One of my favorite investing maxims of all time comes from Sir John Templeton, who advised us to buy at the point of maximum pessimism. Seth Klarmen of Baupost Group later expanded on that idea, telling investors that he wants to be the buyer of last resort for various securities.
All of these are derived from the Baron Rothschild’s advice to buy when blood is in the streets. When I look around the world today, I do not see a lot of pessimism, and the streets are relatively dry in terms of distressed market opportunities.
One place in the world that is showing signs of economic disruption and maximum pessimism is right under our noses. Puerto Rico is looking like this year’s Greece. The economy has endured seven years of economic slowdown, and the U.S. Territory is heavily indebted with over $70 billion in debt outstanding.
To make matters worse, the rating agencies have lowered the island credit rating to just above junk, and for all intents and purposes, the municipal bond markets are closed to the government and its agencies right now. The situation has become so bad that people are simply leaving for greener pastures and we are seeing more people leave Puerto Rico than any time since the 1950s.That sounds a lot like maximum pessimism to me.
This type of panic is starting to attract some of the smart money that follows the maximum pessimism approach to investing. Investors like EJF Capital, Renaissance Technologies and OakTree Capital (OAK) have started buying the Puerto Rican Bank stocks. While these shares have recovered somewhat from the depths of the financial crisis, they are still much cheaper than their U.S. counterparts.
Popular (BPOP) is the largest bank in Puerto Rico and also operates a branch network and a vehicle leasing unit in the United States. The bank has 175 branches in its home territory with a total of more than $35 billion in assets. Right now the stock is trading for less than 80% of tangible book value, as pessimism about the future has weighed heavily on the shares.
Along with partners Apollo Global Management (APO) BPOP recently sold more than 5 million shares of Evertec (EVTC), a payment processing firm, to help shore up its balance sheet. The stock is attracting the attention of some very smart investors right now, and brokerage firm Stern Agee just picked the stock as one of its best picks for 2014.
FirstBanc (FBP) is another Puerto Rican bank that appears to have substantial recovery potential. The bank has attracted two large private equity funds, Oaktree and Thomas Lee Partners, in a recapitalization, and each of them owns 20% of the bank.
EJF Capital is a financial-services-focused hedge fund that initiated a new position in the stock during the third quarter of the year, as did Highlander Capital Management, a fund that specializes in undervalued securities. The bank has 154 branches and a little more than $12 billion in assets, and earnings appear to have turned the corner. Stern Agee also named FBP as a top selection for this year.
There is a state akin to maximum pessimism developing in Puerto Rico, and the smart vultures are flocking to the island territory. Aggressive, patient investors should consider doing the same.
As of this writing, Tim Melvin was long BPOP.
