TwoCitiesCapital

1) can someone break down in layman's terms Lamberth's reasoning? I've read through both Epstein and Howard's analysis and am still fuzzy on this. Might just need to read it a few times. 2) how does the Fairholme trial differ from the Perry injunction? It was my understanding that they made similar arguments but one was requesting an immediate stop to the third amendment while the other was suing for government taking. 3) How should we be adjusting our potential for success now that one of the big cases has been thrown out

I though foxconn was only responsible for lower end devices and high profile ones would still be handled by BBRY?

Hi guys, I've been reading up a lot of behavioral biases and forecasting errors recently and I came across a bit of information that appears contradictory. In Thinking Fast and Slow it's stated that investors that watch their positions every day are more likely to be risk averse at the regular bad news that comes out and more likely to trade on it. In general, this decreases financial performance and the suggestion is to commit to holding onto a position for a minimum timeframe I've also read elsewhere that investors don't like to lock losses in and are more likely to sell winners too soon and hold onto losers too long. I understand that more than one bias can affect you at a time and these aren't exactly opposites, but seem irreconcilable enough that they both couldn't be generally true. What am I missing?

I've been coming to the same conclusion. In fact, once I'm able to roll my 401k into an IRA, I plan to simply buy the lowest P/B stocks I can find that are available to me. This will be about 30-35% of my investable assets. The only question is the holding period before rebalancing. I'm doing this as a hedge. I know the statistics. I know that this is generally the ceiling. But I hate that additional knowledge doesn't help. It's so counterintuitive. I've been spending most of my time studying behavioral and decision making biases recently with an intent to build myself guard rails and systematize some of my thinking. The remainder of my 65% will be invested this way with the hope that I can find an intelligent way to improve on simple blind baskets of stocks. If I continue to fail over time, the portfolios will rebalance for me over time with. Heavier weighting towards systematic and less to active. I might even switch over some of the 65% but I think I will always want to attempt to improve on the results. It just doesn't make sense that we can't use an understanding of business and securities and valuation to better separate the wheat and chaff.

They say that something like 90% of all options expire worthless - sellers can generally do alright and make a few percentage points a year doing this. Buyers almost all of the time BUT when they do win, they win big. I don't know the exact statistics though. In general, calls are more expensive then puts too because of unlimited upside potential so it could matter and what you're buying and selling.

very good rewards. extremely good service. and they make their customers feel like they are an exclusive "club". they make them feel special. it's a trusted prestigious brand. This. I know my below evidence is anecdotal, but I'm positive that this isn't limited to just myself. 1) AmEx has a storied brand and a type of allure. I remember hearing about the Centurion card back in high school and thinking it was awesome. Ever since then, I've associated AmEx with wealth, success, and a form of extravagance that we all dream about. I was very pleased to be associated with these mental images when they offered me a card. 2) their customer service is phenomenal. I recently had a flight that was delayed by 40 minutes and was going to make catching my connecting flight very difficult. United airlines told me they couldn't hold the plane for 5 minutes so I could get on and they told me there was nothing they could do to get me back to NYC that night. I called AmEx and was immediately moved to the front of the queue because the machine could tell I was traveling right at that moment based on my flight itinerary (brilliant and tons of goodwill for this!). Within 10 minutes they had me rebooked on another flight to NYC that I could make as a connection and there was no charge. The kicker is that it was another United flight....AmEx did what United said they couldn't do and did it in less than 10 minutes. Was very pleased with the experience and this one instance alone is enough to convince me the annual fee is well worth the peace of mind. 3) my building doesn't charge me a fee to pay rent by credit card. I literally spend thousands of dollars on my AmEx card a month simply by paying rent in Manhattan. AmEx collects a percentage of my rent every month and I collect air miles simply for changing a method of payment. I'm sure that situations like this are more common with AmEx holders then others since they do target more affluent people in higher cost areas and those individuals are more likely to be financially savvy enough to recognize these kinds of situations.

Really great book for a higher level perspective of the value investment framework. As others have mentioned it's more generalized and conceptual. I really liked it though as it's one of my first books that I've read from the generalized perspective that I felt was useful. I started out reading the Intelligent Investor, the Little Book that Beats the Market, etc. and I generally took from those very specific criteria for value investments. They have to have a low P/E, or a low P/B, or high ROIC with a reasonable price, etc. It was very specific and very limiting. Over time I've been generalizing value investing theory to better be able to apply to different securities and situations. This book is very good at synthesizing at this higher level to get you thinking about investments in that way. I would have this in my top 5 - not necessarily because the writing is stellar but because the content is great and it's hard to get this view elsewhere (from what I've read over the past 7 years).

Haven't red the "little" book so I don't know how this compares. This has been one of the better books on value investing that I've read. Most value books are anecdotal and they cherry pick ideas that worked out or didn't work out where hindsight is 20/20. This is great from a case study type of approach to dig into the thinking and reasoning but it doesn't do much to give you confidence that value investing works. This book is packed full of research and studies that support multiple types of value strategies. I love how this is backed by data and diverges from many value books in that regard. Further, as the title suggest, it has a behavioral/psychological tilt that goes a long way in identify mental and behavioral biases to help the aspiring value investor develop practical approaches to addressing it. My only complaint was that it's seriously repetitious at times. I don't know if this is the actual book, or a flawed transcription into the digital version of the Kindle, but at times it felt like entire paragraphs were being repeated from a few pages back. I've experienced this with the other Montier book I've read so I'm suspicious that it's just him. I've been reading value books for the past 7 years and this would definitely go in my top 5 that I'd recommend to others. Worth every penny.

Thanks for the reply. This could explain it - if the $320M that was realized was reinvested then they'd only need about 5% gains in the portfolio which is far more reasonable. I qasnt.thinking Eurobank as it wasn't on their 13F. It does look like they're letting winners run and keep hedges static. We've come from 98% hedged on 6.4B in equities to 85% hedged on 7.7B in equities. Net exposure wont mean much to us but it does look like we're beginning to see alpha generation above and beyond the short index hedges. Finally! Let's hope Eurobank and Blackberry continue to do well going forward.

So I ran the numbers and Fairfax would've had to have made 11% on the equity portfolio this quarter to end up with an 85% hedge ratio after realizing 320M assuming no cash infusion to the equity portfolio. Only problem is that their top 4 holdings wouldnt have produced this return given that Sandridge, Bank of Ireland, and RFP all did too poorly to anywhere close 11%. What am I missing? No one wants to give this case a try? I think it's a big deal if it really does mean they're reducing equity hedges substantially

Been doing some thinking on this and what the possible outcomes are and the best ways to gain exposure. Most presentations shows the GSEs as a single entity with figures for the combined entity. I wanted to make sense of current securities so I separated this out for FNMA below. Possible Outcomes: [*]Injunction is denied. Government is found to have acted lawfully. i. Preferred mostly worthless ii. Common stock is worthless [*]Injunction is approved. Government is found to have acted unlawfully A. Current excess sweep used to reduce the government's preferred outstanding. FNMA overpaid by about $76B in 2013 reducing government lending from $117B to $41B. This means that the gov was only owed 4.1B in dividends thus far in 2014 and has paid 9.4B further reducing government balance to 35.7B. i. Preferred stock totals ~55B between gov't and private holders. Definitely some value here with $15B in earnings enough to recapitalize and eventually cover anticipated dividends of ~5B in 7 years time. Expected return for preferreds is 14% per annum for this 7 year period. ii. Common stocks would eventually rally to catch up with the remaining $10B in earnings owed to them. A multiple of 10x puts the enterprise at $100B valuation meaning about common shares would be around $17.22 apiece with expect returns of 24% per annum. B. Fairholme proposal is executed. Past government sweep and any profits from wind down of business used to pay down government. Preferred holders would exchange shares for common shares of new entity to raise capital. $17B in warrants rights offering. About 57% of the company would belong to FNMA preferred holders. i. Based on Ackman presentation figures/margins, we can estimate that the co. could earn around $20B per yer and continue to capitalize up to 10% capital levels while charge 20 bps more in g-fees. A multiple of 10 puts the value of the combined co at $200B. FNMA common holders entitled to 57% resulting in value of 593% of face value to preferred holders or 64% per annum over 5 years. ii.Common shareholders wiped out. C. Ackman's proposal wins out. Preferred stocks are maintained, fees are raised, common remains in tact. 7 year recap. i.Preferred shareholders receive 2.5x current price for expected returns of 14% per annum over next 7 years. ii. Common holders receive somewhere between 10-15x current price (depending on future offerings to recap faster) resulting in nice profits no matter how it's sliced. D. ??? Now let's handicap them. I think the probability of government winning the case is low. So let's focus on the probabilities of a successful injunction. Fairholme's plan makes sense for the government. Democrats get continued service that will keep costs of mortgages low and Republicans can claim a victory for small government and private enterprise. The gov would likely receive close to $200B in addition to current profits over the next 10 years of wind down ($51B from FIA business as estimated by Ackman, and $15B per year from legacy book) so it wouldn't be a total forfeiture of rights. Only makes sense to own the preferred in this scenario as common shares are totally wiped out. If either Ackman's solution is accepted, or some derivation of the first possibility of the sweep reducing current obligation to gov, then common shares are likely the way to go but preferred benefit too. There's still unknown solutions that could surface that could affect one or both differently. It seems like the present solutions suggest that the majority of exposure should be held via preferred stock that will be worth something in every scenario (and worth a lot in Fairholme's scenario). An argument could be made for having 20-30% in common makes to boost returns in any other scenario but you don't want to end up with an absolute loss. Does the board generally agree?

Thanks. Must have scrolled right past that previously as I don't recall having seen it. Appreciate the help.

Would be curious as well. Have been doing the same thing as OP.

How does one look up all the currently outstanding preferred shares and their terms? Also would this source contain those also issued to the U.S. gov? Wouldn't think there'd be a difference but you never know

Huh? There is no set time limit on declaring a receivership. HERA not only gives the option to FHFA to declare a receivership if, in the Directors opinion, it appears that assets < liabilities or the enterprise will not be able to meet its obligation when they come due, but requires the appointment of a receiver if the Director determines that for any period of 60 days assets < liabilities. The accounting standard is not specified so there is wide latitude for interpretation and misuse. Note also that a receiver can be appointed even if current cash and payment obligations are being met. I'm sure you're right. I must have misinterpreted what I read. What recourse do investors have against the FHFA for gross negligence as conservator? None? Also, I still think receivership is unlikely not that the hedge funds are getting press. It's clear to drive with a brain that the gov's 80% is worth something and throwing it away is irresponsible. I think it's also clear that the private sector simply doesnt have the scale to put up capital like us required for their proposed solutions

I thought capital requirements for the GSEs were set by statute in 12 USC 4612: "For purposes of this subchapter, the minimum capital level for each enterprise shall be the sum of— (1) 2.50 percent of the aggregate on-balance sheet assets of the enterprise, as determined in accordance with generally accepted accounting principles..." As of 6-31-14, FNMA had total assets of $3,218 B and equity of $6.1 B or less than .2%. But with the remaining credit line from Treasury under the SPSA ( about $83 B), one could argue under sec. 4502 (23) that FNMA has total capital of $89 B available under conservatorship or 2.76% which meets the statutory minimum. Note that FNMA had cap ratios of 4.66%, 4.92%, and 4.98% before the crisis for YE 2005-07. While I agree plaintiffs are likely to prevail in court, you are correct that the consequences of a victory are uncertain -- and that's what gives me pause from increasing my position. Bad case scenario: 1. plaintiffs win 2. Treasury ordered to return $80 B. 3. Treasury terminates the SPSA under sec 6.7 and/or 6.12, and demands full repayment 4. FHFA deems the GSEs critically undercapitalized and converts them to a receivership. Obviously there are other possible scenarios, but it's obvious that we need Treasury cooperation/support even if the cases are won. I'm pretty sure this scenario can't happen. The Conservator has a set time limit to transfer from conservator ship to receivership and that time is long past. I don't think they could get away with ending the conservatorship before the purpose of conservatorship (stability) has been achieved only to turn around and liquidate it since it could be argued that this wouldn't be substantially different from simply transferring to receivership which isn't allowed. My concern is that they find a way to screw shareholders through the recap (which only hurts themselves and tax payers). I think this is unlikely. It's more likely that they'all try to build political support around saving the institutions by touting how much money th govt will make off of them and maximize those earnings...just need a new administration without egg on its face to do it. I think the common makes out pretty well here. Just a question of how well and how long. Ackman's presentation said could be as long as 7-10 years to recap based on retained earnings and released from conservatorship. Share offerings after a clear schedule is in place could accelerate this return to common holders but also clearly dilutes it. I think we'll see a nice pop if 3A is overturned. That might be a time to take profits, reduce position, and re-evaluate time frame/expected returns going forward with development of the companies. They are substantially different securities even if they are similar companies. Wash sale doesn't apply here.

So, I just read every post on timhoward717 and want to make sure I'm summarizing this correctly for myself as I'm looking to make this a significantly bigger position than the current speculative-starter position that I have. 1) Conservatorship is intended to restore the health of the company until it can be business as usual. This is supported by the following quotes: Judge Sweeney confirming that the there should be an end envisioned for the conservatorship and that Fairholme may proceed with it's discovery to prevent case dismissal on the grounds that the court doesn't have jurisdiction since the FHFA isn't the government. Current FHFA head agreeing that conservatorship will end eventually... 2) The value still resides with the shareholders even though they forfeit other rights during conservatorship Common and preferred shareholders are entitled to the value of such shares. So it seems pretty clear to me that conservatorship is a temporary solution and that stock holders retain economic interests. The profit sweep goes against the very purpose of conservatorship which was to stabilize the company back to "business as usual." Any earnings above and beyond the 10% owed on the gov't preferred securities belongs to the other preferred security and common shareholders and were taken. Is there a gov't response to this allegation why this sweep was appropriate or justified? That being said, the Treasury stated in a memo back in 2010 that they were committed to preventing existing shareholders from receiving economic profits - this is an admission that they thought profits were a possibility and the beginning of the formulation of plans to sweep those profits to the Treasury. They then coordinated the 3rd Amendment profit sweep in 2012 to ensure this was the case. This suggests to me that the FHFA was working in tandem/cooperation with the Treasury and it's motives. Does this not make it a government entity for the purposes of this case and validate the current courts jurisdiction and invalidate the government's request for dismissal? How does one define a government agency for the purposes of determining if the court has jurisdiction? It seems like there are a few things that have to happen here for shareholders to receive value: 1) Profit sweep is overturned and profits are returned a) Can be accomplished via a ruling in favor of the Perry injunction or Fairholme's suit. Fairholme's case looks strong. I've seen less commentary on Perry's. 2) Company's are recapitalized a) Retained profits b) Conversion of preferred to common c) Gov't exercises warrants 3) Company's leave conservatorship and return to BAU. 4) Shareholders profit If anything above is incorrect, please feel free to correct me or provide counterpoints. I intend to read through this thread over the next couple of days but devoted my time to Tim's site this evening. 1) It seems like a safe assumption that Fairholme's discovery will lead to continuation of the suit given the documents that have already been leaked. It also seems like it's an open and shut case in regards to the conservator sweeping profits to the Treasury being contrary to the purpose of conservatorship AND unrightfully taking some profits that belonged to others. Does anyone have an opinion to the contrary or why the courts may rule otherwise? 2) Does the government have any incentive to kill these entities, screw shareholders, and forfeit massive profits? 3) What are the ways that preferred and common shareholders could be screwed in the recapitalization?

Thesis summary Buy FNMA common at $4.00 because: 1. Regan-appointed Judge Lamberth will invalidate the 3rd amendment (3A) via summary judgement in the Perry case soon after his current Blackwater murder trial goes to jury. 2. He will rule based on facts that are not in dispute (which will expedite the time frame and offer investors a quick catalyst). 3. The 3A will be vacated based on either (a) a finding that Treasury violated HERA by invoking the 3A and creating a new security beyond the 2009 time limit. (Note: Even Treasury's own enforcement of tax law deems the 3A a new security), or (b) a finding that the 3A was arbitrary and capricious due to the fact, admitted to by FHFA, that FHFA failed to comply with the APA requirement that they compile an administrative record at the time of the 3A. (Note: FHFA did compile an administrative record at the time of the 1A and 2A.) 4. Vacation of the 3A will put $80bln of excess dividends (above and beyond the 10% as required pre-3A) into question. 5. Perry will pursue the obvious remedy and successfully have the $80bln used to reduced the $117bln Treasury senior preferred currently outstanding. 6. The incremental gain of $80bln will be reduced by $12bln (goes to private preferred to bring them to par) and then diluted by 4:1 (80% of common shares goes to Treasury via warrants) leaving $68/ (1.15*5) about $12/share value for the non-US Govt common shareholders, or a 200% gain. My only dispute with the thesis is that one could buy the private preferred's today and get a return of over 150% and avoid the risk of steps 4 & 5 entirely. In my opinion, the common thesis of 7x - 10x return rests in the fact that the government is doing the taxpayer an incredible disservice by not exercising its warrants and unlocking that value to the American taxpayer. Any future reform can include the existing common as it stands as opposed to wiping it out and starting over, effectively costing the taxpayer over $150 billion. I think logical heads in the Treasury/FHFA/government will eventually prevail and realize the value the taxpayer would sacrifice. The 7x-10x is certainly within the realm of plausible. But consider all that would need to happen: Prevailing powers in DC need to agree that the GSEs should be saved and then agreed to act on it, GSEs fees would need to be raised (Ackman suggests 60-100bp), and then the market would need to apply a 15x multiple to GSE earnings. Whew! How can anyone put a time frame on it? Even if it took 20 years, 7-10x corresponds to 10-12% per annum. I don't think it's the time frame thats going to work against you here.

I'm reading a book by James Montier - he cites research that suggests that value managers have an average holding period of 4-5 years and that relative out performance for a position (as compared to an index) was the most in years 3-5. This suggests there is something to holding on BUT.... He also citrs research that splits the markets into quintiles by P/E and the bottom one nearly always out performed the second which out performed the third and so on. This suggests there is something to recycling to the cheapest every year. So there is two possibilities: 1) the years that value doesn't outperform absolutely kill returns enough to ruin years of out performance relative to slightly lesser value stocks 2) or there's something about the persistence/momentum of a stock that moves from 2x P/E to 4x P/E that's not shared by other 4x P/E stocks. My guess is on the later.

So I ran the numbers and Fairfax would've had to have made 11% on the equity portfolio this quarter to end up with an 85% hedge ratio after realizing 320M assuming no cash infusion to the equity portfolio. Only problem is that their top 4 holdings wouldnt have produced this return given that Sandridge, Bank of Ireland, and RFP all did too poorly to anywhere close 11%. What am I missing?

I know zerohedge isn't popular here, but they do generally have good info...it's just coupled with negative rhetoric. The quality has been slipping lately, but they were talking about things like algorithmic trading leading to flash crashes (happened), the London whale (happened), and HFT scalping months before traditional financial media. it's certainly interesting and valuable if you take the data, ignore their commentary, form your own opinions.

I generally don't pay any attention to sovereign bonds because there are so many ways to screw holders. 1) implicit default via inflation (often over night with pegged currencies) 2) structured default that avoids protective hedge triggering (Greece) 3) No one to enforce proper settlement/recovery when default occurs (Argentina a few years back) I'm sure there is good value in this sector, just whether or not you're lucky enough to get what should come to you. I'd stick with distressed corporates.

Regarding 1) the way I understand it is this way: Say your hedges/shorts are 3b and your Equity/Longs are 3b so you are 100% hedged. Now your Equity/Longs increase to 3.3b, your hedges/shorts are still at 3b. You are now 3/3.3 or 91% hedged. :) If they realized gains of 300M it means that the 3.3B goes back down to 3B for a 100% hedge ratio (unless if they reinvested 300M). I would've thought we'd hear about a new 300M position given that's a sizeable piece of their equity portfolio so I'm not sure that this was reinvested. Hedges should've been largely flat so it could be that Fairfax closed a large portion of hedges that only show a deceptively small gain of 2M but I would think they'd mention this new stance towards being under hedged but instead said it was due to equity outperformance so I'm still lost.

Great quarter. Two questions for you forensic accountants out there. 1) Fairfax realized 300M in equity investments. How do hedges drop to 85% if they realized 300M in gains without realizing any gains/losses in hedges? Did they just reinvest this 300M and continue to do crazy well through out the quarter? It clearly wasnt Russel shorts doing well because unrealized gains on hedges is too small. 2) anyone surprised at continuous CPI losses despite most exposure being in Europe that has had sub 1% inflation for past several months? Would've thought people would think deflation is a possibility at this point.

Great question. I was thinking about this the other day because SAN is one of my largest holdings at this point. I've been adapting my investment approach to compensate for behavioral issues. I'm trying to limit what I consider important to thesis and largely ignore everything else. Research suggests the more info you have, the more confident you are but you dont improve accuracy of forecasts. I wanted to pick 5-6 data points to synthesize from and ignore everything else. I think the points will largely change based on your thesis for the co. I decided that my thesis for SAN is that it's a recovering bank with a global competitive advantage and that earnings power will greatly improve as loans losses come down. I chose the following metrics to pay attention to. Is thesis true? Whats risk of being wrong? 1) Solvency - Texas ratio 2) leverage - assets/equity 3) loan quality - NPL/loans Earnings Power and expected value 4) NIM (how much "revenue") 5) efficiency ratio (margins on that revenue and competitive advantage) 6) deposits (can earnings grow at low cost) I'm thinking I'm only going to pay attention to the above 6 when evaluating the holding over time