David Tepper's Appaloosa Sells Bank of America (BAC) and Wells Fargo (WFC)?

David Tepper's hedge fund Appaloosa Management filed their 13F early with the SEC and in it are some noteworthy moves. The filing reflects portfolio activity as of June 30th, but it does give us a glimpse as to what he was up to in the second quarter.

The big talking point here is that in the second quarter, Tepper sold 41% of his position in Bank of America (BAC), selling over 7.2 million shares. He also sold 5% of his position in Wells Fargo (WFC) and 6% of his position in Citigroup (C), his top equity holding at the end of Q2.

However, David Faber at CNBC is hearing that Tepper has since sold completely out of BAC and WFC in recent weeks. He also apparently sold a chunk of his stake in C too. Tepper has not confirmed this though.

Turning back to the factual information from the 13F we do have though, Tepper also sold 54% of his stake in Hewlett Packard (HPQ).

In terms of new positions, Appaloosa started new stakes in Mosaic (MOS), Western Refining (WNR) and Google (GOOG). It's likely that Appaloosa took advantage of the MOS secondary as Dan Loeb's Third Point also bought MOS. Tepper also bought more CVR Energy (CVI) which we already highlighted back in June.

On the long side, refining seems to be a big theme for Appaloosa as they ramped up their stake in Valero (VLO) by 202% in the second quarter in addition to starting their stake in WNR. To see what other top hedge funds have been buying & selling, subscribe to our Hedge Fund Wisdom newsletter as a new issue is due out in just a week and a half.

John Paulson Buys Citigroup (C) Shares?

Please note that we don't typically like to post 'rumors' here at Market Folly as we usually focus on concrete information such as SEC filings and investor letters. So, obviously take everything in this post with a grain of salt. However, we believe the sources to be reliable/credible and as such have decided to post them.

The NY Post has a piece up stating that John Paulson's hedge fund Paulson & Co has slowly acquired a 2% ownership stake in Citigroup (C) over the past few weeks. Sources in the story say that Paulson has bought because he believes that Citi's assets are undervalued. He apparently sees shares worth book value and thinks they should trade between $5-7 per share. With his new stake, Paulson would also join the US Government, who owns roughly 34% of Citigroup.

This comes after last week when we revealed that Paulson's hedge fund had amassed large stakes in numerous financials including Bank of America (BAC), Capital One (COF), Goldman Sachs (GS), JPMorgan (JPM), and Regions Financial (RF) amongst many others. You can view a summary of Paulson's new financial additions here. We'll of course continue to monitor the situation and will post up any other concrete information we receive. (Know something we don't? Get in contact with us).

John Paulson: Long Financials Including Bank of America, Capital One, Goldman Sachs & More

John Paulson's hedge fund Paulson & Co has disclosed long positions in numerous financial stocks, most notably Bank of America (BAC). In their 13F filing just released yesterday (detailing their positions held as of June 30th, 2009), they reveal a massive $2.2 billion stake in shares of BAC which they received at a nice price of around $10 per share. BAC shares now trade well north of $15, so they've already profited handsomely on that play. And, more importantly, Paulson sees fair value at around $30 within the next 2 or 3 years. We actually noted that we had been hearing Paulson had a large BAC stake earlier on in our recent piece on Dan Loeb's hedge fund Third Point. And, the release of this 13F obviously confirms that. (Dan Loeb's Third Point also owns BAC around $10 and put on a similar play to Paulson). While Paulson's entrance into financials is by no means new, it is definitely more emphatic this time around. Paulson is definitely focused on the recovery meme for now, as he also will be starting a real estate recovery fund.

When we covered Paulson's portfolio last quarter, we noted that he had picked up stakes in Capital One (COF) and JPMorgan Chase (JPM). This time around though, he has expanded his arsenal of financials and has also added Bank of America (BAC), Goldman Sachs (GS), Fifth Third Bancorp (FITB), Regions Financial (RF), First Horizon National (FHZ), Marshall & Ilsley (MI), State Street (STT), Suntrust Bank (STI), and People's United Financial (PBCT).

In order of size, Paulson's top 5 largest financial plays are:

1. BAC: $2.2 billion

2. COF: $372 million

3. GS: $295 million

4. JPM: $238 million

5. RF: $141 million

We also would be remiss if we didn't mention the fact that Paulson has picked up an $83 million stake in the exchange traded fund (ETF) ProShares Ultrashort Financial (SKF), presumably as a hedge to his position. His election to use this vehicle as a hedge is quite curious, as its flaws as an investment vehicle have been well chronicled. Ultrashort funds are leveraged and carry more inherent risk. At the same time, they seek to replicate 2x inverse the *daily* performance of their underlying index (in this case, the financial index). Since it resets performance daily, the fund experiences compounding issues over time. So, the longer you hold the vehicle, the potentially further you drift from accurately tracking the index. While the vehicles do a good job of tracking on a *daily* basis, they are simply better suited for trades, not holding positions.

Daytraders galore will swear by SKF as it minted many of them a pretty penny last October and November when financials were tanking on a daily basis and SKF was soaring. So, it strikes us as very odd that Paulson would use this as his hedging mechanism. You'd think a hedge fund of their reputation and research ability would know the mathematical flaws inherent in the vehicle they've selected. Maybe they are completely aware of it and decided to use it anyways, rather than shorting an index, buying puts on the index, or buying puts on their individual holdings. Who knows... it is all speculation on our part. The main thing to take away here though is still Paulson's large exposure to financials, namely through Bank of America.

At the same time, they undoubtedly have short positions in the sector as well. We have been hearing that Paulson is complementing their long moneycenter banks play by going short select regional banks that have major exposure to commercial mortgage-backed securities (CMBS) and commercial real estate (CRE) in general. This falls under the thesis that these firms would not have to write it down until later this year or until next year and do not have sufficient loan loss reserves set aside. Additionally, we've heard they have shorted select European financials as well. Back in June, we detailed how Paulson had covered their Barclays (BCS) short. We now wonder which institutions they may be targeting, since they had previously been short Lloyds too.

Overall though, the 'recovery' theme plays on for Paulson. Over the past few months, we've seen Paulson go long financials, buy distressed debt he was once shorting, start a real estate recovery fund, and more. One other notable thing to point out about Paulson's portfolio is their massive gold position as they continue to hold a large stake in the SPDR Gold Trust (GLD). However, we want to make sure everyone realizes that this has been labeled a hedge for their fund share class that is denominated in gold. At the same time though, one has to wonder why they also have large positions in gold miners too.

This is not our usual in-depth look at the hedge funds we report on when covering a 13F filing. So, rest assured that we will still be covering Paulson in our upcoming second quarter 2009 edition of our hedge fund portfolio tracking series. We just wanted to cover this major point for now as mainstream media will undoubtedly run like the wind with this development. Stay tuned for more!

Bank Stress Test Results

Drumroll.....

The eagerly awaited, somewhat informative, yet probably not completely accurate, overhyped and underdelivered, "it is what it is": Financials/Bank Stress Test Results.

(RSS & Email readers may need to come to the blog to view the presentation).


Bank Stress Test Results Overview - Free Legal Forms

Gap Between Tangible Common Equity and Tier 1 Capital

Since yesterday we took a glance at tangible book/asset ratios, we'll today take a glance at tangible common equity and tier 1 capital ratios courtesy of Paul Kedrosky. Keep in mind, obviously, that you need to take all of these ratios that we've been throwing at you with a grain of salt. (Taking things with a grain of salt seems to be the theme this week, slash this entire crisis). Because, of course, a few ratios here and there are not even close to being able to sum up a financial institution's situation. Note that tangible common equity is typically the more 'stringent' of the two measurements.

(click to enlarge)

A Look At Financial Instutions' Tangible Book / Asset Ratio

We recently read some very interesting research courtesy of Pali Capital that examined the tangible book/asset ratio of various financial institutions. They looked at this ratio of institutions all over the world and so we wanted to highlight some of the major ones we saw. For instance, we see that Washington Mutual, who already essentially 'went under' by nature of forced acquisition, has a tangible book/asset ratio of 3.66. And, that number is on the higher end of the scale/list. So, the thinking would be that many of the institutions with ratios lower than that could potentially be in trouble as well. Because, after all, their ratios would be categorically 'worse' than that of an institution that's already had problems. Of course, we do realize that each institution is an individual entity and should be treated as such; its situational. But, as we run through the list, you'll start to notice that the lower the ratio, the more troubled banks we run into. Let's have a look, noting that those listed in bold have either already failed, been forcibly acquired, or are known to have major problems.

First, the US banks & their tangible book/asset ratios:

BB&T (BBT) 6.86
PNC (PNC) 5.87
Northern Trust (NTRS) 5.51
Goldman Sachs (GS) 4.86
Morgan Stanley (MS) 4.35
JPMorgan (JPM) 3.83
Washington Mutual (WM) 3.66
---
Wells Fargo (WFC) 3.50
Merrill Lynch (MER) 2.84
Bank of America (BAC) 2.83
US Bancorp (USB) 2.74
Lehman Brothers (LEHMQ) 2.39
Citigroup (C) 1.52

And now the Internationals & their tangible book/asset ratios:

Mediobanca (MB:IM) 8.35
Unione di Banche Italiane (UBI:IM) 5.1
Intensa Sanpaolo (ISP:IM) 4.5
Banco Santander (STD) 3.76
---
Unicredit (UCG) 2.82
Societe Generale (GLE) 2.68
HBOS (HBOS:LN) 2.55
Credit Agricole (EPA:ACA) 2.38
Lloyds (LLOY) 2.26
BNP Paribas (BNP) 2.12
Credit Suisse (CSGN) 1.94
Barclays (BCS) 1.28
ING Groep (ING) 1.18
Deutsche Bank (DB) 1.17
Northern Rock (NRK:LN) 1.07
UBS (UBS) 1.06
RBS (RBS) 0.95

Again, note that those listed in bold have either already failed, been forcibly acquired, or are known to have major problems. You'll also notice that the international banks seem to be in worse shape by examining this ratio alone. So, that should be interesting to watch. It's no surprise to see Citigroup at the bottom of the US list, considering how much trouble they're in and how much government assistance they've needed. And, similarly, RBS has been in a world of hurt on the international side and has the overall lowest ratio of all the institutions measured, regardless of region.

We've noted in the past that hedge fund Paulson & Co has made a fortune by betting against all things sub-prime. Additionally, they've profited from shorting UK financials and in particular, they've focused on Lloyds. Also, in our hedge fund tracking series, we recently covered Paulson's portfolio, which you can view here, along with his year-end letter & report. He's been quite successful, having made correct bets against Barclays, RBS, and Lloyds (which all conveniently fall at the lower end of the list above). We would be remiss though if we didn't point out the fact that John Paulson has become slightly constructive on some other destroyed assets he had been previously short, and is looking to slowly start buying them. It remains to be seen though if he would reverse such a bet against the institutions themselves.

Obviously, not all institutions are listed here. We noted back in January that many people thought HSBC needed capital as well. But then again, who doesn't need capital these days? And, back in October, we had examined the leverage ratios of financial institutions. But then again, who doesn't need to delever these days?

Keep in mind this is simply one aspect of an enormously big picture in a gorge of an industry right now. You cannot even begin to unravel the woven complexities of a financial institution from a few ratios here and there. We just thought the information was interesting and highlighted that even institutions with ratios perceived to be of 'better quality than others' did not escape unscathed (i.e. WaMu). Which, by the way, is pushing the definition of 'quality' to an extreme for sure. Everyone should, of course, take all these ratios and measurements with a grain of salt. For instance, if you look at Bank of America's (BAC) tangible common equity at the end of last year, you'll note that it was a positive $35 billion before acquiring Merrill Lynch (MER), but then falls to a negative number once everything is marked at fair value and adjusted. Jonathan Weil at Bloomberg notes that if you use these fair value numbers, Bank of America needs a ton more common equity. He also examines Wells Fargo (WFC) and finds the same underlying problem. Their tangible common equity was a positive $13 billion at the end of last year. But, if you adjust everything to fair value, it also becomes negative.

This obviously highlights the recurring problems of the abyss known as a financial institution's balance sheet. So many balance sheets essentially have artificial values in place and its impossible to gauge just how well or poorly positioned they might be. We will just go out on a limb (not much of a limb, really) and assume that everyone's just simply going to need more capital. End of.

And now back to your regularly scheduled implosion.

HSBC (HBC) Needs Capital

At least, that's what Morgan Stanley thinks. Yesterday (1/14/09), they came out with a pretty big research note on HSBC (HBC), saying they think HBC will need up to $30 billion in equity and will need to halve its dividend. The note comes a day after our post highlighting interesting record options activity in HSBC, where we mentioned HSBC's lack of equity raises amidst the current crisis. Also worth noting per UK regulatory disclosures, hedge fund Eton Park Capital ran by Eric Mindich has had a short position in HSBC for many months. We recently covered Eton Park in our hedge fund portfolio tracking series where we examined their long holdings here.

With 57% of their loans in the US and UK, HSBC is definitely exposed to trouble, despite being a true international bank. Morgan Stanley thinks HSBC has one of the weaker capital ratios in Europe and the second weakest in Asia, and will face problems for the next two years.

An excerpt from Morgan Stanley's report,

"We have reduced our 2009 PBT forecast by 34%, which equates to a 39% drop in EPS and flows through to a 32% fall in 2010. We now forecast 2009 EPS of US55¢ and 2010 of US50¢; 46% and 60% below FactSet consensus, respectively. We have reduced our price target to 455p from 550p previously.
...
In 2007 HSBC paid out $10bn in dividend. Since 1992 investors have on average elected to take 26% of the dividend in scrip. Analysing the history suggests investors become more risk adverse in times of distress, and in our view it would be imprudent for the management team to assume an average take up in 2009 and 2010. If we combine this with our estimate of the capital requirement discussed above, a sharp reduction in attributable profits in 2009 and 2010 as structural and cyclical headwinds take hold (2009: $6.6bn, 2010: $6.2bn), it suggests to us that HSBC will cut its dividend in 2009.
...
Post a $20bn capital increase and a 50% dividend cut, we calculate HSBC would carry a clean Core Equity tier 1 of 7.2% (stripping out the AFS and insurance double counting), which looks reasonable given historical HSBC capital ratios and broadly in line with the recapped Santander, which has 7.1%. [Note Santander is not allowed to add back its €3.8bn AFS reserve, which equates to 80bp of capital]."

While HSBC might have weathered the subprime thunder relatively speaking, it seems as if they are still not out of the storm. As we highlighted in our January 13th post on HSBC, they have the oh-so-fun mix of leverage, large writedowns, and low capital raised. Add record options activity on top of that and things start to get interesting. We also highlighted the $45 level as a "make or break" level for HSBC on technicals. Wednesday at the open it gapped down below it. While a re-test of $45 from the underside is probable, things could get ugly for HBC shares.

Full disclosure: At the time of publication, MarketFolly was short HBC via puts
Links: Marketwatch, FT Alphaville

Leverage Ratio of Financial Institutions

I wanted to post up this image (courtesy of Paul Kedrosky), because it illustrates the amount of leverage employed at various financial institutions. Numerous institutions on this list have high leverage. And, the scary part is that many of them have increased leverage from 2007 to 2008.

(click to enlarge)

Then, take the info above and compare it to a list from my previous post on financial institutions regarding writedowns, losses, and capital raised. Although the data is very generalized and does not offer specifics into each institution's situation, it still provides us with a list of some banks that would make very good shorts assumming the short selling ban on financials is not in place. After all, a mix of high leverage, large writedowns, and low capital raised can be quite deadly.

(click to enlarge)

Full disclosure: At the time of publication, MarketFolly was short HBC via puts
Leverage Image Source: Paul Kedrosky

Hedge Funds Reveal Short Positions (Blue Ridge Capital, Paulson & Co)

To comply with new UK regulations, hedge funds are being forced to disclose financial short positions. Two very well known hedge funds whom we've covered a lot here on Market Folly have already disclosed their positions. Firstly, Blue Ridge Capital is ran by John Griffin, a 'Tiger Cubs' (a.k.a. pupil of Julian Robertson while at Tiger Management). Griffin is well known because he was Julian Robertson's right hand man. So, needless to say, the dude knows his stuff. Blue Ridge seeks absolute returns by investing in companies who dominate their industries and shorting the companies who have fundamental problems. I've covered Blue Ridge's latest long positions here, but now we finally get to see some of what he's shorting. According to a disclosure made in the UK, Blue Ridge is short 0.95% of the shares of Alliance & Leicester PLC. Additionally, they have a short position in Anglo Irish Bank.

Another fund we're seeing some short positions from is John Paulson's Paulson & Co. Paulson is famous for the fortune he made by betting against subprime at the beginning of the crisis. And, now, it looks as if he's ready to turn his focus to some UK financials. Taken from StreetInsider, we get a solid breakdown of what Paulson is shorting: "Paulson & Co. yesterday disclosed short positions in four of the five largest British banks. The bet now makes Paulson the largest short seller of UK banks. According to the filing, Paulson's hedge fund has taken a $650 million bet against shares of Barclays (BCS), a $542 million bet against Royal Bank of Scotland (RBS), and a $483 million bet against Lloyds TSB (LYG)."

If you're interested in seeing how Paulson and various other hedge funds have performed year-to-date, check out my hedge fund performance update posts from July here and from September here.


Sources: WSJ, StreetInsider, & investEgate

Writedowns, Losses, and Capital Raised

Amid all the financial chaos, I thought it would be a good idea to post up a simple chart breaking down the financial landscape in terms of writedowns, losses, and capital raised. From Bloomberg, you'll see how institutions are looking in terms of raw numbers: writedowns/losses versus capital raised. One institution in particular I want to point out is HSBC (HBC): $27.4 billion in writedowns and losses, but only $3.9 billion raised. They by far have one of the more lopsided ratios. Now, we obviously know that this simple chart does not tell the whole story, but I thought it was worth highlighting.

(click to enlarge)

Full disclosure: At the time of publication, MarketFolly was short HBC via puts

Lehman Brothers Liquidation Looks Likely

Undoubtedly, you already know this news. Lehman Brothers (LEH) will file for bankruptcy protection, as they couldn't seem to sell themselves this weekend. Additionally, Merill Lynch looks like it will be bought out by Bank of America for around $25-30 a share ($29 a share offer being voted on). Lastly, AIG will be restructuring. If you want more info on all this than you can handle, just head to any major financial publication, as the news is all over the place. I'm not here to regurgitate this news. Instead, I want to turn my focus to a way to possibly play this madness. In the event that LEH does liquidate, the following stocks will undoubtedly trade lower. Why, do you ask? Well, because they are some of LEH's top holdings.

The List

• General Electric (GE)

• Pfizer (PFE)

• Target (TGT)

• UBS (UBS)

• Linn Energy (LINE)
  

• GLG Partners (GLG)
  

• Merck (MRK)

• Microsoft (MSFT)

• Chicago Mercantile Exchange (CME)

• Bank of America (BAC)

• Apple (AAPL)

• Flagstone Reinsurance (FSR)

• Wellpoint (WLP)

• Walmart (WMT)

• Exxon Mobil (XOM)

• United Health Group (UNH)

• Google (GOOG)

• Johnson & Johnson (JNJ)

• Baidu (BIDU)

A few names from the list I want to highlight: Firstly, Bank of America (BAC) has been actively involved in all the talks this weekend and for all intensive purposes it looks as if they'll pick up Merrill Lynch (MER). I think the market sells off BAC simply because MER is not in the best of shape, and it looks like they'll be overpaying for the deal. If MER needs to be rescued, BAC could surely pick them up for much cheaper than where they're trading now. So, BAC could trade lower for this reason (along with the fact that oh yea, they've still got the whole Countrywide Mortgage mess to worry about). Then, if Lehman Brothers liquidates their BAC shares, you can guess where that name is headed: lower.

Secondly, as I wrote about here, Apple (AAPL) isn't looking too hot on the technicals right now. It looks about ready to really breakdown, since it hasn't responded well to support levels. If LEH needs to liquidate their large AAPL position, this only presents more headwinds for AAPL.

Thirdly, Walmart (WMT) appears on this list and I want to point this out for investors who have wanted to get in this name. If LEH liquidates its WMT position, this will present an opportunity for those who want to get long WMT on the thesis of the American consumer trading down for cheaper items, which WMT supplies. I've written about this thesis numerous times, notably here and here. So, watch that name for any major dips. Also, I'd throw Johnson & Johnson (JNJ) as a possible name to buy off of any LEH liquidation weakness. They are firing on all cylinders and their consumer staples line-up works well in this mess of an economy. Keep in mind though, that things undoubtedly will be crazy this week. So, don't rush out and do something stupid. And, if you feel the need, keep it small. There will undoubtedly be opportunities from this. But, this is a huge mess just waiting to unravel. Watch the Volatility Index (VIX), and watch for panic and capitulation. Special thanks to "The Fly" over at ibankcoin.com for posting up this list of LEH top holdings.

Brazilian Banks/Asset Managers Continue to Gain Assets

With Brazil's emergence onto the global economy, there have undoubtedly been some excellent investment opportunities. But, most of the gains have been concentrated in the energy and natural resource spaces. As Brazil continues to emerge as a growing nation with a strong economy, I've turned my focus to the next wave of investments to make in Brazil. And, I think it can come from a sector that has been touched on by many before, but has never really garnered the spotlight. I'm talking about Brazilian banks and asset managers. Over the long term, their financial landscape will continue to evolve and the underlying financial firms are poised to benefit, seeing as Brazil has now become a net foreign creditor. Also, due to the booming economy, many Brazilians have started to enjoy new-found wealth and are turning to banks/asset managers looking for a place to put their hard earned money to work.

Institutional Investor has a piece out that discusses how Brazil will see an influx of cash from foreign pension funds. The reason behind this is because the nation's long term foreign currency debt was recently upgraded to investment grade. Also in the article is a quick list of Brazil's biggest money makers. In it, you will notice that some of the mainstream banks that trade on ADR's here in the states are among the biggest asset managers in the country: Banco Bradesco (BBD), Banco Itau (ITU), and Unibanco (UBB). Numerous hedge funds I track here on Market Folly have been in and out of these names, but they have never been major stakes or top 10 holdings. These are larger cap names which could be great long term investments (5-10 years).

And, even more hidden from the limelight are mid-cap Brazilian banks and asset managers. You won't find any of these mid-cap names traded on ADR's here in the states. Instead, you'll have to go directly to Brazil to buy them. Obviously, these names are difficult for the average joe to just invest in. And, they are also riskier investments. Firstly, you have to overcome the barrier of entry and find a way to personally invest in Brazil directly. Secondly, you have the added currency risk. But, nevertheless, they represent an interesting opportunity within Brazil's burgeoning financial landscape.

Individual risks aside, Brazil as a whole also has some risks investors need to be conscious of. Over the past few years, they have been heavily reliant on commodity sales abroad. Should a global economic slowdown present itself, Brazil's growth rate would obviously be in jeopardy. That would be the true test as to whether or not they could diversify their exports enough to protect their long term growth. Having enjoyed low borrowing costs and record commodity prices on exports for nearly five years, Brazil has been on 'easy street.' The question remains, "How will they respond if and when tough times arise?" It's always something to keep in the back of your mind. Additionally, one must be concerned with the Brazilian currency, the Real, which has seen massive appreciation to near its highest levels since 1999. Over the past few years, the central bank has been continually purchasing US Dollars in an attempt to slow further appreciation. Obviously every investment has risks, and its important to understand all the various risks associated with investing in a booming country like Brazil. Stay tuned in the coming weeks, as I am in the midst of completing my research on both the larger cap and mid-cap Brazilian names as I search for prospects for my über long-term portfolio.

Source: Insitutional Investor here and here.

Wow...

So, fresh off my post about owning MA and V as your play on financials, I receive this chart... what timing! Barry Ritholtz over at Big Picture has a nice graph (seen above) of banks that have accessed the fed's discount window. As you can see, this year has been record setting to say the least in terms of banks needing help. So, what's next? Implosion? Just another reminder as to why I want to avoid the financials in general and stick to best of breed in the space if you really feel the need to be in there. Some of these companies' balance sheets are giant mysteries, and Lehman (LEH) scares the crap out of me right now with all their level 3 assets or whatever. Click on the graph to enlarge it and get an up close and personal view of how "well-run" our banks are at the moment.

Why the only "financials" you need to own are Mastercard (MA) and Visa (V)

I love it when the media (especially those yaks on cnbc) always ask "Is now the time to buy the financials?!?!" Personally, I steer clear from most of them, except for a revered few. And, they don't even really count as true 'financials.' I'm talking about Mastercard (MA) and Visa (V). I want to preface this by saying that by no means do I recommend jumping into these names right now at these levels. They've had massive runs and undoubtedly are due for pullbacks. But, I just want to put it on your radar for when they eventually do pull back. I've been selling into the strength and only have a little bit of each left and am dying for a pullback to load up on these names. I'm starting to feel empty inside because I can't have full positions in these dominant companies haha.

(Side Note: Now, don't get me wrong, there are 2 ACTUAL financials that I like, US Bank (USB) and Goldman Sachs (GS). USB because of the strong 5% dividend and solid dividend growth, as well as a pretty cautious management team. They seem to have weathered the majority of the storm in terms of the credit crisis/housing woes, and the stock mainly trades sideways. So, I just pocket the dividend and write some covered calls on that badboy to create some nice cashflow. Treat this name almost like a CD or a high yield savings account (but higher yielding). GS, on the other hand, is by far the best of breed investment bank and they get dragged through the mud with the other banks due to guilt by association. In the long run, look for them to distance themselves from the pack and truly outperform. Look to really load up on shares around $160 or even $150 if it trades that low. GS and USB are the only "true" financials I touch with a ten foot pole.)

The main thing that prompted me to post about MA and V has been SunTrust's analyst coverage of the names. Normally, I don't pay much attention to analyst estimates because half the time the analysts are wrong. But, I pay attention to these calls solely because time and time again, SunTrust has been ahead of the pack (and rightly so) in terms of realizing the true revenue that MA and V can grow. Notable Calls has been right on the money by flagging this for their readers. SunTrust now has a street high estimate for MA 2008 and 2009 EPS. Last week, SunTrust raised fical 2008, 2009, and 2010 EPS estimates for V. For V, they raise 2008 estimates from $2.04 to $2.11, 2009 estimates from $2.69 to $2.96, and 2010 estimates from $3.55 to $3.82. As you can see, these are pretty substantial boosts. Then they come right back this week and raise MA's estimates even higher. They boosted MA's 2008 estimates from $8.68 to $8.94 and 2009 estimates from $11.08 to $12.17. Once again, a pretty notable increase. SunTrust suggests that MA could see sustainable EPS growth of at least 20%, which is huge. The overall belief is that MA and V are seeing pricing power in their industry niche of payment processing with no credit risk. They have operating leverage (and are continuing to reduce operating costs) and are seeing massive volume growth. Voila - my investment thesis all along. Suntrust has an argument for those who say MA and V are rich in valuation now: They believe that this is due to the fact that analyst estimates are simply too low and flat out unrealistic.

This reminds me of the exact situation that has been occurring in the fertilizer segment of the agriculture trade. Analysts simply have too low of estimates and these companies are actually trading at much cheaper multiples than we think. 6 months later in the fertilizer game and analysts are STILL playing catch-up. Now, I don't think MA and V are seeing the kind of secular growth explosion that MOS or POT are obviously; but, at the same time, I definitely agree that analyst estimates are too low on MA and V and there is a secular trend building. SunTrust is the only analyst I'll follow on this group simply because they are leading the pack of analysts right now and until the others play catch-up, SunTrust is the only bank out there who "gets it." Through my time in the markets, I've found that certain analysts in each sector are just flat out better than others (surprise, surprise), and you've got to find those analysts and only listen to them. Listening to the others is just a truckload of garbage and noise. So, SunTrust is way ahead of the game here and look for others to follow suit once they crunch the numbers and take a look at what is really happening in the world of global payment processing and realize that their estimates are way too low.

The phrase "global payment processing" is all you really need to know about these companies. They are global stories and most of the growth is occurring away from American shores. Despite an economic slowdown/recession in America, MA and V continue to see huge revenue growth due to international consumers' willingness to use plastic rather than cash. The slowdown in spending from American consumers is not even a chink in the armor of these guys. Think of the rest of the globe as Americans 10 years ago. Eventually, everyone gets used to using debit/credit cards and starts carrying less cash. I can't underscore this point enough. The international opportunity for these names is huge. If they can get consumers in other countries to use their cards even HALF as much as American consumers, they will see record numbers.

Plain and simple, MA and V are payment processors who bear ZERO credit risk. If you want some credit risk, you can always go with some American Express (AXP), if that's your cup of tea. I can see the appeal there, and so does Blue Ridge Capital (seeing as they really loaded up on shares of AXP last quarter). But, I prefer MA and V due to the sheer volume of cards they have in consumers' hands worldwide. I want to stress again that I usually do not pay a ton of attention to individual analyst estimates. But, when you see a firm come out with street-high estimates, constantly leading the pack of analysts, it gets your attention. I think these guys are right on the money and that's why I wanted to point it out. They've been talking my investment thesis in these processors all along. Oh, and did I mention that Lone Pine Capital has a pretty hefty position in MA and V, as detailed here.

Disclosure - long MA and V at the time of writing, but have been selling into strength lately. Looking for a pullback of any size to really begin to add. Keep these names on your radar.