Reducing Expenses

Controlling expenses to maintain the standard of living is the chief challenge faced by those trying to exit the rate race. A few life choices aimed at reducing monthly expenses can make the overall task of attaining financial independence less onerous:

a) Choosing To Own As Opposed To Rent:

Any item used on a daily basis is a candidate for owning as opposed to renting. Examples include the house one occupies and automobiles. Normally regarded as the major outlays of money one might ever make, home ownership is a special case that merits special attention. We have explored the issues associated with home ownership through a series of articles (click to read them).

A variation on the same theme is to reduce/eliminate subscription style expenses. Cable TV, DSL, Movie Rentals, Cellular Phones, Club Memberships, etc fall in this category. Your best bet is to always choose life time membership without monthly charges, if such a choice exists.

b) Frugal Living:

Frugal living is a life choice that allows people to spend less money for the same standard of living that they are used to. In exchange of spending less money, the practitioner spends a little bit of extra time and energy looking for “better deals”. We have looked at our experience practicing frugal living through a series of articles (click to read).


Related Posts:

1. Exiting the Rat Race - Definition.
2. Rat Race Exit Strategies. 
3. Passive Income - Part 1 - Network Marketing.
4. Passive Income - Part 2 - Royalties. 
5. Passive Income - Part 3 - Rental Income. 
6. Passive Income - Part 4 - Dividends.
7. Passive Income - Part 5 - Pension Plans. 
8. Passive Income - Part 6 - Employer Plans. 
9. Strategies to Beat Inflation.
10. Strategies to Reduce Expenses.
11. Frugal Living - A Definition to go by. 

Last Updated: 06/2011.

Anthracite Capital (AHR) – Part 3 - Outlook

Anthracite Capital’s ratio of exposure to commercial and residential mortgage backed securities was 2:1 in 2003. Since then they have brought down the residential exposure to zero, and diversified within the commercial mortgage asset class. Below is a summary of Anthracite’s percentage investments by asset class over the last five years taken from their annual report:

Year	2007	2006	2005	2004	2003
Commercial Real Estate Securities	49.3	53	49.7	44.6	62.8
Commercial Mortgage Loan Pools	26.9	27	32	36	-
Commercial Real Estate Loans	23.5	11.8	10.6	9.1	4.4
Commercial Real Estate Equity	0.2	2.3	1.3	-	-
Residential Mortgage Backed Security (RMBS)	0.1	5.9	6.4	10.2	32.8

Anthracite investments are well diversified by property type both globally and within the US as detailed in the below tables taken from their annual report:

Property Type	Percentage
Office	32.8
Retail	28.8
Multifamily	22.7
Industrial	7.5
Lodging	6.7
Healthcare	0.7
Other	0.8

Geographic Location	Percentage
California	16.8
New York	12.2
Texas	9.6
Florida	8.6
Other	52.8

Anthracite is trading well below Net Asset Value (NAV) and book Value of $10.87 as indicated in their latest quarterly report. This discount partly reflects the negative sentiment harbored by the market towards companies that have credit exposure and partly the anticipation of margin calls as 21% of the company’s assets are exposed to mark-to-market adjustments and margin calls. Alternative financing in lieu of short-term borrowings can reduce such exposure but in a tight credit environment, such restructurings calls for substantial associated costs. YTD margin calls to May 14, 2008 already stand at $91.7M and that compares to just over $82M for the whole of 2007. This explains the rapid decline in the market value of Anthracite’s assets as a result of the credit crunch. Anthracite responded to margin calls adequately by raising liquidity – issued common and preferred stock resulting in net proceeds close to $100M and renewed certain credit facilities. Although the terms of these deals make it expensive, the company could use some of that cash to fund the purchase of distressed assets, which should provide handsome returns when the credit situation eases.

Outstanding yield, BlackRock’s management expertise, and the discount to NAV make an investment in Anthracite a compelling proposition. However, the risks are very real and because of the 3:1 leverage, one can visualize scenarios where the company’s assets can end up being valued less than its outstanding borrowings thereby making the equity worthless. This risk should be weighed against the positives before making an investment decision on Anthracite. In a diversified portfolio, Anthracite is a fit as a small position in the small-cap portion.

Related Posts:

1. Anthracite Capital (AHR) - Part 1 - Introduction.
2. Anthracite Capital (AHR) - Part 2 - Business Issues.
3. Anthracite Capital (AHR) - Part 3 - Outlook.

Strategies to Beat Inflation

Beating inflation is critical to make savings last longer. The spreadsheet below tabulates how much money can be withdrawn (inflation adjusted) annually from a representative investment of $1,000,000 at different levels of after-tax returns assuming a withdrawal period of 60 years starting from the current year- 60-years withdrawal period defines a family in the 40’s yearning for financial independence as early as possible:

After-tax Return Percentage on Your Investments (Projected/Assumed)	0	3	4	6	8	10	12
Safe Withdrawal Amounts at 3% inflation for 60-year time horizon	$6,000	$17,000	$22,000	$34,000	$49,000	$65,000	$81,000
Safe Withdrawal Amounts at 5% inflation for 60-year time horizon	$3,000	$9,000	$12,000	$22,000	$34,000	$48,000	$64,000
Safe Withdrawal Amounts at 11% inflation for 60-year time horizon	$0	$1,000	$1,000	$3,000	$7,000	$13,000	$21,000

The highlighted figures indicate that even at higher levels of inflation, 2% is a good withdrawal rate, provided the investment beats inflation on an after-tax basis by at-least one percentage point - the highlighted amounts in Red (all above 2% of investment) are what can be withdrawn safely, if your investments beat inflation by exactly 1%. If your after-tax returns are below the inflation rate, the amount that can be withdrawn goes down progressively (amounts to the left of the highlighted figures).

US Stocks have historically outpaced inflation by a much-wider margin over prolonged time frames. This out-performance is correlated to the actual GDP growth rate over the years and should continue moving forward conditional to US being able to grow its GDP. An alternative strategy is investing in a global basket of securities from a representative list of countries that are projected to grow their GDP in the upcoming years. Minor asset allocation adjustments every 5-10 years based on the countries expected to grow GDP highest is a simple house keeping task. It is to be stressed that the consistent return associated with stock investments hold true only over extended periods of time.

A more cautious strategy that GUARANTEES moderate levels of inflation out-performance is the inflation-protected securities. In the US, the Treasury Inflation Protected Securities (TIPS) and series-I savings bonds are examples of such instruments. The caveats that need to be analyzed with such securities are:

• The inflation index such securities are pegged against. ie, if the index doesn’t accurately reflect the overall inflation rate, the guarantee of beating inflation may not provide the expected real return, and
• Tax implications – The tax effects for TIPS in the US makes it less desirable under certain situations. Specifically, the income from TIPS and the inflation adjustment are both taxable. The series-I savings bonds fare a little better in this regard as taxes are due only upon cashing them.

Related Posts:

1. Exiting the Rat Race - Definition.
2. Rat Race Exit Strategies. 
3. Passive Income - Part 1 - Network Marketing.
4. Passive Income - Part 2 - Royalties. 
5. Passive Income - Part 3 - Rental Income. 
6. Passive Income - Part 4 - Dividends.
7. Passive Income - Part 5 - Pension Plans. 
8. Passive Income - Part 6 - Employer Plans. 
9. Strategies to Beat Inflation.
10. Strategies to Reduce Expenses.
11. Frugal Living - A Definition to go by. 

Last Updated: 06/2011.

Anthracite Capital (AHR) – Part 2 – Business Issues

Anthracite Capital is managed by BlackRock Financial Management Inc – a subsidiary of BlackRock, Inc. (BLK) a publicly traded asset management company with $1.37T in assets. With this structure the company can afford to have NO employees. BlackRock Financial Management provides the operating platform for Anthracite’s CMBS operations as well as the expertise with asset originations and risk management. Investments in mezzanine level debt and preferred-equity is managed through Carbon Capital Funds, a private real-estate debt fund management by BlackRock.

Anthracite’s board of directors has adopted an indebtedness policy that limits the company’s recourse debt-to-equity ratio at 3:1. This is consistent with the financial covenants in the company’s credit facilities and the strategy helps with limiting risk.

Below is a recap of the company’s borrowings by maturity, type, and cost taken from their annual report:

Borrowing Type	Within 30 days	31 to 59 days	60 days to 1 year	1 year to 3 years	3 years to 5 years	over 5 years	Total, Cost
Reverse Repurchase Agreements	$80.12M						$80.12M, 5.44
Credit Facilities			$261.89M	$409.71M			$671.60M, 6.06
Commercial Mortgage Loan Pools		$17.93M	$44.27M	$368.43M	$130.68M	$657.78M	$1.22B, 3.99
CDOs		$16.74M	$16.43M	$149.54M	$548.80M	$1.09B	$1.82B, 6.11
Senior Unsecured Notes						162.50M	$162.50M, 7.59
Senior Convertible Notes						$80M	$80M, 11.75
Junior Unsecured Notes						$73.1M	$73.1M, 6.56
Junior Subordinated Notes						$180.48M	$180.48M, 7.64
Totals	$80.12M	$34.67M	$322.60M	$927.69M	$679.68M	$2.25B	$4.29B, 5.72

* Weighted Average Maturity – 6.5 years.

Below is a summary of the company’s investments by maturity, type, and cost taken from their annual report:

Commercial real estate securities outside CDOs	Estimated Fair Value	Adjusted Purchase Price	Loss Adjusted Yield
Investment Grade CMBS	$149.86M	$158.22M	6.56
Investment Grade REIT Debt	$20.03M	$23M	5.49
CMBS rated BB+ to B	$316.21M	$417.20M	8.71
CMBS rated B- or lower	$144.80M	$166.38M	10.73
CDO Investments	$46.24M	$63.99M	20.56
CMBS Interest Only (IO) securities	$15.92M	$14.73M	8.80
Multifamily Agency Securities	$37.12M	$36.82M	5.37
Sub Total	$730.18M	$880.32M	9.34
Commercial real estate loans and equity outside CDOs
Commercial real estate loans	$618.33M	$601.14M
Commercial mortgage loan pools	$1.24B	$1.24B	4.15
Commercial real estate	$9.35M	$9.35M
Sub Total	$1.87B	$1.85B	4.15
Commercial real estate assets included in CDOs
Investment grade CMBS	$768.67M	$759.52M	7.09
Investment grade REIT debt	$226.06M	$224.61M	5.85
CMBS rated BB+ to B	$466.56M	$486.16M	10.01
CMBS rated B- or lower	$54.34M	$68.69M	14.98
CDO investments	$3.39M	$3.48M	7.79
Credit Tenant Lease	$24.95M	$23.87M	5.66
Commercial Real Estate Loans	$464.46M	$434.36M	8.73
Sub Total	$2B	$2B	8.28
Total	$4.61B*	$4.73B	6.57

* Face Value - $6.53B

Anthracite is exposed to losses resulting from fluctuations in interest rates. Specifically, changes in the level of LIBOR money market rates affect the company’s net interest income – Anthracite’s short-term collaterized liabilities outside of CDOs are floating rate based on a market spread to LIBOR. As the level of LIBOR increases or decreases, Anthracite interest expense moves in the same direction. Below is a look at the company’s quantification of the risk, taken from their annual report:

Change in LIBOR +/- basis points	Projected Change in Earnings Per Share*
-200	$(0.03)
-100	$(0.02)
-50	$(0.01)
Base Case	None
+50	$0.01
+100	$0.02
+200	$0.03

*Their 5/15 quarterly report states a significant change to this with a 50 basis point LIBOR resulting in an adjustment of $0.04.

There are also risks associated with the treasury/credit yield curves/levels:

• When treasuries are priced to a higher yield, Anthracite’s portfolio becomes less valuable and vice-versa.
• Treasury yield curve changes affect Anthracite’s portfolio valuation, as the prepayment assumptions have to be adjusted.
• Anthracite’s portfolio valuation is dependent on the market’s perception of how valuable the company’s assets are as reflected by the credit curve and relation to the treasury yield curve. Specifically, as supply increases, the assets become less valuable as yield needs to increase.

Changes in portfolio valuation affect the company’s ability to borrow. While the interest rate sensitivity is quantifiable as indicated above, the yield curve risks are somewhat less so. Anthracite uses a hedging strategy to limit risks.

There are also a few other risks that can have an impact on Anthracite’s business:

• Credit Risk: This is the exposure to loss from loan defaults. The risk is mitigated by the fact that most of these assets are financed on a non-recourse basis in the company’s CDOs, where a significant portion of the risk of loss is transferred to the CDO bondholders.
• Asset and Liability Management: The risk is associated with the timing and magnitude of the re-pricing and/or maturing of assets and liabilities. The risk is mitigated by matching the term of the liabilities as closely as possible to the holding period of assets. Exact matching is however not possible because different kinds of assets and liabilities react differently to market conditions.
• Currency Risk: Certain of Anthracite’s CMBS and loans are in Euro, British Pounds, Canadian dollars, and other currencies. Fair-values of assets and earnings can both be impacted by currency fluctuations. The risk is mitigated by using local-currency denominated financings and foreign currency forward commitments and swaps.

Related Posts:

1. Anthracite Capital (AHR) - Part 1 - Introduction.
2. Anthracite Capital (AHR) - Part 2 - Business Issues.
3. Anthracite Capital (AHR) - Part 3 - Outlook.

Blockbuster Online Movie Rentals – User Experience/Review

Blockbuster ran a one-month total access promotion that allowed consumers to rent out three DVDs at a time for an entire month (actually four weeks) in 2008. The standard promotion offered by most online movie rental places at the time was for just two weeks although Netflix was the first one to offer a longer promotion.

We signed up with Blockbuster a month ago and here is a summary of our experience:

• Sign-up was a breeze and the entire process took less that 15 minutes. One can add movies to their queue without having to sign up which is handy as it allows pre-viewing their collection. Selection is light on the foreign language front, but overall the selection is remarkable although a little shy of Netflix’s 90000 and odd collection.
• Blockbuster offered a unique in-store exchange feature which allowed exchange of their online DVD at their local Blockbuster store for another movie as well as the ability to return the movie at your local store. Both these options are time savers as it cuts down on the 2-4 day turnaround when mailing in. We did not use this feature and hence cannot comment on its practicality.
• Shipments were from their San Jose facility and made it to our home within a day for the most part – on a couple of occasions it took two days. Shipments back consistently made it in a day.
• We experienced a few glitches with the service but none can be deemed deal breakers by any stretch of imagination:

• They shipped the wrong DVD once – reported it immediately through their web link for reporting problems, and it was immediately taken out of our mailed queue,
• One of the DVDs we received was damaged – sent it back immediately, reported the problem and got a replacement DVD the very next day, and
• We ordered the Pearl Harbor DVD which is a 2-disc version and they shipped it separately. On receiving them back, they were counted as two DVDs with the result that they shipped a total of four DVDs at one time although the program allows only three DVDs out at one time. The glitch was automatically corrected the next time around.

• Canceling the service before the end of the trial period was also a breeze – just had to ensure there was enough time to ship back the last DVD’s for them to receive it before the 4-week trial period ran out.

Overall, the service was excellent and reactivated the account several times as free-time allowed.

Last Updated: 05/2010.

Anthracite Capital (AHR) – Part 1 - Introduction

Anthracite Capital (AHR), is a Real-Estate-Investment Trust (REIT) focused in the Commercial Mortgage area. The REIT structure permits companies to minimize or eliminate corporate taxes and requires them to distribute 90% of their income to shareholders as dividends. The shareholders are taxed for the amount. REIT allows shareholders a more liquid way to participate in the real-estate market, albeit with far less leverage. The invested enterprises may choose to use leverage on their investments, however risk increases as the amount of leverage increases.

REIT primer:

The REIT structure parallels closely the concept of stock mutual funds – similar to allowing investors to own a basket of securities without having to buy each one of them – REIT provides a way to own a basket of real-estate assets without having to actually purchase any real-estate.
REIT structuring varies across countries. In the US, the major requirements to qualify as an REIT are:

• Distribute at least 90% of their taxable income as dividends.
• Dividends, interests, and property rental income should form 95% of income earned.
• At least 75% of income should be derived by rents or mortgage income.
• Cannot be a financial institution or an insurance company.
• Ownership in taxable REIT subsidiaries cannot be more than 20% of assets.

There are also a number of other restrictions that regulates REIT, the primary aim being to limit abuse – without such regulations in place, one could structure personal assets as REIT and gain tax benefits, especially when pooling assets from like-minded individuals.

REIT is classified under three different types:

• Equity REIT: They have ownership interest in real-estate properties. Rents form the primary source of revenue for such REIT.
• Mortgage REIT: They have ownership interest in real-estate property mortgages. Interest earned on the mortgages owned form the primary source of revenue for such REIT.
• Hybrid REIT: They combine the characteristics of an Equity and Mortgage REIT by owning both real-estate properties and mortgages.

There are a number of sub-categories under each of these broad REIT categories. Anthracite Capital (AHR) is a specialized firm focused on investing in high-yield commercial real-estate debt and equity. The company purchases pools of mortgages in the form of Commercial Mortgage Backed Securities (CMBS) and provides strategic capital to commercial real-estate industry in the form of mezzanine loans and purchase of an equity stake. To fund these purchases and to issue mezzanine loans, the company issues equity and/or debt backed by CMBS. As with most REIT, there are a couple of other factors that affect returns of Anthracite Capital’s (AHR) investments:

1. Spread: It represents the difference between the interests paid by the company for debt issued vs the realized returns on investments.
2. Leverage: It represents the ratio of the company’s debt-to-equity.

Below is an overly simplified example of how the use of Leverage can affect total returns:

Spread	Realized Investment Return % (=No Leverage)	Projected Return at 3:1 leverage	Projected Return at 6:1 leverage
2%	6%	12%	18%
0%	6%	6%	6%
-2%	6%	0%	-6%

Related Posts:

1. Anthracite Capital (AHR) - Part 1 - Introduction.
2. Anthracite Capital (AHR) - Part 2 - Business Issues.
3. Anthracite Capital (AHR) - Part 3 - Outlook.

Avenue Of The Giants – Trip Report/Review

We did a daytrip to the Avenue of the Giants from Mendocino. Avenue of the Giants is a 38-mile detour along the side of 101 freeway 45 miles north of Leggett were Pacific Coast Highway (PCH – Highway 1) meets 101 freeway and about 40 miles south of Eureka. This avenue cuts right through the middle of the Humboldt Redwood State Park and is aptly named as it provides visitors with a visual treat of the vast amount of giant redwood trees that occupy the area.

En-route at Leggett is the world famous Chandelier tree – the Drive-Thru Tree – this tree has a 9X6 foot enclosure cut through it. Entrance to the park was $5 per vehicle and from the entrance a dirt road takes you through the tree. There is a very nice, serene picnic area and a gift shop with ample choices of curios made with redwood. There are several such trees commercialized with an entrance fee and gift shop dotted all along the way. It is easy to be distracted by the commercialization and the small shops that run businesses by selling wares of questionable value along the entire stretch of the Avenue of the Giants. While the general theme of all of these is the same and runs amuck the notion of preservation and saving, it is worthwhile to visit at-least one such place.

Another experience on that route is the gravity house and the train ride at Confusion Hill. The admission to the gravity house was $6.50 for adults and $4 for children between 4 and 12, and the admission to the train ride was $8.50 for adults and $5 for children between 4 and 12. The gravity house fails to amuse adults but our kids definitely found it a welcome distraction. The train ride is a reincarnation of an old relic, but as all train rides go, it does provide entertainment. You get to see up-close a few Madrones and some Douglas Fir too. It was intriguing to hear the train engineer recount the story of the giant redwood trees that were felled in the 1993 timeframe – loopholes in logging rules were exploited as ownership changed in rapid succession, each new owner exercising their quota (double-dipping) with the result that the giant redwoods were mostly cut down and the absence of the wind break barrier brought down as many as 240 trees in a storm in 1996 – as you ride the train, and notice the lack of trees at the summit you have to wonder…

The best way to experience these giants is to try and stop by as many groves along the stretch as possible. Usually an information plaque detailing the hikes at that spot is also available. You are limited only by your own time, inclination, and ability. It is extremely important that people taking these hikes take care to stay away from the poison oak growing along most of the trails.

In summary, Avenue of the Giants provides an awe inspiring, unique experience for visitors to the area.

Related Posts:

1. Mendocino, Fort Bragg, CA – Trip Report/Review.

Last Updated: 10/2008.

Small Caps In Our Portfolio – An Update

Below is a summary of the small capitalization stocks (Market Capitalization less than $1 Billion):

Business	Invested %	Date Of Investment	Return %	Dividend Yield
Click Software (CKSW)	1.66	11/09/2007	(33.19)	None
iRobot Corporation (IRBT)	2.85	12/18/2007 & 04/18/2008	(24.23)	None
MCG Capital (MCGC)	3.34	12/21/2007 & 04/01/2008	(46.22)	16.4
Anthracite Capital (AHR)	4.36	11/09/2007	18.44	14.60
Patni Computer Systems (PTI)	3.40	08/10/2007	(36.79)	1.0
Totals	15.61	Various	(20.70)	7.81

Overall, the stocks returned roughly –17% in a little less than six months under-performing the Russell 2000 Small-Cap Stock Index ETF (IWM) by a wide margin. This underperformance is significant considering our entire portfolio outperformed the Wilshire 5000 overall US stock market index by a significant margin over the same period.

Click Software had a string of outstanding quarters last year, which were followed by a couple of tepid ones and the stock price reflected the ups and downs. As the business prospects remain solid, the valuation looks very attractive. iRobot had a decent quarter, but pared down expectations for the coming year. One of their key retail customers (Linen N’ Things) ended up in bankruptcy and that has affected the stock. However, the prospects and valuation continues to be attractive. For MCG Capital, the real concern is liquidity. The combination of tight credit environment along with pay-in-kind transactions has made it especially hard for the company to find cash to fund its capital needs. This situation could decline in an extended downturn in the economy. Anthracite Capital has been fairly static although it saw a low of $5.20 in early March at the peak of the liquidity crisis. The company’s prospects are directly tied to the commercial mortgage market and its concern parallels the residential market concerns on the number of bad loans in the portfolio. For Patni Computer Systems (PTI), the stock has always trailed its peers such as Cognizant (CTSH) and Infosys (INFY). As competition picks up pace in the outsourcing business, Patni’s margins will continue to stay pressured. Even so, the valuation looks attractive and our expectation is that the company will get acquired.

We will look at adding to some of these positions while staying within our target of roughly 20% commitment to small-cap portion in our portfolio.

Related Posts:

1. Click Software (CKSW) - Stock Analysis.
2. iRobot Corporation (IRBT) - Stock Analysis.
3. MCG Capital (MCGC) - Stock Analysis.
4. Anthracite Capital (AHR) - Stock Analysis.
5. Patni Computer Systems (PTI) - Stock Analysis.

Last Updated: 10/2008.