Michael Durante Western Reserve Blackwall Partners 1Q12
BlackwallPartners1QTR 2012- Update April 19, 2012
Detroit - Just the New Fannie Mae?
Negative Yield Gaps Persists…
Blackwall posted a 30.0% net performance for the
first quarter of 2012. As we are focused on financial
firms, we have been dealt a hand that is
fundamentally perfect… yet few recognize this and
consequently the sector endures a faux uncertainty
that has exacerbated volatility. The hand we have
been dealt is one of fundamental strength, low
valuations, under-ownership and high volatility. It’s a
winning hand, a royal flush… but we must be patient.
Right now, it is time to buy these undervalued
franchises and thus “let the pot build-up.”
The fundamentals of these financial firms are so
strikingly appealing that we already can anticipate the
future pangs of regret that we know we will feel when
this historic opportunity set begins to fade. Currently,
there is an overwhelming and ubiquitous public
presumption that low beta and high returns are
sustainable. This has been the case recently in low or
no growth investments such as REITs, bonds and
commodities… but we’ve been around the track a few
times and we know better. There is no such thing as
sustained out performance with low risk and no
The low risk / low volatility investments of REITs,
bonds and commodities are affectively a mirage in the
desert and those that thirst for shelter from volatility
doom themselves to continue to drink the sand.
Investors do so, not because they don’t know its sand,
but because they don’t think they have a choice in a
world of cyclical “performance chasing.”
In our view, it is unwise for these investors to
continue to equate volatility with risk.
The performance chart (top right) illustrates our
career-length performance over the last decade plus.
Manager Career Performance
See: Chart footnotes on last page…
Our classic “Jones-style” fundamental long / short
investment strategy has produced a net total return
of 146% from 1999 to the present. This is markedly
superior to 43% for the HFRX Equity Hedge Index;
27% for the HFRX hedge fund absolute return
index; a loss of 20% for the S&P 500; and an
otherwise devastating 65% decline in the S&P
financial composite respectively.
Needless to say, over the worst decade for financial
stocks since the Great Depression; we are pleased
with having handily bested our benchmark composite
index as well as both the larger market indices and the
other major hedged strategy benchmarks. This is
despite our being focused on financial services.
“Assets can fluctuate greatly in price and not be
risky as long as they are reasonably certain to
deliver increased earnings power over their holding
period. And as we will see, a nonfluctuating asset
can be laden with risk.”
– Warren Buffett
Hypothetical Growth of $100M Invested with Durante (1999-2012)
Equity Risk Premium & the Yield Gap
Recently, we were intrigued by Goldman Sachs’ (GS)
global strategy research piece dated March 21, 2012 –
“The Long Good Buy; the Case for Equities”
Goldman states - “After more than a decade of de-
rating, equities are implying unrealistically large
declines in growth and returns into the future.”
No sector embodies this reality more than U.S.
financial stocks, many of which currently trade at
market values below their net cash-on-hand! In other
words, these stocks are trading as though they have
“no going concern” value. This is the ultimate “de-
rating” of future growth and economic returns.
Nobody can select a royal flush in a card game, it just
comes to you. But one must recognize it in order to
capitalize on it. A novice might mistake it for a hand
lacking any pairs.
Goldman goes on to warn investors who are obsessed
with yield (“pairs”) and lite on growth (equities) –
“The ex-post equity risk premium has been
strikingly poor in recent years. Annualized ten and
twenty year relative returns between stocks and
yield-centric investments have been at their most
negative in over a century.”
Over a century!
In other words, Goldman has calculated that the
equity risk premium has all but completely collapsed.
This hasn’t been witnessed since World War I.
The “yield gap” is a measurement of the yield on
stocks minus the yield on bonds. Today, the yield gap
is negative. According to Yale finance professor
Robert Shiller, the last time this gap was negative was
in 1982 which was the beginning of the greatest stock
market bull run in history (1982-1999).
On these topics, Buffett once suggested the following
in an investment letter of his dated early 1982…
“The long-run historical evidence suggests that the
equity risk premium is almost always positive and
that… investors ignore periods of negative yield
gaps at their own peril.”
– Warren Buffett
It is interesting to note that stocks still have out-
performed bonds since the year 1900 by 1.7 to 1. This
out performance is despite the “lost decade” that
stocks have recently encountered. Yet all we hear
from the pundits is the delusion of a “new norm.”
This seems all the more in-step with
BlackwallPartners’ supposition as we’ve patiently
watched the U.S. financial sector repair their balance
sheets and set-up for the bull run of a career.
Today, financial firms hold more liquid capital than at
any other point in history. In fact, greater than half of
all of the liquidity (cash) in the United States (a.k.a.
M1) is held at The Federal Reserve. But not held by
The Fed as an asset but as a liability! This cash is
held on account by its largest member banks - J.P.
Morgan (JPM); Wells Fargo (WFC); Bank of
America (BAC); Goldman Sachs (GS); Morgan
Stanley (MS) and Citigroup (C) et al.
In central banker parlance, this capital is referred to as
“excess reserves” as these are monies voluntarily held
in a member bank’s reserve account at the central
bank. This is capital that is in excess of the minimum
reserve requirement. We often hear pundits
misappropriate these monies as being excessive
liquidity in the economy when in reality they are idle
or untapped. Put simply – these are monies that are
not in circulation and thus not levered by the “money
multiplier” within our fractional reserve banking
The fact that banks have stock-piled so much liquidity
should be of no surprise as we all witnessed the
onslaught of attacks on the bankers by politicians
since 2009. Consequently, bankers have
understandably been reluctant to lend. Why would
banks subject themselves to additional financial ratio
criticism (due to the lessening of their capital via
lending) in an ultra-low rate environment? They can
earn a near commensurate return on over-night funds
and at zero risk!
It is simply the mechanics of risk and reward
amplified by the unintended consequences of a
government rife with anti-business policies. A
government that has overreached into the private
sector economy like no living American has ever
encountered before. The good news is that this is not
a negative for banks and banking stocks. The reality
now is that this exercise is now a positive. Banks are
minting profits at no risk while they merely await
a reversal of the overreach.
This already showed-up in first quarter profits as
JPM and WFC reported RECORD quarterly
profits… and this has been followed by one strong
bank earnings report after another.
Yet, their valuations remain materially below their
empirical average let alone their historic high. This
combination of low valuation multiples applied to
cyclically low earnings affectively positions a
“double leverage” effect. Similar circumstances were
seen coming out of the Savings & Loan Crisis which
resulted in a dramatic 900% return for financials in
The Federal Reserve in an abundance of caution
continues to “stress test” these banks and is slowly
allowing them to release these massive excess
reserves in the form of paying dividends and buy-ins
of their stock. We suspect that the Fed’s slow and
steady approach is largely ceremonial in an effort to
signal to the public that the Fed is applying the
greatest of care in their larger capital assessment
process. A certain degree of “theatre” is necessary in
this post “financial crisis” world. But with that being
said, it is getting harder and harder to justify all this
capital and liquidity.
Blackwall has published extensively over the last
number of years on mark-to-market accounting and
illustrated in great detail the false inflation of bank
credit losses. These “losses” were inflated to the
tune of seven-fold at the height of 2008-2009 crisis.
In addition, we perpetually run our CAMEL analyses
of financial firms which indicate an historic
opportunity per the de-coupling of valuations and
fundamentals in the sector. Only now are these facts
beginning to pierce the veil of some main stream
Fortunately there are far more skeptics than factual
observers in the investment world regarding
financials. The evidence of this lies in the utter lack of
both institutional and retail ownership of these stocks.
Currently, financials remain barely off the lowest
valuations they’ve encountered in history. They are as
under weighted by investors as has been seen in
Soaring Bank Dividend Yields (%)
US Banks S&P 500
Source: SNL Financial; Guggenheim Securities LLC; and
The chart above is quite straight forward. Banks
historically pay higher dividend payout ratios than the
average US publicly traded non-financial corporation.
This is due to the nature of their recurring revenue
and low capital expenditure needs. Inherently, banks
produce very high levels of internal capital generation
as has been illustrated since 2009 in their massive
liquidity and capital builds. In regard to this point,
this is reflective of how quickly bankers were able to
repay TARP whereas the carmakers have yet to repay
Nevertheless, as a function of public opinion and
political expediency in the after-math of the “financial
crisis”; U.S. banks were required to cease paying
dividends in an effort to grow their capital and
support their financial ratios. (See the dotted line
decline on the chart above.)
What began as a prudent balance sheet exercise by
banks escalated into the hoarding of capital. This cash
hoarding was exacerbated by the open demonization
of the banking industry by either unwitting or
unscrupulous politicians. The remainder of the chart
outlines what will happen if banks merely returned to
“normal” payout ratios - the yield-spread is going to
widen to a record level even if the banks did nothing
but continue to collect a riskless spread moving
Therefore, from our perspective there is much to look
forward to for the contrarian or brave bank stock
investor. Banks will provide both a growth and a high
income opportunity. This will become very attractive
to many types of fund strategies as this becomes
apparent to investors.
As we noted in our last musing, we believe the attacks
on the banking industry and on free market capitalism
have peaked. U.S. banks have focused on building
iron-clad balance sheets to withstand even the most
Bolshevik of “end-runs.” Even in the most unlikely of
scenarios, where one assumes no earnings growth for
U.S. banks (despite both earnings and valuations
currently positioned as a two-fold “coiled-spring”);
the yield spread over the S&P 500 would soar to a
record of nearly 400 basis points. So, when
considering the historic yield spread for banks relative
to the S&P 500, even a simple dividend discount
calculation portends the sector rising 200% by 2014.
Therefore, whether it is the yield hungry mob we
referenced earlier or the repurchase of their stock
from the banks themselves… one way or the
other… we anticipate these bank stock prices
rising significantly beyond the 200% default of a
basic dividend-discount calculation.
Blackwall strongly suspects that not only will US
bank payout ratios increase materially but free cash
flow will also see substantial growth acceleration. We
anticipate the untoward regulations that have been
holding back normal banking activities will be largely
watered-down if not repealed in total. This will be the
result of a pro-growth agenda returning to
Washington and these steps will be instrumental in
ushering in a substantial economic recovery.
The opposition to President Obama’s regime has
openly acknowledged that these reforms and unwinds
will be an immediate priority. Surprisingly, few fund
managers have signaled any enthusiasm to add US
financial stocks to their portfolio. We find this curious
on the one hand; however, we are well aware that the
intoxicant of recency bias can have a powerful effect
on even the most sober of managers.
So what does this all mean for financial stocks? It
means that some short term volatility is par for the
course but it will pay off in a big way. The earnings
acceleration that we just referenced will eventually
drive the sector from under-ownership to normal
weights and then ultimately to over-ownership.
Valuation expansion will track this step-by-step.
Naturally, investors that currently equate volatility
with “risk” will miss the boat. Period!
Detroit… another Government
As our review of the facts should clearly outline, we
believe GM is not being managed in their
shareholders’ best interest. There is a cozy and
questionable relationship between the federal
government directly subsidizing financings for GM’s
dealers and customers which is akin to Fannie Mae
and Freddie Mac. We believe a traditional
reorganization-style bankruptcy is likely for GM
should this “arrangement” with the federal
government come under scrutiny, a serious risk factor
in our view. Under such a scenario, the current equity
of GM could be substantially impaired and perhaps
My father mentioned several months ago that he was
going to buy a new Cadillac after having surveyed
numerous other competing foreign brands. I asked
him – why the newfound interest in Cadillac? His
short answer (no pun intended) sort of surprised me.
He quipped, “I’m taking from the government hand-
out machine since I’m paying for it anyway.” I
believe this behavior is what is more commonly
referred to as “capitulation to wealth transfer
What he was referring to was the taxpayer owned and
funded de facto finance arm of GM and Chrysler,
formerly known as GMAC, now mysteriously
renamed - Ally Financial. Ally offered my father
zero money down, 0% interest and 72 months of “free
time” to repay the loan if he took the Caddy instead of
the BMW. And he’s a cash buyer. They also offered
him a couple grand below MSRP.
My father, a pragmatic engineer and business owner,
clearly sees through what is taking place at GM.
The question is… How long will the unwitting
taxpayers continue to provide car buyers with zero
down, zero interest “APR” and 72-month free
financing? We suspect few Americans yet realize
that this is the quid pro quo “arrangement” that is in
place between the current Administration and the
UAW, oddly now GM’s largest shareholder.
Eventually, we believe others, even politicians, will
catch-on to the fact that Detroit’s “come-back” is
driven, in large part, by a sizeable taxpayer
subsidy. Is this just another Freddie Mac?
Ultimately, we suspect that Detroit’s taxpayer
subsidized financing of both dealer and end market
car buyer will be cut-off. If this were the case, the
competitive advantage of being run by a government
with an “open checkbook” would abruptly end. And
at that very moment, sales, earnings and capital would
be discounted closer to reality.
GM’s cost structure remains non-competitive in
the global auto marketplace without the “juice”
Question: Why was General Motors Acceptance
Corporation (“GMAC”) renamed Ally Financial? We
only can hypothesize… but no theory rings true other
than political expediency.
We also would note that GM’s joint venture in China,
“Shanghai GM” has some promise, but we can’t see it
offsetting a reshuffling of the way the company
finances its dealers and car buyers in the world’s
largest market without the U.S. government subsidy.
Chart of GM’s Stock Since 2010 IPO
Should the taxpayer subsidized financings be pulled,
we believe GM could find itself again in a serious
spot of trouble. Artificially subsidized financings are
driving the sales at GM. It’s a classic “sales finance”
Smart Money magazine recently ran this cover…
“How Car Buyers Can Land the Elusive 0% APR”
- Smart Money; Dumb Taxpayers…
As Smart Money pointed out – “Try to find 0%
deals on more popular European luxury models
or Japanese compact cars and it will be an
exercise in futility.”
Now, you can call us sticklers for those pesky details,
but aren’t there U.S. anti-trust laws like the Sherman
and Clayton Acts that protect companies from price
predation? Zero percent loan rates are below a
bank’s marginal cost and therefore they are a
potential breach of prevailing law. Not to mention a
moronic idea if you’re a banker. It’s no wonder Ally
Financial scored DEAD LAST on the Fed’s recent
The government of course is no ordinary banker.
They are none other than the “visionary venture
capitalists” that invested in LightSquared; FirstSolar;
Ener1; Solyndra; Fisker and the Chevy Volt et al.
So one may ask… what’s a few upside-down car
loans? Well, Ally Financial provides approximately
$50 billion of financings per year or the lion’s share
of Detroit’s sales through put and that’s all on the
taxpayer’s dime… dimes that we suspect the taxpayer
may not substantively recover. This may pressure an
unwinding of the current relationship between Ally
and GM at some point, perhaps very soon.
Blackwall’s negative call on GM is a simple one – if a
new, more fiscally responsible administration takes
hold in Washington, then we suspect that this
subsidized financing arrangement by the taxpayer
would likely end. Detroit’s on-going “bail-out” gets
cut-off and pop-goes-the-weasel.
As an aside, AmeriCredit was a small, very well
managed and profitable subprime auto lender based in
Fort Worth. This was before they were acquired by
GM (at the eleventh hour) just prior to their IPO, so
they could then be used as what appears to be nothing
more than a “prop.” AmeriCredit, now “GM
Financial” remains a small subprime car lender based
in Fort Worth, Texas. But the “heavy lifting”
financings of GM’s sales are being done by Ally
Financial out of Washington.
And Ally Financial just flagged the Fed’s stress test
by 100%! The Fed’s stress test indicates that their
Tier 1 Common equity ratio came-in at just 2.5%
under stress or half the minimum 5% threshold.
For Ally to be recapitalized to meet the Fed’s “stress
test” minimum, its owners, the taxpayer, would need
to chip in another $40-$50 billion or more by our
calculations. We don’t believe there’s much political
appetite for this to happen.
Ally has $19 billion in equity and $19 billion in
intangible assets or no tangible common equity.
Treasury, perhaps seeing this Ally problem arising
has been “shopping” it around if the rumors are true.
GM has been sighted as the natural buyer, but GM
can’t afford to become a “SIFI” and thus be regulated
by the Federal Reserve and thus also subject to the
“stress test.” Ally needs as much as a $50 billion
capital infusion and GM has net negative short term
assets and negative tangible common equity itself!
GM cannot be the buyer. So, it’s shaping-up to be a
rather dicey situation in our estimation.
A Swindle for the Ages?
General Motors Company announced pricing of the public
offering of common stock of $33.00 per share on
November 17, 2010. GM’s common shares began trading
on the New York Stock Exchange and the Toronto Stock
Exchange on November 18, 2010.
The UAW sold an astonishing 89 million shares on
the “new” GM IPO, netting the union a windfall of
$2.9 Billion. And again, the UAW sold 13.4 million
shares in December 2010 (just shortly after the IPO)
for net proceeds of some $437.2 million. Not too bad
for an organization that previously had NO EQUITY
OWNERSHIP in this company… that is, no equity
ownership prior to the Obama Administration getting
heavily involved in a pre-packaged bankruptcy which
resulted in the “redistribution” of the ownership of the
company which many called into question legally.
Major Insider Holders in GM’s Stock (After the
Pre-Packaged Bankruptcy) But Pre-IPO
Holder Shares % of Shares
UAW -- 20%
US TREASURY -- 61%
All Insiders 100%
Source: company reports; Securities & Exchange Commission
Major Insider Holders in GM’s Stock Today
Holder Shares % of Shares
UAW 160,150,000 10%
US TREASURY 186,876,283 12%
All Insiders 54%
Source: company reports; Securities & Exchange Commission
The U.S. Treasury (taxpayers) recovered less than $5
billion in the GM IPO. This is a fraction of what has
been put into the company by taxpayers (See: Next
Page “bail-out” table).
The U.S. taxpayer has seen its ownership in GM fall
from 61% pre-IPO to only 12% today with virtually
nothing to show for their ownership percentage
And in April 2011, it appears the U.S. government
may have ceded back 113 million shares of GM
and received nothing in return. Did the U.S.
taxpayer “cede” or “forgive” some ownership?
The UAW sure didn’t. For their inclusion in the GM
bankruptcy reorganization, the Union walked away
with cash proceeds exceeding $9 billion and 20% of
the company’s stock.
The Canadian government sold 36 million shares as
part of the IPO to net some $1.2 billion. Canadian
taxpayers are also badly “in-the-hole” on their GM
investment. However, they are not nearly as bad off
as American taxpayers.
Pre-bankruptcy, GM bondholders held some $27
billion of senior debt (SECURED). They ended up
with 10% of the stock, worth only $4 billion today.
Therefore, the bondholders recovered only 15% of
their invested capital and yet they were the most
senior in the capital structure of the company.
By amazing contrast, the UAW held UNSECURED
claims estimated at $20 billion and they ended up
with 18% of the company; $9 billion in cash; cashed-
in $3.3 billion so far in stock and still hold $4 billion
worth of stock at currently market values.
So, all told, the union has RECOVERED 82% of the
value of an UNSECURED credit while secured
bondholders recovered 15%. At the IPO price, the
Union would have recovered approximately 100%...
thus being “made whole.” Pretty astonishing when
one considers that secured creditors received only 15c
on the dollar.
The U.S. taxpayer netted just $5 billion in cash
recovery in the IPO after being relieved of 80% of our
ownership position. The $5 billion the U.S. taxpayer
has recovered from “Detroit” is less than 3% of our
investment. And it’s questionable where the $5 billion
loan repayment from GM actually came from. It, in
effect, came from other monies the taxpayer provided
the company through TARP e.g.. We don’t believe
the U.S. taxpayer has been repaid anything at worst
and at best is still over $100 billion in the whole
Adding probable insult to injury, U.S “car czar,”
appointed by President Obama, Stephen Girsky
personally netted $312,002 from the GM IPO. And
interim CEO Ed Whitacre netted over $500,000 in the
GM IPO. Nice work if one can get it.
And as if all of this wasn’t concerning enough, GM
recently paid out bonuses to UAW workers on
“profits” that are the result of the upside-down
lending at Ally Financial. In other words, we don’t
think GM’s reported profits are sustainable or, in
effect, “real” in this regard due to the arrangement
Total Estimated Auto Industry Bail-Out
Federal Program $Billions
Auto Supplier Support Program:
General Motors Suppliers
Automotive Industry Financing Program:
Term Asset-backed Securities Loan Facility
Car Allowance Rebate System
Advanced Technology Vehicles MFG
Source: U.S. Treasury; CBO, BlackwallPartners and White House
Essentially, losses at Ally incurred in the price
predation car loan program are offset as GM
books a sale and a profit. By our observation, the
taxpayer owns the losses and the union owns the
Today, GM’s total market capitalization is about $40
billion. This is less than 20% of the combined
injections by the U.S. and Canadian governments
through the various auto “bail-out” programs. The
two sets of taxpayers only own about $8 billion at
prevailing market values… or about 4% of what was
This is a shameful taxpayer swindle to the tune of
approximately $133 billion for US taxpayers. GM
shares have sunk 38% since the IPO and any
significant recovery for the U.S. and Canadian
taxpayers appears increasingly less likely. And
obviously, we believe there is a potential serious risk
that the shares have a lot further to drop if the
subsidized financings are pulled.
As Barron’s wrote - “Never has an American union
done so well at the expense of shareholders and
Barron’s also of note that of the 779 Chrysler dealerships
that were closed as part of Chrysler’s reorganization… 778
had made no donations to democrats or democrat causes.
The one standout? They donated to Hilary Clinton.
Steal You Blind (Until the Money Runs Out)?
United Nations Conference on
What many investors in GM may not realize is that
the United Nation’s “Agenda 21” which calls for
wealth redistribution is now ingrained in how General
Motors Corporation appears to be governed and run.
“Sustainable” is nomenclature for wealth
redistribution whether it be shareholder capital or
profits distribution. GM pays no dividend e.g. Yet,
the company’s union workers received lucrative
bonuses from GM in 2011, but neither the salaried
employees nor the firms’ stockholders received any
bonus or “dividend.”
In part, this makes GM now the world’s largest
corporation governed by United Nations edict
This is corporate governance through wealth
redistribution conveniently and benignly referred to
as “sustainable” management. In the real world,
this might appear more akin to “highway robbery” of
shareholders in any reasoned person’s view.
GM investors should be aware that this is how their
company is being managed. We believe that the
objective of the firm and the way in which it is
currently being managed is not in any way in sync
with stockholder interests.
Would you invest in a company that espouses the
edicts of an organization as backward and corrupt as
the United Nations? If invested in GM stock, you
indeed are investing in a company that puts the
United Nations’ agenda ahead of you as a
This issue is a key component in why we believe
there is the serious risk that GM will fail to deliver for
The following sections are highlighted on GM’s
investor relations website.
GM Sustainability Report
Our inaugural annual Sustainability Report is a discussion
of our global economic, social and environmental
responsibilities, and industry challenges and opportunities.
Why would a public company whose sole purpose is
to reward capital investment need a “sustainability
report”? There is the Rule of Law that protects all
other parties from any wrongful acts or omissions by
companies such as GM. The law isn’t enough?
The GM Foundation helps communities across the U.S.
through investments in Education, Health/Human Services,
Environment/Energy and Community Development.
Why would a public company just coming off the
brink of collapse and bankruptcy reorganization need
a foundation that supports outside endeavors? How
can shareholders afford this? And when will
taxpayers be repaid for such “community” endeavors
described? This is very much “Agenda 21” sounding.
Diversity at GM
Diversity is an integral part of our culture and
success. Learn how we drive diversity for the benefit of our
customers, employees, communities, suppliers and dealers.
And while diversity is important in our society, there
are laws that govern such. Why does GM see a need
to intrude on the diversity policies of its customers;
suppliers; dealers and communities? And what right
do they have to do so? Shouldn’t GM be managed to
just be concerned with compliance with the law as it
relates to GM and its shareholders?
These “policies” smack of a conflict of interest or
perhaps an alternative agenda for the
management of GM. BlackwallPartners believes
these “policies” are inherently adverse to
Ally Financial: The New Fannie Mae?
The following outlines the taxpayer subsidy that
nobody seems to talk about… we believe this could
very well force GM into a proper reorganization
under a potential new administration in 2013-2016.
This is the same type of reorganization that the
President’s likely opposition has advocated on the
campaign trail. Therefore, this is a large and tangible
risk to the current stockholders of GM. An election
could change everything abruptly.
Since we have raised concerns about how the
managing of General Motors is in-step with
stockholders and creditors (such as the U.S.
taxpayer), let’s take a closer look at Ally. Can GM
prosper or even survive without it?
Regardless of the name change, Ally Financial
continues to act as Detroit’s “captive finance” arm
and they continue to lose money. As previously
referenced, they are doing so through subsidized
loans to both car buyers and car dealers at rates below
market including 0% APRs.
Is this not overt sleight of hand? All of the following
are simply not carried on GM’s balance sheet and
income statement, but they are the taxpayer’s
And a potential re-shifting of these liabilities back
to GM could be disastrous for GM’s stockholders.
Here are the facts:
• Ally Financial in 2011 has continued to be
the nation’s #1 automotive financier
• Ally did $43 billion in automobile loans in
2010 and over $50 billion in 2011, which
represents approximately 60% of all of GM
and Chrysler’s throughput car sales
• Ally grew car loan receivables by over 70%
in 2010 and another 40% in 2011
• Less than 30% of Ally’s balance sheet is
core or “deposit” funded and thus it
survives merely off of an implied taxpayer
backstop in the credit markets
• Including original issue discount (OID)
amortization, Ally has lost $billions over
the past several years including 2010 and
• Ally’s net interest margin is ONLY 1.4%
compared with normal consumer finance
bank margins of 5% to 8% due to their
underpricing credit terms
• Ally in 2011 increased its dealer floor plan
lending by 90% to potentially “channel
stuff” inventory… this was some 2.9 million
cars financed for GM and Chrysler
• By contrast, Ally financed actual purchases
by consumers of 0.9 million units, so there
was over 1 million (unaccounted for) car
sales reported by GM and Chrysler that
“sat” in dealer inventory… yet still counted
as a “sale”… and union workers’ bonuses
were based on these economics
• When recently “stress tested” by The
Federal Reserve… Ally came-in dead last
with only HALF the minimum capital
required, yet they keep on growing loans as
the major support mechanism
underwriting Detroit’s “miracle” recovery;
And at a breakneck pace that is
• Ally’s net interest margin has plummeted
40% between 2009 and 2011 amid the low
and no APRs offered… thus “taxpayer
• Earning asset growth at Ally was 17x that
of the private sector banking industry in
2011; was it perhaps “necessary” to keep
sales up at Detroit automakers politically?
• Despite the heady asset growth, Ally’s
provision for bad credit (credit loss reserve)
has dropped to nearly zero in recent
quarters, clearly not sustainable
• Yet, Ally’s loan loss reserve stands at just
1% of loan receivables or an inadequate
67% of delinquent loans; typical losses on
car loans are as high as 50%, so Ally is
potentially massively under-reserved for
future losses, a taxpayer liability that could
be and perhaps should be transferred to
GM at some point
• If an adequate loan loss provision were in
place right now… Ally would be losing
• And this at a time when the “stress test”
scored their capital adequacy the lowest in
the large scale finance industry
• Ally’s parent company liquidity at the end
of 2010 was ONLY 109% of debt maturities
over the coming 24-month period… thus
providing no margin for error
Conclusion – Ally Financial is on very shaky
financial footing as the recent Fed “Stress Test” has
indicated. Our analysis suggests that a major
recapitalization from the taxpayer at some point in
time may be inevitable. This is assuming that Ally
continues to be used by the federal government as the
primary support underlying the recovery of GM (and
It’s no wonder that Ally Financial failed to price an
initial public offering in late 2011 as was their initial
plan. They don’t have the financial footing to support
the private sector scrutiny involved in going public.
Should a new administration take office in 2013 and
“cut-off” this massive government subsidy for
Detroit, we believe GM’s sales and “profits” would
be materially pressured. As a result, we would
anticipate the strong possibility of another trip
through bankruptcy reorganization. If this occurs, this
is a serious threat to the stock.
Bonds and REITs… Big Bubble
We are ending a bond bubble the likes of which was
last seen post-1929. The question is how close to the
end are we?
Equities Over-Discounting Profit Growth
Implied Earnings Growth %
Source: Goldman Sachs; BlackwallPartners
The chart above implies that investors actually
believe (discount) U.S. corporate profit growth will
be the worst in a hundred years. Investors are so over
loaded in yield strategies that the valuations of growth
strategies (stocks) have been discounted dramatically
and in some sectors to Armageddon levels.
The peak in bonds (and what many managers have
been substituting for bonds – REITs) is at a multi-
generational top. We would argue that this is likely
near an end (the top) given the following facts…
• There are massive stores of excess liquidity on
the sidelines of the U.S. economy which are
earning virtually nothing
• The empirical reality previously outlined of a
negative yield gap… historically speaking,
this has never been long sustained
• The overwhelming adherence to low volatility
fixed income or yield strategies by portfolio
managers and asset allocators despite the
valuations of such securities reaching absurd
levels by historic standards
In addition to the bullet points above, the approaching
presidential election is paramount. The result of this
election could end what many view as the most anti-
business period in our country’s history since FDR.
The potential pain that would follow in the bond (and
bond proxy) market could be epic.
In the event that this election ushers in a new pro-
business administration, it is likely that trillions of
dollars currently sitting in cash will be reallocated to
more productive asset classes. This will have an
upward force on interest rates which poses a great risk
to the very asset classes that have garnered so much
cash (REITs and bonds) over the last three years.
Accordingly, BlackwallPartners is short long-tailed
bonds and traditional REITs.
US stocks have been rising of late because US
companies, inclusive of our banks, are now “lean and
mean” as a function of self-preservation. They have
honed their survival instincts after three years of
incessant attacks, an ever changing and unpredictable
regulatory and tax environment, and weak end
As a result, the upside in financial stocks is heavily
levered to even the smallest ray of economic
sunshine. In addition, the cost structure of
financial firms is so "tightly wound" that every
single dollar of revenue has an incremental margin
of a de facto 100%.
U.S. stocks are much cheaper than advertised as most
investors do not realize that financial firms’ earnings
"power" is like a “coiled-spring.” Fortunately, this is
the case in a number of sectors and industries in our
American services based economy; but none so much
as the financial sector.
The fuel for economic recovery and releasing this
“coil” of earnings power lies in the record amount of
unproductive cash and other forms of fungible monies
and near monies sitting on the sidelines awaiting
relief from this government.
Michael P. Durante
Blackwall Partners LLC
The manager's historic gross performance record above reflects his performance while at AIG/ John McStay Investment Counsel (1999 -
2002) and at Western Reserve Capital Management (2004 - 2010). The "Gross" data in the benchmark analysis and the corresponding
charts above reflect cumulative performance data for each year illustrated and does not reflect all fees and expenses.
A limited partner's net return would be dependent upon when that LP entered and exited the fund relative to their high water mark and
thus their "net" return after management and performance fees.The "net" performance above is estimated for (1999-2002) as McStay was
long-only institutional separate accounts and Western Reserve was long/short. All historic performance results are audited and are AIMR
/ GAAP compliant. Past performance is not indicative of future performance.
To more accurately reflect the manager's performance while Western Reserve was distributing assets, an expense ratio consistent with
AUM of $25M for the final trailing twelve month period (July 2009 thru June 2010) was applied to performance calculations.
S&P Financial Services Composite consists of equally weighted long-only Financial Indexes. Components include KBE and RKH.