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McGregor Staying Cautious With Banks

Shannon Zimmerman

Shannon Zimmerman: A couple more questions about Oakmark Global. So Oakmark International is fairly significantly exposed to financials, European and otherwise. You own Credit Suisse, I believe, in Oakmark Equity and Income and in Global?

Clyde McGregor: Just in Global.

Zimmerman: I interviewed David Herro recently about his fund. So I have a little bit of the back story on Credit Suisse. What attracted you to that name, and what's your take on European financials generally? I know that Oakmark likes to take advantage of volatile areas of the market because there could be mispricing there. What is your take on financials, European financials in particular?

McGregor: Our European financial holdings have been based on the idea that the private-banking sector was underpriced within the total framework of the banks. So that we were in essence getting the investment bank not just free, but for a negative value in essence. At the private-banking level we had transactions. We continue to see small transactions of rollups of Swiss private banks. This suggests that whether it's Credit Suisse or for that matter UBS or certainly Julius Baer, which is another one we have in Global, that private-banking [businesses] are wonderful assets that are mispriced or underpriced in the market.

The risk in something like Credit Suisse is that the investment bank could have a big negative number in front of it, which is what we saw happen with UBS in the great recession. And to some extent we have seen that with Credit Suisse. But we prefer the management team there to some other opportunities.

We don’t have U.S. banks because I felt that the blend of assets or the blend of businesses in the Swiss banks was more attractive than what we had available to us in the U.S. Now, I will not say never. I am certainly thinking a lot more about U.S. financials today than I was in the previous few years.

Zimmerman: In the financials sector, in particular, a couple of things are in play to a greater degree than in other sectors of the market. There is regulatory risk, and that happened recently with Credit Suisse. They were well on track to get their reserves where they needed to be and they were called out for not doing it quite fast enough, even though they were going to meet the deadline in advance. So that kind of regulatory risk is very difficult, I have to imagine, to discount for when you’re doing valuation work.

McGregor: Absolutely.

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Zimmerman: Then, I don’t know that you’ll agree with this, but there is a lack of transparency that's sort of baked in to financials because it's book value, which in some ways is not smoke and mirrors, but it's, "What do we think right now at this moment?" And then next quarter given macroeconomic circumstances or things that are company-specific, the book value can change rather dramatically. How do you get comfortable with that in the valuation process? Again as with energy, is there a greater discount that you are looking for because of that risk?

McGregor: Well, it's a difficult question for me because you can see on the Equity and Income fund side, I don't own any banks. And it has been my international colleagues who have been far more enthusiastic about the Swiss bank space particularly than has been the case for me. By the way, we do own Santander, the Spanish worldwide bank really, which I think is an interesting situation because of their assets in Mexico and in Brazil and for that matter in the U.S. They announced the IPO of their Mexican business at a very high valuation relative to the parent company and that will add to bolstering their capital.

But your question is the right one. It is very difficult to do these valuations. We rely on the banks having a capital base that is sufficient to give us the confidence that if things do not go right, we are protected, that our clients' shares are protected. But when you have a business that is as leveraged as that is, periodically you're going to have problems. That's the nature of it.

Zimmerman: Comes with the territory, right?

McGregor: Yes.

Zimmerman: So, just a final question. Looking forward, right now, where are you finding attractive opportunities? What is of interest to you? Again, I know that the managers aren't macro folks, but every company on some level is cyclical and is affected by economics, and you have to factor that into the discussion, as well, I assume. What looks attractive going forward?

McGregor: I think, I've been finding more interesting names in what I'll call the smid-cap space, the $1 billion-$5 billion market-cap space, but they have not been thematic in terms of particular industries. They've been idiosyncratic companies. Every company is unique in its own way, but some are more unique than others. And so, I'd say that, we just started a new holding in the Equity and Income fund recently, and it again would be very different from what we have in the portfolio already.

But it was not thematically chosen because we didn't have that space filled in the portfolio. So, I think that stocks that have been knocked down unduly by the market for reasons we think are very transitory, that's what I'm really finding value today and that could be in any sector.

Zimmerman: Clyde McGregor, thank you very much, for being with us today.

McGregor: Thank you.