Fortune did a good profile of Fairholme Funds Bruce Berkowitz: “Bruce Berkowitz: The Megamind of Miami”, December 10.
On his big bet on financials, including Citi and AIG:
Berkowitz’s bet on banks now comes down to this: He’s convinced that the worst is over. And his certainty is all the more compelling because he sensed disaster coming early. In 2006, Berkowitz sold his stakes in mortgage lenders Countrywide Financial and Freddie Mac after he noticed a proliferation of overleveraged balance sheets, aggressive lending, and exotic mortgage securities in the financial sector. “Worldwide, financial institutions may ultimately write off hundreds of billions and are being forced to raise equity to survive — if they can,” he wrote in Fairholme’s 2007 letter to investors. Shortly after, he put much of the fund’s money in defensive stocks like Boeing and Pfizer.
When the markets subsequently collapsed in 2008, Berkowitz saw it as a once-in-a-generation opportunity. The one mistake he didn’t want to make was to plunge in too early. Cultivating a healthy paranoia is a hallmark of his investing approach. As he is fond of saying, “The first rule is: Don’t lose money. The second rule is: Follow the first rule.” So, he says, he spent nearly every day of 2008 and 2009 studying the banks. He combed through congressional testimony from Wall Street executives. He studied TARP filings and loan data from the Federal Reserve. All the while he monitored balance sheets. And only when he was convinced that it was impossible to lose money did he plunge in.
Fairholme’s $450 million investment in Citigroup in the fourth quarter of 2009 was his first sizable bet. Citi lost almost $30 billion in 2008 alone, and its shares fell more than 90% during the credit crisis. But by the fall of 2009, Berkowitz could see that good, conservative loans were replacing bad ones in Citi’s lending businesses — and even its so-called toxic assets were yielding more than 5%. “You have to normalize the environment — that’s the arbitrage,” he says. “Are they going to make it through the tough times? And what are they going to look like in more normal times?” So far in 2010, Citi shares are up 34%, and Berkowitz believes they could easily double from here.
His boldest, least understood investment by far is his huge position in AIG — the single largest holding in his fund. Conventional wisdom on Wall Street said AIG would never repay the government the $180 billion in bailout money it was extended after its London-based credit derivatives group posted billions in losses on bad mortgage bets. Institutional investors have shunned the insurer, and last year more than one Wall Street analyst wondered whether the stock was worthless. By early 2010, it was down 98% from its pre-crash level.
But when Berkowitz dissected AIG’s businesses, including its core property and casualty insurance arms in the U.S. and its Asian life insurance unit, he found that cash flows were positive, even as mark-to-market losses in other parts of the company continued to cause billions in losses. “All of my most intelligent friends in the insurance world think I’m an idiot,” he says of his AIG stake. “These are CEOs of insurance companies. But it’s just right there.”
After restructuring charges, the giant lost $11 billion in 2009, but “at its core, their intact franchises make money,” says Berkowitz. It’s those core businesses that Berkowitz is betting on. After sketching the value of its operations, some of which would be sold off to pay back the government, Berkowitz predicts that U.S. taxpayers will eventually get repaid, although he admits that is still a ways off.
Berkowitz started buying AIG bonds and preferred stock as well as common equity in February. Since then the stock has risen more than 75%. “The good thing about AIG is that it’s just so complex,” he says. “For a mere mortal with an average intelligence, it takes a long time to try to put all the pieces together. It’s all there to be put together, it’s just that you need to have no social life and not too many investments.”
On his biggest score so far in mall REIT General Growth Properties:
Over lunch at a small Italian restaurant in Coral Gables in November, Berkowitz takes a call from activist hedge fund manager Bill Ackman of Pershing Square Capital in New York City. Ackman is congratulating Berkowitz on the day’s news: General Growth Properties, the country’s second-biggest mall owner, has officially emerged from bankruptcy after a year and a half under court supervision.
The call lasts only a minute, and afterward Berkowitz asks Fernandez how much Fairholme shareholders are making from their investment in GGP. Fernandez quickly responds: $1.4 billion. It’s a huge return, and, as Berkowitz quickly says, it wouldn’t be possible without Fernandez.
Fernandez, 48, joined Fairholme in 2007, shortly after marrying Berkowitz’s cousin. To outsiders it smelled of nepotism, but Berkowitz says he had been looking for someone like Fernandez for a long time. Even though Fairholme posted 20% annualized gains in its first five years, by 2005, with the fund at $1.5 billion in assets, Berkowitz thought it needed a change. He wanted someone with the right experience to help him branch into opportunities outside public securities. Fernandez was a restructuring whiz who had worked at companies controlled by pharmaceutical billionaire Phillip Frost. Soon after Fernandez’s arrival, Pitkowsky and Trauner left Fairholme. Berkowitz then changed Fairholme’s charter to allow the fund to invest in debt for the first time and take larger stakes in companies. Shortly thereafter Berkowitz insisted that Fernandez move into the house next door to his, the better to work on deals.
Their biggest project so far has been General Growth Properties, and it’s a good example of the types of transactions Berkowitz wants to do more of. Soon after the largest real estate bankruptcy in history made headlines in April 2009, Berkowitz and Fernandez began reading through the court filings. Aided by a veteran bankruptcy lawyer in New York, they determined that some of the company’s battered debt could be paid off with the rent checks still coming in. Fernandez called more than 100 holders of GGP bonds and made bids over the phone. After six weeks he had accumulated bonds with a face value of $1.8 billion.
At that point Ackman, who had acquired a huge equity position in GGP, and property owner Brookfield Asset Management invited Fairholme to join them in recapitalizing the company’s stock. “We set it up so there was room for others, and Bruce was my first call,” says Ackman, who made a huge return when the stock rose from 50¢ to more than $15. “The guy is the most stand-up investor I’ve ever worked with.”
Berkowitz in his home office with his 12 year old poodle Jazz: