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December 10, 2007

Time to Buy Financials?
by David Shvartsman

Looking over the news this morning, it seems the big story in the US market is an $11.5 billion "capital injection" for subprime-beleaguered bank UBS.

The European bank will raise the money from Singapore and Middle Eastern investors by selling stakes in the company.

Financial shares, including those of UBS, reacted positively this morning to the news. Which of course, leads all to wonder: is it time to buy financials yet?

Of course the big concern looming over financial companies and their shares is exposure to subprime mortgages and the illiquidity of assets in SIVs.

And in case you still thought the subprime problem was well "contained", you obviously haven't been with us here on Earth these past few months.

As FT Alphaville and Bloomberg point out, even the bond insurers are suspect. Monoline insurer MBIA is now facing scrutiny over its AAA rating as the company faces problems over the subprime CDOs it backs. This in turn spells trouble for all the AAA ratings of the bonds it insures, which could also mean trouble for investors in municipal bonds.

And as we've seen in recent weeks, these concerns are weighing heavily over the shares of Fannie Mae and Freddie Mac. Recent losses at Freddie and Fannie has increased worry over the state of the GSEs' balance sheets.

So where's the bright spot? Ah, but that's where the value investors come in. You've heard the bear case for financials and GSEs Freddie and Fannie (for a refresher, see the link above). Now get ready for the bull case.

The bullish case for financial stocks was made by several noted value investors at a recent Value Investing Congress seminar hosted by Whitney Tilson.

Tilson highlighted some of these investment ideas in a recent FT column, starting with a buy analysis on shares of Freddie Mac.

On the long side, Rich Pzena of Pzena Investment Management shared his analysis of Freddie Mac, which he prefaced with this emphatic statement: "I'd go so far as to say that Freddie Mac is the single cheapest stock I've seen in my career." (On the day before his presentation, Freddie Mac shares traded at just under $26.) Given his highly successful career, that is saying something.

Pzena's argument is twofold: first, Freddie Mac's earnings are likely to be much higher going forward. That is because the prices it is paying for mortgages that it will package into securities have improved markedly, thanks to mortgage sector distress.

It should be noted that not all present at the VIC were bullish on financial shares. Tilson mentions two investors who shared their short ideas. Bill Ackman of Pershing Square Capital gave a thorough presentation on likely future problems at MBIA and Ambac, while David Einhorn at Greenlight Capital was wary of future losses at Lehman Brothers.

For more on this and other insights from the VIC, see Tilson's column.

So now that you've heard the bull and bear case for several leading financial stocks, this leaves us with only one important question (as heard on Bloomberg TV this morning): "What should the Fed do tomorrow?".

I can only shake my head and smile slightly...

David Shvartsman
Finance Trends Matter

Copyright © 2005-2009 David Shvartsman

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