Betting on a financial industry rebound

Benj Gallander and Ben Stadelmann
Friday, August 28, 2009

Experience can be a wonderful teacher. When the financial crisis hit last fall, one of us took his 30 years-plus of investing knowledge and deduced, quite simply, that the banking and mortgage realms would survive, as in previous cycles when these sectors had become distressed. The biggest difficulty was trying to figure out which players would fall by the wayside.

Playing with fire, he purchased Freddie Mac at 61 cents (US) and sold it before three months elapsed at $1.08. Lehman Brothers was spun out in a day for better than a 100 percent gain. Perhaps emboldened by these early successes, he stepped in to acquire other positions, starting with Bank of Ireland, Citigroup and MBIA.

Alas, the short-term results this time were woebegone, as all three took a pounding and two were quickly dumped. Stubbornly, perhaps, the two that had been dispensed with were repurchased after thirty days, allowing the tax losses to stand.

Remaining convinced that the contrarian strategy made sense in the face of stiff expert opposition, additional purchases in both stocks and bonds followed. These included Centrue Financial, CIBC, General Electric, HSBC, Irwin Financial, National Bank, Royal Bank, Thornburg Mortgage and VIST Financial.

The logic was that while some of these institutions could fail, or simply end up trading at far lower values, overall the winners would handsomely outpace the losers.

Some of these positions were also paying dividends, and very reasonable ones, especially compared with the anemic returns from other investments. By purchasing those stocks, one was being paid to wait for the recovery.

Banking and insurance corporations have staying power. That sets them apart from fields with rapid innovation, such as technology, where today’s cool toy is tomorrow’s recyclable. Financials are the pillars of economic society, and they will continue to exist for the foreseeable future.

The sectors are also enormously profitable during normal times. Though for a period of time many of these enterprises will have to deal with write-offs — some due to the recession, others because of their own stupidity — once these are taken care of, the bottom lines in most cases will once again be very black.

By investing in a number of companies, the risks are spread out. In some ways, this is like buying a financial mutual fund, without paying all of the associated fees, and being able to cherry-pick fewer positions than those entities hold. The costs, therefore, work out to be far less.

Of all these holdings, besides the aforementioned Freddie and Lehman, the only one for which there is a verdict is Thornburg, sold for a loss slightly north of 40 percent. Currently, Centrue is down almost 20 percent, but all of the other positions are comfortably ahead.

The two that were highlighted in last April’s Contra the Heard investment letter, Bank of Ireland and MBIA, are up a whopping 312 and 43 percent respectively in the four months.

There is an excellent chance that the best is yet to come for the financial and mortgage players as the economy recovers, which it will. Whether that is sooner or later is open to debate, but ultimately the global marketplace will return to normal and many of these positions will thrive.