During the 2007/2008 financial crisis, bank stocks were one place many investors fled from – like herds of lemmings. I can’t say this was unreasonable as these companies sustained blow after blow – some deserved and some not. When a company such as Lehman collapses, mortgage GSEs are federalized and mortgage lending comes to a grinding halt one has to consider the Chicken Little scenario – is the sky really falling? From this systemic failure emerged a new dawn on the heels of legislation, notably Dodd-Frank. Though far from perfect, this bill in 2010 established a floor from which the system could be rebuilt.
To paraphrase Warren Buffett, my view was this fear and dysfunction presented an opportunity. With the dust beginning to settle, in early 2013 I dipped my toes back into Financials. With the exception of Prosperity Bank (PB), which I classified as a Core position at that time along with a few others, these holdings – peaking at about 32% of the total portfolio in aggregate – didn’t exceed the 1% threshold individually. Financials currently hold 29.9% and are trending down. Truth be told, this group did provide the octane enabling my portfolio to consistently exceed the benchmark.
The Dividend Diplomats employ a similar small bank strategy but our approaches differ. Whereas their baseline is the dividend screen process, I rely more on size and geography. This is due primarily to embedded distortions in a TARP (and post-TARP) world as well as historical factors regarding bank failures. For example, Lanny’s Isabella Bank purchase wouldn’t make it onto my list as I consider Michigan banks inherently risky due to the number of failures within the state during the last crisis. You could posit a macro versus micro view in our perspectives.
Since I began this strategy I’ve periodically reported my results with my 2015 and 2016 reviews. I was remiss earlier this year as the pace of significant mergers decreased in the post-Trump world. This activity is now accelerating due to two factors, I think. The first being the Dodd-Frank modifications enacted in May making it less onerous for banks of a certain size to combine. The second being rising interest rates. This one is less obvious as rising rates should be a boon to banks. However, the spread between long and short rates is compressing (perhaps inverting soon?) which is where much of the profit is derived. So the results, please?
Note: through 7 Oct 2018
Of interest is that the majority of 2017 was mostly a year of consolidation with smaller banks (usually thinly traded or private) being acquired by one of my holdings. 2018 is interesting in that a number of mergers have a cash component which adds to the complexity of determining the ‘real’ valuation resulting in some initial pricing or recommendation assessments by firms on Wall Street. I bought into two of these before the assessment changed in my favor (resulting in an unanticipated unrealized gain).
Now that this sector is pretty much fairly valued unless some compelling opportunity presents itself I’ll hope for some of the remaining 73 to be acquired and place my cash elsewhere. 🙂