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7/21/2019 Baupost on Thrifts
1/11
The
Baupost
Group
Speaks
ut
on Thrifts
7/21/2019 Baupost on Thrifts
2/11
The
Baupost
Group
Speaks
ut on
Thrifts
The
Baupost
Group has
been
a sizeable
nvestor
n
thrifts
over
the
last
several
ears.
Why
do
you
find
thrift
stocks
o
be attractive
nvestments?
We find
the nvestment
pportunity
reated
y
the
mutual
o stock
conversion
rocess
o
b
compelling.
ssentially.
hen
a thrift
converts
rom
mutual
o stock
orvnership,
epositor
are
given
he
opportunity
o
buy
shares
epresenting
00%of the nstitution. nlike all
other
nitialpublic
offerings
f
shares,
owever,
he
proceeds
rom
a thrift conversion
o
not
go
to
a
sellingshareholder,
ut rather
are added
o
the capital
of
an
nstitution.
Since
al l
the
shares
f the nstitution
are sold
on
the
offering,
and
here
are
no original
shareholder
buyers
fshares
eceive
he
full
benefit
ofthis
additional
apital.
n
effect,
purchasers
f
shares
uy
their
own
capital
and receive
he
bank
or
free.
In
addition
o this
"free
unch",
a
thrift initiaipublic
offering
hasseveral
ther
attractive
characteristics.
nlike
a
typical
public
offering
where
nsiders
ell
shareso the
public
and
pocket he cash, n a thrift
offering
nsiders
buy
shares
t the same
price
and
on the
same
terms
as he
public.
Unlike most public
offerings
where
shares re
offeredat
a
steep
multiple
of earnings
nd a
high
price
o book
value
ratio,
thrift conversions
rc
virtually
always
priced
at
a significant
discount
o book
value
and
at a low
price
o earnings
atio.
Unlike
a usual
nitial
stock offering
where
a
company
and
ts shareholders.benefit
rom
pricing
the offering
as high
as
possible,
n
a thrift
offering
there s
no such
nterest
becaus
there
are no
stockholders oing
in to
the
offering.
n fact,
since n
a thrift conversion
management
uys
shares
nd
receives
tock
options
at the
offering
price.
here
s
some
incentiveo holddown he nitialofferingprice.
Thrifts
are
underfollowed
by
Watl
Street
analysts.
With 400-500
estimated
onversions
n
the
last 4
years,
no firm
or analyst
can
hope
o follow
them
all.
Those hat try
usually
produce
one ine
of computerprintout
on each
stock.
Most
firms
choose o follow
20-30
stocks
on a more
ntimate
basis,
while
ignoring
hundreds
of others.
The
smallest
ones
are
nearly
always
gnored.
This
obviously
creates
nvestment
pportunities.
Does his mean hateverythrift conversions anattractive nvestment?
Not
at alil
When
you
invest
n
a
well
run
thrift
with
significant
earnings
and book
value,
an
investor
n
effect buys
his
own
capital
and eceives
he
valuable
existing
bank
for
free.
Whenyou
invest
n a
troubled
hrift
with
bad
oans, oodwill
or
poor
results,
ou
may
be
buying
a business
f questionable
alue
or
evenof
negative
worti,
where
he
iabilit iis
exceed
he
assets.n this
circumstance,
ou
are
no
longer
buying your
own money
and
getting
a business
or free.
Rather, ou
are
pouring
your
dollars
down
the drain,
by
subsidizing he net worth deficit of the existing nstitution.An investor n the conversionof
an institution
with
positive
economic
value
s, because
f the
mathematics
f thrift
conversions,
uying
something
elow ts
underlying
alue.An
investor
n a
thrift
of
negative
rue worth
is converseiy
paying
above
ntrinsic
value.
7/21/2019 Baupost on Thrifts
3/11
.
.
You
have
been
eferring
almost
exclusively
o
value
and net
worth.
How
do
you
analyze
thrift stocks,
and
what importance
do you
place
on eamings?
There
are many
ways
o evaluate
thrift
investment.
Many
investors
ocusexclusively
on
e-arnings
nd earnings rowth.
Others
emphasize
hrifts
as
nterest
ate
plays (this
despite
the
mproved
matching
f
assets
nd iabilit ies
y most
hrifts.)
We focus
our attention
more
on assets
nd iabilit ies
han
most
nvestors.
The Baupost
Group hasa value nvestment hilosophy,wherewe try to buy dollars or fifty
cents.
We
focus
on risk aswell
as
return,
hoping
o minimize
downside
isk
for
each
investment
ndwithin
our
porlfolio.
Risk
s a complex
subject,
nd
some
people
use t to
refer
o volatility,
while
others
use t
when
referring
o outperforming
or underperforming
the market.
We
arenot concemed
with
relative
performance.
nd
believe hat
volatilitv
often
creates
pportunities.
o us,
isk
is how
much
you
can ose
and heprobability
of
losing t.
A thrift
with
high
quality
assets
s less
isky
hanone
with lower quality
oans
and
investments.
thrift
with
a high
capital
atio
s less
isky
han
a thrift that s
at
or below
regulatoryminimums.A thrift with a slowgroMh rate
s safer han
one
growing
rapidly,
as
quick
growth
s
o{ten
accompanied
y risk
taking.
When
analyzing
hrifts,
we
look
only
at low
risk
nstitutions.
Many
business
roblems
an
be
overcome,
ttt
not bad
assetquality.
There
s no spread
on a loan
that would
convinceus
that
a thrift
shouldaccept
a couple
of
percent
of extra
return or
risking
100%
of its capital.
When
we look
at
a high
quality
thrift,
we
attempt
o
calculate
ts
value
n a conservative
way.
We have
a
calculation
e
call adjusted
ook
value,
where
we
beginwith
book value
and adjust t up for such temsashiddenrealestate alues, nvestments ofih more than
carrying
alue,
and he value
of a
stable
ow cost
deposit
ase.
We
adjust ook
valuedown
for
goodwill.
ikely
oan osses,
nd oans
or investment
ecurities
hat
could
be soldonly
for
less han
carrying
value.
Our
adjusted
book value
s
one stab
at what
a thrift
mieht
be
worth
asan ongoing
business.
We
calculate
eparately
what
a
thrift
might
be worth
in a
takeover,
using
scent
comparable
deals
as
a
guideline.
More
often
han
not,
our
adiusted
ook
value
and
merser
valueare
very
similar
We
also
ook
at
earnings,
which
we
adjust
or
nonrecurring
tems
both
up and
down.
To
us,
nonrecurring
tems nclude
all
securities
ains
and
osses,
eal estate
gains
and
osses,
branchsales.
eal estate
evelopment
rofits,
accounting
hange
gains
and
osses,
nd he
like.
Quality
of earnings
s extremely
mportant
o
us;
earnings erived
rom recurring
spread
ncome
are ar more
valuable
n
our eyes
han
nonrecurring
tems
or than loan
origination
eeswhich
are highly
volatile.
nstitutions
with
low
overhead
osts
are
clearly
preferable
o high
cost
shops;
both because
fthe profitability
and
also he
greater
flexibility in
timesof interest
margin
pressures.
7/21/2019 Baupost on Thrifts
4/11
.
.
In sum,
we emphasize
sset
alue
more
than
shoft-term
earnings
n
our
analysis
and
prefe
thrift
investments
vhere
management
s
oriented
oward
building
long-term
value
rather
than
playing
uarter ly
arnings ames.
Nobody
deliberately
akes
bad
oans.
How
do
you
anticipate
vhere
roblems
re
ikely
o
appear?
We
try to
imagine
ourselves
n the
headquartersf whatever hrift we areanalyzing.We
say
o
ourselves,
ere
n Poughkeepsie,
r
Albany,
or
Johnstown,
an
we make
oans
n
California
or
Florida
or North
Carolina
and
have
a
clue
about
what
is really going
on?
Wh
would
borrowers
n
these laces
se
a thrift
2,000
or 3,000
miles
away,
f it
*.."-n't
u
parlicularly
good
deal or
the
borrower?
We
ask
ourselves
f the
management
hich
has
made
only
residentia
mortgage
oans
or
the past
wo
decades
an pcssibly
evaluate
construction
r commercial
oans,
r if
they
can
possibly
monitor
he
mediocre
ommerci
bankers
brought
n to
make
hese
oans.
We
ask
ourselves
f
a thrift
u,hich
made
only
$25
million
of
loans
3
years
ago
can
possibly
e
monitoring
oan
quality
f
they
are
making
$250million of loans oday.
Management
ay be
able
o achieve
ll
of
the above.
f
they
do,
hey
are
super
managers
and
deserve
much
credit.
Since
we
cannot
sepal'ate
head
of time
who
will
be ,u"".rr-fuI
and who
won't,
we
simply
avoid
betting
whcnever
here
s
apparent
isk.
We
thus
avoid
thrifts
with
a
significant
exposure
o
construction
oans,
commercial
mortgage
oans
and consumer
oans
unless
hey
have
a long
track
record
of success
n
thos
areas.
We
avoid
thrifts
with
any
meaningful
exposureo out of state oans, o unsecured
personal
oans,
o
exotica
such
as
ax
shelter
nstallment
notes,
o
real
estate
evelopment
activities
conducted
y the
thrift
itself,
or
to
unk
bonds.
Aren't
you
excluding
a large
number
of
potential
nvestment
pportunities
y ignoring
he
more
aggressive
hrilts?
Higher
risk,
higher
retum.
Right?
We
don't
mind
rnissing
some
opportunities
n
the
thrift
area
or
in
anyother.
Thrifts
which
stick
to
traditional
.ul
"_t111"
lending
practices
re
airly
easy
o analyze.Their
assets
re
understandable,heir liabilities areclear.Their coststructure anbe analyzed,theirmarket
studied.
Riskier
hrifts
are
much
harder
o
understand.
he
riskiness
of the
assets
s unclear
o
outsiders,
ossibly
even
o
insiders.
Thus
you
are
n
the
dark
about
eal
asset
alues
and
realeamings.
When
a portfolio
consists
f only
very
low
risk oans,
a minimal
oan
oss
reserve
ill
suffice'
With riskier
oans,
a
greater
oan
oss
provision
s critical.
How much
is
enough
loA,Toh,
5o/o,
more?
This provision
will
have
a major
impact
on
earnings, et
is
virfually
unanalyzable,
xcept
n hindsight.
We are not
saying
hat
a riskier
hrift
cannot
be
a
good
nvestment.
We
are simply
saying
that
we
are
not
capable
of analyzing
hem
as
nvestments.
.
.
7/21/2019 Baupost on Thrifts
5/11
You
didn't
mention
market
share
as
part
of
your
investment
analysis.
why not?
A strong
market
presence
s
obviously
of value.
This
value
should
ranslate
nto
earnings
over
ime.
Thus,
we
believe
hat
market
share
s already
mplicitly
part
of our
earnings.
analysis.
A n'umber
f
thrifts rve
have
spoken
with
speakof
market
share
as
an asset
n
its
own
right.
An assetonly hasvalue f it generates resentor fufurecash low or earnings. ursuitof
market
share
at the expense
f current
profits
can
be
misguided.
Market
share
should
be
cherished
or
the
returns
t can provide,
but
is not
of value
f
current
eturns
must
be
continually
acrificed
o
maintain
hare.
You
evidently
purchase
hrifts
upon
heir
conversion.
Do
you
ever purchase
hrifts
that
have
beenpublic
or
awhile?
Yes.While hriftsareoftenmostundervalued t he timeof conversion,heyoccasionallv
fall
to
acceptable
iscounts
ecause
f market
orces.
We try
to keep
an eye
on
all
public
thrift
stocksand
new
offerings
hat
meet
our quality
an
criteria
o
take
advantage
f
opportunities
rising
rom
price
disparities.
you
concemed
with
short-term
rice
fluctuations
of thrift stocks?
e are
aware
of short-termpricemovements ecausewe are always n themarket looking
oppoftunities
o
both
buy and
sell.
we
own
a
thrift
stock
as
an
nvestment,
nd
have
confidence
n
the asset
quality
and
the
ong-term
motivations
of management,
e
are
not
concemed
with
short-terrn rice
ong-term
business
alue
is
our focal point.
When we
find
out that
the assets
of low
quality
or that
management
s
not
shareholder
riented.
we
seli.
do
you
decide
when
to
hold and whento sella thrift stock?
willing
to
hold
a thrift
stock
ndefinitely,
as ong
as t is
managed
with
low risk
and
concern
o
shareholder
alue,
and
as
ong
as
he
value
s
increasing
ufficiently
over
stock,
no
matter
how
well
run
and
no
matter
how
secure,
s a
good
buy at
some
price
a
good
sale
at
another.
A
10
year
government
ond
purchased
t
a 10o/o
ield
in a low
environment
might
represent ood
value.At a 3o/o ield, it shouldprobablybe sol
healthyprofit,
asmost
of the
l0 year
return
s
available
n
the
form of a capitalgain
The
bond itself
hasnot
changed;
he price
has
mproved.
same
with
thrifts'
When
we purchase
thrift
at half
of an understated
ook
value
and
times
recurring
earnings,
he
underlying
value
of
our investment
s
growing
at 25%o
inverse
of
the
p/e
multiple.)
When
this
thrift
appreciates
o
l2So/oof
book
value
and
te
7/21/2019 Baupost on Thrifts
6/11
t imes
earnings,t is relatively
ully
valued.
An investor
t
this
price
wiil
eatn
some eturn,
but
the returnwill
not
be satisfactory
o us compared
o
our
other
nvestment
ltematives.
The
thrift is
still a fine institution
with
soundeamings
and
good
prospects.
he
market
simply ecognizes
ts
prospects
nd
discounts
hem n
the
stock
price.
We
are always ooking
at
the universe
of
thrift stocks
and at thousands
f other
securities
o
invest
n the
bestvalues.
You
say hat
you
rvill
hold thrifts
fbr
the long-term
as ong
as the value s
increasing.
What
are
he
ways
of measuring
alue
ncrease?
We believe
hat all managements
f public
thrifts
should
ask hemselves hat
their
thrift
is
worth today.
This value s what
each
shareholder ould
receive
f the thrift were
sold.
f
management
s buildingvalueat
a healthy
ate,an
nvestormight
be better ff
holdinghis
shareshan
having he hrift
sellout.
f, on theother
hand, alue s only
ncreasing
lowly.
an nvestorwould be betteroff if the hrift soldout odayand he nvestedheproceedsn
other
undervalued
hriftsor evenmunicipal
bonds.
This
gronth
in value s best
quantified
y return
on
equity. f a thrift with
a
$20.00
book
value
per
share s eaming
$3.00,
r
15o/oeturn
on equity,
he
value
of that hrift
is
growin
15Yo
year.
f a thrift with
a
$20.00
book value
s
earning
nly
$1.00,
or a'5o%.o.e.,
he
value
s
gror.ving
scant5Yo
ayear.
Even f the 5o/o
.o.e.
ises o
60/o r 8%, he
nvestor
would probably
be better
off if the
hrift
soldout
and he
put
the
proceeds
nto
municipal
bonds.
His
returnwould
be he
same,with
far less isk or volatility.
we
think the
management
ndboard
of every
public
hrift
shouldbe making
hese
calculations.
What can
a management
o to make
value ncrease,
f they
are
currently
burdened
by a low
return
on equity?
Many thrifts
with
a
low return
on equity
have he
enviable roblem
of
excess
apital.
Som
recent lyconvef tedthr i f tshavecapital
f
l }Voto20Voormoreof
ssets,
r2or3t imesthe
prudent
60/oevel.
Some,but
not
all,
of
these nstitutions
are
eaming
good
returns
on their
core
business,
while the
excess
apital
s
only earning
nterest
at
moneymarket
rates.
The
excess
apital
can
be a drag
on the
overall
return
earned
by the thrift.
For
this
reason,
recentiy
converted
hrifts
often
feel pressured
o deploy
newly
raised
capital
o
improve
returns.
There
are several
ways
o deploy
excess apital.
One is
intemal
growth.
Another is
growth
through
acquisition.A third is
related
or unrelated
iversification.
A fourth s to retum he
excess apital o
shareholders,
ither hrough
high dividends
or share
epurchase
rograms
7/21/2019 Baupost on Thrifts
7/11
.
Can
you
comment
on
the opportunities
or
deploying
excess
apital
hrough
ntemal
growth?
Unfortunately'
hrifts
are
not
faced
with
infinite
loan
demand
or low
risk
loans
at attractive
rates
f return.
Quite
he
opposite.
n
fact.
n today's
ighly
competitive
inancial
world,
there
s
a
great
deal
of money
chasing
elatively
ew
lending
opportunities.
Borrowers
and
depositors
re
more
sophisticated
han
ever
n understanding
nd
"hoo.ing
among
heir
many
altematives.
iftle
by
little,
he
best
asset
f
many
hrifts,
their
5.S%opassbiok
depositsactually balance heet iability), s eroding.Opportunitieso lendat above
market
ates
with
low
risk
are ew
and
far
betvveen.
T'he
competition
o lend
money
s so
intense
n some
areas
hat institutions
practically
give
the
money
away'
Teaser
ates,
no point
loans,
no
credit
verification
loanswith
minimum
down payments
nd
other
orms
of economic
suicicie
re
commitreri
by many
nstitutions.
We recently
heardof
one
institution
offering
four
year
automobile
oans
at
4o/o,
rate
nat
may
be
below
what
could
be
earned
n
U.S.
reasury
ecurities
f
servicing
osts
were
figured
n.
This
s
before he
costs
of
making
he
oan
and
before osses
or credit
isk
are
figured n. Suchbusiness racticesmakeno sense.
And
yet
in today's
eregulated
inancial
world.
bankers
f all
types
are
under
a
compulsion
to
lend.
Money
center
anks
have
hrown
money
at
LDC
ioans,
gricultural
oans,
eal
estate
oans
and
energy
elated
oans.
Many
have
strayed
housands
f
miles
from
their
own
geographic
rea
o
make
these
bad
oans.
Today,
hese
bankers
avoid
the
mistakes
of
the
past,
hoosing
nstead
o
throw
unds
at highly
everaged
ompanies.
he
ury
is
still
out.
but we
suspect
he
losses
n this
area
could
eventually
ival
the
energy,
eal
estate
and
LDC
debacles.
Thrifts
face
a
problem
similar
to
money
center
banks.
Opportunities
o
grow
low
risk
attractively
priced
oans
are
rare.
Thrifts
thus
face
he
alternative
of
slow
groqh
and
inadequate
eturns
or rapid growth
in
new
and riskier
areas.
nadequate
etums
will result
1
tremendous
hareholder
ressure
n management
o
increase
alue.
Rapid
growth
in
new
areas,
uch
as commercial
eal
estate
oans,
development
oans,
out
of itate
loans,
oint
ventures
nd
real
estate
development
rojects,
onsumer
oans
and
unk
bonds,
aiie
ongoing
concerns
egarding
isk.
It
is
difficult
for
the
experienced
enders
n
these
areas
o
earn
decent
eturns
with
limited
risk.
It
is
nearly
mpossible
or
new
entrants
nto
these
areas
o
achieve
acceptable
esultswithout eopardizing he financialhealthof the
institution.
Are
you
suggesting
hat thrifts
should
grow
through
acquisition
ather
han
hrough
ntemal
growth?
Not really.
Acquisitions
re isky
too.
Thereare
manli
buyers
of thrift institutions,
o
prices
paid
are
relatively
high.
Often goodwill
is
created,
which
reduces
he
tangible
asset alue
of
the
acquiring
nstitution.
Earnings
may
or
may not
be
diluted.
For
us, heiritical
flaw
in
most
acquisitions
s that theymakeeconomicsense nly if what areoftenquiteoptimistic
7/21/2019 Baupost on Thrifts
8/11
assumptions
re
borne
out.
n the
real
world,
managerial
nthusiasm
ver
doing
a deal
often
exceeds
ny possible
enefits
rom
the
acquisition.
Managements
ften
refer
to
cost
savings
rom
a takeover.
usualiy,
cost
savings
are
confined
o
minor
areas
ike
advertising,
ccounting,
omputer
ystems
nd
he
ike,
These
savings
re
usually
dwarfed
by
the
costi
of
doing
[e
deal.
Managements
eriously
interested
n
cutting
costs.would
ake
ough
perionnel
decisions,
specialiy
mong
highly
paid
op management.his s usually nconsistent ith thepoliticsoir".ging twJfinancial
institutions.
verall,
we
rarely
ind
that
expected
ynergies
rom
thrift
mergers
are
achieved.
Are
there
any
mergers
hat you
support?
Merger
conversions
ften
make
sense,
f
the nstitution
eing
acquired
s
good
qualify
and
haspositive
alue.
of course,
t
is
hard
o
find partners
or
rierger
conversions.
Generally'we believeacquirors aysomuch o do deals hat
deals
don't
make
sense.
When
the
stock
market
s very
strong.
we
choose
o
sell
our
stocks
t high prices.
when
it
declines.
e
buy
at ow prices.
Buyers
of
business
hould
act ikewiie.
When
prices
paicl
for
thrifts
are
high,
t is
better
o
be
a
seller.
Whenprices
paid
are
ow,
hen
t
may
be
ime
to buy'
Right
now'
considering
he
ack
of opportunities
o
expand
ntemaily,
wetelieve
many
hrift
institutions
should
be
carefully
evaluating
opponunities
o
sell.
Investment
bankers
often
argue
he
attractiveness
f thrift
mergers.
Don,t
hey
know
what
s
best?
Maybe'
But
they
have
an
enornous
conflict
of
interest.
They get
paid
if
transactions
ake
place,
not
if
value
s increased.
We
are very
skepticat
auout
an"y
dvice
rom
investment
banking
irms,
ranging
rom
mergers
and
acquiiitions
o
hedging
o
covered
all
writing
programs
o
risk
controlled
arbitrage.
Unfoffunately,
hese
often
capable,
ften
very
bright
people
only get
paid
from
transactions.
hey
may
be
capable
f
adding
value,
but
their
advice
must
be aken
with
a
grain
of
salt.
How aboutdiversificationby thrifts into
other
inancial
services,
ike
leasing,
nsurance,
money
management
r
real
estate
rokerage?
In
general"
n
acquiror
s
far
more
ikely
to
overpay
o
expand
nto
one
of
these
areas
han
to.get
a
good
deal.
The seller
of a
business
lmost
always'knows
more
about
t
than
he
buyer,
hus
the
buyer
s at
a great
disadvantage.
he
,"i1.,
-uy
know
ofa
current
problem
or
future
rend
that
the
buyer
cannot
oresee.
The stockmarketgenerallypreferssimplicity to complexity.Thuseven f a thrift were o
expand
successfully
nto
one
of
these
areas,
t
is
possible
hat
the
market
would
lower
he
/e
ratio
of the
acquiror
o reflect
earnings
hat
aie
more
difficult
to
understand.
7/21/2019 Baupost on Thrifts
9/11
a.
A.
Many
thrifts
have
expanded
heir
mortgage
banking
activities.
Do you
find that
an
attractive
area?
Mortgage
banking
seems
o us to
be
an unattractive
usiness.
xcept
as
part
of
traditional
thrift
activities.
t is a
highly
cyclical
business
vith
ew
effective
entry
barriers.
hus
n
good
imes
t
is
highly
competit ive
ith
a tendency
o build
overhead
n lieu
of generating
profits.
n
bad
imes,
ou
are
eft
with
the
overhead
nd
arge
osses.
Normally
conservative
ankers
'ho
use
cautious
ssumptions
hen
ending
money
have
been
knorvn
o become
aving
optimists
whenprojecting
oan
originations."We
re skeptic
that
mortgage
banking
will
ever
be an
attractive
businesi.
and
during
cyclical peaks
when
it
is
profitable,
we
believe
he
stock
market
will
correctly
lace
a
very low
multiple
on
mortgage
banking
profits.
Your remaining
lternative
or deploying
excess
apital
s returning
t
to the
stockiolders
n
the
orm
ofshare
epurchases
r high
dividend
ayouts.
Do you
favor
hose?
In a
perfect
vorld,
we think
thrifts
should
etain
adequate
apital,perhaps
n
the
range
f
6Vo
o 8oA
of
assets,
nd return
he
remainder
o
shareholders.
We
recognize
hat
the
regulators
ould
be unlikely
o approve
recently
onverted
hrift
mailing
ts
excess
apit
to
shareholders.
he
next
closest
ltemative
o this,
which
s
acceptabl"
o th"
regulators.
s
the
repurchase
f
shares.
Share epurchasesy thrifts areattractive or manyreasons.
or
thrifts
trading
below
book
value
andbelow
15-20
imes
eamings,
hare
epurchases
ncrease
arnings
nd
book
value
per
share,
swell
as eturn
on
equity.
This
benefits
oyal,
ongoing
shareholders.
o the
extent
hat share
epurchase
ctivity
sops
up
shares
eld
by
short-term
holders.
raders
and
hedge
unds,
t
solidif ies
he
shareholder
ase
f
an institution.
he stock
price
may rise
o
reflect
he enhanced
alueper
share,
enefitt ing
on-sell ing
hareholders.
Share
epurchases
hould
be viewed
as
a
business
pportunity
ike
anyother.
When
he
business
pportunities
acing
hrifts
are
poor
no
point
oans, easer
ates,
0
year
oans
prepayable
t
any
ime,
high
risk
loans,
deposit
ate
wars),
share
epurchases
ay
be
a
uniquelyattractivebusiness pportunity.Share cpurchases ." u
"hun..
to buy a fractional
interest
n
a business
hat
is low
risk (all
our
thrifti
are ow
risk),
well
runug"i
lull
managements
hat
we
know
think
their
thrifts
are
well
managed),
nd
which
can
be
purchased
t
a
substantial
iscount
rom
underlying
valuc.
C"ompareo
o
a takeover,
where
you
buy a
l00o/o
nterest
n
a
thrift
that
s often
iskier
hanyour
own,
ess
well
run,
certainly
ess
well
known
and
or which you
must pay
fult
value,
share epurchases
re
a
slam
dunk.
share
epurchases
an
rigger
adverse
ax
consequences
or thrifts,
and
we
urge
managements
o evaiuate
he complete
mpact
of
share epurchases
ith
their
financial
and
taxadvisors. oldingcompany ormation n some ases an mprove heeconomics.
a
7/21/2019 Baupost on Thrifts
10/11
High dividend payouts
are
another
way
of returning
excess
apital o
shareholders.
While
we
dislike
he
double axation
f common
stockdividends,
ividends
re
wellreceived
by
the
stock
market,and he
share
prices
of
many hrifts
are
mproved
by
high dividend
payouts.
A
thrift with
l0%-2}Yo
capital s,
in
effect,
wo investments.
t is
a thrift with
6%
capital
earningperhaps
cceptable
eturns,
and
a
pile
of
excess
apital
earning4%
-5%
after ax
returns U.S.governmentecurities r ajustable ortgages,fter ax.)We like the first
investment,
specially
henpurchased
t
a
large
discount
o underlying alue.
We
strongl
dislike
he
secondnvestment.
We
could
do better f
we
put
he money nto
municipal
bonds,
and we certainlyprefer
our own
investment
ecisions
o those
of others.
We
urge hrifts
that are unable
o deploy
excess
apital
with low
risk and healthy
returns o
find ways
to return t to shareholders.
hareholders
houldnot have o tie up large
amounts
of excess apital
hat earnsonly
40/o-60/o
n
order o own
shares n the thrift. Freeing
up
excess apital,which he stockmarketvalues t less han 100centson thedollar. o
shareholders
ho valuea dollar
at
100cents,
nlocks alue
benefitting
veryone.
Is return
on assets
reasonable easure
f a thrift's
profitability?
No. While
this s a common
measure
f
performance
mongcommercial
anks,
we believe
it
is
not
valid when
comparing
hrifts.
This s primarily
becausehrifts
havecapital
atios
that vary
from
3%o r
less
o 20%o
r
more.
Highly capitalized
hrifts
have
substantial
ssets
with no
cost
of funds
which
enhances
etum
without
increasing
ssets roportionally.
Refurn
on assetss
of
interest
only
when
comparing
nstitutions
with comparable
apital
ratios.
Otherwise,
he ratio
causes
ne o
compare
pples
and
oranges.
Do
you prefer
o
invest n
thrifts
that
arewell
matched?
We
think matching
anbe a useful
concept
or
asset/liabiliry
anagement.t is
cerlainly
better
han ignoring
assetand iability
maturities.
However,
t often
is used
nappropriately
and simplistically
o understate
isk.
Many institutions
ocusmyopically
on their
one
year
gap,
he difference
between
assets
nd
liabilities
repricing
within
one
year.
One
year
s
a convenient
but
highly
arbitrary
ime
frame
or examining
he
matching
of
a thrift's
assets
nd riabilities.
We think
concepts
uch
as one
year
gap
can
be informative
and llustrative,
but
are hardly
a
replacement
or
commonsense.
ot
all deposit
iabilities
re he
same, nd 5.5o%
assboo
arecertainly
ar more stable han
umbo
CD's. We think
a
high percentage
f
passbooks
an
be assumedo be long-term iabilities,which neednot be matchedagainst hort-term sset
to the
detriment
of an institution's
profitability.
Matching s
not
sacred, omething
o
be achieved
or
its
own
sake.
Managements
f thrifts
need
o incorporate
nto the
analysis
of their
oan portfolios
many things, ncluding
yield,
7/21/2019 Baupost on Thrifts
11/11
credit
isk,
diversification.
iquidity,
maturity,
ollection
osts,
nd
he valuc
of
each
customer
elationship,
swell
as
such
concepts
s
gap
andmatching.
Should
hrills
hedge o
reduce
heir gap?
Most
hedging
strategies
ork
within
a relatively
narrow
range
of
assumptions.
ut
break
down
outside
hat range.
Risk
controlled
arbitrage,
which
is extremely
populai
today,
works
this
way.
Our great
concern
s
not
what
happens
o
a thrift with
a
minoi
movement
n
interestates, ut rather,thempactof a majorswing.Most hedges reof no help n such
situations,
nd
n fact
often
serve
o
increase
isk.
You speak
f
some
hrifts
as better
managed
han
others.
What
makes
a thrift
well run?
Primaril.v
oncern
with
shareholder
alue
and
atteniion
o the boilom
iine.Thrifts
with
iow
risk
assets,ow
costs,
arning
healthy
eturn
are
well
run. Such
nstitutions
o
not need
o
resoft
o
esoteric
nvestment
r
hedging
strategies
r risky
oans o
earnmoney.
They
do
not book
one
ime
gains
o achieve
record
of earnings
rowlh.
They
do not
attempito
ool
their shareholders
r
themselves
bout
what
hey
are
doing.
The management
f well
run institutions
lmost
lways
owns
shares
nd
has
stock
options
that
give
them
a substantial
take
n
the
business.
hey welcome
a
dialogue
with
shareholders
egarding
ssues
f
mutual
concern.
hey
view
alternatives resented
o
them
as
opportunities
o be
explored
ather
han
ascriticism
to be ignored.
What
are
your
views
on
management
ncentives?
Very
suppofiive.
We
believe
hat
management
hould
hink like
shareholders,
eighing
everyactionagainsthe mpacton shareholderalue.We asshareholdersleepa lot Uette,
when
we
know
that
management
nd
directors
have
he
financial
ncentive
o
act
in the best
interest
ofshareholders,
ecause
hey
are
shareholders
oo.
This
is not
to say
hat shareholders
re
he
only
constituency
hat
matters.
Certainly,
employees,
ustomers
nd
he
community
all should
be rnportant
o
management.
e
simply
believe
hat he
rights
of shareholders
hould
ake
abackseat
o no
other
constituency,
nd
hat
management
hould
earn
o think
more
like
shareholders.
Are you
worried
about
he
future
of
the
thrift
industry?
We have
many
serious
oncerns
anging
iom
macroeconomic
ssuesike
deficits,
nterest
rates
and
federal
deposit
nsurance
o microeconomic
ssues uch
as rapid
oan growth,
poor
Ioanquality
and nadequate
apital.
On the
other
hand,
w-e
are very
comfortable
hat
well
managed,
well
capitalized,
iquid
and
low
risk
thrifts
will not
only
survive
but
actually
prosper
n the
future.
Thank you
for
expressing
our
views.
l l