It’s reasonable to argue that the greatest banker in the United States today isn’t a banker at all—he’s an insurance guy.
You might have heard of him.
As the chairman and CEO of Berkshire Hathaway, an insurance-focused conglomerate based in Omaha, Nebraska, Buffett oversees one of the largest portfolios of bank investments in the country.
Berkshire owns major stakes in a Who’s Who list of historically high-performing banks:
- 9.9 percent of Wells Fargo & Co.
- 6.8 percent of Bank of America Corp.
- 6.3 percent of U.S. Bancorp
- 5.3 percent of The Bank of New York Mellon Corporation
- 3.7 percent of M&T Bank Corp.
That Buffett made such substantial investments in banks isn’t a coincidence.
If there are two things he appreciates at a visceral level, owing to his experience in insurance, it’s leverage and cycles—the same two qualities that make banking so unique.
This is why it’s worth listening to Buffett when he opines on 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 bank] industry—mistakes that involve only a small portion of assets can destroy a major portion of equity. And mistakes have been the rule rather than the exception at many major banks. Most have resulted from a managerial failing that we described last year when discussing the ‘institutional imperative:’ the tendency of executives to mindlessly imitate the behavior of their peers, no matter how foolish it may be to do so.”
Buffett is referring to the havoc wreaked on banks during a pronounced downturn in commercial real estate in the early 1990s, when Berkshire bought 10 percent of Wells Fargo.
His point is that it’s critical for bankers to maintain discipline, especially when all of those around you are not.
Another thing Buffett talks about a lot is competitive advantage.
Here he is in a 2009 interview with Fortune:
“If you're the low-cost producer in any business—and money is your raw material in banking—you've got a hell of an edge. If you have a half-point edge . . . half a point on $1 trillion is $5 billion a year.”
And here‘s a selection from his 1987 shareholder letter flushing out the idea more fully, though in the context of the insurance industry, which faces nearly identical competitive dynamics to banking:
“The insurance industry is cursed with a set of dismal economic characteristics that make for a poor long-term outlook: hundreds of competitors, ease of entry, and a product that cannot be differentiated in any meaningful way. In such a commodity-like business, only a very low-cost operator or someone operating in a protected, and usually small, niche can sustain high profitability levels.”
One nuance about efficiency in banking is it doesn’t just boost profitability directly by freeing up more revenue to fall to the bottom line; equally important is its indirect effect.
This is a point U.S. Bancorp’s chairman and CEO Andy Cecere made in a recent, albeit unrelated, interview about the bank with Bank Director.
Efficient banks needn’t stretch on credit quality to generate satisfactory returns, which reduces loan losses at the bottom of the credit cycle, Cecere says. And as a corollary, efficient banks can compete more aggressively for the most creditworthy customers, further limiting credit losses in tough times.
It isn’t a coincidence, in turn, that U.S. Bancorp has consistently been one of the industry’s most efficient banks and disciplined underwriters since its transformative merger nearly two decades ago.
And while neither Buffett nor his philosophy came up during the interview with Cecere, Berkshire Hathaway is one of U.S. Bancorp’s biggest shareholders.
A final lesson about banking that can be gleaned from Buffett involves his approach to mergers and acquisitions.
Buffett has said repeatedly in the past that he’d rather pay a fair price for a wonderful company than a wonderful price for a fair company. Also, all things being equal, Buffett has always preferred for existing management to stay and continue on their path of success.
“Because leverage of 20:1 magnifies the effects of managerial strengths and weaknesses, we have no interest in purchasing shares of a poorly-managed bank at a ‘cheap’ price. Instead, our only interest is in buying into well-managed banks at fair prices.”
It’s a style reminiscent of the uncommon partnership approach to mergers and acquisitions used by John B. McCoy, who dined annually with Buffett, to transform the former Bank One from the third largest bank in Columbus, Ohio, into the sixth largest bank in the country, before later merging into JPMorgan Chase & Co.
In short, although it’s true that most people don’t think of Buffett as a banker, that doesn’t mean bankers can’t learn a lot from his observations on the industry.