Monday, January 31, 2011

[RED DEMOCRATICA] My Largest Personal Investment


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More Sense In One Issue Than A Month of CNBC
The Daily Reckoning | Monday, January 31, 2011
  • Make a "boring" 38.2% in these low-risk special situations,
  • The investment equivalent of Marilyn Monroe in black and white,
  • Plus, Bill Bonner on the world's top non-thinkers and plenty more...


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The "Thrift Conversion" Story
Profiting from the experiences of a former banking insider
Eric Fry
Eric Fry
Reporting from Laguna Beach, California...

In today’s edition of The Daily Reckoning, Chris Mayer, editor of Mayer’s Special Situations, discusses an investment opportunity that is as simple as it is sexy – kind of like a black and white photo of Marilyn Monroe.

The opportunity is called a “thrift conversion.” The name is boring, but the potential investment return is not. Chris made 38% on thrift conversions last year. That’s not boring.

Intriguingly, Chris comes to this idea as a former insider. He was a banker for 10 years, most of which he spent working for a thrift. He knows this business...and understands firsthand that thrifts sometimes possess underappreciated values.

The “thrift conversion” story is a fascinating one. So please resist all narcoleptic urges and take a close look at what Chris has to say. The story begins with Chris’ firsthand experience in the banking industry. he recalls:

My first job out of college was at Riggs National Bank in Washington, DC, as a credit analyst in the corporate lending department in 1994. I had just graduated in the top 5% of my class from the University of Maryland with a degree in finance and was eager to tackle the real world.

The analyst job was a plum. Riggs was an old blue-blood bank. The Bank of Presidents was its tagline, and it was true. A signed check by Abraham Lincoln was on display in the executive dining room. (The fact it still had an executive dining room tells you something.) I remember the analyst job paid a salary of $28,000, which I thought was all the money I'd ever need.

I showed up the first day in a blazer and dress pants. "You look like you work at an S&L," chided one of the older analysts.

Nobody wanted to be an S&L guy. They were unsophisticated simpletons who lived out in the suburbs and made mortgage loans all day. I was a city banker, a corporate guy. Our meat was big, complex transactions.

Anyway, I noticed everyone at Riggs wore a suit – mostly dark suits. Needless to say, that first weekend, I went out and got a couple of dark suits. Banking is not a place for non-conformism.

Two years later, though, I did take a job with an S&L. It was a little outfit called Citizens Savings Bank with its new headquarters in Gaithersburg, Md. It had just started a corporate lending department. The members of the new S&L corporate team were all from bigger banks. And we had a lot of freedom in creating that new department. It was a lot more entrepreneurial than being at Riggs. Heck, at Riggs it was unwise to leave your desk without putting your jacket on.

One year later, Provident Bank, from Baltimore, bought Citizens out. This is the fate of many S&Ls. It made me wish I had come sooner and bought stock.

I would stay with Provident for seven more years. I had a great run there, rising to vice president before I was 30 years old (the youngest in the bank). I'm glad I had that banking career. It helped me gain a lot of practical financial skills that come in handy as an investor. I saw thousands of balance sheets and valued hundreds of businesses and assets. There were millions of dollars at stake with every decision, and I can say I never lost money on a single deal. Yes, some loans went bad, but we always got paid because I was sure to have ample assets backing my deals.

My stint as a banker also made me appreciate how hazardous the banking business is. There are lots of ways to get in trouble. Banks are not low risk. What profits they earn today often seem merely borrowed against the losses of the future. Most banks are opaque, complex and highly leveraged.

So while I used to make fun of those simpleton S&L bankers, I now hold them as the only ones I'd invest in.

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The Daily Reckoning Presents
My Largest Personal Investment
Chris Mayer
Chris Mayer
I’m going to share with you something that I have put a good deal of my own money into. In fact, I have more money invested here than in anything else – about 40% of my personal investment account at the moment. Last year, I made 38.2% in these low-risk special situations – easily whipping the market’s 13% return. It was some of the easiest money I’ve made in my investing career. I’ll tell you how you can do the same thing.

I’d like to call these special situations one of the market’s best-kept secrets. Though many people still don’t understand the basic mechanics, or even know these opportunities exist at all, the truth is that these aren’t really secrets.

Investing great Peter Lynch wrote two chapters about them in his bestselling book Beating the Street. (This is one of the best books about investing out there, by the way, along with One Up on Wall Street. My well-thumbed hardcovers have made me a lot of money over the years.) Lynch called the idea a “can’t-miss proposition (almost).”

And Seth Klarman, another famous and skilled investor, has a chapter about them in his book Margin of Safety. Even the measured Klarman, a master of understatement, calls this special situation “a compelling investment opportunity.”

Heck, even Barron’s recently called these a “once-in-a-lifetime investment opportunity.” And that may be literally true, as the biggest opportunity in these ideas may disappear forever by the summer of this year. (More on why below...)

I’ve been an enthusiast of these things for years. I first wrote about them in 2005 in my Capital & Crisis newsletter.

You would think such opportunities would close with all this coverage. Yet nearly every year, new deals crop up and the opportunities persist. I have a few hunches why more people still don’t buy these. Part of it is that they seem boring. Part of it is the payoff doesn’t often come right away. I earned 38% over the course of a full year. Sometimes it might take a little longer. Ideally, you should look at these as three-year holds. And part of it is simply that people have prejudices that prevent them from buying.

So what am I talking about? I’m going to tell you, but I want you to keep reading even if, initially, the idea has no appeal to you. It’s important you understand the full story before you pass judgment.

I’m talking about thrift conversions. A thrift, or a savings and loan, is a bank. But it is a special kind of bank. It is a bank owned by its depositors. When a thrift goes public, it’s called a thrift conversion because the thrift is converting from a company owned by depositors to one owned by public shareholders. This process is what creates the investment opportunity. Let me give you a simplified example.

Say we have a thrift worth $100. For simplicity’s sake, let’s just say that all of its assets are in cash and it has no liabilities. The thrift decides to convert to a public thrift. So it sells 10 shares at $10 each. Now it has $200 in cash and there are 10 shares outstanding.

But look at it from the investor’s point of view. He put $10 in, but he owns a stock backed by $20 of cash – $200 divided by 10 shares outstanding. Put another way, he owns a bank at 50% of book value, or net worth, per share.

In the real world, the values are not usually as extreme, but the idea is very much reality. As Klarman writes:

“The preexisting net worth of the institution joins the investors’ own funds, resulting immediately in a net worth per share greater than the investor’s own contribution... In a very real sense, investors in a thrift conversion are buying their own money and getting the preexisting capital in the thrift for free.”

Peter Lynch called it the “hidden-cash-in-the-drawer rebate.”

Imagine buying a house and then discovering that the former owners have cashed your check for the down payment and left the money in an envelope in a kitchen drawer, along with a note that reads: “Keep this, it belonged to you in the first place.” You’ve got the house and it hasn’t cost you a thing... This is the sort of pleasant surprise that awaits investors who buy shares in any S&L that goes public for the first time.

It’s pretty simple. You get a bank at a big discount to book value – a book value that includes a whole bunch of fresh cash.

Most bank stocks over time gravitate toward book value, at least. What often happens to these thrifts is that they get bought out at premiums to book value. According to SNL, a research organization, about 59% of the 488 thrifts that have converted since 1982 have been bought out at a premium to book value. In recent years, the pattern is even stronger. Since 1995, 64% have been acquired.

The multiples paid are pretty good right now. In the last quarter of 2010, there were four pending acquisitions. The average multiple was 111% of book value. There was an additional transaction that closed in that quarter at a value of 148% of book value.

So now you can see the opportunity. If you pay even 80% of book value for a cash-rich thrift and it trades to just book value, you’ve got a 25% gain and you’ve taken very little risk. Of course, you can do much better. But there are a few points you need to understand...

First, new thrifts have to follow some rules. One is that they can’t sell for three years. This is why I said you should look at these investments as three-year holds. Ideally, you want to give the thrift time to ripen and give yourself a shot at maximum gains. (Lynch tells the story of Morris County Savings Bank. It went public at $10.75 per share and sold three years later for $65.)

Of course, you don’t have to wait three years. I made my 38% in one year and I could sell if I wanted, but I’m content to let the investment story play out. My thrift still trades for less than book value. And more good things can happen after that first year – and this gets us to our second point.

New thrifts can’t buy back stock for at least one year. This is another important date in the life of a thrift – its one-year anniversary. After that, the thrift could use its ample cash to buy back stock at a discount to book value, thereby enriching the remaining shareholders even further.

So after one year, if the thrift trades for less than book value, a stock buyback is likely the best use of cash. And many thrifts do implement buybacks. In the last quarter of 2010 alone, five different thrifts announced buybacks of 5-10% of their shares.

The third point is why buy these now. The reason is there are many new deals to choose from. After only a handful of conversions in 2009, things started to pick up in 2010. Last year, there were 23 deals completed and they raised $2.2 billion in capital. This year looks like another rich one for thrifts. There are 17 deals in the pipeline already.

The flurry of activity is due to uncertainty over the new financial overhaul bill, which would take effect this summer. It could mean the end of this long-running investment gold mine: the thrift conversion process. So many thrifts will try to convert before the summer.

Finally, one last point before we look at specific opportunities: There are no free lunches. Even here. That is to say you have to be careful which thrifts you buy. Some thrifts come with problems and risks you probably don’t want to take. Remember the 1980s? Charles Keating in handcuffs? The S&L crisis? Lots of thrifts got in trouble doing all kinds of stupid things. Greedy guys always manage to ruin a good thing. You can easily avoid the problems with a little attention upfront to some key details.

Peter Lynch goes through some of his favorites in his book, and I’ve relied on his guidance when investing in these things over the years. There is a certain kind of thrift we want to own to increase our odds of success. Lynch calls them the “Jimmy Stewarts.”

Surely, you’ve seen the classic It’s a Wonderful Life, in which Jimmy Stewart plays the part of a humble banker at an old savings and loan. Lynch wants to find the Jimmy Stewarts. The no-frills, low-cost neighborhood thrifts that make old-fashioned mortgage loans. They don’t have splashy advertising. They don’t pay to have their names on stadiums. Their branches don’t look like Greek temples.

So the first thing we want to pay attention to is the loan portfolio. We want low-risk loans, like simple old-fashioned mortgages. We don’t want a lot of construction loans or anything that smacks of high finance. We also want to look at nonperforming loans (stuff that’s gone bad) as a percent of assets. Ideally, we want low numbers, like 2%.

Second, we want to look at financial strength. We want lots of equity. This is usually not hard to find with recently converted thrifts because they just went public and have lots of cash. It’s pretty common to find ones with equity to assets of 13% or 17%, or even 20%. For perspective, the nation’s biggest banks – the JP Morgans and Citis – have ratios of 5% or 6%. (And that’s surely overstated, given all the off-balance sheet stuff. More likely, they have ratios of 1% or 2%.) This is why they are always getting in trouble. They operate with huge leverage. Thrifts are financially strong.

We also want to look at book value. Ideally, we want to buy for less than book value for all the reasons I went through above.

As Lynch advises, “Pick five S&Ls that fit the Jimmy Stewart profile, invest an equal amount in each of them and await the favorable returns. One S&L would do better than expected, three OK and one worse and the overall result would be superior to having invested in an overpriced Coca-Cola or a Merck.”

This is the plan I am implementing for the subscribers of Mayer’s Special Situations. I don’t expect this opportunity to be around forever, but it is around for the moment.


Chris Mayer,
for The Daily Reckoning

Joel’s Note: Want to get Chris working for you? What could you do with a “boring” 38.2% return on your money this year? Right now he’s divulging the details to his Mayer’s Special Situations readers. Get yourself on the mailing list right here.


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Bill Bonner
When All Roads Lead to Default
Bill Bonner
Bill Bonner
Reckoning from Baltimore, Maryland...

Friday may have been a key turnaround day. Stocks fell 166 points on the Dow. Gold leaped $22.

What’s up? Hard to say... We’ll have to see what happens this week.

A falling gold price means people think things are under control...that they believe the present system works...and that it will deliver growth without excessive inflation.

When people lose confidence in the system, on the other hand, the gold price goes up.

By the end of last week, people must have been losing confidence.

Egypt seemed on the brink of a major blow-up, possibly destabilizing the entire mid-east.

And from Japan came more disturbing news:

“S&P Downgrades Japanese Debt,” said the headline. Standard and Poor's said Japan had no plausible plan for keeping itself from bankruptcy.

The country has the highest debt to GDP ratio in the world. And it just keeps adding debt.

Is that a problem? Lenders – mostly the Japanese themselves – don’t seem to think so. They lend money to the Japanese for 10 years and ask only 1.24% interest. Can you imagine? If the yen lost only 2% per year – which is the TARGET in most advanced economies – the real interest rate would be negative. Meaning, the lender would lose money every year.

And how will the Japanese repay the money? Lenders are putting up money to a borrower who, as the S&P puts it, has ‘no plausible plan’ for paying it back. And asking only 1.24% interest. What are they thinking? Are they thinking at all?

Saving rates in Japan are falling. People are getting older. More people are retiring than entering the workforce. How can this movie possibly have a happy ending?

Meanwhile, here’s another headline. This one probably didn’t rattle investors. But it should have shown them where we’re headed:

Spain to Raise Retirement Age to 67

MADRID – Spain’s government and main labor unions agreed on Thursday to raise the retirement age as part of an overhaul of the country’s pensions system, averting threatened organized protests and responding to investors who have been demanding that Spain clean up its public finances.

After a year of negotiations, the draft deal ensures that Spain’s normal retirement age will rise to 67 from 65. As part of a compromise, however, the government agreed that workers could retire at 65 if they had contributed to the state pensions system for at least 38.5 years. The agreement is also intended to cut the cost of future pension payments by basing the calculation for such payments on a worker’s last 25 years of earnings, rather than the 15 years under current law.

Pension reform has been a political hot potato in several European countries, including France, which was hit last autumn by a nationwide strike and protest movement before the government won support in Parliament for its plan to raise the minimum retirement age to 62 from 60. Similarly, Greece was the scene of serious unrest after its government also agreed last June to radical changes to its retirement program – including cuts in benefits and curbs on early retirement – as part of changes promised by Athens in return for a €110 billion, or $150 billion, bailout.

Like many other Western countries, Spain is facing mounting difficulties in supporting the cost of an aging population, at a time when its economy is showing little signs of recovering from the worldwide financial crisis. Last year was the first in which Spain’s pension system did not manage to run a surplus.

What is this? It’s a default. Spain is defaulting on promises made to its working classes.

We’ll see a similar default in all the advanced, social welfare economies. America included. They all made promises they can’t keep. Now, they have to many different ways.

Some will cut back fast on promises in order to protect their credit. Others will let themselves be pushed to the wall – like Argentina in ’01. They will not willingly cut back...they will be forced to do so. Then, when they run out of money, they will be unable to keep their promises. In desperation, they will seize assets and cause all sorts of mischief – just like the Argentines did.

Still a ruined man reaching for a loaded pistol...will turn to the printing press.

It doesn’t matter how many bailouts you give them. It doesn’t matter how far down the road you “kick the can.” All will default. The only questions are how and when...

And more thoughts...

Now here’s something interesting. Every year, Foreign Policy magazine produces a list of the Top 100 Global Thinkers in the World. We picked up the list...looking for our own name.

But wait...

The key is that these are “global” thinkers. They’re not just thinkers, in other words, they are people who are thinking about how people on the other side of the planet should conduct their business.

We were suspicious even before we looked at the list. “Foreign Policy”? We’re against it. Why should we worry about things that don’t concern us?

“Well... You can’t put your head in the sand,” you might reply. “You have to be concerned, because things that happen overseas do affect you.”

Yes, that is true. They affect us. But so does the price of whiskey, the traffic on the Beltway, and the weather. None of them is worth thinking about. We can do nothing about them. And it would be indecent for us to try.

Imagine if we took an interest in the whiskey distiller’s business. What could we do? Try to force him to lower his prices? Try to show him how to operate more efficiently – as if we could know? Set up a buyers’ cartel to negotiate for lower prices? At best, we’d be wasting our time. At worse, we might succeed! Then, whiskey producers would be responding not to market forces...but to meddlers’ forces. What a mess that would be!

Meddling with things close at hand is bad enough. Meddling with things far away is worse. Remember our Daily Reckoning dictum: ignorance increases by the square of the distance. The farther you get away the harder it is to tell what is going on. The details disappear. All you can make out are the rough outlines. Shadows...reflections...silhouettes... In the darkness, you step on every rake and fall into every hole.

The next thing you know, you are calling for “reforms” in countries you’ve never even visited...setting the price of China’s money...and invading Iraq.

But let’s look at who Foreign Policy magazine thinks are the 100 Top Global Thinkers.

Uh oh. In the first and second place are Warren Buffett and Bill Gates. Hmmm... They’re smart guys. But what makes them “thinkers”? What have they been thinking about? And what are their thoughts on the subject?

FP says they are there, not for their contributions to the wealth of mankind, but for their philanthropic activities. Wait a minute. What’s philanthropy got to do with thinking?

Okay... We’re stumped on that one... So, who’s the number 3 thinker? Barack Obama! Hold on... This is getting silly. Have you ever heard Barack Obama come up with an original thought? Or any kind of thought worthy of the word? No. That’s not his thing. He’s a politician. Politicians are not thinkers. They may be doers...but they’re not thinkers. Obama gives us plenty of empty expressions and hollow words – “change you can believe in”...“hope”... “winning the future” – but real thoughts? Original ideas? Nope.

Generally, politicians are not thinkers. Occasionally, you get a politician who pretends to be a thinker – such as Princeton University chief Woodrow Wilson. But he almost invariably turns out to be a jackass and a fool.

There must be exceptions – Marcus Aurelius and Thomas Jefferson come to mind. But they seem ill-suited to the political profession and probably should have eschewed public office in the first place.

So let’s keep moving. There must be someone on this list who is a real thinker.

Let’s look back at last year...let’s see...who was FP’s top thinker?

Ben Bernanke!

Well, that does it for us. What’s the matter with these people? Can’t they tell the different between tired hacks with worn-out, crackpot ideas...and real thinkers?

The Foreign Policy editors should do some real thinking of their own. Then, maybe they’d mind their own business.


Bill Bonner
for The Daily Reckoning


Here at The Daily Reckoning, we value your questions and comments. If you would like to send us a few thoughts of your own, please address them to your managing editor at

The Bonner Diaries The Mogambo Guru The D.R. Extras!

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In the event, the Obama team is going to redistribute $1.5 trillion more than it can collect in taxes. Let's throw out some more numbers. That's $5,000 per person...$20,000 for a family of four. And we're talking spending IN EXCESS of tax receipts. This is just the deficit.

Inflation: Inevitable...But Not Predictable

Masters of Monetary Policy

Investing in Gold and Silver for the Long Haul
Chris Mayer was quoted in the 5 Minute Forecast newsletter as having noted that "If history is any guide, inflation will likely get much worse." Being the kind of guy who goes absolutely insane about inflation in prices, you can imagine the effect this had on me...

Inflation to Help the Less Fortunate?

The Troubling Doubling of Money Supply

Strong US GDP Estimate on... Consumer Spending?
Well... The euro (EUR) (and the rest of the currencies) got slammed on Friday, from mid-morning on... The euro, which was well into the 1.37 handle when I hit send on Friday, fell 1.5-cents... And while the euro was getting slammed, gold and silver woke up from their doldrums, and rallied strongly.

Stay Focused Gold Investors

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The Daily Reckoning: Now in its 11th year, The Daily Reckoning is the flagship e-letter of Baltimore-based financial research firm and publishing group Agora Financial, a subsidiary of Agora Inc. The Daily Reckoning provides over half a million subscribers with literary economic perspective, global market analysis, and contrarian investment ideas. Published daily in six countries and three languages, each issue delivers a feature-length article by a senior member of our team and a guest essay from one of many leading thinkers and nationally acclaimed columnists.
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