SEPTEMBER PERFORMANCE SUMMARY AND LOOKING AHEAD TO OCTOBER
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- Largest winning position in September: WMIH +19.61%
– Largest losing position in September: HMPR -7.84%
– New additions to portfolio: SBCF
– New liquidations in portfolio: None
– Portfolio exposure as of September 30th: 85% long/15% cash
Portfolio Highlights For September:
---- WMIH provided a bulk of the gains in the portfolios during September. The position had the fortunate distinction of being both the largest holdings in the portfolios, as well as the largest gainer for the month of September. Since initiating in July of 2012, the position is now up 150%. During that time, I have kept it a large position for several reasons, apart from the obvious “receiving billions in NOLs at a steep discount” angle.
The first reason has to do with the general murkiness surrounding the entire situation. That murkiness is what caused the stock to fall into an abyss of pricing depression that had its shares trading at and below .50 cents for a period of several months. You don't get that type of misguided pricing in shares without confusion as to the structure and potential of the company. There simply hasn't been much thought or attention given to WMIH shares until very recently.
The second reason is focused on the confusion regarding the mortgage reinsurance arm of the entity that has been in captive, run-off status for a number of years now. Taking a very simple look at the structure of the company, including the tax shelter in the form of NOLs, it would seem that the solution to their problems already exists in the form of cultivating WMMRC (Washington Mutual Reinsurance) into an entity that exists beyond paying maturing policies. It is, after all, true that reinsurance is getting a lot of attention from some of the most influential financial companies, mostly hedge funds, which have taken large stakes and in some cases formed their own reinsurance entities offshore for the various tax benefits. As the era of cloak and dagger transfer and masking of assets comes to an end, hedge funds are increasingly focusing their attention to domestic reinsurance opportunities. There certainly is a market for the business that WMMRC currently participates in.
The third reason has to do with the fact that when court experts came to their conclusion regarding the potential valuation of WMIH, focusing primarily on WMMRC and the NOLs, the economy as a whole was in a much different state than it is now. The valuation given to WMMRC at that time was $140 million. How much of a premium can be added to that total given the vast change that has taken place not just in the general economy, but the real estate economy in particular? How much would the valuation of WMMRC be today if the same expert witnesses came forth to testify?
One way to ascertain the type of valuations we would be looking at would be to look at the increase in valuations that have taken place for similar companies since 2011, when WMMRC was assigned its value to be included in the holding company that is WMIH.
RDN – Radien Group - Radian Group Inc., through its subsidiaries, operates as a credit enhancement company in the United States. The company operates in two segments, Mortgage Insurance and Financial Guaranty. The Mortgage Insurance segment provides credit-related insurance coverage, primarily through private mortgage insurance that protects mortgage lenders from all or a portion of default-related losses on residential mortgage loans made to home buyers, as well as facilitates the sale of these mortgage loans in the secondary mortgage market; and risk management services to mortgage lending institutions.
Since the beginning of 2012 to present, RDN has seen an increase of nearly 500%.
MTG – MGIC Investment Corp - MGIC Investment Corporation, through its subsidiaries, provides mortgage insurance to lenders and government sponsored entities in the United States. The company offers primary mortgage insurance coverage that provides mortgage default protection on individual loans, as well as covers unpaid loan principal, delinquent interest, and various expenses associated with the default and subsequent foreclosure; pool insurance coverage, which covers the excess of the loss on a defaulted mortgage loan that exceeds the claim payment under the primary coverage; and bulk transactions, in which the individual loans in the insured portfolio are insured to specified levels of coverage.
Since the beginning of 2012 to present, MTG has seen an increase of 100%.
And this from MTG during their Q4 2011 conference call:
MGIC Investment Corp , the largest publicly listed U.S. mortgage insurer, said reinsurers were interested in entering the mortgage reinsurance business, attracted by the high returns that could be earned from underwriting new mortgages.
While the mortgage insurers are struggling under the weight of defaults from loans underwritten during the housing boom, stricter underwriting standards by banks and insurers mean the current crop of mortgages are of a much higher quality.
"I think in discussions that we've had, there are people that are interested, as the quality of the (new) business is very good," MGIC Executives said on their post-earnings conference call.
While WMMRC is not writing any new business, the value equation that was given to the company during the depths of the real estate market depression can no longer be relied upon. At the same time, the fact that real estate market has pulled a 180 degree turn in terms of current and future outlook, increases the possibility that WMMRC will be seen as a valuable asset that should not simply be “wound down” as their legacy policies mature.
This angle on WMMRC is icing on the cake for a WMIH investment that is being recognized only for its tax shelter status at present.
---- After posting a gain of 18% last month, EVOL followed up in September by posting a 15% gain for the month. This was enough to cause me to take half the position off during September with a 45% profit since inception in late June-early July.
This is certainly a position that I would happily buy on weakness should the stock decide to pullback over the coming months.
---- CIDM posted a gain of 6% during the month of September as it continued its trend towards tight, sideways action on very little volume. I don't believe this trend of sideways action is going to last past the end of Q4, with the most likely direction of a break being to the upside.
Cinedigm has been in the process of transforming itself from a cinema deployment service in the past to a provider of digital content and software over the last couple of years. In
order to make this transformation happen, there have been capital requirements that have caused a good deal of dilution to take place in the shares. This dilution has been and continues to be the biggest risk to the share price.
What needs to occur in order for the dilution factor to be in hindsight is a justification for the trouble of both management and shareholders. That justification comes from the growth in the new business model. The growth in this new business model should start becoming evident in the quarters ahead, as partnerships with all the major providers of digital content, as well as a drive towards acquiring revenue generating content comes together in the form of top and bottom line growth.
Given the focus of the company to streamline their debt structure, while generating future growth initiatives, the results should be impressive once the momentum takes hold.
Recently, it was announced that the CEO of the company received a highly incentivized compensation package tied to the stock price. Aligned interest in an increasing stock price among shareholders and management is always a positive.
---- SBCF was added back to the portfolios during the second half of September as I remain bullish on the prospects of regional bank companies throughout the United States.
Seacoast Bank just last week announced what amounts to an independence in their operations for the first time since 2008 as the regulatory agency that oversees distressed
bank companies terminated their agreement, considering SBCF as “well-capitalized” going forward.
While this was certainly expected, the share price is not reflecting the new reality for regional banks. They are no longer distressed companies that offer tremendous risk due to the uncertainty of plunging commercial and residential real estate. The balance sheets of SBCF is back to pre-crisis levels, with profits that are slowly following the resurgence.
What is causing the slow movement to the upside is the fact that, in order to survive, these banks had to face the reality of the dilution of their shares in order to be able to come out of the other end of the black hole that was 2008-2012. This type of framework for recapitalization does not typically lend well to sudden and dramatic appreciation when things turn around, as they have recently. It takes more time due to the number of shares outstanding, the dramatically changed investor base and the general lack of recognition companies like SBCF face.
The most important aspect of the investment in SBCF is the fact that risk is virtually non-existent in the current share price. That gives me the opportunity to simply remain patient knowing that in the worst case scenario I will not lose very much and in the best case scenario there is, at least, 100% upside from these levels. As Monish Pabrai puts it, “Heads I win, tails I don't lose very much.” It's exactly what I look for in every investment I make and SBCF embodies that philosophy.
Portfolio Lowlights For September
---- HMPR declined 5% during the month of September, following what was initially a gain for the company into the middle of the month. There is not much liquidity in the name and it seemed that there were some anxious sellers attempting to find out where the liquidity in the name was in order to relieve themselves of the shares they were holding.
Markets, in general, do tend to gravitate towards liquidity. It is prevalent in all aspects of trading, becoming especially transparent in small-cap companies. As an example, when you have a large seller who wants to get out of a stock, as we seem to have had in HMPR during the second half of the month, at some point they are forced to lower their bid in an attempt to find out where they can find the liquidity needed to exit their position. In the case of HMPR, that liquidity pocket turned out to be in the 1.30 range. There was certainly enough demand at this price to meet the seller's supply.
What does this mean for HMPR? Nothing, really. Buyers and sellers exist. The fact that they want to sell doesn't necessarily mean that “smart money” is looking for an exit.
HMPR falls into the category of an attractive regional bank investment without much downside risk here. It is the type of asymmetric opportunity that is becoming more difficult to find in the current market.
Looking Ahead To October
In typical October fashion, we are entering the month with a great degree of uncertainty. The uncertainty in this case, as has been the case so many times over the past several years, has to do with governmental issues as they relate to disagreement that has become chronic in Washington.
I'll spare you from my governmental analysis, as I am sure you can find countless opinions regarding what the shutdown means and perhaps more importantly, what it reveals about a newly evolved governmental system that places partisan political ideology over the well-being of all else.
Instead, I will focus on what can actually make a bottom line difference to the portfolios I manage. In assessing the current state of the market, there seems to be undertone or chatter that involves excessive levels of optimism signaling an imminent end to the current bull market.
We have, after all, come from an environment where persistent chop was the name of the game. From 2000-2012, there have been wide ranging fluctuations in the S&P 500 that have caused investors to come to rely on indicators that perform well in choppy, consolidating markets. Many of the measures of sentiment that have been relied upon for information that may have proven profitable in the past, will tend to fail during a new secular bull market, as I believe that we are currently in.
I don't remember many things that have happened in my past well. In fact, it is probably one of my major flaws. My wife reminds me of certain important events that happened to us in the past, with me just staring back at her blankly, hoping that it doesn't send her into a half hour rant about my lack of care regarding touching moments we've shared. And don't you dare think about asking me what I had for lunch or what I did over the weekend because it is for the most part a blur.
There are, however, market events that stick with me like they were yesterday. One recent example was the Yahoo IPO in 1996 resembling the Facebook IPO both in price action and general sentiment. I have written about this several times over the past 12 months, as those of you who have been following along know. Another event that took place in 1996 that has stuck with me for some reason or another was the “irrational exuberance” speech given by Alan Greenspan to the American Enterprise Institute in 1996. I recall the speech. The market's reaction to the speech in the hours that followed. And what happened to the market in the months following that speech.
At the time the speech was given, the financial media was behaving as if a group of financially proficient space aliens had landed on Earth with vast knowledge of future events to come. Greenspan's speech was greeted by the markets with an attitude that the rally was finished in all shapes and forms.
As the markets got over the initial shock of the Fed Chairman basically saying that investors were smoking reefer, the power of the secular bull market that marked the 90s exerted itself and pushed the markets ever higher. In fact, it turned out that the markets were nowhere near irrational exuberance, with the rally pushing on for years to come. All the meanwhile, for many months that followed, financial media and investors alike kept referring to the “irrational exuberance” speech as either a reason to have little exposure to the stock market or none at all.
Investors, both professional and not so professional, all have a tendency to underestimate the power of secular bull markets. While Greenspan wasn't attempting to call a top to the market back in 1996, investors used that event as ammunition for bearish arguments until the sustained nature of move up became too painful to miss out on any further.
Human nature being as it is, similar arguments are being levied against the current market, without the realization that these types of affairs typically go on longer and can become greater than any of us expect. Whether the reasons have to do with supposed smart money investors taking a large short position in the market. Or investors endless appetite for social media stocks propelling companies like YELP and FB to stratospheric valuations. The reasons for which this market is at an imminent top will continue being discussed and argued.
The job of the astute investors is not to rationalize every single data point. The job of the astute investor has nothing to do with determining whether his mailman being bullish on the stock market means the Dow is headed for 8,000.
The job of the astute investor is to maximize profits when the environment for doing so is favorable while mindfully controlling risk. Maximizing profits has everything to do with both doing less and paying less attention than you feel you should. In other words, ignorance in the financial markets can indeed lead to bliss. The greatest dilemma investors face today is the fact that they have access to a hundred times more information than is necessary to make informed decisions. These sources of information inhibit the ability of an investor to pursue their original thesis because it eventually becomes drowned out by all the noise taking place.
Mindfully controlling risk has everything to do with making slight adjustments to allocation along the way. It has nothing to do with moving in and out of stocks at the speed of light in the hopes of avoiding any short-term drawdown. Simply buying when the markets favor your play and raising cash when they do not is what risk management comes down to.
Unfortunately, this isn't the forum to go into technical details regarding the how's and why's of risk management. I do have close to 1,000 posts on my website, with probably 20% of those posts detailing risk management in one form or another. I encourage those who are interested to browse around a little bit.
Thanks for reading.
Regards,
Ali Meshkati
