The S&A Digest: Begging "bankers"

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As of 06/25/2013

Begging "bankers"... Buffett on the move... Tom Brown is buying... Builders liquidate... More SIV downgrades... Unforgiven on Antigenics... What to do about the Penny Letter?...

"I'd be supportive of whatever it took for the industry to be on stronger footing," said Kerry Killinger, the CEO of Washington Mutual at a government-organized conference on the housing market this morning. Likewise, Angelo Mozilo, the CEO of Countrywide, says the government must do something. "This is the time for Freddie and Fannie to step up to the plate and take action... "

Unmentioned was the role Killinger and Mozilo played in creating the huge number of bad loans that are now the problem. These two guys were the Batman and Robin of excessive lending – superheroes of bad debt. The risks they took willingly now threaten the solvency of their customers and, therefore, their banks.

But... it sure was fun on the way up. Killinger, the CEO of WaMu for 17 years, led the bank's expansion into negative amortization loans, ARMs, and subprime lending. In the last five years, he earned more than $50 million. Mozilo co-founded Countrywide. He has earned more than $160 million in the last five years. My humble suggestion? Let Killinger and Mozilo be the first to donate to a voluntary bailout fund. They could "do something" – and they should. But for those of us who have lived within our means and who knew better than to take out a huge loan against the equity in our homes, we should be left alone. It is not our problem.

What will happen? Oh, you already know. The government will bail out the deadbeat borrowers in one way or another. And you and I will pay for it, in one way or another – most likely via inflation, which the government pretends doesn't exist.

Nearly 100 years ago, when money was real and couldn't be repaid by simply turning on a printing press, J.P. Morgan was asked about his bank's lending decisions. He replied that collateral was only a secondary consideration. "The first thing is character... Money cannot buy it, because a man I do not trust could not get money from me on all the bonds in Christendom."

I'd be willing to bet that J.P. Morgan never made a negative amortization loan in his entire life... and couldn't have imagined a mortgage loan without a substantial down payment. Mozilo and Killinger aren't bankers... they only look the part, like a prostitute pretending to be a lady at a cocktail party.

Buffett on the move: Berkshire Hathaway (BRK-A, BRK-B) bought $2.1 billion of utility company TXU junk bonds from Goldman Sachs. Buffett said they're the only junk bonds he's interested in because some recent issues give new meaning to the word "junk." Private-equity group Kohlberg Kravis Roberts bought TXU earlier this year in a $45 billion leveraged buyout. Buffett calls the deal a bet on the utility sector. Why bet on the utility sector now? It's a great hedge against inflation. We made the same bet recently in my newsletter, PSIA.

Is a recession coming? Merrill Lynch economist David Rosenberg thinks it's "already arrived." Corporate profits fell $19.3 billion in the third quarter, and domestic profits fell $41.2 billion. Profits for S&P 500 companies fell 25% in the third quarter, the biggest drop in five years. S&P's chief economist, David Wyss, expects profits to fall 30% next quarter.

Richard Pzena wasn't the only financials bull at the Value Investing Congress. Tom Brown, one of the country's top financial sector analysts, is calling the bottom. Tom's hedge fund, Second Curve Capital, focuses exclusively on financial stocks and has taken a beating in the past year. But Tom thinks it's time to buy into the panic, as some sectors have bottomed.

His big idea for the year is First Marblehead (FMD). The company securitizes private student loans and has no credit risk. Tom thinks the stock will be a three-bagger in two years. He cites growing college enrollment rates, increasing tuitions, and First Marblehead's depressed share price (six times forward earnings). Tom did throw out one warning... Stay away from banks with market caps between $1 billion and $10 billion with high commercial lending activity. These banks increased commercial lending from 20% of total lending in 1992 to 47% today. Tom says the problems in commercial real estate are "just beginning."

Signs of a bottom in the homebuilders – liquidation. Lennar sold 11,000 home sites to Morgan Stanely's real estate arm for $525 million – $0.40 on the dollar. The sites in 32 underperforming communities were worth $1.3 billion as of September 30. Lennar has a 20% stake in the deal and the option to buy back some of the properties. This deal comes just weeks after D.R. Horton sold 7,000 acres in Phoenix for $70 million. Homebuilders always buy too much land at the top... and sell at the bottom.

Moody's may lower the ratings on $105 billion of debt sold by SIVs after the net asset value of the SIVs fell to 55% from 71% last month. That's down from 102% of net asset value in June. As these leveraged mortgage-holding assets collapse, so does the regulatory capital in Citigroup.

New highs: Berkshire Hathaway (BRK-A), Plum Creek (PCL).

In the mailbag... a host of critics. We retort... and offer amends... below. Send us more chaff here: feedback@stansberryresearch.com.

"As November comes to a close, I am reminded that it was three years ago this month that PSIA said the following: The single best stock of 2005. Make 21 times your money, safely. No risk, five months the biggest profits of your life. The single best opportunity in your entire career as an equity analyst, you said. Then when AGEN collapsed in March of 2006, YOU WERE SILENT. I still have that infamous November 2004 PSIA, and will never forgive you for what it said." – Paid-up subscriber Douglas Whitman

Porter comment: Then I remain unforgiven, I suppose. But I was hardly silent – either about the risks of investing in Antigenics or about the company's trial failure. That's why I cautioned readers not to buy the stock for more than $10 a share and to only make a very small investment – not more than 2% of your portfolio. I repeatedly warned all of my readers that investing in this experimental drug was extraordinarily risky. Thus, I suspect while it might make you feel better to blame me for your loss, perhaps you'd have more to gain by looking elsewhere for the source of your trouble.

As for me, I'm happy to stand by my overall record in picking medical stocks. Of course, nobody writes in to tell me how "unforgiven" I am for recommending Elan – which I picked three times as it moved from $2 to $20. Or Celgene. Or Intuitive Surgical. Or Esperion. Or ID Biomedical. Or Celera. Or Mentor. Or Imclone.

"It looks to me that you should be sending out refunds to everyone who has paid for your S&A Penny Letter research. I'm canceling all my s/a research subscriptions, how could a person do any worse than 0 winners. YOU SUCK!" – Paid-up subscriber Fred Evans

Porter comment: In this case, I must agree. The performance of our Penny Letter couldn't be worse. We are profoundly disappointed that our best single stock analyst, Dan Ferris, hasn't been able to make his approach work in stocks trading for less than $10. We do recognize the scope of the problem. We will adjust our strategy moving forward.

In fact, I just got off the phone with Dan Ferris about these issues. Hopefully you'll stick around long enough to see the improvement. As for our policies regarding existing subscribers, you can be sure we recognize our obligations and will act accordingly. We'll be making an announcement about all of this before the end of the year.

"In regards to Ferris's rebuttal of Pzena, he has to understand that Freddie and Fannie only buy certain types of mortgages. As a mortgage broker, we can run scenarios through DU or DO and get it approved in minutes from Fannie for example. We cannot get approval for neg am loans though... All those neg am loans are loans created and held on the books by the mortgage companies who sold them. Call them portfolio lenders. Banks like FMT/LEND etc – the guys who are bankrupt. Option ARMs do not get packaged and sold to Freddie from what I am aware. Again, they only take the cookie-cutter deals. Maybe I am wrong. Most regular mortgages though all have the same underwriting guidelines based on Fannie or Freddie. So no matter where you shop it, a borrower will get approved if it's cookie-cutter. It then just comes down to spread and fees for that broker and borrower. All these subprime loans and option ARMs that go neg am have different underwriting guidelines depending on the bank who will fund it. One Option ARM that gets approved at Wachovia may get declined at Countrywide. That is not the case for Fannie-style loans. That tells me it stays on the books of the lender. It is probably why Wamu is getting crushed, and Countrywide. They were both big players in the option ARM world. Wachovia is another. They bought World Savings Bank. World Savings is famous for offering Option Arm's to subprime. It's probably 90% of their originations, and I believe they are the only company to offer it to commercial property owners. I have co-workers were able to get Options ARMs to people based on stated income with 499 FICOS through World Savings/Wachovia. If I were buying financials, I'd buy the mortgage giants who didn't have the option ARMs. BAC/WFC/FRE etc and short the crap out of Wachovia and Wamu. I guess time will tell if that ends up being right. Maybe Wachovia is a great short candidate for Jeff Clark?" – Paid-up subscriber T.A.

Regards,

Porter Stansberry

Baltimore, Maryland

December 3, 2007

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