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The Baupost Group analyzes thrift stocks by focusing on asset quality and value over short-term earnings. They emphasize minimizing risk over returns and calculate an "adjusted book value" to estimate what a thrift may be worth. They avoid thrifts with significant exposure to riskier loans like construction, commercial, or out-of-state loans unless the thrift has a proven track record in those areas. While this excludes some opportunities, it allows them to analyze thrifts with more understandable and lower risk traditional residential lending practices.
The Baupost Group analyzes thrift stocks by focusing on asset quality and value over short-term earnings. They emphasize minimizing risk over returns and calculate an "adjusted book value" to estimate what a thrift may be worth. They avoid thrifts with significant exposure to riskier loans like construction, commercial, or out-of-state loans unless the thrift has a proven track record in those areas. While this excludes some opportunities, it allows them to analyze thrifts with more understandable and lower risk traditional residential lending practices.
The Baupost Group analyzes thrift stocks by focusing on asset quality and value over short-term earnings. They emphasize minimizing risk over returns and calculate an "adjusted book value" to estimate what a thrift may be worth. They avoid thrifts with significant exposure to riskier loans like construction, commercial, or out-of-state loans unless the thrift has a proven track record in those areas. While this excludes some opportunities, it allows them to analyze thrifts with more understandable and lower risk traditional residential lending practices.
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