Tuesday, August 19, 2014

Analysis of First Republic Bank



Please read the disclaimer here:http://greedydragoninvestment.blogspot.com/p/about-greedy-dragon.html. Enjoy the article, bitches!


I finally got around to playing GTA V a few days ago. Shit! Playing that game makes me want to fuck shit up and make some fucking money. But instead of robbing a jewelry store with a carbine rifle, I will make my money by reading annual reports and crunching numbers with my Hewlett-Packard 12C financial calculator. But you’re not here to listen to me talk about video games, you’re here to read about my stock analysis (or at least that’s what I think you’re here for). I recently bought some shares in First Republic Bank at USD 46.19 per share. If banks were thought of as fashion brands, First Republic would be the Prada of banks due to its business and high net worth clientele. This is evidenced by the larger than average deposit accounts First Republic is able to attract. The bank had 275,000 deposit accounts as compared to the US industry average of 1,776,000 deposit accounts for banks with total assets of $35-$65 billion.  I think First Republic is a high quality bank and that its shares offered value when I bought it.


Update on the Greedy Dragon portfolio: I recently sold my stake in Monster Beverage and reduced my stake in Mercadolibre to raise cash for some unexpected expenses. Unfortunately for me, I sold Monster just a few days before the stock soared 30% when Coca-Cola announced that it’s taking a stake in the company. I obviously feel like a fucking moron, but that’s life. I’ll just have to deal with it.


For the quarter ended June 30, 2014, First Republic achieved annualized return on average assets and return on average equity (ROE) of 0.98% and 9.77% respectively. A ROE of 9.77% may not exactly be great, but it’s still pretty decent if you take into account the low credit risk exposure of the bank’s loan portfolio. According to the company’s investor presentation dated August, 2014, charge-offs have averaged only 0.12% per year over the past 10.5 years; the net charge-offs averaged 0.43% per year over the past 10.25 years for the top 50 U.S. banks by asset size. As at June 30, 2014, non-performing assets to total assets ratio was 0.11%. The company’s low credit risk exposure is a result of its prudent loan underwriting standards. The loan-to-value ratios required by the bank (at origination) as at June 30, 2014 was 60% for single family, 55% for HELOC, 57% for multifamily, 53% for commercial real estate and 55% for construction loans.


Note: I calculated the bank’s ROE and ROA using core net income (net income excluding the impact of purchase accounting) instead of conventional net income.


First Republic is expected to incur between 6.5% to 9.0% higher noninterest expenses to invest in its regulatory, audit and compliance infrastructure. These investments are necessary to meet the higher regulatory requirements and standards associated with institutions that have over $50 billion in assets. As at June 30, 2014, the bank had total assets of $46.2 billion. The bank expects its four quarter ending moving average assets will reach the $50 billion mark about the end of 2015. The higher expenses should put pressure on First Republic’s ROE in the short-term. However, I think profits will continue to grow and ROE will increase over the long-term as the bank continues to increase its loan book (by attracting more deposits to fund the loans) and interest rates eventually rise. 


First republic has a decent capital buffer to help it absorb losses. As at June 30, 2014, First Republic had at a leverage ratio, tier 1 capital to risk-weighted assets ratio and total capital to risk-weighted assets ratio of 9.73%, 13.74% and 14.35% respectively. To be considered well-capitalized, a bank needs to have ratios of 5.00%, 6.00% and 10.00% respectively.


First Republic has been expanding at a pretty impressive rate. For the 4-year period of 2010-2013, the bank increased deposits and wealth management assets under management at a compounded annual rate of 20.41% and 23.64% respectively. Deposits and wealth management assets under management increased by 11.60% and 17% respectively in the first half of 2014.


Note: I excluded certificates of deposit from my calculations of deposit growth.


Assuming an extra $20 million in regulatory compliance expenses, First Republic’s core net income would drop to $96.28 million a quarter (that’s if nothing else changes from the second quarter of 2014). Warning: My calculations of First Republic’s core net income after adjusting for the increase in regulatory compliance expenses is likely to be off from the actual figures in the future.  After the preferred shares get their cut, annualized diluted earnings per share would be around $2.32 giving the stock a P/E ratio of 19.90 at the price ($46.19) I bought it.


I think that the price I paid for First Republic’s stock is reasonable as it has good growth prospects. I think I will be rewarded with pretty decent returns for sitting on this stock for the long-term. Thank you for reading. Take care and stay rational.

Thursday, August 7, 2014

Drinks with the Dragon: Life, hedging, junk bonds and more

Hey guys, I know it has been a very long time since I last updated my blog. It’s just that I didn’t have much to talk about and I didn’t want to put out half-assed articles. Anyway, this article is called “Drinks with the Dragon” as I will just be shooting about random finance related stuff as if I were in a bar with a friend. I have to be honest though, you won’t see me doing vodka shots or chugging down a jug of beer in a bar. You will probably find me drinking a coke or sipping on some girly cocktail as I don’t like the taste of alcohol.

My life: Things are starting to pick up for me lately. I passed my CFA level 2 exam which is awesome. I’ve also been kept busy analyzing some pretty interesting investments. If the recent pullback in stocks continues, I just might be able to scoop up these investments at a good price. But I think that right now the pullback is still too small to offer up many good bargains.

Hedging: Recent events such as Argentina’s technical debt default and the bailout of one of Portugal’s largest banks really highlights the need for investors to hedge their risks.  I personally am trying to increase my cash holdings so that I can take advantage of buying opportunities during the next major correction. I’m also thinking of adding some gold to my portfolio to hedge against the shit storm that will eventually happen as a result of the retarded easy money policies of the Fed, ECB and other central banks.

Position sizing: I think most investors would be better off limiting each of their positions to a certain percentage of their portfolio. I don’t think any position should exceed 5% of the portfolio, except maybe for very safe blue chips bought at a reasonable price; even then, I don’t think any position should exceed 10% of the portfolio. Warren Buffett said that “Diversification is protection against ignorance. It makes little sense if you know what you are doing.” However, it’s fact that a lot of investors don’t really know enough about evaluating businesses to bet 40% of their fucking portfolios on a single counter. I obviously think that I know what I’m doing as I don’t really do position sizing for my own portfolio. But time will tell whether I’m “The Shit” or just plain shit when it comes to investing and capital allocation.

Junk bonds: Yields on junk bonds are at stupidly low levels. I don’t think the current yields on junk bonds are nearly enough to compensate bondholders for the credit risk that they’re taking on. I think that the junk bond market is a disaster waiting to happen. Now, I don’t know when it will happen (I don’t even know what the fuck I’m having for dinner tomorrow), but I do know that a market can stay in full retard mode forever. I’m interested in an ETF that shorts junk bonds, but I need to do more research before deciding whether or not it’s a good investment.

Pulling the trigger: I have been guilty of waiting around for a stock to drop a few percentage points more even though I knew that the stock was a screaming buy. The stock would then go up and I would just ignore it even though I knew it was still very cheap. I missed out on a lot of money doing shit like that. I didn’t buy Harley Davidson, American Express and etc. in 2009 because I was waiting for those stocks to drop another 50 cents or something. When I look how far those stocks have ran up today, I can’t help but think that I was an absolute fucking moron back then. I really need to start having more trust in my analysis and stop focusing on nickels and dimes when there’s a truckload of money sitting right in front of me.  


I will try to prepare the first annual performance report of the Greedy Dragon portfolio early next month, and to be honest I’m kinda anxious to see how I do. I know that short-term results shouldn’t mean much, but it’s the first year of the Greedy Dragon portfolio and I want it to kickass (unfortunately, I think it’s unlikely that I will beat the S&P 500 this time around). Anyway, I hope I can come up with more ideas for articles so that the blog will be updated more frequently. Thank you for reading. Take care and stay rational.    

Tuesday, July 1, 2014

Investing in UOA REIT using margin financing



Disclaimer: This article does not represent advice to invest in UOA REIT or to use margin financing. This is my first time using margin financing and my understanding of how things work may be flawed. There may also be errors in my analysis, calculations and other errors. Do your own damn research and take responsibility for your own damn investments.


I recently decided to use margin financing to try to unlock some hidden value in my portfolio. I still have positions in 2 Malaysian stocks (my margin facility doesn’t accept foreign shares as collateral) which I think will perform decently over the long-term. However, I could get even more value out of my Malaysian shares by pledging them as collateral to get some financing. As I only have a small margin facility, the effective rate that I got was around 5.76% which isn’t great but it isn’t too bad either as I’m just experimenting with a small amount of debt. The effective rate drops to a pretty reasonable 4.71% if I have a larger margin facility and borrowed more. Just like how a kid starts off with a Happy Meal before moving on to a Double Quarter Pounder set, I need to start out small and learn how to effectively utilize debt. Before I continue, I would like to bring you guys a quick update on the Greedy Dragon Portfolio. Apart from investing in UOA REIT, I also sold my shares in Overseas Education Limited as it went up quite a bit since I bought it and I wanted to increase my cash holdings.


Anyway, I figured that if I could find an investment with a higher income yield than the margin loan’s interest cost, I could increase the cash my portfolio generates every year. I also needed to be confident that the investment’s yield is sustainable or I could find my margin financing strategy turning cash flow negative.


There weren’t many investments in Malaysia that had a high enough yield to pay off the interest and still have a little somethin’ somethin’ left over for me. However, I did manage to find UOA REIT which I think is a suitable candidate for this margin financing strategy. I invested in the REIT at Ringgit Malaysia (RM) 1.39 per unit. UOA REIT has a portfolio of office buildings located in Kuala Lumpur, the capital city of Malaysia. Based on the 2013 distributions per unit, the REIT’s after tax distribution yield of 6.91% is high enough that I can still service my debt if the REIT experiences a small drop in earnings and distributions. You don’t want to be in a situation where the spread between the investment’s distributions and the debt’s interest is like a dollar; you need a margin of safety. According to the 2013 annual report, UOA REIT’s properties also have pretty high occupancy rates of between 87.3%-98.5% which should increase the odds of the REIT being able to maintain the rental it charges its tenants. Another advantage of investing in REITs with this strategy is that REITs are required by law to distribute most of their earnings. So, unless a REIT starts making losses, investors should still receive some income even during downturns.


Note: According to this article in The Star, Malaysia REIT’s distributions will be taxed at the lower 10% rate for local and foreign retail investors until at least 31 December, 2016. I don’t know much about tax laws, so please do your own research or consult a tax expert before making any investments.


I also tried to reduce my risk to a very low level with this position as I don’t want to end up being my bank’s boy. One of the main risks of margin financing is that interest rates might rise and result in the cost of servicing the debt being higher than the income from your investment. Interest rate risk is very low for my position as my cash holdings are large enough that I can easily pay off my margin loan anytime; I also have cash inflows from other sources that can be used to service the debt. Another risk of margin financing is of course the dreaded margin call where your position can get wiped out if you don’t top up your account. I mitigated this risk by over collateralizing so something really bad would have to happen before my ass gets margin called. A major risk for this specific position is that there might be a supply glut in Kuala Lumpur office space for a while. However, I think that even if UOA REIT’s occupancy rates and rental rates do come down a bit, it should still be at a healthy level in the near future.


To further reduce risk, I will set aside RM 1,441.15 in cash (2 years of interest payments) specifically to help me meet interest payments in case this position turns cash flow negative and I decide to wait on a recovery. Any positive cash flows (and I hope the cash keeps rolling in) will be used to reduce the debt or replenish the cash buffer if I had to tap into it in previous periods. The idea over the long-term is to pay off the debt using the cash generated by the REIT and convert the position into pure, yummy, delicious equity.


A good scenario to use this margin financing strategy would be when there are opportunities to invest in assets with 9%-10% yields. If I find myself in such a situation and my capital structure can afford the extra debt, then I might take a margin loan large enough to get the lower interest rate of 4.71% (assuming that the base lending rate stays the same). However, I think that financing some UOA REIT units with a margin loan is alright for my portfolio. This is the case as the debt that I took on is small relative to my portfolio’s size. I’m also treating this position as a learning experience to build up my competence in debt and cash flow management. I also think that buying units of UOA REIT on margin at its current price actually creates value for my portfolio. The following table breaks down the returns that I could potentially earn assuming that UOA REIT’s distributions per unit and the base lending rate stay at current levels:

Cash buffer
RM 1,441.15
Borrowings
RM 12,510
Effective Interest
5.76%
After tax yield
6.91%
Interest cost
RM 720.57
Income distributions
RM 864.27
Net cash inflow
RM 143.69
Cash on cash return
9.97%

1Cash on cash return = Net cash inflow/cash buffer
2Again, the cash buffer represents the cash set aside specifically for this position and not my total cash holdings.

Whatever positive cash flow I get, I’m using to pay down the debt which gives me a reinvestment rate of 5.76% (not bad in this market, not bad at all). Really awesome things start to happen if UOA REIT is able to increase its distributions and/or if there’s an increase in the market price of the REIT’s units. If UOA REIT is able to boost its distributions per unit by 10%, the annual cash-on-cash return should increase to 15.97%. A 10% gain in the REIT’s unit price should result in about an 87% return on the cash buffer. I’m not taking this position with the expectation that UOA REIT will increase its distributions or that the price of its units will rise (although I think both of these things are likely to happen in the long-term).


Before I end this article, I would like to advice you guys to never take on debt for investing if you don’t understand debt and cash flow management. And even if you think that you can manage debt and cash flows well, don’t ever take on too much debt and put yourself in a position where your financial future is at risk of getting bitched out by a margin call. Thank you for reading. Take care and stay rational.

Saturday, June 21, 2014

The 4 main investment categories: Game Changers, Cash Gushers, YOLOs and Condoms.



To make the process of constructing or reconfiguring a portfolio simpler, I think of the portfolio in terms of its exposure to the 4 main investment categories: Game changers, cash gushers, YOLOs (you only live once) and condoms. In this article, I will be explaining these investment categories.


Game changers are generally top quality companies with durable competitive advantages which allow them to achieve superior returns on capital. However, unlike companies like McDonald’s or Apple which have a wide economic moat and generates high returns on capital, game changers still have a lot of opportunities to reinvest profits and grow their business. In short, game changers are companies that have the potential to become the next Starbucks or Berkshire Hathaway. It may be difficult to identify companies in this category. And even if you do find such companies, they may be trading at a rich valuation. However, investors should be patient in trying to build up this category of their portfolio. An investor could potentially move up a notch or two in life by buying a game changer at a reasonable price and holding it for the long-term, hence the term game changer.


Cash gushers are investments that have healthy income yields. The purpose of this category of investments is to provide you with a stream of cash to reinvest and expand your portfolio. It’s important that your cash gusher investments are able to maintain decent income distributions during a crisis as that’s when you will need cash the most to take advantage of bargains. Some examples of cash gushers are REITs, high dividend paying blue chip stocks, rental properties and private businesses.


Condoms are positions that give your portfolio some protection when shit goes down. I call these positions condoms because whenever I think of risk management, I think of a couple who don’t want to have kids and use a condom to prevent the risk of conception (because having the dude to pull out before he cums is too risky). The main asset in the condom investment category is of course cash. The investor can use his cash to buy up assets during a market downturn when they’re cheap; this will of course improve the investor’s odds of coming out ahead when the market recovers. If the investor uses leverage, he can dip into his cash reserve to in the event that the cash inflows of his portfolio drop below the cost of servicing his debt. Another asset that falls in the condom category is gold. Gold is thought of by a lot of people as a safe-haven asset and could help with maintaining some of your portfolio’s real value if really fucked up things like hyperinflation occurs. Short positions can also be considered as a position that falls into the condom category. An investor’s short positions are likely to go up in a recession; she can then liquidate her shorts and use the proceeds to go long on undervalued assets. I personally never took a short position in my life and know next to nothing about shorting. But it is something that I’m interested in learning more about.


YOLOs are investments that you won’t normally make but are attractive as they’re trading at stupidly low prices. Some examples of YOLOs are mediocre stocks with deep discounts to intrinsic value, undervalued distress debt, and commodities trading at below their cost of production. Investments that fall into the YOLO category are not meant to be held for the long-term and should be sold once they are no longer selling at stupidly low prices. Investors should allocate only a small percentage of their portfolio to YOLOs as this investment category can be riskier.  


As always, thank you for reading. I’m sorry if I haven’t analyzed any stocks recently, I know that’s the main reason you guys read my blog. It’s just that it’s very difficult to find attractive investment opportunities in this market as most of the stuff are either overvalued or fairly valued. Please e-mail me or drop a comment if you think there is an interesting stock that I should analyze. Take care and stay rational.

Sunday, June 15, 2014

Bullshit financial theories part 5: Risk-free investment



I recently read an article by a Malaysian investor claiming that certain stocks had no risks. Let me just clarify, I don’t think that this guy is bullshit. In fact, I think he is a successful businessman and that he means well. But I strongly disagree with his opinion on certain plantation counters having no risk. To be fair to him, he later clarifies that by saying there may be short-term market risk, but in the long-term investors will certainly make exceptional profits. But how can he be so sure? After all, the profits of palm oil plantation companies are highly dependent on the price of crude palm oil. And there’s always the possibility that if CPO prices are high, supply will increase and drag CPO prices down to levels that allow plantation companies to only earn average returns on capital. When I say there’s no such thing as risk-free investing, I meant both in the short-term and the long-term. Anyway, the rest of this article will not be related to what this investor said, instead I will further elaborate why I think the idea of risk-free is a myth.   

Side note: I personally have no idea how the palm oil plantation sector will perform in the long-term (I hope it does well, as a stock I own has some exposure to this sector).  

If you studied finance in university, you would have been taught that government securities were risk-free assets. All you have to do is look back at the European sovereign debt crisis to know that this isn’t the case. In fact, by investing long-term in U.S. treasury bonds (which are thought of as one of the safest assets in the world) at current yields, you will almost guarantee that your investment will get fucked in real terms when all is said and done. The ten year treasury has a yield of 2.60% and the long-term inflation rate is around 3-4%. Good luck using the proceeds of the Treasury bond in the future to buy as many cheeseburgers or mamak dinners as you could buy today.  

Even companies with large economic moats bought at low prices are not a sure thing. Sure, it would take a real shit storm for a company like P&G or Nestle to get its intrinsic value impaired. But such shit storms are still within the realms of possibility. Before I invest in something, I have to be reasonably sure that it can deliver above average returns. But I understand the risks, and I monitor the performance of the company to see if any major risks materialize and act accordingly. Once you think your investments are risk-free, you start becoming sloppy and the probability of losses increase. Thank you for reading. Take care and stay rational.