Dan Culloton: One area where there is a lot of low multiples is in the financial industry, particularly in banks, and you could look at all of the various reasons why that is, are fairly obvious. There are new regulations, Dodd-Frank, the new Basel Accords, all sorts of other regulations.
You pick up the paper every day and you see talk of capital requirements going higher and higher. ...Why would anyone buy a bank at this point? I know you don't own as many as you used to, but what's attractive at all in the banking industry right now?
Ken Feinberg: It's a very good question. One of the things we did going back a couple of years ago, and the reasons really were from what you just said, Dan, there are so many things and so many entities and regulators and politicians and consumer groups going after the profit pool of these big banks, that it didn't seem to be as easy a decision to certainly buy new positions or hold some of the ones we had, than to find companies that would be out of that spotlight, and I think, you know, the big issue, our big funds only own one real bank today, and that's Well Fargo and it's a top-5 position, but we don't really own any other bank except Bank of New York Mellon, which is a non-bank bank. We have a tiny, tiny position still in J.P. Morgan, but that's really all we own.
And the reasoning behind that is, you can go down the line. You can go look at whether--and it's important today because the Fed Chairman just came out just out yesterday talking about this cushion to Basel III--so you have regulatory capital issues that you know banks will need more capital and you know that the way the assets are going to be marked under Basel III is much more severe than they would have been under Basel I. And now these 19 most important financial institutions will need a buffer of perhaps 300 basis points more over the 700 basis points, so call it 10%, which may sound low but it's actually quite large, the way it's calculated. So any company that's forced to, or required to hold so much more capital should depress the return on equity, the return on capital. It's good for America. It's good for the system, the financial system. It's bad for the individual companies. So that was one issue.
Then what you also have is you've got so many different forces trying to reduce the profits of these large banks, and you can use J.P. Morgan as an example. J.P. Morgan Chase has about $88 trillion of notional value of derivatives, and Jamie Dimon, who is a great CEO in our minds, has been public for over a year saying that if a lot of those derivatives contracts had to move to a clearing house, they might lose about $3 billion of revenue at J.P. Morgan Chase, and no one knows if that's going to be the number, but that was his guess. So, that's obviously a big headwind, and now you've got a lot of the banks trying to actually fight the clearing house regulatory effort. So, we'll see if and when it gets done.
But then you have risks such as a consumer protection agency. So, you've got another bureaucratic layer again trying to see that consumers get a fair deal, which is great. We all want consumers to get a fair deal, but the issue is again another government bureaucracy trying to see that that happens is a difficult thing to really do efficiently and effectively.
Then we've seen lots of attacks on other revenue streams. You've got the Volcker Rule with proprietary trading and again those rules haven't been written yet. You've got other rules in Dodd-Frank that haven't been written yet, such as debit cards, which are very profitable for the banks, where the Fed is proposing to regulate the fees that banks can charge on debit cards. You’ve already had reform on the credit card business that has already cost J.P. Morgan Chase about $1 billion of revenue, because you can't reprise your product anymore for the changing risk of your customer. Then you had the overdraft fees that had to be ratcheted down, which is good for the consumer. So you can go on and on, and you don't know when the end will be in sight.
But what we do know is that the leading banks with good market shares will probably do OK, if you can buy them at a reasonable price, and if they don't have big legacy holes. And one could say that companies that have made big acquisitions, perhaps Bank of America with Countrywide and Merrill Lynch perhaps, there could still be surprises in there that they might not have their arms around yet, could be related to mortgages and litigation at some companies.
But if you can find companies that don't have a lot of those risks, considering the whole sector has been out favour for several years now, you had a snap-back from the bottom in February 2009, but one can say, or at least we would believe, that companies like Wells Fargo are still very attractively priced, and you still have plenty of time to get in and they don't have the same issues as J.P. Morgan Chase or Bank of America. They have some, but nowhere near as much.
So, if the economy grows, if loan growth comes back over time, if there aren't very serious negative surprises on any of the litigation issues that have been swirling around that may take years to settle, may come sooner, we still think selectively there are some good banks to own.
