AIG, Bank of America, Wells Fargo: Bruce Berkowitz Finding Value in Financials

FAIRHOLME (FAIRX)Bruce Berkowitz founded Fairholme in 1997, and is a former senior portfolio manager for Lehman Brothers and managing director for Smith Barney. Berkowitz was named Morningstar's domestic stock fund manager of the decade for 2000-2009. Berkowitz has managed to beat the market for every year but 2003, and in 2010 the Fairholme Fund returned 25.5%, beating the market by 10%.

Fairholme recently filed a 3Q 13F with the SEC, keeping their 13F holdings heavily invested in financials—over 75%. Berkowitz’s big themes that stuck out to us were that he kept things relatively stable at the top of his 13F portfolio, but did make some key changes, exchanging Jefferies and CIT Group for more Wells Fargo shares.

American International Group, Inc. (NYSE:AIG) remained Fariholme’s top 13F holding at over 86 million shares, making up 40.5% of the fund’s portfolio. Even though the insurer is up almost 50% year to date, it still trades below tangible book and at a discount to peers at a 0.6x P/B. Part of the upward swing in shares so far this year have been thanks to the steady reduction of Treasury ownership, and the stock’s 1.9 beta. Although AIG did not make our list of top stocks loved by hedge funds, AIG saw fifteen of the funds we track with over 5% of their 3Q 13Fs invested in the insurer, including George Soros, who initiated a new position.

Bank of America Corp (NYSE:BAC) remained Fairholme’s 3rd largest 13F holding worth 12.9% of the fund’s portfolio. Trading the cheapest amongst its peers at a 0.4x book value, compared to other top banks Citi at 0.6x and Wells Fargo at 1.2x, Bank of America appears to be positioned nicely for continued growth, despite being up over 60% so far this year. A strengthening balance sheet and capital position is helping to drive the company higher. Loan loss provisions declined from $13.4 billion in 2011 to an expected $8 billion in 2012. The provision is expected to fall even further in 2013 to $4.5 billion. Bank of America is also one of the top ten stocks loved by hedge funds in 3Q.

Wells Fargo & Company (NYSE:WFC) was Fairholme’s largest increase at 540% from 2Q—now ranking at Fairholme’s 12th largest holding. Wells Fargo saw Warren Buffett maintain his stronghold as its largest fund owner with 420 million shares, but the bank also saw Ken Fisher up his stake by 70%. Wells has seen industry leading performance thanks to its exposure to the mortgage refinancing market. Total revenues are expected to be up 5.3% by the end of 2012 on the back of loan growth (2.5%) and net interest income growth (1.0%).

CIT Group Inc (NYSE:CIT) was one of the financial stocks that Fairholme was downsizing, essentially trading out some CIT Group shares for Wells Fargo. Fairholme downsized its position by 20%, now making up 6% of the fund’s 13F. This 20% downsize in 3Q comes on the back of a 24% downsize in 2Q. CIT saw much weaker than expected fee income and a generally weak quarter for 3Q. Earnings have been erratic of late and are expected to be down over 2000% by the end of the year, compared to 2011 levels. Once concern is that EPS has grown at a five-year CAGR of -50% over the last half-decade. We remain cautious over CIT's ability to make such a drastic turnaround.

Jefferies Group Inc (NYSE:JEF) was another reduction, with Fairholme lowering its 2Q stake in Jefferies by 37%. The move came at an inopportune time, as since the end of 3Q, Jefferies is up 15%. Jefferies announced a merger agreement with Leucadia National last week that has driven in the bulls, so to speak. Upon approval, the deal would close in the first quarter of 2013. Jefferies should be able to continue strong growth while taking market share from European investment banks that are downsizing, with revenues expected to be up 17% in 2012.

We see Berkowitz’s move into Bank of America as a positive move for a play on financials. While the bank is a bit more speculative than say Wells Fargo, we see BAC's valuation as more compelling. There's also value to be had in AIG and the insurer's declining Treasury stake. For a complete look at Berkowitz's holdings, continue reading at Insider Monkey.

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