THE MEMO ABOUT BANK STOCKS

If you study the best bank investors, it's obvious what you should do right now.

Mr. John Thompson, the veteran, was asked yesterday if he didn't think this rather a risky time to start such an enterprise. He said: "I have just come from the Dry Goods Bank, which is closing up its affairs. I told them that this is just the time to start a bank. Everything is at the ebb. Everything has touched bottom and got as low as it can. If there be any change at all it must be for the better."

The Chase National Bank of the City of New York, 1877-1922

On September 23, 1990, The Washington Post ran a headline that asked, “Why are the Tisch brothers buying bank stocks?”

Most investors were as interested in bank stocks at the time as Superman was in kryptonite. Moody’s Investors Service downgraded Chase Manhattan’s debt to junk status two days later after the country’s third-largest bank said it would set aside $1 billion to cover future loan losses, lay off five thousand employees and slice its dividend in half. The outlook was so bleak that regulators had begun to openly question the viability of the FDIC’s deposit insurance fund. “We’ve got a mini panic,” a bank analyst told The New York Times later that week.

Larry and Preston Tisch didn’t get the memo. The patriarchs of Loews Corp., a corporate empire once described as a mutual fund that sold cigarettes, were stockpiling shares of regional banks like Bank of Boston, Continental Bank and Equimark Corp., the parent company of Pittsburgh’s Equibank. To be clear, this wasn’t the Tisch brothers’ first rodeo. When Larry wasn’t investing Loews’ hoards of cash in the stock market, he was serving as the chief executive officer of CBS. And his younger brother Preston had just served as U.S. Postmaster General, was the then-chairman of Loews, and would soon own half of the New York Giants.

The Tisch brothers weren’t the only investors left out of the loop. Neither Gerald J. Ford in Dallas nor James M. Fail in Phoenix got the memo about avoiding bank investments either.

Ford had partnered with Ronald Perleman two years earlier to buy five failed thrifts from the Resolution Trust Company then merge them into First Gibraltar Bank. That same year Fail combined a mere $1,000 of his own money with millions of dollars in loans from insurance companies he controlled and $3 billion in Federal aid to acquire fifteen insolvent Texas thrifts which together became Bluebonnet Savings Bank.

Not even Warren Buffett was privy to the premonitions against bank stocks. One month after The Washington Post profiled the Tisch brothers, Buffett’s company Berkshire Hathaway disclosed in a regulatory filing that it had accumulated 9.8 percent of Wells Fargo’s outstanding shares.

“Our purchases of Wells Fargo in 1990 were helped by a chaotic market in bank stocks,” Buffett wrote in his shareholder letter that year. “The disarray was appropriate: Month by month the foolish loan decisions of once well-regarded banks were put on public display. As one huge loss after another was unveiled — often on the heels of managerial assurances that all was well — investors understandably concluded that no bank's numbers were to be trusted.”

Did these guys understand something about bank stocks that other investors didn’t? And are todays savviest investors applying the same principles in current market conditions? The answer is obviously yes, but let’s dig deeper.

In the first case, folks like these tend to be blessed with an almost sixth sense for the market cycle. Is it high? Low? Headed up? Down? Intuition like this is invaluable in an industry like banking with little margin for errors and infinite opportunities to commit them.

The second element is more mechanical and the most important.

Given that even the best banks don’t tend to earn much more than 14 percent on their equity in most years, the sole lever an investor has to bend the return curve in their favor is the price, or rather, value paid for the stock. For a bank bought at half of book value will compound, holding all else equal, at four times the rate as a bank stock bought at two times book value. It’s for this reason that the savviest investors I know have all spent the past few weeks loading up on shares of their favorite banks, one of which I disclose below.