Baupost on Thrifts

7/21/2019 Baupost on Thrifts

1/11

The

Baupost

Group

Speaks

ut

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.


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.


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.

.

.


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


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


7/11

.

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


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.


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


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,


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

Baupost on Thrifts

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Transcript of Baupost on Thrifts