The Credit Crunch

The Credit Crunch: 2 Ways to Profit From Credit Crisis Opportunities

by Alexander Green, Chairman, Investment U;
Investment Director, The Oxford Club
Monday, January 21, 2008: Issue #754

We’re six months into the greatest credit crunch of the modern era. Defaults on mortgages, especially subprime mortgages, have rocketed as individuals have found it more advantageous to toss the house keys back to the banks rather than making the payments they can’t afford on the houses they shouldn’t have bought.

But it’s not just the borrowers who are suffering. It’s also the banks, pension funds, life insurance companies and individual investors that bought toxic mortgages, repackaged as complex securities from Wall Street investment banks.

Of course, every crisis creates opportunities, as well. Here are two, one for risk- averse investors and another for those of you who feel like swinging for the back fence…

Credit Crunch Strategy #1: Increase Your Returns as CD Rates Soar

The credit crunch has caused the CD rates at several mortgage banks to soar. (That’s what these banks have to do to attract new deposits right now.) Some are paying close to 2% above the yields available on the 10-year Treasury note. Yet your investment in these CDs is insured by the FDIC. Here are a few examples:

Countrywide Bank is paying 5.45% APY on 3 month CDs in amounts as low as $10,000.
IndyMac Bank is paying 5.40% APY on as low as $5,000 for CDs opened online.

The credit crisis enables you to lock in CD yields at above-market rates that wouldn’t exist otherwise.

Credit Crunch Strategy #2: Buying Beaten Down Stocks with the Billionaires

The most successful investors - including Bill Miller, the country’s top equity fund manager, and billionaire hedge fund guru George Soros - have been buying shares of beaten down financial stocks. Given the magnitude of the credit crunch, this seems wildly contrarian to many investors. But Soros, Miller and others believe the problems in the sector are well understood and fully reflected in current share prices.

A good example is First Horizon National (NYSE: FHN). Based in Memphis, this bank has been operating at a loss lately and said last month that it is adding a larger-than-expected $150 million to its loan loss provisions. (The culprit, of course, is residential construction lending and mortgages.)

However, you can make the case that the current market price fully discounts the problems in the sector:

The stock is down 65% over the past 52 weeks.

It is now selling for 1.1 times sales and 86% of book value.
This has pushed the yield up to 10.4%.
Furthermore, top executives and directors bought tens of thousands of shares in October and November.

Today you can buy the stock significantly cheaper than they did. That may not be a bad idea. Last week’s Bank of America deal for Countrywide is signaling further consolidation in the industry. And Bernanke is making it clear he stands ready to cut rates aggressively. Both bode well for beaten-down banking shares.

Historical Profits From Past Credit Crunches

In 1992, for example, during another credit crunch, Goldman Sachs sold a 500 million dollar stake to Hawaii’s Bishop Estate, a trust that benefits children of Hawaiian ancestry. When Goldman went public in 1999, that stake was worth at least three times as much as Bishop had paid. While the Bishop Estate has since sold out, if they would have continued to hold the shares in Goldman the stake would have quadrupled again since the public offering.

Another example is the Saudi Prince Alwaleed bin Talal Alsaud’s Citibank investment. His net worth is estimated at over $20.3 billion. He is ranked by Forbes Magazine as the 13th richest person in the world. He was nicknamed by Time magazine as the Arabian Warren Buffett. Half of his wealth came as a result of an investment he made in Citibank in the early 1990s.

At the time, Citibank was reeling from bad investments. (The company had made enormous real estate and business loans in Latin America that had gone sour.) The stake Prince Alwaleed bought in Citibank for $550 million is now worth over $10 billion. He has also taken out many millions of dollars in dividends in the almost two decades of holding these shares.

The Future of Today’s Financial Markets

When you see foreign investors lining up to take stakes in Bear Stearns, Barclays, Citigroup, HSBC, Morgan Stanley, realize that some savvy investors are looking beyond the storm in today’s financial markets to a recovery later this year or next. Over the next three to five years, financial stocks could provide outstanding long-term returns.

Again, banks are likely to be volatile in the short-term. But if you want to have the opportunity to tell your grandkids you made a bundle in “The Great Credit Crunch of 2008,” you might at least plunk for a few shares.

Good investing,

Alex

Today’s Investment U Crib Sheet

First Horizon and Countrywide have plenty of company at the bottom of the barrel. Want a few more ideas for the “Great Credit Crunch of 2008″? Here’s a list of financial stocks down more than 50% over the last 52 weeks:E-Trade (Nasdaq: ETFC) -88%, MBIA (NYSE: MBI) -86%, Countrywide (NYSE: CFC) -86%, MGIC Invest. Corp. (NYSE: MTG) -77%, First Marblehead (NYSE: FMD) -73%, Washington Mutual (NYSE: WM) -69%, First Horizon (NYSE: FHN) -65%, Thornburg (NYSE: TMA) -63%, CIT Group (NYSE: CIT) -61%, SLM Corp. (NYSE: SLM) -61%, Doral Financial (NYSE: DRL) -60%, Sovereign Bancorp (NYSE: SOV) -60%, AmeriCredit Corp. (NYSE: ACF) -57%, Bear Stearns (NYSE: BSC) -56%, National City Corp. (NYSE: NCC) -55%, CB Richard Ellis (NYSE: CBG) -54%, Freddie Mac (NYSE: FRE) -53%, Citigroup (NYSE: C) -52%
To get the 8 high-income plays currently on the “buy” list, see how Alex’s “Perpetual Money” portfolio can generate thousands of dollars a month for you.