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Week 73: A short update

Portfolio Performance

(Note that I am now posting my portfolio composition and list of trades at the end of the post)

Update

This is going to be a short update.  I wanted to get this out over the weekend but did not have time.  The performance snap-shot is as of last Friday, so it does not include the rather impressive moves that occurred yesterday in Impac Mortgage (IMH), Nam Tai (NTE) and Equal Energy (EQU).  To just briefly touch on what happened yesterday, a fund named Iszo Capital announced a 6.2% position in Impac Mortgage after the market closed yesterday.  As for Nam Tai, the company released a video on their website that suggested sales could hit $300 billion per month in the future.  This would be quite the jump from current levels, as the company did $380 million in sales in the third quarter. Read more

Why is PHH Corp so cheap?

Let’s just get right to it.  I don’t understand why PHH is as cheap as it is.

I have talked about this before, and I don’t want to reiterate the conclusions of my prior post on PHH (You can be a stock market genius: By Buying PHH Corp), but I do want to take a look at the company from a slightly different perspective to show that, even after the 50% run up since my original post, it remains undervalued.

This week, during one of my lunch hours, I made a comparison between PHH and Nationstar.  I was somewhat surprised by the results.   The table below lists key statistics of the mortgage origination and servicing businesses for both companies. Read more

Those who know it best…

There was a time when I was a big commodity bull.

Now just to clarify, I am still somewhat of a commodity bull. I like some oil stocks, I like a gold stock or two, I think natural gas is going to surprise to the upside and I’m looking at the lumber stocks.  But there was a time, back in 2004 and 2005 and even 2006 when I was a real China growth story commodity bull.  I was all about copper and zinc and nickel and demand for those metals from China.

Well that was another time but there are lessons to be learned.  Here is an anecdote that has relevance today.  Around the end of 2004 I was trying to figure out if I should get into Aur Resources. Aur was a Canadian stock mined copper in Chile.  I  remember it was around this time of year that I was looking at the stock, and it had just moved higher yet again.  So I liked what I saw about the company, and I really liked the idea that we were near the beginning of a super-cycle in the base metals, but there was this problem – the stocks had jumped significantly.  Aur Resources was a $2 stock that had quickly become a $6 stock in the past year.

And what’s more, the insiders were selling.

I remember this, because at the time I was pretty new to investing and from what I had read insider selling was a really bad red flag.  If the insiders didn’t want the stock, and I mean they knew everything there was to know right, there must be a disaster around the corner.

I don’t have all the statistics from 2004, but here is a list of insider sales I dug up from January 2005, available from the Northern Miner.  Take a look; its mining company after mining company, some of them with directors and executives selling hundreds of thousands or millions of dollars worth of shares.  It was a rush to the exit.  There is Aur Resources, along with other names like Inmet Mining, Teck Cominco, Inco and so on, all with big sales. Read more

Impac Mortgage: A Growth And Value Story

I wrote the following article on the weekend for SeekingAlpha publication.  Hopefully it will be published on SeekingAlpha in the next few days.

Impac Mortgage Holdings (IMH) is a very simple thesis and so I am going to get straight to the point. Impac is a mortgage originator and real estate services provider that has been growing their origination business at an impressive rate. In addition to its two operating segments, the company has discontinued operations in run-off associated with its pre-2008 activities in mortgage lending and as the manager and residual holder of non-recourse trusts.

Impac earned $1.50 per share from mortgage originations and real estate services in the third quarter. The mortgage origination business pulled in earnings per share of $1.04, while real estate services business earned $0.46. Below are earnings for these two segments over the first three quarters of 2012.

In addition to these strong numbers, growth is expected to continue to be strong going forward. The company noted on the third quarter conference call that origination volumes in October were another 22% higher than the average monthly volume in Q3. Read more

Why I added to MBIA

I decided to re-establish my original position in MBIA Inc.  I did so after the drop Tuesday and Wednesday that was precipitated by Bank of America’s offer to buy MBIA holding company indentures.

I don’t want to rehash the background of Bank of America and MBIA in this space.  For background on the MBIA consent solicitation and the tender offer by Bank of America in response I would recommend this article by Christian Herzeca, this Bloomberg article, and this blog post by analyst firm BTIG for background.

What I want to focus on is why I decided to add my position.  I could have just as easily cut my losses and run.  The market sucks this week and I am losing money.  My instinct right now is to cut my losses (and in most places keep my profits) and sell.  Moreover, I do not often add to a losing position, which is what I am doing with MBIA.  I try to make a habit of doing less of what doesn’t work, and while MBIA has been profitable for me through most of the time I have held it, it recently has not been.

Yet I decided to add.  Why?

I decided to add to the position because I believe that the market has unfairly priced in an increased chance of an NYDFS takeover of the securitization subsidiary (MBIA Corp.) that would lead to a bankruptcy of the holding company (MBIA Inc.), and has decided to ignore a number of the potential positive catalysts that could occur over the next couple of months.  It just seems to me like a case where the market got the wrong news at the wrong time and panicked a bit too much.

Positive catalysts for the stock in the near term

The positive catalysts include:

  1. A positive ruling on the Article 78 proceedings (this is a verdict on the legality of MBIA severing its municipal insurance business from its securitization business.  It is being contested by Bank of America.  It has been on the desk of Judge Kapnick for over 5 months now)
  2. A positive summary judgment on the fraud and breach of contract lawsuit that MBIA has against Bank of America.  There was a recent article on the summary judgment here.
  3. Perhaps a bit more nebulously, the response of MBIA to Bank of America.

To expand on that third point, I find it hard to believe that MBIA did not consider the potential that Bank of America may respond this way.  By issuing the consent solicitation, MBIA was effectively backing Bank of America into a corner.  The holding company wanted to remove the remaining necessary ties to the securitization business by redefining the holding company bonds so that they would no longer have the ability to be accelerated in the event of a default at the securitization subsidiary.  All of Bank of America’s claims reside in the securitization sub and much of them are subordinated in the event of a bankruptcy.  Thus MBIA was really about to cut Bank of America off at the knees.  So Bank of America responded in kind.

MBIA Counter-measures

There are a few different counter measures that MBIA could respond with.  I can’t take credit for these ideas.  I got them from some of the very astute tweeters that follow MBIA (hat tip to @cherzeca,   and @alex_ryer)

  1. A consortium of largest holders of the common stock combine to put together a better offer for the bond indentures.  The idea was put forth by BTIG in this article, where they said “we would not be surprised to see an announcement that some of MBIA’s deep-pocketed friends had formed a limited-liability corporation (LLC) that they would use to top BAC’s offer and buy up the 50% of the 5.7% Notes that would be needed to push a consent solicitation over the top.”
  2. MBIA buys the indentures back themselves.  The bond issue that Bank of America is going after are callable by MBIA.  It wouldn’t be cheap, I read that the price to call the bonds is par plus future interest payments.  MBIA would have to pay for the re-purchase through a new private placement which also would be more expensive than the existing indentures.  But it would effectively allow MBIA to pressure Bank of America with the leverage that if Bank of America does not pay a reasonable settlement, the MBIA holding company could put the MBIA Inc. insurance subsidiary into bankruptcy with no consequence to the holding company.

The third option that MBIA has is to let Bank of America buy up the indentures.  Now I haven’t heard this from anyone else so maybe I’m off-base here, but it seems to me that it is significant that Bank of America is buying the bonds because they don’t want the holding company to have the option of throwing securitization sub into bankruptcy without consequence to the holding company.  But by buying bonds of the holding company that are contingent on the viability of securitization sub it becomes even more in Bank of America’s interest to not see the insurance subsidiary go into bankruptcy.

By allowing Bank of America to buy the bonds, MBIA is raising the probability that the worst case outcome in their dispute is that the MBIAwalks away without a bankrutpcy, and with the municipal insurer National intact.   The National franchise is worth maybe $20 per share, so that outcome is extremely accreditive to the current share price.  If we could end this all today with this outcome I would take the consequences.

Liquidity

The final piece of the puzzle is the company’s liquidity, which is the other element that has the market spooked.  The securitization subsidiary has a limited amount of liquidity to pay claims.  While the overall statutory surplus at the securitization subsidary is $1.1 billion, a little less than $500 million of this is invested in common stock.  What the common stock refers to is the interest the securitization sub has in its subsidiaries, primarily in UK Holdings, which does business in Europe, and makes up about $450 million of that common stock number.  This $450 million is based on the statutory capital available at UK Holding, which is not immediately available to MBIA.

If you remove the common stock from the equation, MBIA Inc. has $386 million in cash and liquid assets, and another $250 million or so that is in bonds.  While the company has been non-committal about how long this cash will last them, the consensus is that it is more than enough to get them through the first half of next year.

While I see how the securitization sub will eventually be pushed into liquidity problems if nothing changes, I think that it is far enough off that I can discount it for now.   My re-established position in the stock is based on much shorter term factors that should play out before year-end.  I am willing to wait this out a month or two, and see how it plays out.

My Spec play in First Mariner Bancorp

I have probably devoted too much time researching and soon to be too much space writing about this little bank called First Mariner Bancorp (FMAR).  They are a very small position for me, and as they are illiquid and still a little confusing, they will likely remain that way.  But they are such an interesting case.

How often do you run into a bank with negative tangible book value and with earnings over the last 6 months that exceed the current share price?

Not very often.

As it turns out, First Mariner has some warts that make it a speculative holding, but there is also much to like about the company, in particular a profitable and growing mortgage banking business and an extremely cheap price in comparison to earnings, and that makes it worth a small “punt” in my opinion.  As I conclude at the end of the post, we are left waiting to see how the situation plays out.

How I stumbled on the idea of First Mariner

One of the ways that I come up with ideas is by doing Google searches of phrases that might be found in a release or article about a company.  The search terms that I pick can be as generic as “10-bagger” or “double digit earnings growth”.

About a month and a half ago I was searching for ways (aside from Impac Mortgage) to play the mortgage origination market.  I used searches like “strong mortgage banking”, “growth in mortgage banking”, and “increasing mortgage income”.

These searches led me to the following 3 banks:

  1. Monarch Financial (MNRK)
  2. PVF Capital Corp (PVFC)
  3. First Mariner Bancorp (FMAR)

I have positions in all 3 right now.

I wrote up a brief analysis of Monarch and PVF Capital Corp here.  I didn’t write-up First Mariner at the time.  My position was too small.  Though not for lack of trying.  The bank is difficult to purchase, extremely thinly traded, and there are no reasonable bids or asks to speak of.  Maybe its because I have a Canadian brokerage account, but the over the counter market in the US is basically opaque to me.  Every day that I look at First Mariner the bid is 20 cents and the ask is 75 cents.  Yet if I throw a bid out there at some amount in between every once in a while it gets filled.  Even more oddly, other times it doesn’t though shares trades at a higher price.

Well those are my thoughts on the OTC market, but by having a bid on the table for the past couple months I have been able to pick up a few shares between 55 and 65 cents.  My average cost is 58 cents.

While Monarch and PVF Capital are more conventional stories, with both being a “recent growth in the mortgage banking business is not reflected in the stock price” ideas, First Mariner is more complicated, more risky, and much more fun to figure out.

Just as an aside, I am keeping this post to the facts that seem relevant to the company’s survival going forward, but there is so much more interesting information available if you start going through their history.  If you are interested, I would start by reviewing the archives of both First Mariner and their former CEO Edwin Hale at the Baltimore Sun and on the Baltimore Business Journal.   And google those names.  Its good stuff.

The pre and post mortgage banking versions of First Mariner

First Mariner is a Baltimore based bank that has historically had a strong mortgage lending presence, but that got itself into trouble when it began to relax lending standards along with most everyone else.  According the Baltimore Sun

First Mariner has lost about $120 million over the past four years, racking up 18 straight quarters in the red. Toxic mortgages, falling real estate values, commercial loans gone bad and a rough economy all contributed.

First Mariner’s troubles started when a Northern Virginia division got into “liar loans” — mortgages requiring little or no documentation of borrowers’ finances — that it then sold to the Bear Stearns Cos.

Borrowers defaulted. Bear Stearns sent the loans back to First Mariner under a buyer’s remorse clause. Those mortgages ultimately cost the bank about $60 million, Hale said, and more losses piled up as the recession hit.

The stock traded to as low as 5 cents at the end of 2011.  It used to be a $6-$7 stock pre-2008 after adjusting for dilution since that time.

Before this year, the prospects of the bank looked dim.  It was losing money, had a negative book value, there seemingly was no way out of the downward spiral.

And then the company started to get back into the mortgage business.

Well, to be clear, the company had actually never gotten out of the mortgage banking business, but it wasn’t until this year that they made the concerted effort to grow the business to a size that was a material impact to earnings. This article was from the Balitmore Business Journal in March:

First Mariner Bank’s mortgage-lending unit, First Mariner Mortgage, expects to hire about 50 people this year as it expands in the Washington, D.C., and Baltimore areas, said Ned Perry, First Mariner Mortgage’s president. Perry said he is looking for experienced mortgage loan officers with at least two years experience. They are paid on commission, with an average income of between $75,000 and $100,000.

Below is a chart of bank earnings and mortgage banking income over the past couple of years.  You can see the growth in mortgage banking income and how that has driven earnings from losses in 2011 to rather impressive profits in 2012.

The carrot here is that those earnings have become large in relation to the banks capitalization.  Earnings per share in the 3rd quarter alone were about 2/3 of the current share price.

First Mariners Fiscal Cliff

The problem at First Mariner is the debt at the holding company.

First Mariner Bancorp is a bank holding company. It wholly owns its banking subsidiary, First Mariner Bank, but they are not the same company.  While this distinction exists for most banks, it is usually irrelevant because the only asset of the holding company is the banking subsidiary.  For First Mariner, it is an important distinction because along with the holding company banking asset come some other holding company liabilities.

In particular, the holding company has debt in the form of Trust Preferred Securities (TruPS).  The holding company used this debt in the past to help the growth of the banking subsidiary.  The idea was that the banking subsidiary would grow and pay dividends to the holding company, and those dividends would more than pay for the TruPS.

Of course it didn’t turn out that way and the holding company has been left with the following debts:

So now the holding company is stuck with $50 million of TruPS debt.  The debt itself is not due for a long time, until 2032 at the earliest.  But they still has to pay interest on that debt.  And they haven’t had the cash to do that.

At the end of 2008 the company suspended dividends on the TruPS.  Under a clause in the securities, they could get away with doing this for 20 quarters, but after that time the holders of the TruPS had recourse to send the holding company into bankruptcy. The grace period ends at the end of 2013.

The company is going to have to begin to pay back the accrued dividends at the end of 2013.  Since the TruPS are held by the holding company, it is the holding company that is going to have to make the payments.  Payments on dividends accrued by the end of 2013 will be around $10 million, and future dividends that will need to be paid on a going forward basis appear to be about $1.6 million per year.

Now one thing that isn’t clear to me about this, and it is something I plan to find out, is whether the company has to pay back all accrued dividends at the end of 2013, or whether it only has to begin paying back its accrued dividends  on that date.  The distinction is worth noting. The language of the 10-K is as follows:

This deferral is permitted by the terms of the debentures and does not constitute an event of default thereunder. Interest on the debentures and dividends on the related Trust Preferred Securities continue to accrue and will have to be paid in full prior to the expiration of the deferral period. The total deferral period may not exceed 20 consecutive quarters and expires with the last quarter of 2013.

When I first read this, I took it that in 2013 the company would have to pay dividends on the first deferral, but other later deferrals would not come due until their 20 quarter period had expired. But based on the correspondence I’ve had with some others, and after re-reading the clause a number of times, I’m not so sure I’m right about that.  I now think that its likely that First Mariner has to pay back all dividends, or the full $10 million, at the end of 2013.  That is going to be the assumption I make going forward until I am told otherwise.

The off-white knight

In 2010 a hedge fund named Priam Capital gave the company a way out, albeit with significant dilution to existing shareholders.  Priam and First Mariner defined an agreement whereby Priam would invest approximately $36.4 million in First Mariner.   But the agreement was subject to First Mariner raising another $123.6 million from other investors.  Priam was going to pay 50 cents per share for their stake.  Presumably the shares offered would also be around this level, with the result being massive dilution to the existing shareholders (there are 18 million shares outstanding right now).

The agreement had an original deadline of April 2011.  This deadline was amended to November 2011, and when no capital raise was concluded by that date, the agreement seemed to sit in limbo for the last year, neither on nor officially off the table.

Until Friday.

On Friday First Mariner  announced that they had terminated the agreement with Priam.  Mark Kiedel, the CEO, said the following in the press release:

“Circumstances of the bank have changed considerably since we entered into the agreement over a year and a half ago, and the Board of Directors believed it was in the best interest of the Company to withdraw from the agreement at this time.”

“Over the last nine months, 1st Mariner has steadily improved its capital position with positive earnings. While our capital ratios remain below the levels required by regulatory orders, we are making progress and will continue to work diligently to increase capital to levels required by regulatory agreements.”

I would say this is a pretty positive development, as it suggests (at least tentatively) that management does not feel the need to raise at least this level of capital.  But we’ll see…

How is this likely to play out

In order to draw some conclusions about how things play out for First Mariner, I think that it is helpful to start by estimating the capital that will likely be available at the bank subsidiary at the end of 2013, when the company will have to make payments on the accrued dividends of the TruPS.  I’ve done that below:

The company has added around $5 million to tangible book over the last two quarters, or since its mortgage banking business has really began to ramp up.

It seems reasonable that the company could continue this trend for the next 5 quarters, adding around $25 million to capital by the end of 2013.

Tier 1 Capital, which is the metric the regulators use to evaluate the balance sheet health of the company, is, according to the 10-K, “common stockholders’ equity less certain intangible assets plus a portion of the Trust Preferred Securities”.  The 10-K also states that none of the TruPS currently qualify for Tier 1 equity, so they can be excluded from the calculation.  With no intangible assets on the balance sheet that I can see, this leaves common stockholder equity as the only source of capital.

Using this as my starting point, I estimated current Tier 1 capital at the banking subsidiary of a little less than $40 million, and risk weighted assets at $687 million (I backed-out risk weighted assets from the existing Tier I Capital ratio of 5.8%).  Looking ahead to the end of 2013 results in the following:

So at the end of 2013 the company will have Tier 1 capital of 9.4%. This compares to the current order they are under from the FDIC and the Maryland Commissioner of Financial Regulation to get their Tier 1 capital ratio up to 7.5%.  Comparing it to some other banks, it still remains very much on the low side.  In particular, PremierWest, which considered itself still undercapitalized, has a ratio of 11.4%.   The ratio at Community Bankers Trust is 15.6%.  Atlantic Coast Financial, another bank I have been looking at that is also considered to be short of capital, is 9.4%.

The conclusion here is that I don’t think we should expect the regulator to allow significant dividends to be paid from the banking subsidiary to the holding the company.  Getting $10 million out of the bank seems unlikely.  If the TruPS accrued interest needs to be paid off in full at the end of 2013, the cash is going to come from somewhere else.

What other solutions are there

This is where it gets tricky, and why this situation is so speculative.  What we really have to do now is wait and see is what the company does about the TruPS.  At this point, I am going to leave it open in the comments to work out scenarios that could play out.  There are a few basic directions that I could see it go:

  1. Equity is raised at a reasonable level
  2. Equity is raised an extremely dilutive level
  3. A deal is struck with TruPS holders to pay back accrued interest and potentially the TruPS themselves over a longer time period
  4. A deal is struck with TruPS holders to convert the securities to equity, either at a reasonable or extremely dilutive level

I’m honestly not sure which one trumps.  A lot of it is up to management and whether they want to work hard for shareholders or not.  It has been pointed out to me that the current management does not have a large stake in the company, which may bode ill for such a resolution.

Nevertheless, if the company decides to raise equity on the cheap, its still difficult to see how it would be too negative for existing shareholders.  If, for example, the company issued shares to cover $60 million at 50 cents per share, a lot of the upside would be taken out of the stock.  You’d be left with 140 million shares and a bank earning maybe $35 million per year (assuming that Q3 earnings are sustainable going forward).  But that would still put earnings per share at around $0.20 or $0.25 per share. What’s the bank stock worth in this scenario?  Probably still more than 60 cents.

Therefore I think its worth holding on to a few shares and watching how this plays out.  That’s what I plan to do.

Week 70: A stock pickers Market

Portfolio Performance

(Note that I am now posting my portfolio composition and list of trades at the end of the post)

Update

I didn’t get around to writing an update last week because I was busy with other research that could not wait.  So its been 3 weeks since I updated my portfolio and transactions and quite a bit has happened over that time.

Over time my portfolio has slowly morphed into a vehicle for playing the housing recovery. I had large moves to the upside in a number of my housing related positions, with the most pronounced being of course Impac Mortgage (IMH), but also from Radian Group (RDN), MGIC (MTG) and a number of my regional banks with strong mortgage banking operations.  Its been a good 3 weeks.

In this post I want to talk about some of the changes I’ve made over the last 3 weeks.  To summarize:

  1. I sold out of all my gold stocks other then Atna Resources (ATN)
  2. I made a brief foray into, and then out of, US E&P’s
  3. I am out of JC Penney (JCP)… for now
  4. I am into Avenex Energy (AVF) and a homebuilder (HOV)

I will address each of these in order, followed by a brief discussion of what to expect from Nam Tai, which reports earning on Monday and of which I want to be clear of my expectations and actions.  But first I want to talk generally for a moment.

Twitter

I’m finding that I am using twitter quite a bit to post what I am doing on a more regular basis.  Whenever I find a relevant article, or if I start to buy a new stock, I try to put a post up on twitter.  I have also found a number of folks on there that have been useful to follow.  Its a useful tool, and has the advantage over the traditional message board format in that you follow a person rather than a subject.  So you aren’t wading through garbage to find nuggets.  You can follow me @LSigurd. Read more