Mon, 22 Feb 2010 02:21:44 +0000

Third Avenue recently filed its 13F report with the SEC.

It seems that as of December 31st, Martin Whitman’s hedge fund no longer had a stake in CIT. The fund had been selling off portions of their holding in CIT Group since at least back in 2008 and finally sold off their last chunk during the 4th quarter of 2009.

Third Avenue’s investment in CIT Group went from a $90 million invested in the 4th quarter of 2007 to $42 million a year later in the 4th quarter 2008, to $377,000 in the 3rd quarter of 2009.

And now as of the 4th quarter in 2009, Third Avenue is done with CIT.

One of the only new stakes Third Aveunue took up this year is KeyCorp, which is also a financial services and banking company. It’s based in Ohio and currently has only one branch in Manhattan.

Third Avenue purchased around $60 million in KeyCorp stock last quarter. Their stock has since rebounded from being down in November and December last year.

Third Ave’s biggest two holdings are in Brookfield Asset Management with almost $500 million invested and Posco $600 million invested in the iron and steel company.

See all of Third Avenue’s holdings listed on their 13F report from last quarter.

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Hi All,

I am having technical problems with sending the email out.  If you ever don’t receive the email (Monday – Friday) and you want to read it, just go to my site: www.leedsonfinance.com.  Normally, I have posted by 8 AM.

Thanks.

Please forward this email to others who may want to be interested.  It is important that the blog grows.  At the bottom of this write-up, you will find instructions so that you can get on the mailing list.

I will contact you individually, but I want to thank everyone who responded to my request for help for three friends whose firm was dissolving.  All three have found positions (without my help).  Thanks!

Here’s what I read today…

There are really three big stories to think about (and then some smaller issues).  The three big stories are:

1. the Fed’s reported profit
2. China provides more evidence that they will slow their economy
3. China might stand up to the evil empire

1. The Fed’s Reported Profit

Imagine that you invested in a hedge fund.  In 2008, the hedge fund made $35 million.  In 2009, it made $52 million.  Most likely, you’d be happy.  But, what if you found out that the hedge fund came close to tripling its risk in 2009.  How would you feel then?

Well, here’s the bad news…you did invest in this hedge fund and it’s called the Fed.  Unfortunately, the “millions” are actually “billions.”

At the end of 2009, the Fed’s portfolio was approximately $2.2 trillion…up from approximately $800 million the prior year.  According to the WSJ, these assets are approximately 43X the Fed’s capital.  In effect, the Fed is highly levered…even more levered than Bear Stearns, Lehman and Long Term Capital Management.  If a normal bank was levered at 43X equity, a loss of 2.5% would eliminate all equity.

It’s also alarming that the Fed could really hurt their position if they raise interest rates.  Higher rates will decrease the value of their portfolio (if those rates affect the long end of the yield curve).  In addition, higher rates will result in an increase in the amount that the Fed will have to pay for excess reserves.

I’m reminded of a guy that I met approximately ten years ago.  I asked him what he did and he said, “I work at the world’s largest hedge fund.”  I asked him who that was and he said, “Freddie Mac.”  Those words turned out to be prophetic.  Unfortunately, the world’s largest hedge fund was acquired by the US government.   The investors are you and your kids.

2. China Slowing Their Economy

China raised the yield on one-year bills by 8 bps to 1.8434% after holding steady for 20 auctions.  Last week, they raised the yield on three- month bills by 4 bps to 1.3684%.  The bottom line is that these are small moves, but they are BIG signals.  China is worried about inflation and a real estate bubble.  They are likely to continue to increase rates.  This could impact the world economy.

In addition, China reduced the amount of cash banks have available to lend.  Starting Monday, commercial banks will be required to put 16% of their deposits on reserve.  This is a half point increase.  This often is a leading indicator of future interest rate increases.  Bankers expect China to target an 18% increase in loans this year, after a 30% increase last year.

3. Google Battles the Evil Empire

Google may back out of China after being hit by cyber-attacks that originated in the country.  The attack resulted in the theft of intellectual property from Google.  Google believes the attackers were aiming to access the Gmail accounts of Chinese human rights activists.  Google also referenced China’s attempts to limit free speech on the web.

You MUST take time to read this article in the WSJ:

http://online.wsj.com/article/SB126335402591827235.html?mod=todays-us-page-one

This article deals with the ethical conflicts that Google and others face when dealing with China.  Most importantly, what we’re talking about is the Chinese government.  As many of you know, I love the Chinese people.  But my personal view is that the Chinese government is evil.  They jail people for expressing opinions that are contrary to the government.  They don’t respect intellectual property rights.  They censor any opinions that are contrary to theirs.

Amusingly, I’ve been talking with some people recently about the fact that I am censored in China.  I don’t know that for a fact…but I have enough intuition about numbers to know that I’d bet my last dollar on this.  Every day, I can look at the number of people that click on my site.  In a typical day, a couple of thousand of Americans will click on my site.  Then, there are a fair amount of Mexicans and Canadians.  I’ll have readers from Germany, Qatar, Australia, Iraq, Cayman Islands, the UK, India, Japan, Lebanon, etc.  The number of clicks from each of those countries is usually between 3 and 50.  But every day, China has just one click.  The numbers just don’t work out that this could be legitimate.

As another example of censorship from another country, in the past few weeks I’ve had a lot of people from the United Arab Emirates read my posts.  I don’t spend much time looking at this, but one day (for example) the number was around 25.  I thought that this was interesting – it just seemed so high.  But everyday, I had a fair amount of clicks from the UAE.  On Monday, I mentioned the animal from the ruling family that was acquitted after being videotaped using a cattle prod on an Afghan.  On Monday, my UAE traffic dropped to one.  Again on Tuesday.  They don’t like the truth and they censor you.  I guess that’s their right.

At the end of the day, what discourages me is that there are very few Americans who feel good about the human rights record of the Chinese government.  Yet, we do business with them.  They’re a huge potential market and we love money.   It’s really sickening.  This is a government that should be ostracized.  But instead, we kiss their butt.

Smaller Issues

US expects slightly higher energy prices. The US Energy Information Administration expects global GDP growth of 3.7% in 2011 (from 2.5% in 2010).  They expect this to keep oil prices stable or let them move slightly higher.  Oil producers have much more capability to increase output quickly now – making shortages less likely.  OPEC also has 6MM barrels (per day) of spare capacity by 2011 (compared with 2.8MM during the past decade).

The trade deficit expanded 9.7% to $36.4 billion in November.  Exports have gained for seven consecutive months. Imports increased with oil prices.  Exports grew .9%.  Imports rose 2.6%.

Homebuilder issues mixed report. KB Home said that it delivered 22% fewer homes in Q4 (YOY) and the average selling price dropped 12%.  The good news is that the cancellation rate dropped 15% to 31%.  But order growth slowed significantly from Q3.  Backorders fell 6% YOY.

Bank compensation could be even more costly. The FDIC voted 3-2 to seek public comment on a proposal which would impose higher fees on banks which have compensation structures which encourage risky behavior.

Who loses? Bond insurers are suing investment banks, claiming that lousy underwriting standards resulted in bonds defaulting.  Some estimates are that the bond insurers could transfer $10 billion of losses back to the banks.  I would say that this is a “zero sum game” from the financial industry, but it’s much worse when you consider the attorneys fees.

CIT considers Thain. Former Merrill Lynch CEO John Thain is being considered for the CEO position of CIT.  CIT exited bankruptcy in December.  CIT would probably like Thain to repeat his performance – find someone to overpay for the company.

Is this a good thing? The WSJ reported that Bank of America (BAC) dominated REIT underwriting in 2009.  This really reflected the synergies of BAC’s real estate lending relationship with Merrill Lynch’s real estate investment banking practice.  (BAC had many relationships with real-estate borrowers and ML had experience doing the banking work.)

The synergies come from the fact that REITs borrow lots of money (and recently they’ve also issued lots of equity since debt financing wasn’t available to them).  Many REITs won’t use a bank for an equity offering unless they also lend them money.  BAC is a lead lender on $43 billion in credit facilities to 53 REITs.  This is more than any other bank.  Public REITs raised $24 billion in equity in 2009 (double 2008).  BAC was the lead banker in 39 or the 78 offerings by existing public REITs in 2009.  They earned $208MM in fees from REIT equity offerings in 2009, nearly double second place JPM ($119MM).  BAC was the lead lender to the REIT in 26 of the 39 stock offerings it led.  In the coming year, it is possible that some private companies will want to tap the public markets.

Here’s what’s weird.  The WSJ presented this information as a great source of profits for BAC.  But if you look at the idea that BAC had to do this lending in order to get the banking business, it doesn’t seem that profitable if the loans go bad. BAC reported that net charge-offs on loans in commercial real estate increased $244MM to $873MM in Q3.

Were low interest rates to blame? People continue to debate Bernanke’s comments that low interest rates were not to blame for the crisis.  Economists are split on this statement.  My personal view is that low interest rates had an impact (it resulted in the demand for CDOs and other securities which created demand for high yielding subprime mortgages).  But, rates were low for a reason – we had a recession after the tech bubble ended and 9/11 happened.  There were many reasons for the subprime crisis that were much more significant than low interest rates.  In sum, I side with Bernanke on this one.

This is terrible on an hourly basis. Bernanke’s salary: $199,700 in 2010.
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