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Is John Paulson Seriously Bullish on US Banks?

When I first saw the Bloomberg headlinethat indicated that as of the end of Q2 John Paulson was the 4

largestshareholder of Bank of America (BAC), I wasn’t actually too surprised. For a man who had navigated thetreacherous markets of both 2007 and 2008 as well as anyone in the world, I just assumed that he had bought BACwhen everyone thought it was going to be nationalized. My first thoughts were that either Paulson had anticipatedthat the government would not let BAC fail or shrewdly realized that the bank stocks were poised to rally from pretty depressed levels. Obviously I had no idea exactly when during Q2 he had bought his gigantic share but basedon his recent track record I was inclined to believe that it was somewhere at the beginning of the quarter (earlyApril) when BAC was in the $7 range. Before I had looked through the 13F filing and when I saw the stock up 6.7%the day after Paulson’s announcement, the conspiracy theorist in me wanted to believe that he was using theknowledge that his disclosure would prompt others to buy (based on the number of copycats out there) to sell out of his position. But, now that I have taken a detailed look at the 13F, I am not so sure that he is still long the stock.Obviously, my first thoughts on this subject were biased on two fronts. First, I immediately gave credit to Paulsonfor being able to deftly trade in and out of positions and subsequently make money based on the extreme volatilitywe have seen. Second, since I am personally so bearish on regional and money center banks, especially after their incredible runs, I automatically assumed that a man who had made so much money being short financials wasequally as pessimistic on the sector. However, aside from a short paragraph discussing his purchase of RegionsFinancial (RF) in the Bloomberg article, what I and most of the headlines missed is that as of the end of Q2 Paulsonwas quite long the US banking sector. Check out the table below to see what I am talking about:

Paulson and Co.Q1

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Q2PositionTicker Shares OwnedBought (Sold)

Bank of AmericaBAC167,990,464167,990,464Capital One FinancialCOF17,000,00017,000,000Fifth Third BancorpFITB5,000,0005,000,000First Horizon NationalFHN3,000,0003,000,000JP Morgan ChaseJPM7,000,0007,000,000Marshall and IlsleyMI12,000,00012,000,000Peoples United FinancialPBCT2,750,0000Regions FinancialRF35,000,00035,000,000SunTrust BanksSTI1,500,0001,500,000*Although Paulson also owns shares of Goldman Sachs (GS), I do not consider GS to be a similar type of bank despite being classified as a bank holding company

My initial reaction to the fact that Paulson had taken a stake in some of the most troubled regional banks along withmoney center banks BAC and JPMorgan (JPM) was: “Wow, what am I missing about this sector?” I mean look atRF for example. AsKarl Denninger pointed out this morning,the company disclosed in its footnotes that on a mark to market basis its loans (as of June 30th) were worth $22.8B less than the balance sheet said they were. That’s incomparison to $18.7B in shareholder’s equity. Correct me if I am wrong. I know my math skills aren’t top notch, butthat sounds like a $4B hole to me!I have to admit I was perplexed. I saw Paulson speak recently in New York and the way he explained his strategy toshort the RMBS market through buying credit default swaps on subprime-linked CDOs (just nod if you don’tunderstand—it’s not that important) was brilliant. He figured out that only 5% of the underlying loans would have togo bad for the tranches he had insurance against to be wiped out. Then he risked an insignificant amount (you readthat right: he didn’t even have to bet the house) of his capital and due to the asymmetric nature of and levered payouts on CDS he literally made billions. Then he followed up a ridiculous year in 2007 by shorting the investment

The Inoculated Investorhttp://inoculatedinvestor.blogspot.com/

banks that he knew had written CDS contracts on the dodgy CDOs and who were holding a lot of subprimesecurities on their balance sheets. So simple but yet so brilliant. And yes, he made billions more in 2008.So what gives now? He seemed to understand to some degree the toxic balance sheets of the banks last year. Whatdoes he think is different about the ones he owns now? Unless he has used the time since the end of Q2 to reduce his position sizes or eliminate his stakes in these banks (there have yet to be any filings that indicate as much---see below), at first glance it appeared that Paulson may genuinely be bullish about the prospects for these banks, even atthe current price levels. I still didn’t believe it myself so I thought I would compare the prices at the end of Q2 to thecurrent prices to see if I could craft a scenario in which he had sold on recent strength.

Stock PriceStock PricePositionTicker 6/30/20098/13/2009% Change

Bank of AmericaBAC$13.20$17.0028.79%Capital One FinancialCOF$21.88$35.3061.33%Fifth Third BancorpFITB$7.10$10.8452.68%First Horizon NationalFHN$12.00$13.6013.33%JP Morgan ChaseJPM$34.11$42.9025.77%Marshall and IlsleyMI$4.80$7.3252.50%Peoples United FinancialPBCT$15.07$17.0012.81%Regions FinancialRF$4.04$5.2028.71%SunTrust BanksSTI$16.45$21.2729.30%Average Increase33.91%

Well, isn’t that interesting? Even if Paulson did not buy these stocks at their 52 week lows, he still could haverealized significant appreciation just in the last 45 days. Remember these increases have occurred in less than amonth and a half so even if he bought the last day of Q2 the returns are enormous on an annualized basis. You canonly imagine how well he has done if he bought in April or May. So, with the lag between reporting and filing andthe potentially stale nature of the June 30

data, he very well could be out of all of these positions. But wouldn’t hehave had to file with the SEC indicating that he had sold out of a material position? Intuitively you would say no because he had not filed a 13D on any of them. But I thought I would check just to make sure.