Charlie Munger, vice chairman of Berkshire Hathaway, and chairman Warren Buffett haven't shied away from bank stocks over time. In fact, today Bank of America (NYSE:BAC) is their biggest holding in terms of number of shares held -- and the second biggest by market value.
Still, Munger has concerns right now about the U.S. banking sector. He says there might be trouble ahead -- and it's linked to the commercial property market. But before you go out and sell your financial shares, let's take a closer look at what the billionaire investor said in an interview with The Financial Times.
Commercial property prices fall
First, a quick note about what's going on in the property market. In the first quarter, prices of U.S. commercial properties dropped for the first time in more than a decade. That's according to Moody's Analytics.
A few factors are hurting the market. The shift to working from home has weighed on demand for office space. As a result, vacancy rates are high. Meanwhile, banks aren't lending as easily as they used to, and interest rates are on the rise -- making it difficult for new renters to get into the market. And the increase in interest rates means any mortgages that must be refinanced will face higher rates too.
Now, let's get back to Munger's discussion with The Financial Times. Munger told the newspaper that the drop in property values could have a very unpleasant consequence: certain commercial property loans held by banks could fall into the category of "bad loans."
Munger expects banks will face headwinds in the near term due to the decrease in property value and the increase in office vacancies. And their commercial real estate portfolios could suffer.
But there's a silver lining in this dark cloud. Munger told The Financial Times he doesn't expect this crisis to be as bad as that of 2008.
Recent banking turmoil
First of all, it's important to note that the recent turmoil in the banking system -- the failures of Silicon Valley Bank and First Republic Bank in recent months -- weren't linked to real estate holdings. Second, as we look back to 2008, we can see that one particular factor preceded the crisis. And that's the introduction of subprime mortgages.
Lenders offered these mortgages to high-risk borrowers -- with terms the borrowers couldn't meet. What followed was the collapse of investment bank Bear Stearns due to subprime mortgage losses.
Today, high-risk loans are no longer part of the picture. And that means the economy and stock market aren't likely to follow the path they took in 2008.
A few weeks ago, the Federal Reserve predicted a "mild" recession for later this year. Munger's comments echo this forecast. Of course, this isn't great news for banks in the near term. But in these challenging times, it's important to focus on the long term. And here, the outlook for financially sound banks remains bright.
Munger and Buffett surely believe that. My colleague Sean Williams recently wrote about how more than 90% of Berkshire Hathaway's portfolio is invested in four sectors -- and one of them is financials. Munger and Buffett invest for the long term. So, they don't let short-term problems like economic weakness or property trends scare them away from industries set to perform over time. And that's why certain bank stocks still make solid holdings today.
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