The Value Investor Case for MBIA, BoFA, AIG and NewMarket

Fernbank earned 5.03% in 2012. For the first quarter ended March 31, 2013, the Fund earned 10.73%.

Since inception on September 1, 2010, the Fund has earned 58.40% despite holding, on average, over 24% in cash for the period ended March 31, 2013. Below is a summary of why the value hedge fund likes MBIA, AIG, BAC and several other stocks, followed by the full document in scribd:

The Value Investor Case for MBIA, BoFA, AIG and NewMarket

Your individual results to date will vary depending on the timing of your investment. Neither leverage nor short selling was a significant factor in the returns displayed above. Despite reported returns of just over 5%, 2012 was a good year. With the exception of MBIA Inc.(NYSE:MBI), our largest holdings substantially appreciated in price. The market prices of our largest holdings at the beginning of 2012 and their respective prices for the period ended December 31, 2012.

MBIA Inc.(NYSE:MBI), which remained one-third of the Fund throughout the year, declined 32% in 2012 to $7.85. As a result of this concentrated position, the Fund’s assets vary a great deal from period to period. This effect is illustrated in the below table.

In order to isolate MBIA’s effect on the Fund’s performance, consider the March 15, 2013 figures presented above. You will notice that MBIA’s price on December 31, 2011 is nearly the same as on March 15, 2013. Since we maintained the position at 34% (on a cost basis), MBIA Inc.(NYSE:MBI)’s impact on the funds performance is, in essence, non-existent for this period. Meaning, the fund’s performance for the period December 31, 2011 through March 15, 2013, was entirely driven by our other (non-MBIA) holdings.

NewMarket Corporation (NYSE:NEU)

NewMarket Corporation (NYSE:NEU) continues to report record earnings and its corresponding price has increased significantly since we acquired it. Our assessment of NewMarket as a wonderful business with a very strong competitive position within the lubricant additives industry remains unchanged.

American International Group Inc (NYSE:AIG)

This “systemically important financial institution” continues to make progress and improve its business. American International Group Inc (NYSE:AIG) was hated by investors during the recent financial crisis primarily because the company received a $79 billion “bail-out” from the New York Federal Reserve in exchange for 79% equity ownership. Five years later American International Group Inc (NYSE:AIG) has paid back the Fed, wound-down its mortgage related derivative exposures and bought back $13 billion of its own shares for significantly below book value. Furthermore, as of Q4 2012, the federal government sold all of its shares of American International Group Inc (NYSE:AIG) back to the public. Lastly, in a display of pricing power not seen for some time, AIG successfully implemented insurance premium increases for many lines of business-a sign that they are regaining their position as a global leader in multiple lines of insurance.

Bank of America Corp (NYSE:BAC)

We bought BAC because it was extremely cheap, by our conservative assessment, selling well below liquidation value. The quality of Bank of America Corp (NYSE:BAC)’s assets and the amount of off-balance sheet mortgage exposure were large contributing factors in BAC’s depressed price. Particular uncertainty could be traced directly to potential asset impairments as a result of legacy mortgages tied to the purchase of Countrywide. However, we acquired knowledge of, and became comfortable with, BAC’s exposures as a consequence of having studied MBIA’s mortgage exposure in pain-staking detail. After all, BAC is MBIA Inc.(NYSE:MBI)’s largest mortgage related counter-party.

The future looks good for Bank of America Corp (NYSE:BAC). It is in the process of eliminating these Countrywide-related mortgage exposures. Moreover, the company has also shed ancillary businesses that management regarded as unnecessary to its core banking business. We welcome these changes and believe that as mortgage losses subside the company’s normal earning power will be hard to ignore and as legal liabilities disappear, the balance sheet will be subject to far less scrutiny. We expect Bank of America Corp (NYSE:BAC) will generate a return on assets of 1% or more in the next few years.

Banks earning 1% on assets are generally worth at least book value in privately negotiated transactions, a fact that we believe will ultimately be rejected in Bank of America Corp (NYSE:BAC)’s market price. BAC’s economics look good going forward largely due to industry consolidation, cross-selling of products to customers, and the advantages of scale afforded to a bank of Bank of America Corp (NYSE:BAC)’s size. Furthermore, at least half of all Americans have some kind of financial relationship with BAC.

Fernbank 2012 Annual Letter value investing


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