Dabqs

Re-examining My American Capital Strategies Position

Najdorf wrote in his 7-24-08 commentary the following to which I would like to add some thoughts--

"The writedowns are in large part an attempt to assess the default risk - are they accurate? It's hard to say because we're talking about high-yield investments in small, illiquid, private companies. It's probably even harder to predict than the mortgage market, since no individual mortgageholder has a big impact on a bank's finances, but a few of their larger positions could significantly hurt ACAS by defaulting."

Two things of note here--

First, as you know, FASB 157 now requires mark to market accounting adjustments be made, yet, as you mention, ACAS holds largely illiquid private equity positions for which active quotes are largely not available. Importantly, we are seeing writedowns in many financial companies which reflect lower than true valuations due to the credit crunch we are currently in. In a credit crunch, due to lack of liquidity, valuations are often beneath true valuation levels not due to a lack of creditworthiness on the part of the borrower, but due to a lack of liquidity in the trading of those credits. Historically, as credit crunches have resolved themselves, liquidity has returned and credits have traded more in line with the actual creditworthiness of the borrower. Also, important to think about is that AmCap has a history of holding its investments to maturity. So FASB 157 forces AmCap to take writedowns as if they were to seek a buyer for their loans in today's credit crunch effected market, which is not their historical operating manner, and which brings up the likelihood that in future quarters, as the credit crunch subsides, we will see a reversal of these Q1 writedowns. As such, these writedowns are largely of a temporary nature, and investors should focus their attention on net operating income, as this will determine future dividend payments and dividend increases.

Finally, I would also ask that you visit the company's website and take a look at the wide diversification in the portfolio of positions held by ACAS. Not only are the investments widely diversified (small positions by percent and diversified across industry sectors, thus, there is no single large position which could meaningfully tip the boat), and of further importance is that the company has specifically targeted investments in non-cyclical companies, which should considerably help them weather this current economic slowdown/recession.

Last thing to mention--

Great work by Davy Bui! Thanks for the legwork, and thoughtful commentary by all message board posters as well!

Dabqs