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Three banking lessons from Warren Buffett

It is reasonable to say that the largest banker in the United States today is not a banker at all – he is an insurer.

You may have heard it.

Warren Buffett.

As president and CEO of Berkshire Hathaway, an insurance-focused conglomerate based in Omaha, Nebraska, Buffett manages one of the largest bank investment portfolios in the country.

Berkshire holds large exposures at major banks:

9.9% at Wells Fargo & Co

6.8% at Bank of America Group

6.3% in U.S. Bancorp

5.3% of The Bank of New York Mellon Corporation

3.7% in M&T Bank Corp.

The fact that Buffett has made such big investments in banks is no coincidence.

If there are two things he values ​​at a high level, thanks to his experience in insurance, it is leverage and cycles – the same two qualities that make banking so unique.

That’s why it’s worth listening to Buffett when he opposes banking, as he often does in his annual letters and media interviews.

This is from his 1991 shareholder letter:

“When assets are 20 times equity – a common ratio in the [banking] industry – mistakes that involve only a small fraction of assets can destroy much of the equity. And mistakes are the rule, not the exception in many big banks. Most of them are the result of a managerial failure we described last year when discussing the “institutional imperative”: the inclination of leaders to meaninglessly imitate the behavior of their peers, no matter how stupid it may be. “

Buffett is referring to the chaos caused by banks during a sharp decline in commercial real estate in the early 1990s, when Berkshire bought 10 percent of Wells Fargo.

According to him, it is critical for bankers to maintain discipline, especially when everyone around you does not.

Another thing Buffett talks about a lot is the competitive advantage.

Here’s an interview with Fortune in 2009:

“If you are a low-cost producer in any business – and money is your raw material in banking – you have a hell of an advantage. If you have a half point advantage. ,, half a point of $ 1 trillion is $ 5 billion a year. “

And here is a compilation of his letter to shareholders in 1987 exhausting the idea more fully, albeit in the context of the insurance industry, which faces almost identical competitive dynamics with banking:

“The insurance industry is cursed with many grim economic features that lead to poor long-term prospects: hundreds of competitors, ease of entry and a product that cannot be distinguished in any meaningful way. In such a commodity business, only a very low cost operator or a person working in a sheltered and usually small niche can maintain high levels of profitability. “

One nuance of banking efficiency is that it does not simply directly increase profitability by generating more revenue; just as important is its indirect effect.

That’s the point of the chairman and CEO of the U.S. Bancorp’s Andy Cecere in a recent though unrelated interview with the Bank Director on Bank.

Effective banks should not strive for credit quality in order to generate satisfactory returns, which reduce credit losses at the end of the credit cycle, Cecere says. And as a consequence, efficient banks can compete more aggressively for the most creditworthy customers, further limiting credit losses in difficult times.

It is no accident, for its part, that the U.S. Bancorp has consistently been one of the most efficient banks and disciplined interviewers in the industry since its transformative merger nearly two decades ago.

And while neither Buffett nor his philosophy came out during an interview with Cesere, Berkshire Hathaway is one of the largest shareholders in the United States.

The last lesson in banking that can be learned from Buffett involves his approach to mergers and acquisitions.

Buffett has said many times in the past that he prefers to pay a fair price for a wonderful company than a wonderful price for a fair company. Moreover, all things being equal, Buffett has always preferred existing management to remain and continue on its path to success.

“As a 20: 1 leverage increases the effect of managerial strengths and weaknesses, we have no interest in buying shares of a bank with poor management at a” cheap “price. Instead, our only interest is to buy at well-managed banks at fair prices. “

This is a style reminiscent of the wicked merger and acquisition partnership approach used by John B. McCoy, who had dinner with Buffett to turn the former Bank One from the third largest bank in Columbus, Ohio, into the sixth largest bank in the country, before later merging with JPMorgan Chase & Co.

In short, while it is true that most people do not consider Buffett a banker, that does not mean that bankers cannot learn much from his observations on the industry


 Trader Aleksandar Kumanov


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