T11 Capital Management commentary for the month ended June 30, 2016.

  • Winning positions in June: KFS +8.05%
  • Losing positions in June: LEHct -10.25%, PIH -7.66%, WMIH -6.33%
  • New additions to portfolio: None
  • New liquidations in portfolio: None
  • Portfolio exposure as of June 30th: 91% long/9% cash
  • Long Positions as of June 30th: WMIH, KFS, PIH, LEHct

T11 Capital Management

T11 Capital Management – Portfolio Highlights

  • KFS stock continued its steady ascent during the month of June. There is a particular insider that has been buying stock on the open market on a daily basis. If you will remember from the April investor letter, upon the announcement of John Fitzgerald to join the board of KFS, as part of his agreement to receive 500,000 in restricted stock units:

The restricted stock units will be issued when certain conditions precedent are met including the purchase for $1 million by Mr. Fitzgerald of common shares of KFS either in open market purchases or directly from the Company at $5.50 per share should the market price exceed $5.50 per share.

Mr. Fitzgerald then has every reason in the world to continue buying stock up to $5.50 per share. With the current stock price at $5.42 (bear in mind, $5.50 is the price he can get shares directly from the company) and with a total value of purchases to date, according to my calculations at just under $700,000, the buying pressure he has been providing in recent weeks may subside in July.

The company continues to be a value at current levels, however. Judging by the willingness of a new board member to put $1 million of his own capital to work in the company, it would seem that insiders agree.

Portfolio Lowlights

  • WMIH continued in what has become a prolonged holding pattern. The volume characteristics of the stock have changed as the company has been added to the Russell 2000 during June, causing a substantial increase in daily average trading volume.

What I consider to be an important piece of analysis was released by KKR in late-June. The extensive analysis provided by KKR on everything from global economic growth expectations to the future of the private credit/direct lending markets is well worth the time to read. It can be found here.

Our investment in WMIH has forced me to become more aware than I ever thought I would be of the private equity world, namely the top tier firms such as Blackstone, Apollo and of course, KKR. Given that KKR is essentially pulling the strings from high up above as to the future of this cash/tax shell, I have become what some people might consider compulsive about learning as much as I can about the firm, its founders, key personnel and their thinking.

Studying private equity firms as much as I have in recent months and years has substantially enhanced my understanding of certain components in the investment process that I did not regularly consider in the past. I suppose, when it comes down it, the greatest appeal of this profession are these spontaneous enhancements to one’s analytical repertoire that occur both unexpectedly and without precondition.

I would like to share some excerpts from KKR’s recent report that provide some important information about where I think WMIH is headed as an operating entity:

– Indeed, some of the more interesting risk-adjusted opportunities we are seeing from a direct and co-investment standpoint are now occurring in situations where banks have fallen away as the traditional lender of choice. Moreover, many of these opportunities are occurring when volatility heads higher, not lower; as such, we like the somewhat counter cyclical component to this offering.

– First, with leveraged lending guidelines now being enforced more strictly, corporate and financial acquirers must look beyond traditional financial intermediaries to support their deals. Second, there is less capital available for small-to-medium-size businesses, as banks reduce their footprints amidst shrinking net interest margins and heightened regulation. Finally, we think that current deal terms now often favor the lender, not the borrower, which is different than 12 to 18 months ago.

– Our basic premise is that — given the asynchronous world that we now live in — economies, markets, and flows are likely to continue to periodically seize up when macro shocks occur. If we are right, then these dislocations create excellent times for asset-based lenders to deploy capital that fills the gap increasingly being created by a smaller, simplified, and more regulated banking system. Maybe more important, though, is just the steady stream of deals that are now having to be negotiated off market, given less commitment to this part of the lending industry by traditional financial intermediaries. Key growth markets now include aircraft leasing, alternative energy financing, acquisitions, and capital spending investments.

Given the fact that KKR is essentially pounding the table on the private credit and direct lending market, having a tax free shell capitalized to the tune of $600 million in cash, with potentially billions in additional leverage at the ready to consummate the right sized acquisition, only makes WMIH that much more attractive as their vehicle of choice for the proper cultivation of private credit/direct lending subsidiary.

  • Similar to a majority of thinly traded micro/small cap names in the current environment, PIH needs a material catalyst for appreciation. Until the catalyst comes to fruition the stock is subject to the whims of small investors, who can subject the stock to volatility simply by buying or selling a relatively small number of shares. The stock price of PIH lost 7.66% of its value during June on what can only be considered inconsequential price fluctuations while awaiting the proper catalyst.

During June, the company did announce its annual reinsurance treaties renewal for the 2016-2017 year. PIH increased reinsurance coverage by 40% from $121 million to $170 million for the treaty year. There are multiple layers to this insurance coverage all of which saw an increase in coverage by similar amounts.

Of course, the increase in coverage does come at an increased cost. The Company estimates that its total cost of reinsurance will be approximately $23.0 million for the 2016-2017 treaty-year. The total cost for the 2015-2016 treaty-year was approximately $13.2 million.

Implicit in the increase of reinsurance coverage are certain growth assumptions in the number of policies the company will be handling versus the previous treaty year. Given that the stock price is more than 20% below where it was this time last year, it is fair to assume that those growth assumptions are not just being ignored by the market, but rather, being discounted to a substantial degree. That discount is unreasonable, especially when you consider that PIH has the most conservatively positioned balance sheet among its peers. In other words, the markets are discounting a company achieving substantial organic growth while in a favorable position to deploy capital to increase return on equity for shareholders moving forward.

In this case, particularly, the markets are not so much irrational as much as they are completely ignorant of the dynamics involved in 1347 Property Insurance as a

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