Skip to content

Posts from the ‘Atlantic Coast Financial (ACFC)’ Category

Week 286: On being wrong a lot

Portfolio Performance



Top 10 Holdings


See the end of the post for my full portfolio breakdown and the last four weeks of trades

Thoughts and Review

The other day I was considering posting an article on SeekingAlpha.  I couldn’t muster the energy.  I wasn’t sure why, but I felt a strong resistance against it.

So I put it aside and in a couple of days it came to me why.

Take a look at my SeekingAlpha history.  I’ve written a few articles for it.  The list of names is, at best, uninspiring.  Hercules Offshore went bankrupt not long after I wrote about them.

The fact is, I’m wrong a lot.  At least a third of the time I pick a stock it doesn’t even go in the right direction.  In a bad market that number is likely well north of 50%.  And even when I’m right, I often miss by degree.  The last couple of months, while my portfolio has done pretty well, it would have done much better if I was not weighted most heavily in two positions that have done absolutely nothing (Radcom and Radisys).  My biggest winners are often afterthoughts where credit should only be taken with qualification.

If there is one redeeming feature about my strategy it is that I am fully aware of my own limitations.  I am never certain.  In my blog write-ups I try to phrase every position in terms of what might happen, both the positive and negative, with the expectation that I may have the thesis totally ass-backwards.  If anything, the limitations of the medium (writing) convey more conviction than I generally have.

This doesn’t play well when writing an article that is trying to convince others about what a great idea you’ve just found.  It might be, it might not. Who knows.  What I can say is that as long as I cut my losses quickly, it presents a pretty good risk/reward.  But I have no particular insight into whether its going to pan out or not.

It doesn’t make a compelling narrative.

Nevertheless after another pretty successful year, despite a whole lot of mind-changing and almost constant self-doubt, I can say that it worked pretty well once again.  To summarize:

  1. I freaked out in January when my portfolio lost over 10% in a couple of weeks.
  2. I only tentatively added back as the market bottomed.
  3. I sold out of the years big winner, Clayton Williams, about $100 too soon.
  4. I mostly missed anticipating the Trump rally apart from a position in Health Insurance Innovations and a couple of construction plays I bought in the days immediately following the election.
  5. (As I will describe below) it only donned on me that community banks should be firing on all cylinders in the last few days.

Yet I’m up about 35% since July (my portfolio year end) and about 40% in 2016 (though with the asterisk that it is with far less than $50 million in capital 😉 ).

Most occupations don’t tolerate excessive uncertainty.  I am fortunate to be involved in one of the few that reward it.

The last Month

Last month most stocks in my portfolio stagnated.  The gains I had were fueled by a few oil names (Gastar Oil and Gas, Jones Energy, Resolute Energy) as well as Health Insurance Innovations, Identiv, DSP Group, and a last day move back up by Radisys.

Health Insurance Innovations has been a big winner for me.  If only I had bought more!  The stock has more than doubled since Trump took office.  I sold some of my position in the last days of the year (I mistakenly sold all of it in the practice portfolio so that is why it doesn’t appear in the list below).

The second big winner has been Identiv.  Unlike Health Insurance Innovations, I have not taken anything off the table.  Identiv remains quite cheap, with only a $35 million market capitalization.  There is a rumor that after a presentation given at the Imperial Conference the company suggested some recent business with Amazon, which, if done in mass, could be quite a big contract for the company.  I have no idea if its true though.  The stock has pulled back in the last few days, but I’m not too worried.  As long as business continues along its current trajectory, the stock should do well in the coming year.

Key Energy Services

In mid-December I took a position in an oil services firm, Key Energy Services (KEY).  I was given the idea by someone in the comments section of the blog.  Key Energy operates a number of well services rigs, as well as having businesses in water management, coil tubing, and wireline services.  This is a tough business, and has been a disaster over the last two years.  At least 3 competitors in the space have been through bankruptcy.

At the time I bought the stock it was still trading in bankruptcy.  Similar to Swift, existing shareholders received a piece of the new company and warrants.

Since exiting bankruptcy in late December the stock has traded up quite a bit but I think there is still some value there as oil services demand rises.  What I remember from past cycles is how leveraged these companies are to improving fundamentals.  They gain on both pricing and volume. With both natural gas and oil moving up, this may be the first time since 2012 where Key Energy has had pricing of both commodities as a tailwind.

The company has reduced its G&A, reduced interest expense via the bankruptcy process, and is the first of  its brethren to make it through the restructuring process.

On the negative side, its a low margin business, I don’t get the sense that management was particularly astute heading into the slowdown, and in the current pricing environment even after restructuring they are still EBIDA negative.

Nevertheless I am willing to see if I can ride the cycle here.  Its probably no multi-bagger, but I am looking for a move into the $40’s where I would sell.

Community Banks

The last thing worth mentioning is that after a month and a half of rallying, and the astute comment of Brent Barber asking me why I wasn’t looking at them, I finally spent some time on the community banks.  Its soooo obvious, its painful to think that if I had spent a few hours on November 9th I would have quickly realized the same conclusion and ended up a number of dollars richer as a result.

Nevertheless, a good idea is a good idea.  Though the names I bought are up between 10-20% in the last month and a half, I still think they have much further to run.  I added positions in SB Financial (SBFG – former Rurban Financial, which I’ve talked about in the past and owned a small piece of of for some time), Sound Financial (SFBL – another bank I’ve owned for years), Atlantic Coast Financial (ACFC – which I have owned and written about in the past), Home Federal Bancorp of Louisiana (HFBL), Parke Bancorp (PKBK), and Eagle Bancorp of Montana (EBMT).  I took a basket approach because all of these namess are illiquid and difficult to accumulate in too much size.  I will write these up in more detail shortly.

Portfolio Composition

Click here for the last four weeks of trades.




Week 38: Waiting on a move

Portfolio Performance

Portfolio Composition

Portfolio Trades

So first of all . . . .

I don’t know what happened with the AUM trade

I think there is a gliche with the RBC Practice Account because somehow I sold Golden Minerals (AUM) on Wednesday and ended up with a long AUM in Canadian dollars and a short AUM for the same amount of shares in US dollars on Thursday.  I am hoping the trade resolves itself (in my actual accounts this sort of matched trade in the wrong currency would automatically resolve) but if it doesn’t I will attempt to clean it up myself.  I wanted to point it out because my current portfolio composition looks a little odd as a result.

Buy more banks . . . .

I’m still buying financials and I am actively looking for more to buy.  I got a few more ideas from a new website that I have signed up to called stocktwits (its like twitter for stocks).  The names are: ORRF, FFNW, SNBC, and GBNK.  I haven’t done enough research on any of these names to make an assessment of them.

This week I added to both Shore Bancshares and to Rurban Financial.  I looked at both in more detail this weekend and I am happy with what I see.  I’ll try to put together a post on each shortly.  I’ve already seen a double in Community Bankers Trust, and I’m up 40% since my original purchase of Bank of Commerce Holdings but I have no plans to sell either.

This week I also noticed that one of the banks I held but sold, Xenith Bankshares, popped.  I may buy that one on weakness.  I’m also watching the newswire for anything on Atlantic Coast Financial.  ACFC has a brutal loan book and could very well kick the can at some point, but the stock also has a book value of over $19 (yes that is right, it is a $2 stock with a $19 book value) so it is imaginable that if the banks continue to be on fire the stock could move up rather substantially.

. . . .Less oil

I sold out of Arcan Resources this week.

Why did I sell? Three reasons.

  1. The company ran into some operational problems (again) that cut back production for a time
  2. Spring break up is upon us and while I’m not certain of the extent that Arcan is impacted I do know that the junior oil investment community tends to go on leave from April until June.
  3. I want to put my money in the best opportunities and right now the best opportunity is in the regional and community banks and in the mortgage servicers.

Maybe I am selling at the bottom.  I’m sure there are a few that would scoff at me selling after a 20% drop.  Stupid retail.  So be it.  The banks are going up right now and Arcan is not.  So I would rather own the banks.

To give you a taste of just how impressive the bank performance has been, consider these charts:

A couple new positions

I also have initiated a couple of new positions that I consider myself “restricted” in talking about, at least for the time being.  The first is Cal-Maine Foods, which is a large egg producer.  If you want to get an idea of my reasons behind the purchase, take a look at my recent tweets ( I also signed up for Twitter this week).

A second position that I started was Golden Standard Ventures.  Golden Standard is drilling in Nevada and they may have hit gold in the way of a Carline style deposit.  A real spec here, but one that from what I hear has a reasonable chance of working.

Week 28: Outperformance of the Regional Banks, Buying Xenith Bankshares, Gramercy CDO-2005 and I admit I was wrong (and originally right) about Argonaut Gold

Portfolio Performance:

Portfolio Composition:

If the regional banks are outperforming…

Donald Coxe had a very good conference call last week.  To be honest, I think his calls have been pretty boring for the last 6 months.  He doesn’t have any better grasp on the Euro-crisis then anyone else, yet the situation in Europe is of such a systemic nature that any insight he provided on anything else, always became prempted with the caveat: Assuming all goes well in Europe.

Well last Friday he broke from this mold and made his first endeavour into the terrain of bullish sentiment in some time.

His reason?

The banks.

The main reason for his bullish outlook is the outperformance of the regional bank index, the KRE. As Coxe said:

When you get 3 months of outperformance while the S&P is itself recovering that is a powerful sign that the market has digested the bad news and that things will get better.

The KRE has indeed been outperforming.

I must admit, I’m tentative to proclaim my outright bullishness just yet.  Tto be fair to Coxe, he qualified his own bullihs stance by pointing out that there was still a lot else that had to go right for the bullish call to play out.

I do admit, however, that the signs are beginning to accumulate.  Jobless claims are trending down, the ISM is looking more stable, news out of China (particularly that inflation has fallen) is starting to sound more positive, and heck, even the Italian and Spanish 10-year yields are trending down at the moment.

So what do you buy if you are bullish?

Well, on the conference call Coxe proclaimed (once again) the supremecy of the commodity stocks.  A bit of a broken record is he, but why stop with what works.  Well I am long oil, long gold, thinking about how I might get long copper or coal (but more on that below).  I have those bases covered.  Perhaps the more specific question you might ask, is what does one buy when the KRE is outperforming?

And the logical answer to that?

…buy the regional banks

I’ve been accumulating the shares of a number of regional banks over the past few months.  What is my thesis?

  • The lows of August felt like a bottom
  • There is volume in some bank stocks that typically have had no volume whatsoever (is somebody starting to care?)
  • The housing market in some regions is bottoming
  • The write-downs at many of these banks has peaked
  • How much further below book value these businesses can go?

I’ve been listening to this mortgage broker and originator podcast called Lykken on Lending on my bike ride into work for the last 3 months.  Its interesting stuff.  The first thing that’s interesting is just how intertwined real estate is with regulation.  They actually have a regular segment on this show that is dedicated to new legislation being considered by congress or the senate. Its crazy!  Second thing that is interesting; there is starting to be some signs of life in the mortgage market.  For the first time we are seeing private lenders getting back into the game.  They had a company on a couple weeks ago that was funded by Lew Raneiri (the godfather of securitization) and that is looking for loans that are just below the level of what passes for the GSE’s.

It’s starting again!

In this short clip below, Jim the Realtor, prominently featured on CalculatedRisk, makes out the bull case for a barn-burner spring.  Says Jim: “I think we get into spring time – if rates are still this low – it’s going to be a real frenzy.”

Kyle Bass and MGIC

Another favorite of mine, Kyle Bass, recently bought a large stake (just under 5%) in MGIC.  I stepped through MGIC over Christmas and will review the work I did another time,  but to make a few brief conclusions I determined the value certainly might be there but I just don’t understand the business (the mortgage insurers are hugely levered companies with massive amounts of housing liabilities against them) well enough to pull the trigger.  Specifically, the solvency of MGIC and the rest of the insurers seems to depend as much on the ability of the insurers to mark their liability per payout (in other words how much they owe for the foreclosure they insured) as anything else, and that appears to be a bit of black magic to me.

Nevertheless, MGIC has moved substantially higher since that time, something that seems unlikely if the housing market were about to (triple?) dip again.  Here is what Bass had to say about MGIC and the housing market a couple of months ago.  From the WSJ:

Mr. Bass said that while the housing market was still around two to three years from firmly “bottoming out,” he said any future price declines would be quite modest. “I don’t anticipate a huge decline,” he said.

I think he’s right.  Residential housing is closer to a bottom then a top.  And its bottomed in some markets.

The Housing Market Turns?

Residential housing is the lifeblood of most regional and community banks.  A turn in those markets could turn the fortunes of these companies.That’s why I’ve picked up shares in the following stocks over the last couple of months:

  • Oneida Financial (ONFC)
  • Bank of Commerce Holdings (BOCH)
  • Atlantic Coast Financial (ACFC)
  • Community Bankers Trust (BTC)

Apart from Oneida, these stocks are not for the faint of heart.  I know there are plenty of well capitalized but fairly valued banks out there that can return you 10-15% per year in all likelihood.  I want a bit more than that though.  So I am willing to step out on the limb a bit further to get it.

Xenith Bankshares and the problem with RBC practice accounts

I’m going to get into Xenith in a second but first let me say something about this RBC practice account.

Great idea.  The idea to be able to put fake money into an account, to have it count commissions and to be able to make buys and sells in real time is super.

The problem lies in the execution.  First there was the problem placing orders.  This started back in September.  I wrote them about it. They said they would fix it.  They wrote:

Here we are in January, I still have to do this clugey workaround where before I can place an order I have to start it through my margin account and then at the last step switch the practice account.

Now, just yesterday, another problem.  Apparently I can’t place an order for select NASDAQ stocks.  In particular those that are NASDAQ:CM (capital markets).  This just started.  I phoned RBC.  Luckily I’m on their gold plus customer plan or whatever its called so I get some service.  They look into it, see what’s wrong, but now they have to send it to their “back office people” to fix it.

We shall see.

Thus it is that while I own XBKS, I do not own XBKS in my practice account.  I don’t know when that will happen.  If any of my readers knows of another better service for tracking a mock portfolio, please email me.

Anyways, that’s the story, onto the stock.

My latest bank pick: Xenith Bankshares

Xenith Bankshares is a community bank centered out of Richmond Virginia.

The bank specalizes in making commercial loans, which make up some 88% of their loan book.

Xenith was involved in two transactions during the summer, buying banks from two other distressed Virginia lenders (Paragon Community Bank and Virginia Business Bank or VBB).  In the case of VBB, the bank was bankrupt and the transaction took place through the FDIC.  In the case of Paragon, Xenith just took over the Richmond based operations of the banks.  In both cases, the company is only responsible for the performing loans on these banks books.

The history of Xenith and these two transactions have already been written up in two excellent posts on a website called Frog’s Kiss, here and here.  I will not dwell on the details of the bank to much further, because all the information is there.

Why Xenith?

Xenith is aggressively growing their loan book in Virginia, both through transactions like the above, and organically through new loans.  They have done a good job of making loans, and so far nonperforming assets are not a significant threat.

And yet you aren’t paying much for this growth.  The company has a tangible book value of a little over $65M, whereas at the current share price of $3.70, the market capitalization is a little under $40M.

Why so cheap?

Well for one, the bank isn’t profitable yet.   Xenith has been losing about $1.5M per quarter all in for the last couple of years.  For two, it is a bank and after all no one wants to own a bank, right?

Of course that might be about to change.

Part of the bet here is that the management at Xenith can integrate these recent transactions and bring their profitability up to the company’s standard.    The company was created originally with a takeover of First Bankshares.  This was a sleepy little commercial lender that had a fairly weak interest margin.  The management at Xenith have been successful in increasing the NIM significantly since that time (see below).  The expectation is that they will do something similar with the newly acquired loan and deposit base.

The second part of the bet is that Xenith has a lot more room to grow.  The company’s tangible equity (as noted above), is about $64M.  Loans and securities and other risk assets are about $360M.  So the company is only employing about 6x leverage.  They should be able to raise this to around 10x over the course of the next year.

If they do, and are successful in their lending endeavors, you might expect the company to deliver a return of somewhere around 1% to 1.5% return on assets.  Taken another way, you might expect the company to deliver somewhere between 8% and 12% return on current equity when its all said and done.  Projecting either of these metrics leads to a fairly cheap earnings multiple (somewhere between 4x and 7.5x earnings depending on their success.   This suggests that as this plays out over the next couple of years, you could expect the stock price to at least double (and optimistically quadruple if the banks become loved again) from current levels as they move ahead.

Gramercy Capital: CDO-2005 passes the over-collateralization test?

With Gramercy, as much sleuthing that I am doing of the company, I feel like I do almost as much sleuthing of other investors.  With Gramercy, one of the best to follow is PlanMaestro.  He posts a blog called Variant Perceptions, also posts on yahoo, investorshub, and corner of berkshire and hathaway.  In this case the relevant piece comes from the latter.  Says Plan:

Jameson Inn was already written off 100% for OC purposes and CDO 2005 passed again its most recent test .

As those of you that read last weeks letter would know, I pointed out that CDO 2005 was unlikely to pass any time soon if it was only curing its undercollateralization with interest payments.  To have passed again, one of two things must have happened.

  1. About $100M of the assets held were paid back, with the proceeds being used to pay out the senior CDO holders
  2. One of the written down loans began to reperform

To discuss the possibility of the latter, there was news this week that the Vegas Hilton, which is in receivership and which has been 60% written down by Gramercy in CDO 2005.  For some time now Goldman Sachs, which holds the mortgage on the LVH along with Gramercy and another party, have been trying to convince the courts to let them run the hotel and gaming operations while it goes through the foreclosure process.  The problem is that the gaming license is owned by the previous owners Colony Resorts.  Colony Resorts had been fighting back saying that if their gaming license was used by the receiver, they could be liable without having any oversight control.

The issue was very recently brought to the court, which ruled that the receiver would only have non-gaming authority.  But then the Nevada Gaming Commission passed its own contrary verdict, allowing for the casino to operate under the existing license.  The matter went back to the courts and just last week news came out that the ruling was in favor of Goldman.

Given the information I have, I can only speculate that this contributed to the change in the collateral test.  The loan sat on the books of CDO 2005 at about $29M as of March.  It was apparently written down 60%, though I have no confirmation of that figure.    CDO 2005 was about $18M short as of last October.  Putting that all together, it seems very unlikely the loan could have had that big of an impact on the collateral test.  Still its an interesting exercise to go through, and a positive development both that the CDO 2005 is now passing, and that the LVH loan is likely accruing some interest again.

Argonaut Gold Pulls together a Strong PEA

This whole short Argonaut Gold trade didn’t exactly work out..  In fact, I don’t know what I was thinking.  I need to start reading my own press clippings.

To recap, two weeks ago I shorted some Argonaut against part of my long of Aurizon Gold. My reasoning was that if gold continued to fall Argonaut, being much more highly valued then Aurizon and at the same time having less cash, would have further to tumble.

I’m a little embarrassed that I made this suggestion. It was only two months ago that I had been arguing that Argonaut was one of the better gold stock investments out there.  I had it right originally. That thesis, which is available here, was that Argonaut had very strong growth opportunities and those growth opportunities could be accomplished with minimal CAPEX. If there is one thing the Street loves, its growth. If there is another thing the Street loves, its not having to put up a bunch of cash up front to get that growth.

Today the company released the PEA it had completed on the La Colorada project.

The PEA showed the following highlights:

  • Initial Capital Expenditure for the project is estimated at $14.5 million with a Sustaining Capital of $11.7 million.
  • Operating costs of $620/oz over the LOM, including $1.50/t mining costs, $2.36/t processing costs, and a 3.4:1 strip ratio
  • Gold equivalent production of 53,000oz per year over 9 years
  • Pre-tax Net Present Value (“NPV”) of $278 million using a 5% discount rate at $1500/oz gold

Overall the numbers would be mediocre if it were not for the capital costs, which at $14.5M is chump change for a project this size.  This is even less than the my estimate of $25M to which I commented: There are not many companies that can boast near term production potential with so little up front costs.

When I had shorted Argonaut against a portion of my Aurizon long it was with the idea that the quarterly results might show disappointment and the idea that the gold price might be susceptible to an even bigger pullback. El Castillo has underperformed the last couple of quarters, and with a mine that is of as low a grade as El Castillo the operators run a very fine line between success and failure.

That could still be the case, but having witnessed the stocks continuing rise I am reluctant to wait and find out. I got out Monday when the PEA came out.  At this level ($8) the stock is too expensive to buy.  I have to just admit I made a mistake by selling it in the first place (I owned both Aurizon and Argonaut back in October, but sold Argonaut after poor 3rd quarter results), and move on.

Is Aurizon a Value Trap?

How bad was that decision I made back in October to sell Argonaut and hold Aurizon?  Well, I owned both stocks until the middle of October, when I sold Argonaut after less than impressive 3rd quarter results.


This is a painful chart for me to look at.

Nevertheless, pain is a necessary condition of learning, and it helps some time to agonize over your own stupidity for a while, just so that its really grilled into you not to do the same thing again.

With that in mind, what did I do wrong?

Aurizon Mines: Visions of Joanna someday

In contrast to Argonaut, Aurizon does not seem to be in much of a rush at all to bring Joanna into production.  This timeline says it all:

May 12th 2008

Aurizon first commissioned a pre-feasibility study on Joanna.

November 11, 2009

Aurizon finally received that pre-feasibility study and proceed to a full feasibility study.

September 14th 2010

Aurizon notifies shareholders that the original recovery process assumed (called the Albion process) would show lower recoveries and higher costs than first anticipated. Additional metallurgical test work would be done and the study delayed until mid 2011.

August 11, 2011

Aurizon delays the feasibility study for Joanna again, saying: “the projected capital and operating costs appear to be significantly higher than previously anticipated. The increased scope of the project, as a result of the expanded mineral resource base, has increased capital costs, including those associated with an autoclave process. The costs of ore and waste stockpiles, tailings and of materials and equipment have also all been trending higher, along with the gold price.”

January 11, 2012

Another update giving an ETA: Feasibility study work on the Hosco deposit will continue in 2012 with completion of the study anticipated by mid-year. The feasibility study will incorporate a reserve update based on the increased mineral resource estimate announced on June 13, 2011, together with results of metallurgical pilot tests, a geotechnical study, updated capital and operating cost estimates, and other relevant studies.

Its been almost 4 years since the original pre-feasibility study on Joanna was complete! At this rate they should be mining by 2100.

As is obvious from above, there have been some metallurgical difficulties with Joanna. Was I too optimistic with my analysis?

To compare, the original pre-feasibility study assumed $187M in CAPEX. The operating costs were estimated at $434/oz. My analysis assumed $215M CAPEX, and operating costs of $717/oz. I think I have been safely conservative on the operating costs. I may turn out to be less so with the CAPEX.

The more fundamental point is that when I invested in Aurizon I strayed from my usual criteria for choosing mining companies in a couple key respects. Both of these have come back to haunt me:

A. Look for miners with a strong pipeline of growth. The market likes growth. It does not always appreciate value. The reason there is supposed “value stocks” is because the market does not appreciate value in itself.

B. Capital costs must be low and mining methods must be simple. The best mine to invest in is a simple heap leach deposit. High capital costs tend to get higher. Complicated mining and recovery processes tend to underperform to plan.

So what am I going to do about it?

Unfortunately there is not much I can do. Argonaut is $8 and Aurizon is $5. Most of the move in AR has been done. I’m not going to chase it at this point. Aurizon is probably much akin to OceanaGold, which I have played much more intelligently by buying the stock at $2.20 and selling it at $2.70 again and again. With Aurizon those numbers are probably around $5 and $6. Indeed I did sell some Aurizon around the $6 range the last time it was there but I think that its time to recognize that without a strong feasibility study for Joanna, that $6-$7 is about all you can expect here.


I’m getting too many stocks in my portfolio.  I am also seeing my cash position dwindle because I keep picking up new stocks without selling old ones.  I am still extremely cautious about Europe, and being so, I am getting uncomfortable with both of these trends in my portfolio.  In the next couple weeks I am going to reevaluate what I own and start paring where I need to.  The problem, as it always is, is that I like the prospects of all the stocks I own.  Unfortunately, as I think I showed rather clearly in my last post describing my 2011 performance, I am just as often wrong about that as I am right.  The likelihood of my own fallibility must never be underestimated.

Letter 26: A Move in ACFC, the end of tax loss selling for gold stocks, Mispricing of Aurizon Mines, and All the Devils are Here

All the Devils are Here (though most have probably moved to Europe)

Over the winter break I read the book All the Devils are Here, by Bethany Mclean and Joe Nocera. The book essentially traces out all the strands that culminated in the panic of September 2008. The book identified the following factors:

  1. A reliance on ideology instead of analysis. In particular this applies to the Federal Reserve and Alan Greenspan, whose ideological “market is always right” view permeated the decisions of the Fed and to some extent those of the other regulatory bodies. But more generally, ideology, specifically free market ideology, seemed to permeate through all the political and financial institutions to the point that it replaced a sober look at reality. Similarly, for many traders and investment bankers, an ideological reliance on “the model” often led to an ignorance of the potential risks of an outlier scenario
  2. The absence of regulation. For a variety of reasons (the power of the lobby groups, the political infighting between the regulatory bodies, the ideological free market view of the participants and the myopic focus on regulators on Fannie and Freddie) an attempt to regulate the subprime industry was hardly even contemplated until it was too late.
  3. The development of securitization. The most important consequence of the innovations to pool mortgages, to tranche pools, and then to create pools of pools (CDO’s) was that the lender and the borrower became further and further divorced by more degrees of separation. The securitization process created so many layers of intermediaries between the party who actually ended up with the loan on their books and the party that took the money that risks were easily lost in the translation.
  4. The rubber stamped AAA status provided by the ratings agencies. Some books focus on how the rating agencies didn’t understand what they were rating. Mclean and Nocera point out that the revenue structure of the agencies was doomed to be corrupted. A system where the raters are paid by the producers of the securities they rate might be considered to be an insane one. The result was that the agencies were played off against one another by the investment banks; market share went to the most relaxed rating. Add to this the fact that the agencies, particularly Moody’s, became focused on profits at the expense of their inherent conflict of interest, and you had a situation ripe for abuse.
  5. Greed. Politicians more concerned with their own campaign donations than with promoting sustainable public policy. Company executives intent strictly on their own promotion and profit. Mortgage originators with essentially no moral compass at all. The system was (and is) corrupt.
  6. A lack of understanding. The same characters at play as with greed. So few people saw the disaster coming. Sure some did, there were a few regulators and a few hedge funds that saw how unsustainable the leverage being piled on in the mortgage sector was. But the vast majority didn’t have a clue. Even the supposed smart money didn’t really get smart until 2006-2007.

It is this last point, the lack of understanding, that I think is most relevant to what we face today. It really surprised me how little the people in influential and powerful positions understood the concepts that they were making decisions with regard to. Even Hank Paulson, who is actually portrayed in quite a positive light, was completely blind to the corruption and leverage being amassed in the mortgage market.

This naturally begs the question of Europe: how many of the politicians and bureaucrats in the EU really understand the situation they are trying to navigate? Do they really know the risks inherent in the decisions that they are making? Do they even really understand the banking sector they are trying to protect?

The last 6 months for me has been an education in how the modern banking system works. I have been trying to read all that I can, all the boring, technical aspects. And I don’t think for a minute think that I’ve wrapped my head around it. There are so many moving and interdependent parts. It’s also not a very tangible subject. It simply isn’t something that is easily understood.

Thus I think it’s a legitimate question as to whether the bureaucrats of Europe have the understanding required to navigate the minefield of sovereign defaults and banking bankruptcies. As Lehman showed, it only takes one mistake to create a loss of confidence that spirals uncontrollably.

How can you take on risk with this in mind?

The end of (tax loss) selling?

The week after tax-loss selling is always an interesting one.  It provides the first glimpse into whether a security has been facing unrelenting selling because of investors simply wishing to take their losses (and their tax breaks) and move on, or whether something more nefarious is at play.  Along the lines of the former, this week provided a rather marked jump in a number of the regional bank stocks that I have initiated a position in.  Most conspicuous of these moves was that of Atlantic Coast Financial.

A Take-over Imminent for ACFC?

ACFC had a rather astounding 50%+ move this week.  I really have no idea what precipitated the move.  To take it with a grain of salt, the volume for the stock this week was less than spectacular, though the same could be said for almost the entire move down.

As I pointed out last week the stock is a bit of a flyer; the bank is a mortgage lender in one of the most crippled mortgage markets (Florida), they have bad loans coming out their wazoo, and a stock that has fallen from $10 to $1 in less than a year generally does not do so on speculative panic alone.  Nevertheless, part of the story is the book value, which even with 3 years of bad loan write-downs lies at a rather surreal $19 per share (versus a share price of $1.70 when I bought it).

The other part of the story is simply the realization that what is going on with this bank (and many of these little community banks that got caught up in making bad loans at the wrong time) is a race between the write-downs of their past transgressions and the earnings of their current performing loan book.   With ACFC it is not at all clear to me that the bad loans will win out; in fact I tried to make the case last week that with a little luck (and an improving economy) the performing book may very soon be able to out-earn the losses on a consistent basis.  If this happens, the shares are clearly worth more than 10% of book value.  Even if it just becomes a possibility, a shrewd competitor may be tempted to take a plunge.  I constructed the chart below to try to see where ACFC is in that process.  The chart compares earnings before provisions (black) to the quarter over quarter change in non-performing loans (red).  Its basically a look at whether the company is out-earning the loans going bad each quarter.  The 3rd quarter was the first in four that the black won out.

Community Bankers Trust: Another Regional Bank with a Move of its Own

While ACFC was the best of the lot of regionals, there were others that showed signs of life.  Community Bankers Trust surged on Friday.  The stock remains at about 1/3 of book value.  If it were not for Europe and the ever-impending doom there, I would add more.  As well, Oneida Financial continues to push higher.  Unlike ACFC, BOCH and BTC, Oneida is a terribly boring bank trading at about book that is probably going to do nothing but increase in price by 10% a year and pay a 5% dividend until one day it gets bought out.  At some point I might get bored with with relatively low return, but in this environment, I am happy to take a reward with so little risk.

Will Gold Stocks Rise now that Tax-loss Selling is over?

As for the golds, Esperanza, Canaco and Geologix all are showing classic signs of a let-up in tax loss selling.  All are well above where I bought them.  Aurizon, on the other hand, continues to be sold rather indiscriminately.  Yes, I realize that the price of gold is getting clobbered on a regular basis.  I can appreciate that investors may be questioning the wisdom of holding gold as a hedge to anything given the fact that it seems to dramatically underperform on risk-off days.

Still, I scratch my head at Aurizon.  Here is a low cost gold producer that is comparatively less correlated to the price of gold than most of its competitors.   For one, if you are low cost you are by definition high margin.  Thus, a $30 move in the price of gold is of much less impact to a producer with $1000/oz margin (like Aurizon), than say a producer with a $500/oz margin.  Yet Aurizon regularly trades down MORE than your average gold producer on the down days.

Going Short Argonaut Gold and long Aurizon Mines

So confounded have I been that in order to hedge my risk with Aurizon I have decided to take a short position in a fellow gold producer, Argonaut Gold.  To be sure, there is nothing wrong with Argonaut Gold.  I wrote the company up rather glowingly a couple months ago.  However that was at $5, and now AR trades at $7, while in the same time Aurizon has fallen to less than $5. Below is a comparison of the key metrics of both companies.

So to briefly summarize the above, Aurizon produces more than twice as much gold, it produces over double the cash flow, and to top it off, Aurizon’s 3rd quarter was stronger than Argonaut’s.  Argonaut potentially has a better pipeline of projects, but this is more than nullified by the fact that Aurizon trades at almost half the price on a per producing ounce basis, produces those ounces at $50-$100 cheaper, and has over $1 in cash on its balance sheet while Argonaut has a mere 30 cents. It simply doesn’t make sense.

While I remain bullish the price of gold, I also remain wary that I am not very right in this bullishness at the moment, and so it seems like the prudent thing to do to short what seems relatively over valued and buy what seems relatively undervalued.  Anyways, that is what I did.

I also bought back OceanaGold for another run.  Its getting to be repetitive, but it has been a consistant source of profits.  Buy OceanaGold below $2.20 and sell it above $2.70.   I must have done this 3 times already in the last 9 months.


Letter 24: Risk and Reward, Atna Analysis, More Community Banks

Last week I wrote that I did not understand why  the market was reacting as favourably as it was to the European proposals that came out of the Dec 9th summit.

A tweak here, a tweak there and pretty soon you have… well not a whole lot to be honest.

In a way I felt vindicated  by the market collapse that occurred in the early part of this week.  In another way I felt sick to my stomach, because though I have been creating an evermore conservative weighting to my portfolio, when the shit hits you still feel it.

Kyle Bass was on CNBC this week giving some more detail on his doomsday-like expectations:

The observation that deposits are leaving Greek banks at an annualized rate of almost 50% is somewhat frightening.  Clearly this crisis is going to come to a head soon.

John Mauldin publishes a great conversation between Charles Gave and Anatole Kaletsky.   It is quite provoking, and its hard to walk away after reading it without feeling the impending doom that awaits the Eurozone.  Kaletsky and Gave both make the quite reasonable point that perhaps Germany would prefer a break-up of the Eurozone.  If you watch what Germany is doing, and ignore the platitudes they are saying, you might question their motives.  Kaletsky points out that of the necessary measures to fix the Eurozone, Germany seems to be steadfastly opposed to both Eurobonds and to ECB intervention.  Absent those  measures, what hope does the Eurozone have?  Perhaps that is the plan all along.

Gold Stocks – I should went all out

Gold stocks got CREAMED this week.  I had been lightening up on my gold stocks the week before in anticipation that something might be about to hit.  I didn’t like the way gold was going, I didn’t like the fact that the WSJ was penning articles describing a dearth of Indian demand, and I didn’t like that Draghi talked tough during the EU summit, suggesting that money printing was still some time off.

Nevertheless being that I was not fully out of gold stocks, I got smacked about pretty good over the course of the week.   Atna, Aurizon, and with Lydian all performed quite miserably.

What’s Wrong with Aurizon?

Aurizon is a surprise to me.  I expected the stock to hold up better than it has been.  I might have expected its performance to be closer to that of Alamos.  Both are low cost producers.  Both are single mine operations.  Yet the valuation difference between the two is somewhat staggering.

I can only guess that there is a strong seller of Aurizon out there that wants to be out of the stock by year end.  I can only hope that the new year will bring some sanity to the stock.

While reviewing Aurizon, I began to wonder how much having a AMEX listing hurts the stock.  Anecdotally it appeared to me  that the Canadian stocks with AMEX listings are much more volatile then those without.  I decided to take a closer look.

I grabbed price data since August 1st for 9 stocks, 5 with AMEX listings and 4 without.  From the web I grabbed a visual basic function that calculates volatility based on the following Black-Scholes formula.

For purposes of Black-Scholes calculations, volatility is the standard deviation of the periodic percent change in prices, divided by the square root of time.  Volatility is emphatically NOT the same as “beta”, which measures the correlation of a security’s price movements with those of the overall market.  Neither is volatility simply a measure of the standard deviation of a security’s closing prices over time.

Here is the volatility of each security:

Is there a correlation?  Perhaps, though its not as clear a one as I had suspected.   The distinction is most clear between Aurizon, Alamos and Argonaut Gold.  There is no reason, in my opinion, that Aurizon is so much volatile than these other two stocks.  But apart from that, volatility seems similar between stocks on the two indexes.

I bought back some of the shares of Aurizon at $5.07 that I had sold at over $6 a few weeks ago.

The NPV of Atna

Another stock to get clobbered this week was Atna Resources.  I mentioned a couple weeks ago that I had finished an analyses of the company and would post shortly.  I never did that post, until now.

Below is the after tax NPV10 that I calculated for Atna at various gold prices.

I based my model on the following assumptions:


  • A 11year mine life, at 40,000 t/d
  • Total produced ounces of 476,000 oz over LOM
  • 0.017 oz/t resource over the mine life, strip ratio of 4 and with 80% recoveries
  • Resulting in gold production of  39,700 oz per year
  • Mining costs of $1.30/t mined, milling costs of $4/t milled and G&A costs of $1.7/t mined
  • Cash costs of $898/oz over LOM


  • A 15 year mine life, beginning at 350t/d and ramping to 750t/d by year 4.
  • Total produced ounces of 940,000 oz over LOM
  • 0.4 oz/t resource over the mine life, diluted by 30% with 90% recoveries, resulting in gold production beginning at 50,000 oz and ramping to 75,000 oz.
  • Mining costs of $110/t, milling costs of $50/t and G&A costs of $11/t
  • Cash costs of $687/oz over LOM


  • A 8 year mine life, at 24,000 t/d
  • Total produced ounces of 292,000 oz over LOM
  • 0.026 oz/t resource over the mine life, strip ratio of 4 and with 80% recoveries
  • Resulting in gold production of  36,400 oz per year
  • Mining costs of $1.30/t mined, milling costs of $4/t milled and G&A costs of $1.14/t mined
  • Cash costs of $560/oz over LOM

Columbia and Cecil:

  • To the current resource of each I assigned a simple asset value per ounce of $40/oz measured and indicated and $20/oz inferred on the total resource of both properties

Atna is, in my opinion, is one of the best gold stock investments out there.  As demonstrated above, the stock is trading at about 1/3 of its NPV 10 at $1500 gold.  If I wanted to get more aggressive in my evaluation, I would note that many companies are moving to value feasibility on NPV5.  On an NPV 5 basis Atna is worth $3.86 per share at $1500/oz gold.  That number jumps to almost $8 per share at $2100/oz gold.  Clearly there is upside once the momentum begins to build.

I added to my position in Atna on Friday at 78 cents.

Taking Advantage of the Collapse

In addition to Atna and Aurizon, I also added new positions in a few juniors.  Call it the beginnings of a basket; I added a couple of non-producing juniors with deposits to my portfolio this week:

Geologix was recommended by Rick Rule as a takeover candidate on BNN about a year ago.  Since that time the stock has fallen significantly.  The company has a very low grade copper-gold deposit called Tepal in Mexico.  The PEA that was published on Tepal a few months ago put the NPV5 of the project at $412M based on $1000/oz gold and 2.75/lb copper.  Geologix has $14M of cash on hand.  With 145M shares outstanding, the market capitalization of the company was $28M at my entry price of 20 cents.  That puts half the market cap in cash and the other half in a project with an NPV that is nearly 10x the value of the company.  Something has to give here.

Esperanza Resources is another old Rick Rule recommendation.  Rule doesn’t talk much about specific stocks anymore, but there is some evidence that he is still interested in the company. .  The company certainly fits the bill of the sort of stock Rule likes.  Esperanza has 1Moz of gold in Mexico.   It’s a heap leach project so it should be able to be brought on production without a massive capital requirement (about $100M).  Like Geologix, the company has almost half its market cap ($100M) in cash on hand ($50M).

I plan to add more to both of these stocks in the coming weeks.

Regional Banks: A  Position in Community Bankers Trust

Community Bankers Trust (BTC) hit my bid when it sold off back down to a dollar this week.  BTC is trading at 27% of tangible book value.  This is, of course, partially because of the large number of non-performing loans on their books.  Non-performing loans make up 8.9% of total loans in the Q3 quarter.  This was down from 10.1% in Q2.  In fact, there are some encouraging signs that the worst of the loan losses are behind us.  The company has shown 3 quarters of lower loan amounts 30-89 days past due.  This trend is beginning to show up in the total non-performing loans, which decreased for the first time in a year in Q3.

Moreover, as I have pointed out previously, insiders continue to buy the stock.  Third quarter purchases by insiders were a little less than $50,000.

And Another Regional Bank Position in Atlantic Coast Financial

To be perfectly honest, I might have made a mistake here.  I’ve only put a very tiny amount of capital at risk, but even that may have been too much.   Atlantic Coast Financial (ACFC) is a lottery ticket.  I bought the stock at $1.70 on Friday.  There is just as much chance that it will go to zero as there is that it will double.

ACFC is a former Mutual Holding company that did their second step bank in February.  The second step added cash to the balance sheet and resulted in a bank trading well below book value.  ACFC trades at a rather crazy 10% of tangible book.  Clearly there is more to the story.

The more to the story is that the bank is centered in Jacksonville Florida.  They primarily make residential real estate loans.  Real estate in Jacksonville has not done particularly well over the last few years (though it appears to be bottoming).

The falling real estate prices have led to skyrocketing non-performing loans.  Those non-performing loans have not shown any sign of peaking yet (thus the possible mistake on my part).

The questions are, how many of these nonperforming loans will eventually be written down, and will there be value left in the equity once the non-performing loans are written down.

What drove me to take a small position in the stock was in part that an improving economy, and stabilizing home prices in Jacksonville, may mitigate further deterioration of the bank assets.  As well, the bank is generating decent earnings before provisions.  Ignoring provisions in Q3, the bank earned $1.16 per share.  In Q2 that number was $0.55.

What is going on at ACFC is something akin to a tug-of-war, whereby on the one hand loan losses strip away value every quarter, while on the other earnings power of the performing loans adds value back.  The share price is so low that it doesn’t take much a a shift in the dynamic between these two forces to change the value equation substantially.  Its easy to see how a stabilization in non-performing loans could quickly allow the earnings power to win the race and shareholder value to go up substantially.

The other factor in my decision to buy was the recent announcement that the company was looking into strategic alternatives.

On November 28, 2011, Atlantic Coast Financial Corporation issued a press release announcing that its Board of Directors has engaged Stifel, Nicolaus & Company, Incorporated to assist the Company in exploring strategic alternatives to enhance stockholder value

Part of the reason that the company is looking for options is that they are not in compliacne with the Individual Minimum Capital Requirement (IMCR) agreed to by the Bank with the Office of Thrift Supervision on May 13, 2011.  Under the IMCR, ACFC agreed to achieve Tier 1 leverage ratio of 7.0% as of September 30, 2011. Tier I capital at the bank is 6.22% right now.

It is a far from perfect scene.  Nevertheless, an improving US economy and stabilizing housing prices could give me a decent return on the stock.  The book value of $19 is unrealistic, a return to $3 is not.

Portfolio Composition