ERICOPOLY

Strange -- AIG never said anything like that.

I'm not sure. Could very well be a good bet. However in late 2011 I had equal parts MBI and BAC. I sold all of the MBI in the $9 range and put it all in BAC. Txlaw asked me why and I told him that I thought Jay Brown was being irrational in asking for 100% recovery and it would get dragged on forever. So, what I said could have been absolute drivel, and what may have passed could have been pure luck, but so far I'm happy I did that. I don't know if the BAC management is being at all emotional about this trial, but if they are, I'd bet it's because they don't like Jay Brown's tone given that Brown put himself in this position whereas the guys he's throwing stones at, BAC management, are new in their jobs and are just trying to clean up their predecessor's mistakes. Plus, MBI made a deal with Merrill Lynch at the time when BAC didn't own them, so it has nothing at all to do with whatever Countrywide did or has not done. From as far as I can tell, the internet doesn't agree with me -- people seem to believe MBI is being beaten down by the mean bully BAC. But then, isn't that why the MBIA CEO writes those scathing shareholder letters? I guess it is dirty, but it works.

Just ask yourself this... Has the BAC CEO written letters to shareholders fuming emotionally about the MBIA litigation? Haha. You are right. Just curious, as a BAC holder, what do you think about article 77? I am weak on legal knowledge. I defer to the earnings power of BofA to take care of any shortcomings. That's the margin of safety, and there is plenty of it. I just know that MBIA put themselves in this hole by hitching their wagon to Countrywide, and by the grace of God BofA bought Countrywide so now Jay Brown and his crew can tell their shareholders that all the fault lies with BofA instead of claiming any credit for digging this hole in the first place. I mean really guys, you thought Countrywide was not fudging? The music played, you danced, take some blame.

Just ask yourself this... Has the BAC CEO written letters to shareholders fuming emotionally about the MBIA litigation?

If we want to imagine scenarios, imagine if Buffett had donated all the money he made from his paper routes and subsequent endeavors to charity and never compounded it. Is that a better scenario? Suppose he put his money in a foundation that can compound it tax-free while distributing the required 5% annually. 5% annual bleed of the foundation's money is similar to being taxed only 16.7% on a 30% gain. So if he could have achieved 30% annually on his own after winding up the Buffett partnership then he should have done better than owning Berkshire. But, that's all with hindsight 20/20. And he deserves to live an interesting life, and being the Chairman of Berkshire has made his life perhaps far more interesting.

I was thinking about this delta return today. Implicitly it means they have confidence that their delta will exceed what they could otherwise earn in fixed income. Otherwise, why not just buy bonds instead? Yup. They go by the balance sheet, giving it a lot more weight than I would when it's a crappy business. For this reason, there is huge basis risk in their "hedging". Nevertheless, It's hard to argue with their long term success. You also had that "Buffett put" strategy with Berkshire trading down near 1.1x book value. Fairfax bought none! That seemed to be a possible holding for them that wouldn't require too much (if any) hedging, and could compound away tax-deferred for a long time. Perhaps they think they can do better than Berkshire with their delta? Or they don't believe in the Buffett put, or they don't want to own Berkshire. Or they believe the hedges won't take long to be wildly useful. Hmm... It's got to be better than JNJ as a defensive blue chip holding, either way.

I was thinking about this delta return today. Implicitly it means they have confidence that their delta will exceed what they could otherwise earn in fixed income. Otherwise, why not just buy bonds instead?

That's a pretty large number -- it isn't like it winds up at 14.99% or something that you can just round up to 15%. .902 * 15% = 13.53%. The interest rate on the debt is higher than the 6.6% assumption you are making on portfolio total return -- so it needs to be stripped out. As for using the "investments per share" number in the AR: I believe in the past they put that number out there despite the fact that ORH and NB had substantial minority interests. In other words, even though FFH didn't own a large chunk of those investments, they were still included in the "investments per share figure". So since then I've never trusted that number again. That’s why I like a margin of safety!! If it is actually 7.6%, instead of 6.6%, I think FFH can achieve a 15% CAGR in BV per share anyway. Even significantly trailing behind its past results! I have a double margin of safety here: one against some errors in my assumptions (as you have pointed out), and another against FFH not being able to replicate past achievements. :) giofranchi “As time goes on I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one’s risk by spreading too much between enterprises about which one knows little and has no reason for special confidence.” - John Maynard Keynes They will meet my expectations if they achieve results that allow me to earn 10+% total return from their stock. The main concern that drives my lower expectations is that: 1) bond yields low 2) bond yields can't go too much lower Their storied history had this terrific tailwind from not only high bond yields, but those yields kept falling and that gave them sizable capital gains! Otherwise, nothing else to worry about. I do hope their underwriting gets better -- it seems there is a trend in that direction with ORH becoming a bigger slice of the pie and the emerging markets businesses getting larger. Should that trend continue, then perhaps underwriting will one day step forward to boost profits meaningfully. But i don't count on it.

That's a pretty large number -- it isn't like it winds up at 14.99% or something that you can just round up to 15%. .902 * 15% = 13.53%. The interest rate on the debt is higher than the 6.6% assumption you are making on portfolio total return -- so it needs to be stripped out. As for using the "investments per share" number in the AR: I believe in the past they put that number out there despite the fact that ORH and NB had substantial minority interests. In other words, even though FFH didn't own a large chunk of those investments, they were still included in the "investments per share figure". So since then I've never trusted that number again.

You need to throw in Andrew Carnegie as well. Absolutely fascinating. And he is very "OG" on American philanthropy -- leading by example and inspiring/imploring other wealthy to give. We only hear about Buffett's "Giving Pledge", but check Carnegie's view on philanthropy via his Gospel of Wealth. He was also a strong advocate of the first inheritance tax. Once I read about Carnegie I began to wonder if Buffett was inspired by him. However, in business it's a bit dirty -- no insider trading laws in Carnegie's time. So he had connections to railroad executives who needed Carnegie's capital to partner with. They'd buy up land in the middle of nowhere, have the railroad build a stop (and town there), and make an instant killing on the land development/sale. Carnegie came to America in rags, literally.

It takes a good deal of managerial magic for FFH to grow tangible book at 15%. I know a lot about FFH and I think about this a lot. However every time I wind up reaching the conclusion that I'd rather be invested in the company that can generate 13% to 15% returns from operational earnings... provided it too is priced such that I'm getting in at tangible book value. The market more reliably puts an earnings multiple on operational earnings. So it's not just about the returns on tangible equity, but the more likely path to an eventual multiple on the earnings themselves (a bonus tailwind of upwards valuation adjustment). And so basically that's why I still keep my oversized BAC position rather than move some to FFH. Not yet! Not yet! In due time... First the easy money. Later, I hope FFH can keep the magic going when it's time to buy back into it. Eric, As I have written in this thread, going forward FFH must achieve an average return of 6.6% on its portfolio of investments to grow BV per share at a 15% CAGR. Historically FFH has achieved an average total return on portfolio of 9.6%. Sincerely, I don’t understand the required “managerial magic” you are talking about… giofranchi “As time goes on I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one’s risk by spreading too much between enterprises about which one knows little and has no reason for special confidence.” - John Maynard Keynes I don't follow FFH but how did you get up with 6.6% in the statement "must achieve an average return of 6.6% on its portfolio of investments to grow BV per share at a 15% CAGR." ? I took giofranchi's math at face value, but now that I've done a bit of number crunching I don't get it. They have: $25b cash and investments $3b LT debt (I believe they paid about 6.9% interest on that debt in 2012) So total return coming in the door at 6.6% on $3b of investments is effectively a wash against the 6.9% interest due on $3b of LT debt (money out the door). So they have $22b of net cash and investments There are 20.2m common shares. That brings us to $1,089 net investments per share. So 6.6% on that brings in $72 before taxes, 19% pre-tax return on $378 BV per share. So 13.3% growth in BV per share at 30% tax rate. More like 13.1% after including the non-controlling interests. Then there is corporate overhead, but hopefully underwriting profits can overwhelm this and then some. I believe they need about 7.5% total return on investments in order to achieve 15% growth in BV per share. (assuming underwriting profit merely nets out against corp overhead)

I had to read your post several times, and I still can't figure out which way you intended it. Either A or B was your intended message (or perhaps I'm missing "C"). A) People don't understand how highly profitable BAC really is. Just wait until they see the earnings power after these mortgages are run off! B) People should be more bearish -- it's going to take so long to run off these expenses that it's not really that cheap at all. C) ? I'm figuring you probably meant "A", because: 1) naturally, these ongoing expenses already exist in the current quarterly earnings. 2) We've only been talking about the runoff of NewBAC expenses and LAS costs. 3) Once these mortgages are also off the books and capital is redeployed in profitable loans, people will be positively surprised. Sorry, for note being clear. The option was actually C. The posters above me were discussing Moniyhan's tenor at the company and said he did an average job. I don't believe they know how challenging his job is operationally. I think people miss what running off those mortgages actually mean. It means foreclosing on families and repossessing their house. It means thousands of small lawsuits from people that don't want to be kicked out their house (which also counters some of the critique on why they can't run these off faster. It's hard to run something off when you have a 4 year court case). At the same time, I think people grasp the operational difficulties of ESL's liquidation strategy with Sears. It wasn't a comment on the financial performance, but on the operational challenges. Granted once these operational challenges are behind BAC, then I think Option A. By the way, during the interview with Charlie Rose Brian Moynihan indicated that they were 60% to 70% through those mortgage issues not 50%. Don't ask me exactly where but I remember that clearly. I believe he said they started with 6 million delinquent mortgages in LAS and entered 2013 with 2.5 million left. By the end of 2013 he said they expect to have 750k left. So they are 60% through and will be 88% through the problem loans by the end of this year. Costs will come down dramatically. I thought they were already hitting the ~750k number at the end of 2012. End of 2013 will be 400k left. Quoting from the Q4 12 CC transcript: We believe our serviced 60 plus day delinquent loans at the end of 2013 may be around 400,000 units versus 773,000 units at the end of 2012, a decrease of approximately 50%. That implies an additional decrease of 150,000 units beyond the 232,000 units that are expected to go with the scheduled transfers. Given the projected declines in 60 plus day delinquent loans, and notwithstanding there being a one to two quarter lag between delinquent loan transfers and expense decrease, we believe we can get expenses in the fourth quarter of 2013, down by more than $1 billion from the $3.1 billion in the fourth quarter of 2012, excluding the impact of IFR and litigation.

I don't disagree with that.

IV doesn't grow 20% if share count is reduced by 10%. Not even if the price paid for the shares were 1 cent.

He has now held his BAC for about 2 years -- he bought in somewhere around $14. It will be about a 10% annual return for him if BAC is at $23 in 3 years. Not a bad return, but hardly phenomenal. So it seems like he may have been wrong on BAC as well, I mean if you listen to him talk about it he seems to be expecting to have made more than 10% a year.

I had to read your post several times, and I still can't figure out which way you intended it. Either A or B was your intended message (or perhaps I'm missing "C"). A) People don't understand how highly profitable BAC really is. Just wait until they see the earnings power after these mortgages are run off! B) People should be more bearish -- it's going to take so long to run off these expenses that it's not really that cheap at all. C) ? I'm figuring you probably meant "A", because: 1) naturally, these ongoing expenses already exist in the current quarterly earnings. 2) We've only been talking about the runoff of NewBAC expenses and LAS costs. 3) Once these mortgages are also off the books and capital is redeployed in profitable loans, people will be positively surprised.

That's exactly the magic I'm talking about. It's not the norm! This isn't a business that has a model of spitting out those returns from operations, they get it by being smarter than the market (booking capital gains). That's hard, but they're very good at it. That's their managerial magic that I'm talking about. It does matter how the profits are made, because the market will reward operational earnings. There is a good deal of logic to that -- the market would have to assume itself to be wrong in order for it to believe that FFH will reliably keep whipping it. Take away HWIC and put an average investment management team in there -- now say that they "only" need to make 6.6%. I do hold some FFH now though -- I bought some last week for my taxable account. I hedged some BAC with puts and the idea is to manufacture some losses with the puts expiring worthless for offsetting future capital gains. Just some tax laundering. The FFH needs to build value at a single digit rate in order for this to come at no-cost to me. Perhaps they'll do more than 15%! Hope so, but not expecting it with fixed income yields the way they are.

Wait now I'm confused again. I was following what you were saying, about the put decreasing in value due to the lift of the uncertainty premium, but then why would the COL increase (from 13 to 20% or so)? Wouldn't it come down in that case, to more in line of a normal leverage cost? You said earlier: "The high cost of leverage is associated with a period of uncertainty, and after that uncertainty is lifted it goes back to normal leverage cost." He's saying that when it comes down, you would have effectively paid 20% for the first two years--e.g., instead of 13% annually, it might be 20% for the first two years and then 8% for the remaining 4 (these are just exemplary figures, probably not accurate). Thus, it would come down afterwards. Yes, that's how I meant it.

It takes a good deal of managerial magic for FFH to grow tangible book at 15%. I know a lot about FFH and I think about this a lot. However every time I wind up reaching the conclusion that I'd rather be invested in the company that can generate 13% to 15% returns from operational earnings... provided it too is priced such that I'm getting in at tangible book value. The market more reliably puts an earnings multiple on operational earnings. So it's not just about the returns on tangible equity, but the more likely path to an eventual multiple on the earnings themselves (a bonus tailwind of upwards valuation adjustment). And so basically that's why I still keep my oversized BAC position rather than move some to FFH. Not yet! Not yet! In due time... First the easy money. Later, I hope FFH can keep the magic going when it's time to buy back into it.

The next round of LEAPS issued will be cheaper once a regular dividend is restored. Stocks with the highest regular dividend payouts usually have extremely cheap LEAPS (loss of dividend is priced in). The way the warrants are priced it seems clear that what you are doing is actually buying that dividend upfront -- an estimate of a future dividend is capitalized into the price of the warrants. This makes sense given that the market isn't going to sell a product with dividend protection without asking for some kind of a premium. So with the LEAPS at least you get that dividend tax-free (you get it by never having to pay for it in the first place).

Why isn't it good to buy shares back at $20? Why would you even be a shareholder anymore if the shares at that price aren't an effective use of capital? Don't you need to put your money where your mouth is and sell your shares if your capital is no longer "effectively" deployed at that price? Surely, if the capital gains taxes are stopping you from selling at $20, then for the life of me I can't figure out why you'd prefer a taxable dividend (where you get taxed on 100% of the payment, versus just a portion being taxed as a capital gain).

Something like that. Basically if you straight-line depreciate the warrant, it costs 13% annually for the leverage. But if company really impresses people over the next two years with the expense reduction plan, then the remaining put's value may depreciate an additional amount due to lifting of the uncertainty premium. Thus, over two years it could cost far more than 13% annually. Maybe close to 20% annually over the next two years. After all, once the stock trades at intrinsic value you might be inclined to want to sell your BAC position. Perhaps that happens in two years. So it might happen on a timeline where you've suffered a significant hit to the put's premium -- this will eat into your gains when you sell.

People pay a premium for a hedge when uncertainty is higher. That will increase the cost of leverage, and in doing so it will increase the point at which the option/warrant breaks even with the common. The common sense explanation is that price of the common stock will be more volatile during periods of uncertainty, so people want to buckle up. Turbulence drives the cost of hedges. Less turbulent times make it less likely that the hedges embedded in the options will be useful, thus their premiums decline as traders lose interest in them. The captain turns off the seatbelt sign and you can move about the cabin freely. People aren't clutching their seat-belts anymore.

I guess you should be careful for what you fear. The recession the ECRI has so accurately predicted has been great for BAC's stock price thus far. There you go, famous last words. Now the market goes down 50%.

Hi Eric, please excuse my ignorance here, but how would you benefit by dumping the $12 calls and buying the common if the common went down to $7. Wouldn't the $12 calls be close to valueless, especially if close to expiration when the stock plummets? Being down $5 on the common is worse than being down a maximum of $2 on the calls. That's what I meant. So the non-recourse approach to leverage wins in this case versus the guy who tries to saves money buying stock on margin and paying only margin interest.