Billionaire Battleground: Bank of America

The numbers for hedge fund stock holdings are in, and Bank of America Corp. was a "battleground" stock in the first quarter, with well-known (in the industry) hedge fund managers on either side of the trade.

On the buy side, David Tepper's Appaloosa Management opened a position of 6.99 million shares, with a market value of $94 million at the end of March. Almost as if they were transacting with Appaloosa directly, a tag-team duo comprised of Canyon Partners (Mitchell Julis and Joshua Friedman) and Louis Bacon's Moore Capital Managementexited their positions with aggregate sales of 6.96 million shares.

All four men are highly respected in the industry as investors and they're paid-up members of the billionaire hedge fund managers' club. Who is making the wiser trade?

David Tepper goes back to the well on a huge winner

For Mr. Tepper, establishing a position in Bank of America echoes the trade that immediately guaranteed his status as a legend in the hedge fund industry. As I wrote earlier this month in "These 5 Investors Took Home More Money Than Goldman Sachs Last Year

The Goldman Sachs alumnus earned his seat in the pantheon with a huge bet on bank shares and securities in March 2009, reasoning that the U.S. Treasury would not allow the financial system to collapse. As the market capitulated -- the S&P 500 bottomed on March 9 -- Tepper scooped up shares of Bank of America and Citigroup. His average cost per share on the Citigroup position: $0.79.
That insight -- and the conviction to act on it -- paid off spectacularly. Tepper's flagship fund was up more than 130% in 2009, earning him a $4.0 billion payday.
Will this bet pay off for Tepper this time around? In this fight, I'm inclined to side with him.
The bear case against Bank of America
I think I understand the bear case against Bank of America: Traumatized by the great financial crisis of 2008-2009, regulators have produced reams of new regulation with the goal of ensuring that no bank is too big to fail. However, these regulations have hamstrung the big three universal banks (Bank of America, Citigroup Inc., and JPMorgan Chase & Co.).
Bears believe that the recent record has demonstrated that the largest banks (or Bank of America and Citi, at any rate) are unable to earn an economic profit in the post-crisis environment. And -- let's give the bears their due -- it's true that Bank of America has not produced a single quarter in the period beginning in 2008 through the present day in which it has earned its cost of capital.
Bears also argue that the ultra-low interest rate environment and, particularly, a flat yield curve are strangling the bank's capacity to earn a profit. A flat yield curve implies long rates are not much above short-term rates; banks earn the difference between the two.
Do banks face a more challenging environment than they did prior to the crisis? Undoubtedly. Will all aspects of the current environment persist indefinitely? I don't think so. The yield curve, for example, is not static -- I'd be very surprised if banking regulators have managed to eliminate the interest rate cycle! I suspect that bears are extrapolating current conditions (too) far into the future. Recency bias is understandable, but it's an error nonetheless.
Siding with the most successful investor of them all
There is one billionaire -- arguably the most successful investor of them all -- who isn't selling down his Bank of America position: Warren Buffett. As he pointed out in his 2013 letterBerkshire Hathaway shareholders (my emphasis):

We can buy 700 million shares of Bank of America at any time prior to September 2021 for $5 billion. At yearend these shares were worth $10.9 billion. We are likely to purchase the shares just before expiration of our option. In the meantime, it is important for you to realize that Bank of America is, in effect, our fifth largest equity investment and one we value highly.
Once he exercises the option to buy those shares, Berkshire will almost certainly be Bank of America's largest shareholder. Of course, Buffett may turn around and sell the shares immediately to realize that multibillion-dollar profit, but I'm pretty confident that he'll continue to hold the shares instead, and he isn't one to become a major shareholder of a business that is terminally unprofitable. In my opinion, investors with an equity-appropriate time horizon would be better off siding with Tepper and Buffett on Bank of America.
The article Billionaire Battleground: Bank of America
Alex Dumortier, CFA free for 30 days considering a diverse range of insights disclosure policy
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