Greenwald: Why First Eagle Favors Amex Over Citi
Amex may not offer as much upside potential, but the risk of permanent capital impairment is almost nil, says professor Bruce Greenwald, director of research at First Eagle.
Amex may not offer as much upside potential, but the risk of permanent capital impairment is almost nil, says professor Bruce Greenwald, director of research at First Eagle.
Ryan Leggio: Hi, I'm Ryan Leggio. I'm a mutual fund analyst at Morningstar. We're here in New York with professor Bruce Greenwald. He's the director of research at First Eagle and a professor at Columbia Business School. Bruce, thanks so much for being with us today.
Bruce Greenwald: It's a pleasure.
Leggio: Well, we're talking in mid-May 2010. The markets are a little jittery. And I wanted to start off talking about financials. And specifically some value investors, who had not owned financials for the last two years, are slowing starting to buy names like Citigroup, etc. Can you give us your thoughts on how value investors should approach owning highly leveraged financial names like Citigroup?
Greenwald: OK, let me start with how we do it, and then I'll talk about how they will do it slightly differently. For First Eagle, preservation of capital is the first priority. We would love a 9%, 10%, 11% return for our investors, above inflation in the long term, but we're not prepared to risk capital to get that.
When you look at the financials, the big downside is from the leverage. It's that there are big potential write-downs in commercial real estate still. The default rates on credit cards are still going up. You have no idea whether there's going to be a new sovereign debt default issue.
When we look at the value, which is there in terms of earnings power, but then we look at the potential for permanent impairment of capital--because if they lose all that money, they're going to have to issue stock at unfortunate levels--for us the risk is just too high.
For other value investors, if you are willing to invest with a four to five times upside and lose all your money, obviously it's a more attractive proposition. So I think that really is the issue, is that they're very highly levered. You can get blindsided and wiped out, as you were [laughs] in Fannie and Freddie, and AIG and Citibank, and so on, in 2008. And that's just not a risk we're prepared to take. But I think, prudently, if they wait, and they get a good enough price, other value investors can do it sensibly.
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Leggio: So the one financial, or at least the big financial, First Eagle owns is American Express, terrific business. How does the price look, though? It's up substantially in the last 12 months.
Greenwald: It is up substantially; if you think that they're capable of earning, in the long run, $3.60 a share. I'll do it in share terms. It's still a 10% return. So, for us, the judgment that we're making is--because there's some growth there obviously--the judgment that we're making is that the risks are tolerable. What we did with American Express is we asked the question, if they could not roll over a single debt instrument in the next three years, would they still be OK? And the answer is "yes."
And there are two reasons for that. One is, their credit card defaults are actually falling, and have been falling for a long time. And the second thing is, they're shrinking their loan portfolio, and it's generating a huge amount of cash. So the chance that they will have to go out and raise equity capital, at a very bad price, is nil in that case.
So, again, since our emphasis is first on preservation of capital, that's the one financial we're prepared to do, because it's a good return. Not as great a return perhaps, on the upside, as the others. It's a good return, but the risk of permanent impairment of capital is almost nil for them.
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