The Baupost Group Speaks out on Thrifts

The Baupost Group Speaks out on Thri fts

The Baupost Group has been a sizeable investor in thrifts over the last several years.
Why
do you
find thrift stocks to be attractive
investments?
We fi nd the i nvestment opportuni ty created by the mutual to stock conversi on process to be
compel l i ng. Essenti al l y. when a thri ft converts from mutual to stock orvnershi p, deposi tors
are gi ven
the opportuni ty to buy shares representi ng
100% of the i nsti tuti on. Cnl i ke al l
other i ni ti al publ i c
offeri ngs of shares, however, the proceeds
from a thri ft conversi on
do
not go to a selling shareholder,
but rather are added to the capital of an institution. Since all
the shares of the institution are sold on the offering, and there are no original shareholders.
buyers ofshares recei ve the ful l benefi t ofthi s addi ti onal capi tal . In effect, purchasers
of
shares buy their own capital and receive the bank for free.
In addi ti on to thi s "free l unch", a thri ft i ni ti ai publ i c
offeri ng has several other attracti ve
characteri sti cs.
Unl i ke a typi cal publ i c
offeri ng where i nsi ders sel l shares to the publ i c
and
pocket
the cash, in a thrift offering insiders buy shares at the same price
and on the same
terms as the public.
Unlike most public
offerings where shares are offered at a steep
multiple of earnings and a high price
to book value ratio, thrift conversions arc virtually
always priced
at a significant discount to book value and at a low price to earnings ratio.
Unlike a usual initial stock offering where a company and its shareholders.benefit
from
pricing
the offering as high as possible,
in a thrift offering there is no such interest because
there are no stockholders going
in to the offering. In fact, since in a thrift conversion
management buys shares and receives stock options at the offering price.
there is some
i ncenti ve to hol d down the i ni ti al offeri ng pri ce.
Thrifts are underfollowed by Watl Street analysts.
With 400-500 estimated conversions
in
the last 4 years,
no firm or analyst can hope to follow them all. Those that try usually
produce
one line of computer printout
on each stock. Most firms choose to follow 20-30
stocks on a more intimate basis, while ignoring hundreds of others. The smallest ones are
nearly always ignored. This obviously creates investment opportunities.
Does this mean that every thrift conversion
is an attractive investment?
Not at alil When you
invest in a well run thrift with significant
earnings and book value, an
investor in effect buys his own capital
and receives
the valuable
existing bank for free.
When you i nvest i n a troubl ed thri ft wi th bad l oans, goodwi l l
or poor
resul ts, you
may be
buyi ng a busi ness of questi onabl e
val ue or even of negati ve worti , where the l i abi l i ti i s
exceed the assets. In this circumstance, you are no longer buying your own money and
getting
a business for free. Rather, you are pouring your dollars down the drain, by
subsidizing the net worth deficit of the existing institution. An investor in the conversion of
an institution with positive
economic value is, because of the mathematics of thrift
conversi ons, buyi ng somethi ng bel ow i ts underl yi ng val ue. An i nvestor i n a thri ft of
negative true worth is converseiy paying
above intrinsic value.
a.
A.
You have been referring almost exclusively to value and net worth. How do you analyze
thrift stocks, and what importance do you place on eamings?
There are many ways to evaluate a thrift investment. Many investors focus exclusively
on
e-arnings and earnings growth.
Others emphasize thrifts as interest rate plays (this
despite
the i mproved matchi ng of assets and l i abi l i ti es by most thri fts.) We focus our attenti on
more on assets and l i abi l i ti es than most i nvestors.
The Baupost Group has a value investment philosophy, where we try to buy dollars for fifty
cents. We focus on ri sk as wel l as return, hopi ng to mi ni mi ze downsi de ri sk for each
i nvestment and wi thi n our porl fol i o.
Ri sk i s a compl ex subj ect, and some peopl e
use i t to
refer to volatility, while others use it when referring to outperforming or underperforming
the market. We are not concemed with relative
performance.
and believe that volatilitv
often creates opportuni ti es. To us, ri sk i s how much you can l ose and the probabi l i ty of
l osi ng i t.
A thri ft wi th hi gh qual i ty assets i s l ess ri sky than one wi th l ower qual i ty l oans and
i nvestments. A thri ft wi th a hi gh capi tal rati o i s l ess ri sky than a thri ft that i s at or bel ow
regul atory mi ni mums. A thri ft wi th a sl ow groMh rate i s safer than one growi ng rapi dl y, as
qui ck growth i s o{ten accompani ed by ri sk taki ng.
When anal yzi ng thri fts, we l ook onl y at l ow ri sk i nsti tuti ons. Many busi ness probl ems can
be overcome, bttt not bad asset quality. There is no spread on a loan that would convince us
that a thrift should accept a couple of percent
of extra return for risking 100% of its capital.
When we look at a high quality thrift, we attempt to calculate its value in a conservative
way. We have a cal cul ati on we cal l adj usted book val ue, where we begi n wi th book val ue
and adjust it up for such items as hidden real estate values, investments wofih more than
carryi ng val ue, and the val ue of a stabl e l ow cost deposi t base. We adj ust book val ue down
for goodwi l l . l i kel y l oan l osses, and l oans or i nvestment securi ti es that coul d be sol d onl y
for less than carrying value. Our adjusted book value is one stab at what a thrift mieht be
worth as an ongoi ng busi ness.
We calculate separately what a thrift might be worth in a takeover, using rscent comparable
deal s as a gui del i ne.
More often than not, our adi usted book val ue and merser val ue are
very si mi l ar
We also look at earnings, which we adjust for nonrecurring items both up and down. To us,
nonrecurring items include all securities gains and losses, real estate gains and losses,
branch sales. real estate development profits, accounting change gains and losses, and the
like.
Quality
of earnings is extremely important to us; earnings derived from recurring
spread income are far more valuable in our eyes than nonrecurring items or than loan
origination fees which are highly volatile. Institutions with low overhead costs are clearly
preferable to high cost shops; both because ofthe profitability and also the greater
flexibility in times of interest margin pressures.
a\
v.
A.
In sum, we emphasize
asset value more than shoft-term
earnings in our analysis
and prefer
thrift investments
rvhere management
is oriented toward building
long-term value rather
t han pl ayi ng
quart erl y
earni ngs games.
Nobody del i beratel y
makes bad l oans. How do you
anti ci pate rvhere probl ems
are l i kel y to
appear?
We try to imagine ourselves
in the headquarters
of whatever
thrift we are analyzing.
We
say to ourselves,
here in Poughkeepsie,
or Albany, or Johnstown, can we make loans in
California or Florida or North Carolina
and have a clue about what is really going
on? Why
woul d borrowers i n these pl aces
use a thri ft 2,000
or 3,000 mi l es away, i f i t *.."-n' t
u
parlicularly
good
deal for the borrower?
We ask ourselves if the management which has
made only residentia! mortgage
loans for the past two decades can pcssibly
evaluate
constructi on
or commerci al
l oans, or i f they can possi bl y
moni tor the medi ocre commerci al
bankers brought in to make these loans. We ask ourselves if a thrift u,hich made only
$25
mi l l i on of l oans 3 years
ago can possi bl y
be moni tori ng
l oan qual i ty
i f they are maki ng
$250 mi l l i on
of l oans today.
Management
may be abl e to achi eve
al l of the above. If they do, they are super managers
and deserve much credit. Since we cannot
sepal'ate ahead of time who will be ,u"".rr-fuI
and who won't, we simply avoid betting
whcnever there is apparent risk.
We thus avoid thrifts with a significant
exposure to construction
loans, commercial
mortgage loans and consumer
loans unless they have a long track record of success in those
areas. We avoid thrifts with any meaningful
exposure
to out of state loans, to unsecured
personal
loans, to exotica such as tax shelter installment
notes, to real estate development
activities conducted
by the thrift itself, or to
junk
bonds.
Aren't you
excluding a large number
of potential
investment opportunities
by ignoring the
more aggressive
thrilts? Higher risk, higher retum.
Right?
We don't mind rnissing some opportunities
in the thrift area or in anyother.
Thrifts which
stick to traditional ..ul
"_t111"
lending practices
are fairly easy to analyze.Their
assets are
understandable,
their liabilities
are clear. Their cost structure
can be analyzed,their
market
st udi ed.
Riskier thrifts are much harder to understand.
The riskiness
of the assets is unclear
to
outsiders, possibly
even to insiders.
Thus you
are in the dark about real asset values and
real eami ngs.
When a portfol i o
consi sts of onl y very l ow ri sk l oans, a mi ni mal l oan l oss
reserve wi l l suffi ce' Wi th ri ski er l oans, a greater
l oan l oss provi si on
i s cri ti cal . How much
is enough - loA,Toh, 5o/o, more? This provision
will have a major impact on earnings, yet
is
virfually unanalyzable,
except in hindsight.
We are not saying that a riskier thrift cannot be a good
investment.
We are simply saying
that we are not capable
of analyzing
them as investments.
a.
A.
You didn't mention market share as part
of your
investment
analysis. why not?
A strong market presence
is obviously
of value. This value should translate into earnings
over ti me. Thus, we bel i eve that market
share i s al ready i mpl i ci tl y part of our earni ngs.
anal ysi s.
A n'umber of thrifts rve have spoken with
speak of market share as an asset in its own right.
An asset only has value if it generates
present
or fufure
cash flow or earnings.
pursuit
of
market share at the expense
of current profits
can be misguided. Market share should
be
cherished for the returns it can provide,
but is not of value if current returns must be
conti nual l y
sacri fi ced to mai ntai n share.
You evidently purchase thrifts upon their conversion.
Do you ever purchase
thrifts that
have been publ i c
for awhi l e?
Yes. Whi l e thri fts are often most underval ued
at the ti me of conversi on, they occasi onal l v
fal l to acceptabl e di scounts
because of market forces.
We try to keep an eye on all public
thrift stocks and new offerings that meet our quality
and
val ue cri teri a to take advantage of opportuni ti es
ari si ng from pri ce
di spari ti es.
Are you
concemed with short-term price
fluctuations
of thrift stocks?
We are aware of short-term price
movements
because we are always in the market looking
for oppoftunities
to both buy and sell.
When we own a thrift stock as an investment,
and have confidence in the asset quality and
in the long-term
motivations
of management,
we are not concemed with short-terrn price
movements. Long-term
business value is our focal point.
When we find out that the assets
are of low quality
or that management is not shareholder
oriented. we seli.
How do you decide when to hold and when to sell a thrift stock?
We are willing to hold a thrift stock indefinitely,
as long as it is managed
with low risk and
with concern to shareholder
value, and as long as the value is increasing
sufficiently
over
t i me.
Any stock, no matter how well run and no matter how secure, is a good
buy at some price
and a good
sale at another. A 10 year government
bond purchased
at a 10o/o yield
in a low
inflation environment
might represent good
value. At a 3o/o yield, it should probably
be sold
at a healthy profit, as most of the l0 year return is available in the form of a capitalgain
immediately.
The bond itself has not changed; the price has improved.
The same with thrifts' When we purchase
a thrift at half of an understated book value and
four times recurring earnings,
the underlying
value of our investment is growing
at 25%o
(the inverse of the p/e
multiple.)
When this thrift appreciates to l2So/oof book value and ten
ti mes earni ngs, i t i s rel ati vel y ful l y val ued. An i nvestor at thi s pri ce wi i l eatn some return,
but the return will not be satisfactory to us compared to our other investment altematives.
The thrift is still a fine institution with sound eamings and good prospects. The market
si mpl y recogni zes i ts prospects
and di scounts them i n the stock pri ce.
We are always looking at the universe of thrift stocks and at thousands of other securities to
i nvest i n the best val ues.
You say that you rvill hold thrifts fbr the long-term as long as the value is increasing. What
are the ways of measuri ng val ue i ncrease?
We believe that all managements of public thrifts should ask themselves what their thrift is
worth today. This value is what each shareholder would receive if the thrift were sold. If
management i s bui l di ng val ue at a heal thy rate, an i nvestor mi ght be better off hol di ng hi s
shares than havi ng the thri ft sel l out. If, on the other hand, val ue i s onl y i ncreasi ng sl owl y.
an i nvestor woul d be better off i f the thri ft sol d out today and he i nvested the proceeds i n
other underval ued thri fts or even muni ci pal bonds.
Thi s gronth
i n val ue i s best quanti fi ed
by return on equi ty. If a thri ft wi th a
$20.00 book
val ue per
share i s eami ng
$3.00, or 15o/o return on equi ty, the val ue of that thri ft i s growi ng
15Yo a year. If a thri ft wi th a
$20.00 book val ue i s earni ng onl y
$1.00, or a' 5o% r.o.e., the
val ue i s gror.vi ng
a scant 5Yo ayear. Even i f the 5o/o r.o.e. ri ses to 60/o or 8%, the i nvestor
woul d probabl y be better off i f the thri ft sol d out and he put the proceeds i nto muni ci pal
bonds. Hi s return woul d be the same, wi th far l ess ri sk or vol ati l i ty.
we thi nk the management and board of every publ i c
thri ft shoul d be maki ng these
cal cul ati ons.
What can a management do to make value increase, if they are currently burdened by a low
return on equity?
Many thri fts wi th a l ow return on equi ty have the envi abl e probl em
of excess capi tal . Some
recent l yconvef t edt hri f t shavecapi t al
of l }Vot o20Voormoreof
asset s, or2or3t i mest he
prudent
60/o level. Some, but not all, of these institutions are eaming good returns
on their
core business, while the excess capital is only earning interest at money market rates. The
excess capital can be a drag on the overall return earned by the thrift. For this reason,
recentiy converted thrifts often feel pressured
to deploy newly raised capital to improve
returns.
There are several ways to deploy excess capital. One is intemal growth.
Another is growth
through acquisition. A third is related or unrelated diversification. A fourth is to retum the
excess capital to shareholders, either through high dividends or share repurchase programs.
a.
Can you comment on the opportunities
for deploying excess capital through intemal
growth?
Unfortunately'
thrifts are not faced with infinite loan demand for low risk loans at attractive
rates of return.
Qui te
the opposi te. i n fact. In today' s hi ghl y competi ti ve fi nanci al worl d,
there is a great deal of money chasing relatively few lending opportunities. Borrowers
and
deposi tors are more sophi sti cated than ever i n understandi ng
und
"hoo.i ng
among thei r
many al temati ves. Li ftl e by l i ttl e, the best asset of many thri fts, thei r 5.S%opassbi ok
deposi ts (actual l y
a bal ance sheet l i abi l i ty), i s erodi ng. Opportuni ti es to l end at above
market rates with low risk are few and far betvveen.
T'he competition to lend money is so intense in some areas that institutions practically give
the money away' Teaser rates, no point loans, no credit verification loans with minimum
down payments
and other forms of economic suicicie are commitreri by many institutions.
We recently heard of one institution offering four year automobile loans at 4o/o, a rate tnat
may be bel ow what coul d be earned on U.S. treasury securi ti es i f servi ci ng costs were
fi gured i n. Thi s i s before the costs of maki ng the l oan and before l osses for credi t ri sk are
fi gured i n. Such busi ness practi ces make no sense.
And yet i n today' s deregul ated fi nanci al worl d. bankers of al l types are under a compul si on
to l end. Money center banks have thrown money at LDC i oans, agri cul tural l oans, real
estate loans and energy related loans. Many have strayed thousands of miles from their own
geographic
area to make these bad loans. Today, these bankers avoid the mistakes of the
past, choosi ng i nstead to throw funds at hi ghl y l everaged compani es. The
j ury
i s sti l l out.
but we suspect the losses in this area could eventually rival the energy, real estate and LDC
debacl es.
Thrifts face a problem
similar to money center banks. Opportunities to grow low risk
attractively priced loans are rare. Thrifts thus face the alternative of slow groqh and
inadequate returns or rapid growth in new and riskier areas. Inadequate retums will result i1
tremendous shareholder pressure
on management to increase value. Rapid growth in new
areas, such as commercial real estate loans, development loans, out of itate loans,
joint
ventures and real estate development projects,
consumer loans and
junk
bonds, raiie
ongoing concerns regarding risk. It is difficult for the experienced
lenders in these areas to
earn decent returns with limited risk. It is nearly impossible for new entrants into these
areas to achieve acceptable results without jeopardizing
the financial health of the
institution.
l.
Are you suggesting that thrifts should grow through acquisition rather than through intemal
growth?
\. Not real l y. Acqui si ti ons are ri sky too. There are manl i buyers of thri ft i nsti tuti ons, so pri ces
paid are relatively high. Often goodwill is created, which reduces the tangible asset value of
the acquiring institution. Earnings may or may not be diluted. For us, theiritical flaw in
most acquisitions is that they make economic sense only if what are often quite optimistic
assumpti ons
are borne out. In the real worl d, manageri al
enthusi asm
over doi ng
a deal often
exceeds any possi bl e
benefi ts
from the acqui si ti on.
Managements
often refer to cost savings
from a takeover.
usualiy, cost savings
are
confi ned
to mi nor areas l i ke adverti si ng,
accounti ng,
computer
systems and the l i ke, These
savi ngs
are usual l y dwarfed
by the costi of doi ng t[e
deal . Managements
seri ousl y
i nterested
i n cutti ng costs.woul d
make tough peri onnel
deci si ons,
especi al i y
among
hi ghl y
pai d
top management.
Thi s i s usual l y
i nconsi stent
wi th the pol i ti cs
oi r".gi ng
twJfi nanci al
institutions.
overall, we rarely
find that expected
synergies
from thrift mergers
are
achi eved.
Are there any mergers that you
support?
Merger conversi ons
often make sense, i f the i nsti tuti on
bei ng acqui red
i s good qual i fy
and
has posi ti ve
val ue. of course, i t i s hard to fi nd partners
for ri erger conversi ons.
General l y' we bel i eve acqui rors pay
so much to do deal s that deal s don' t make sense. When
the stock market i s very strong. we choose to sel l our stocks at hi gh pri ces.
when
i t
decl i nes.
we buy at l ow pri ces.
Buyers
of busi ness shoul d
act l i kewi i e.
When pri ces
pai cl
for thri fts
are hi gh, i t i s better to be a sel l er. When pri ces
pai d
are l ow, then i t may be ti me
to buy' Ri ght now' consi deri ng
the l ack
of opportuni ti es
to expand i ntemai l y,
wetel i eve
many thrift institutions
should
be carefully
evaluating
opponunities
to sell.
Investment
bankers often
argue the attractiveness
of thrift mergers.
Don,t they know what
is
best?
Maybe' But they have an enornous
conflict of interest.
They get paid
if transactions
take
place,
not if value is increased.
We are very skepticat
auout an"y advice from investment
banking
firms, ranging from mergers
and acquiiitions
to hedging to covered call writing
programs
to risk controlled
arbitrage.
Unfoffunately,
these often capable, often very bright
people
only get paid
from transactions.
They may be capable
of adding value, but their
advice
must be taken
with a grain
of salt.
How
about diversification
by thrifts
into other financial
services,
like leasing,
insurance,
money
management
or real estate
brokerage?
In general"
an acquiror is far more likely to overpay
to expand into one of these areas than
to.get
a good
deal . The sel l er
of a busi ness
al most al ways' knows
more about i t than the
buyer, thus the buyer is at a great
disadvantage.
The ,"i1.,
-uy
know ofa current problem
or future trend that the buyer cannot
foresee.
The stock market generally
prefers
simplicity
to complexity.
Thus even if a thrift were to
expand
successfully
into one of these
areas, it is possible
that the market would lower the
p/e
ratio of the acquiror to reflect
earnings
that aie more
difficult to understand.
a.
A.
Many thrifts have expanded their mortgage banking activities. Do you find that an
attractive area?
Mortgage banking seems to us to be an unattractive
business. except as part of traditional
thri ft acti vi ti es. It i s a hi ghl y cycl i cal busi ness rvi th few effecti ve entry barri ers. Thus i n
good ti mes i t i s hi ghl y competi ti ve wi th a tendency to bui l d overhead i n l i eu of generati ng
profi ts. In bad ti mes, you are l eft wi th the overhead and l arge l osses.
Normal l y conservati ve bankers u' ho use cauti ous assumpti ons when l endi ng money have
been knorvn to become raving optimists when projecting
loan originations."We
are skeptical
that mortgage banking will ever be an attractive businesi. and during cyclical peaks
when it
i s profi tabl e,
we bel i eve the stock market wi l l correctl y pl ace a very l ow mul ti pl e on
mortgage banking profits.
Your remai ni ng al ternati ve for depl oyi ng excess capi tal i s returni ng i t to the stocki ol ders i n
the form ofshare repurchases or hi gh di vi dend payouts. Do you favor those?
In a perfect rvorl d, we thi nk thri fts shoul d retai n adequate capi tal , perhaps i n the range of
6Vo to 8oA of assets, and return the remainder to shareholders. We recognize that the
regul ators woul d be unl i kel y to approve a recentl y converted thri ft mai l i ng i ts excess capi tal
to sharehol ders. The next cl osest al temati ve to thi s, whi ch i s acceptabl " to th" regul ators. i s
the repurchase of shares.
Share repurchases
by thrifts are attractive for many reasons. For thrifts trading below book
val ue and bel ow 15-20 ti mes eami ngs, share repurchases i ncrease earni ngs and book val ue
per share, as wel l as return on equi ty. Thi s benefi ts l oyal , ongoi ng sharehol ders.
To the
extent that share repurchase activity sops up shares held by short-term holders. traders and
hedge funds, i t sol i di fi es the sharehol der base of an i nsti tuti on. The stock pri ce
may ri se to
refl ect the enhanced val ue per share, benefi tti ng non-sel l i ng sharehol ders.
Share repurchases shoul d be vi ewed as a busi ness opportuni ty l i ke anyother. When the
busi ness opportuni ti es faci ng thri fts are poor (no poi nt l oans, teaser rates, 30 year l oans
prepayable
at any time, high risk loans, deposit rate wars), share repurchases
may be a
uniquely attractive business opportunity.
Share rcpurchases u." u
"hun..
to buy a fractional
interest in a business that is low risk (all
our thrifti are low risk), well runug"i
lull
managements
that we know think their thrifts are well managed), and which can be
purchased
at a substantial discount from underlying
valuc. C"ompareo to a takeover, where
you
buy a l 00o/o i nterest i n a thri ft that i s often ri ski er than your own, l ess wel l run,
certainly less well known and for which you must pay fult value, share repurchases are a
sl am dunk.
share repurchases can trigger adverse tax consequences for thrifts, and we urge
managements to evaiuate the complete impact of share repurchases with their financial and
tax advi sors. Hol di ng company formati on i n some cases can i mprove the economi cs.
a
High dividend payouts are another way of returning excess capital to shareholders. While
we di sl i ke the doubl e taxati on of common
stock di vi dends, di vi dends are wel l recei ved by
the stock market, and the share prices
of many thrifts are improved by high dividend
payouts.
A thrift with l0%-2}Yo capital is, in effect, two investments. it is a thrift with 6% capital
earning perhaps
acceptable returns, and a pile of excess capital earning 4% -5% after tax
returns (U.S. government
securi ti es or aj ustabl e mortgages, after tax.) We l i ke the fi rst
i nvestment, especi al l y when purchased
at a l arge di scount to underl yi ng val ue. We strongl y
di sl i ke the second i nvestment. We coul d do better i f we put the money i nto muni ci pal
bonds, and we certainly prefer
our own investment decisions to those of others.
We urge thrifts that are unable to deploy excess capital with low risk and healthy returns to
find ways to return it to shareholders. Shareholders should not have to tie up large amounts
of excess capital that earns only 40/o-60/o in order to own shares in the thrift. Freeing up
excess capi tal , whi ch the stock market val ues at l ess than 100 cents on the dol l ar. to
sharehol ders who val ue a dol l ar at 100 cents, unl ocks val ue benefi tti ng everyone.
Is return on assets a reasonabl e measure of a thri ft' s profi tabi l i ty?
No. Whi l e thi s i s a common measure of performance
among commerci al banks, we bel i eve
i t i s not val i d when compari ng thri fts. Thi s i s pri mari l y
because thri fts have capi tal rati os
that vary from 3%o or less to 20%o or more. Highly capitalized thrifts have substantial assets
with no cost of funds which enhances retum without increasing assets proportionally.
Refurn on assets is of interest only when comparing institutions with comparable capital
ratios. Otherwise, the ratio causes one to compare apples and oranges.
Do you prefer
to invest in thrifts that are well matched?
We thi nk matchi ng can be a useful concept for asset/l i abi l i ry management. It i s cerl ai nl y
better than ignoring asset and liability maturities. However, it often is used inappropriately
and simplistically to understate risk.
Many institutions focus myopically
on their one year gap,
the difference between assets and
liabilities repricing within one year.
One year
is a convenient but highly arbitrary time
frame for examining the matching of a thrift's assets and riabilities.
We think concepts such as one year gap can be informative and illustrative, but are hardly a
repl acement for common sense. Not al l deposi t l i abi l i ti es are the same, and 5.5o% passbooks
are certainly far more stable than
jumbo
CD's. We think a high percentage of passbooks can
be assumed to be long-term liabilities, which need not be matched against short-term assets
to the detriment of an institution's profitability.
Matching is not sacred, something to be achieved for its own sake. Managements of thrifts
need to incorporate into the analysis of their loan portfolios
many things, including yield,
credi t ri sk, di versi fi cati on.
l i qui di ty, maturi ty, col l ecti on costs, and the val uc of each
customer rel ati onshi p,
as wel l as such concepts as gap and matchi ng.
Should thrills hedge to reduce their gap?
Most hedging strategies work within a relatively narrow range of assumptions. but break
down outside that range. Risk controlled arbitrage, which is extremely populai
today, works
this way. Our great concern is not what happens to a thrift with a minoi movement
in
i nterest rates, but rather,the i mpact of a maj or swi ng. Most hedges are of no hel p i n such
situations, and in fact often serve to increase risk.
You speak of some thri fts as better managed than others. What makes a thri ft wel l run?
Pri mari l .v concern wi th sharehol der val ue and atteni i on to the boi l om i i ne. Thri fts wi th i ow
ri sk assets, l ow costs, earni ng a heal thy return are wel l run. Such i nsti tuti ons do not need to
resoft to esoteri c i nvestment or hedgi ng strategi es or ri sky l oans to earn money.
They do
not book one ti me gai ns to achi eve a record of earni ngs growl h. They do not attempi to fool
thei r sharehol ders or themsel ves about what they are doi ng.
The management
of wel l run i nsti tuti ons
al most al ways owns shares and has stock opti ons
that gi ve
them a substanti al stake i n the busi ness. They wel come a di al ogue wi th
sharehol ders regardi ng i ssues of mutual concern. They vi ew al ternati ves presented
to them
as opportunities to be explored rather than as criticism to be ignored.
What are your vi ews on management i ncenti ves?
Very suppofi i ve.
We bel i eve that management
shoul d thi nk l i ke sharehol ders, wei ghi ng
every acti on agai nst the i mpact on sharehol der val ue. We as sharehol ders sl eep a l ot Uette,
when we know that management and directors have the financial incentive to act in the best
interest ofshareholders,
because they are shareholders too.
This is not to say that shareholders are the only constituency that matters. Certainly,
empl oyees, customers and the communi ty
al l shoul d be i rnportant to management. We
si mpl y bel i eve that the ri ghts of sharehol ders
shoul d take abackseat to no other
constituency,
and that management
should learn to think more like shareholders.
Are you worried about the future of the thrift industry?
We have many seri ous concerns rangi ng fi om macroeconomi c i ssues l i ke defi ci ts, i nterest
rates and federal deposit insurance to microeconomic
issues such as rapid loan growth, poor
Ioan quality and inadequate capital.
On the other hand, w-e are very comfortable that well managed, well capitalized, liquid and
low risk thrifts will not only survive but actually prosper in the future.
Thank you for expressing your
views.
l l