Bold Buffett Backs Broken Banks

Posted by on Aug 28th, 2011 and filed under Investing.

 Bold Buffett Backs Broken BanksPrabhat Sakya, 9:20, Friday 26 August 2011

Investors in 2011 have taken a fair old battering. almost every share has fallen, but amongst the worst hit stocks have been the banks.

It has been death by a thousand cuts, as bad news has been followed by more bad news. There was the payment protection insurance scandal, the continued difficulty the banks have had dealing with their bad debt, increased regulatory pressure and, worst of all, the European debt crisis.

Shorters’ heaven

I thought Lloyds Banking Group (LSE: LLOY.L – news) looked decent value a while back, as did my colleague David Holding, and other Foolish colleagues did the same for Royal Bank of Scotland (LSE: RBS.L – news) and Barclays (LSE: BARC.L – news) . But share prices have just kept on falling.

Clearly the banks have been a prime shorting opportunity. and I can understand the shorters’ logic — the uncertainties around the eurozone debt crisis and lack of growth in developed world economies mean that bank investors are gripped with fear.

As the stocks have continued to tumble, the falls have gathered huge momentum. We are at a stage now where momentum dominates. I and my Foolish colleagues can continue to bleat on about cheap valuations — Lloyds is half book value, and RBS a scarcely believable fifth of book value — but the markets will take scant notice.

Prices have now fallen so much that banking stocks are nearing the lows they reached during the credit crunch. But that was a time when we genuinely thought the global financial system was under threat, and we were about to plunge into a recession of a ferocity not seen since the great Depression.

Now I have been pretty bearish in recent weeks, but even I am struggling to see us plumbing the depths of despair of spring 2009.

Yet I had the feeling we needed some good news, some sign of hope, before the market would turn.

Warren to the rescue

Could this be it? Warren Buffett’s Berkshire Hathaway (NYSE: BRK-A – news) (NYSE: BRK-B.US) has announced that it is injecting $5 billion into the beleaguered Bank of America (NYSE: IKJ – news) , by buying preferred stock at a yield of 6%, redeemable at any time for a 5% premium. it also receives warrants to buy 700 million B of A common shares at a strike price of $7.14. it has 10 years to exercise the warrants.

Now, just like European banks, Bank of America has come under immense pressure from the shorters in recent weeks, losing a third of its value just in the month of August. Commentators see this move pretty much as symbolic, with Buffett lending his priceless brand to the company. He was basically saying, “Buy into banks. I am.”

The move is redolent of Buffett’s investments in Goldman Sachs (NYSE: GS – news) and General Electric (NYSE: GE-PA – news) at the height of the financial crisis. these transactions also had great symbolic value, though Buffett, being Buffett, would have ensured, then as now, that he would make a tidy profit.

Buffett was quick to express his support for the company: “Bank of America is a strong, well-led company, and I called Brian [Moynihan, Bank of America's chief executive] to tell him I wanted to invest in it. I am impressed with the profit-generating abilities of this franchise, and that they are acting aggressively to put their challenges behind them.”

“Bank of America is focussed on their customers and on serving them well. That’s what customers want, and that’s the company’s strategy.”

Is this the turning point?

The markets seemed impressed, with B of A stock initially bouncing 25% before falling back to be 10% up by the end of the trading day. other banking stocks also did well, with Lloyds up 3% and RBS up 5% on the day.

So, is this the long-awaited turn in banking stocks we have been waiting for? well, I would love to tell you that it is, but I am not so sure. I’m afraid I suspect it will take more to stop the shorters targeting the banks.

Buffett is clearly signalling that banks are looking very cheap, and I would say they are an investment for the brave.

However, after so many people have been burnt investing in banks, I hesitate to recommend buying in now. I would keep them on my watch list, but, for the moment, I think there are other, safer, investing options.

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