Smart Money: Hedge funds sell faltering U.S. banks
The recovery of Citigroup and Bank of America provided famed hedge fund managers like Lee Ainslie and Jeff Altman some of their biggest gains last year, but now the smart money is getting out while the getting is good.
With Ainslie's Maverick Capital, Altman's Owl Creek Asset Management and other major funds backing away from the banking sector in the first quarter, financials suffered the biggest decrease in sector holdings among the Smart Money 30, a group of some of the largest stock-picking hedge funds.
Ainslie, Altman and Stephen Cucchiaro's Windhaven Investment Management dumped their entire holdings in Citigroup and Bank of America during the quarter, according to data compiled by Thomson Reuters.
Eric Mindich's Eton Park Capital, Philippe Laffont's Coatue Capital and Andreas Halvorsen's Viking Global Investors also rushed for the Citigroup exits.
Citigroup, the third-largest U.S. bank, was the top decrease in existing positions by the Smart Money 30.
After making a killing buying the big banks at their nadir, savvy investors are moving on. Bank stocks are still cheap, but investors expect lackluster revenue growth and new regulations to keep prices depressed for some time.
"Financials have become hated in recent months," said Alan Villalon, a senior bank analyst at Chicago-based Nuveen Investments, which owns bank stocks.
The move to sell may be early, but it is no easy task to unwind such huge positions, even for some of the largest hedge funds.
Citigroup remained the top holding of the Smart Money funds even as they sold off almost 29 percent of their combined stake in the company in the first quarter. Bank of America and regional bank Huntington Bancshares Inc were also among the top decreases in existing positions.
Investors even shied away from stronger banks. Appaloosa manager David Tepper sold off his stakes in JPMorgan Chase & Co and Wells Fargo & Co at the same time that he dumped some of his shares of Bank of America and Citigroup. Lone Pine Capital also reduced its stake in JPMorgan Chase and Citigroup.
U.S. banks have largely recovered from the worst losses of the financial crisis. But their profits over the past year have come largely from releasing reserves they once set aside to cover bad loans.
Citigroup, Bank of America and even JPMorgan Chase all reported year-over-year declines in revenues in the first quarter as a volatile trading environment hit investment banking results and loan books shrank.
The broader economy also suffered during the quarter as political turmoil in the Middle East and the earthquake and tsunami in Japan roiled global markets.
"Banks are macro plays on the economy," said Jason Ware, a senior analyst with wealth management firm Albion Financial. "As the economy starts to hit a softer patch, those types of investments become less attractive."
To be sure, not everyone in the Smart Money 30 group was selling the big banks.
John Paulson made only small trims to his huge stakes in Citigroup and Bank of America. And Brookside Capital Investors bought into Citigroup and increased its stake in Bank of America. Glenview Capital also increased its Citigroup stake while buying into JPMorgan Chase.
Both Bank of America and Citigroup are relatively cheap compared to bank stocks in general, Ware said, calculating that both companies are trading under their tangible book value while banks in general are trading slightly above tangible book value.
Bank investors are also worried about the increased impact of regulation. The U.S. Dodd-Frank financial reform law passed last year will restrict banks' profits from a host of businesses, from trading to debit card processing.
But the industry is still awaiting a slew of rulemaking and in many instances does not yet know exactly how deeply the law will cut into revenues.
Bank of America, the country's largest bank, is particularly vulnerable to increasing regulation of the financial sector. The bank has estimated that it could lose $2 billion in annual revenues from Dodd-Frank's restrictions on debit card processing fees.
Citigroup has a relatively smaller U.S. business and less exposure to Dodd-Frank. But its international focus and dependence on growth in emerging markets means it was particularly vulnerable to global instability in the first quarter, including the Middle East upheaval.
"There's been concern about the tightening we've seen in emerging markets and debt issues in Europe. There are some questions about international growth and a bit of softening in U.S. growth," said Timothy Ghriskey, co-founder of Solaris Group, which owns Citigroup shares.
The banking sector is also facing government scrutiny beyond Dodd-Frank. Investors were reminded of that in March, when the Federal Reserve concluded a second round of bank stress tests and allowed only some of the largest U.S. banks to raise their dividends.
"They don't have control of their own destiny at this point," Ghriskey said.
Even though Citigroup and Bank of America have shed U.S. government ownership, the March dividend increases also highlighted their continuing weakness compared to stronger rivals.
JPMorgan Chase raised its dividend to 25 cents a share from 5 cents with the Fed's blessing, but the regulator rejected Bank of America's bid to boost its own payout later this year.
Citigroup had to make do with reinstating a one-penny dividend, which it could only afford after shrinking its outstanding share count with a reverse stock split. Investors have not looked kindly upon the split, which was seen as largely cosmetic; Citigroup shares have fallen about 9 percent since the reverse split took effect in early May.
"There's almost going to be a have and have-not environment -- those banks that return capital to shareholders are going to do well, those that can't, are not," said Ware.
"The interest in owning some of these names is squarely looked upon as, 'How much cash are they going to return to me as a shareholder?'" he said.
[Source: By Maria Aspan, Reuters, New York, 01Jun11]
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