it's the only one. And the reason I struggle in Europe is they didn't raise enough capital. I only bought Bank of America when they finally raised what I thought was the tranche that mattered, when they paid back the TARP, et cetera. We owned JPMorgan, they raised a lot of money as well, et cetera. In Europe, they're stingier on raising the money.

Coumarianos: Yeah.

Gensler: And the whole Euro, Southern Europe issue – and I'm not saying I'm clairvoyant, but I'd be worried about for a couple of years. I was worried about Europe too early actually as it turned out, but the Euro itself is a much – the construct of the euro is very fragile.

Coumarianos: Yeah.

Gensler: And so the crisis I thought was going to trigger the Euro. I didn't realize how right I was going to be because I actually thought they needed Russia to have problems and Russia has stabilized, but the Euro still had problems. The Euro was more fragile than I even knew. So, it's held me back and many of the European banks have not really raised the appropriate amount of capital, because I don't want to play something that I think has solvency risk. I'll play something that I just think I can predict on the fundamentals, earnings power and valuation. When you get the balance sheet risk in there…

Coumarianos: That's too much to handle.

Gensler: What's also is highly correlated, if you have one here and one there and one there, they are all going to go wrong together. And so you really think you have five separate positions, but you have one position that's completely correlated in a risk management sense, it's…

Coumarianos: That's puts you in a difficult position.

Gensler: Yeah, that was funny. In biotech – and we only own a little bit there. You can have things that can go to zero or make a lot of money and there is somewhat uncorrelated because they're all, we call it shots on goal like you're playing hockey, you had a shot on goal. But in financials, they tend to all go wrong together, because there is other external forces that cause that. That's not a fun game.

Coumarianos: Right, okay. Well, Rob, I know you are very busy and you are making trips to Asia, and we appreciate that in your busy schedule, you were able to make it here at Chicago to our conference. Thanks so much for joining us.

Gensler: Thank you.