Richard Perry: Long GSE Junior Preferreds, RBS Tier 1 Securities (Invest For Kids Chicago Notes) ~ market folly

Thursday, November 10, 2011

Richard Perry: Long GSE Junior Preferreds, RBS Tier 1 Securities (Invest For Kids Chicago Notes)

At Invest For Kids Chicago yesterday, Richard Perry of Perry Capital gave a presentation on going long GSE Junior Preferred securities as well as RBS Tier 1 Securities.

Be sure to check out all notes from Invest For Kids Chicago where numerous high profile hedge fund managers shared their latest investment ideas.

Long GSE Junior Preferred Securities

Perry founded his firm 23 years ago and now manages $8 billion. He's only had 1 down year in 23 years. His first pick was to go long GSE Junior Preferred Securities as a highly asymmetric play.

Many people believe GSE's are the cause of the crisis and represent and endless black hole to the taxpayer and numerous politicians have called for their elimination. Perry takes the opposite view and believes GSE's will soon be breakeven and/or in a position to recapitalize themselves. He argues they provide necessary counter cyclical liquidity.

At 8.5 cents on the dollar, Perry thinks they offer asymmetric risk reward for huge upside. By changing the guarantee fee "a little bit," the CBO says they could raise $30 billion for each 10bps increase in fee and that could reopen the mortgage market and spur the economy (could happen over 2-3 years).

Long RBS Tier 1 Securities

Perry's other idea was going long securities of a bank that was at one point the largest in the world. In 2008 & 2009, RBS underwent a big housecleaning. Their Tier 1 securities have 'must-pay' dividends and 'may pay'. 'May pay' was shut off with the bailout through 2014 and trades at a 25-35% discount. This is the security he likes.

With Basel 3, core Tier 1 are likely to go away. All "real banks" will buy back to take off balance sheets. There's £10 billion of these and he expects them to turn on in 2012 (April for RBS and January for Lloyds).

Perry says that RBS' balance sheet is restructuring and you must analyze loan to deposits. US is roughly 95% and Italy is 120% to 150%. The UK has a government asset protection scheme where if RBS has a loss of ~60 billion, the government backstops other pool.

Systematically important banks trade at 7% yield on preferred stocks (Bank of America, Barclays, SocGen, BNP, UBS). If RBS pays the dividend they save 80 bps on funding (where better banks are) or 6 billion and pays 400 million in dividends which he says is good arbitrage.

For more of our coverage of Perry Capital, we've detailed Perry's investment thesis on Iron Mountain (IRM) as well as their thoughts on European markets.

You can view full notes from Invest For Kids Chicago here.

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