How to Earn $7 Billion Betting on Bank Stocks

David Tepper of Appaloosa Management has plenty to celebrate this holiday season. This week, The Wall Street Journal reported that the hedge fund manager made a massive winning bet on bank stocks this year. The numbers are staggering:

  • Appaloosa produced a net gain after fees of 120% through early December.
  • Dollar gains amount to approximately $7 billion.
  • Tepper is set to earn more than $2.5 billion personally this year.

Betting against failure
Convinced that the financial system would avoid total failure, Tepper bought bank shares through February and March, when no one else wanted to own them; his average cost per share on Citigroup (NYSE: C  ) and Bank of America (NYSE: BAC  ) was $0.79 and $3.72, respectively. That equates to current gains of 316% on Citi, and 308% on B of A.

Tepper says he estimated that the risk of the U.S. nationalizing large banks such as Citigroup was 20%. One can attempt to put a number on this type of risk, but I think even Tepper would admit that that probability was fundamentally unknowable.A very small number of banking crises of similar severity to that of 2008-2009 offer few clues. Furthermore, the federal authorities have stepped in before, under less dire circumstances. Recall that Uncle Sam took an 80% stake in Continental Illinois in 1984 to halt a run on the bank. (Continental was ultimately sold to ... B of A.)

Owning "too big to fail" -- in bulk
Although Bank of America and Citigroup were Tepper's largest bets, Appaloosa Management's next five largest holdings at the end of September were also financials. By decreasing order of value, they were Wells Fargo (NYSE: WFC  ) , Fifth Third Bancorp (NYSE: FTB  ) , SunTrust Banks (NYSE: STI  ) , AIG (NYSE: AIG  ) and Hartford Financial (NYSE: HIG  ) . All but Hartford fall under the "too big to fail" category.

A good speculation
Appaloosa's returns on the Citi and B of A trade suggest it had a positive expected value, but it looks to me like a binary bet on an unusual situation, with a possible total loss of capital. That's not the sort of bet I find attractive, but I'm sure Tepper's investors will be filled with good cheer this Christmas.

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  • Report this Comment On December 24, 2009, at 2:17 PM, Fool wrote:

    Anyone who missed this bofa play,what were you thinking. my cost $3.32. Still time for Citi.

    Good Luck

  • Report this Comment On December 24, 2009, at 3:48 PM, IBDvalueinvestin wrote:

    I made same type of returns on percentage terms with my wife's 401k.

    She works for Wachovia now WFC and while the market was crashing I had put all her 401k in moneymarket fund.

    Then there was a huge fall on Wachovia shares down all the way to $1/shr. I took a huge gamble that WB was going to be bought out before it fails because many considered it one of the too big to let fail banks and figuring the Fed. would push someone to buy WB I put in 25% of the 401k money into WB.

    Next couple of days an offer came from Citicorp, which then got bumped by WFC for $7/shr

    Would have been filthy rich if I only was brave enough to put in all 100% of the 401k in WB at $1/shr but thats hindsight, at that time my wife said don't you dare risk it all.

  • Report this Comment On December 24, 2009, at 6:41 PM, mikekerr wrote:

    I wonder if Mr. Tepper had a typo re his buy of Citi at 70 cents, as I believe Citigroup's lowest selling price was 97 cents, not 79 as he indicated. In either case, still a great profit and much room for upward mobility, particularly if Citigroup does not reverse split as did the foolish AIG.

    I, too, got in early, though not as low (my price was $1.83) and I'll be holding on to see how far the stock goes upward. (Also bought AIG at $1.15, which translates to $23 at the reverse split price, so that's going all right, too).

  • Report this Comment On December 24, 2009, at 6:42 PM, mikekerr wrote:

    I wonder if Mr. Tepper had a typo re his buy of Citi at 70 cents, as I believe Citigroup's lowest selling price was 97 cents, not 79 as he indicated. In either case, still a great profit and much room for upward mobility, particularly if Citigroup does not reverse split as did the foolish AIG.

    I, too, got in early, though not as low (my price was $1.83) and I'll be holding on to see how far the stock goes upward. (Also bought AIG at $1.15, which translates to $23 at the reverse split price, so that's going all right, too).

  • Report this Comment On December 24, 2009, at 6:43 PM, mikekerr wrote:

    My own typo in first line,as I meant to say "his buy at 79 cents..."

  • Report this Comment On December 25, 2009, at 10:47 PM, JimmyhDrake wrote:

    Looks like a good thing. We purchaced Citi at $1.80 ,1000 puppies, and we are going to hang on as well.Our next penny peach is MRNW (medical Staffing Network).48 cents a share. we Picked 6000 shares. now that Health Care is going to pass We are a shoe in for a juicy peach, when it rippens.gotta love it.

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