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Financial Sector Analysis & Recommendations Amid Sub-Prime Risks

This presentation provides a detailed analysis of the financial sector, highlighting the current weightings of major entities within the SIM portfolio, including Berkshire Hathaway, Bank of America, JP Morgan Chase, Goldman Sachs, and Citigroup. It recommends reducing the exposure of money center banks by 2% due to fears of a sub-prime meltdown and potential economic downturn. Key strategies include maintaining a diversified portfolio, focusing on well-positioned stocks, and minimizing risks associated with sub-prime crises while considering opportunities in undervalued sectors like iStar Financial.

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Financial Sector Analysis & Recommendations Amid Sub-Prime Risks

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  1. Stock Presentation Financial Sector Roger Chan Chris Curtin Jack Lu

  2. Sector Analysis • Our Recommendation: Maintain weighting (approximately 1.67% above S&P) • Class Decision: Reduce weighting to S&P (approximately 2% reduction) • Reasoning: Fear of a sub-prime meltdown, an impending economic downturn, and over-exposure in the SIM portfolio

  3. Current Sector Weighting • Financial Sector as a part of the . . . SIM 21.52 % S&P 500 19.64 % Overweight 1.88 % as of 8/3/07

  4. Current Holdings • Berkshire Hathaway (BRK.A) 6.00 % • Property and casualty insurance • Bank of America (BAC) 5.50 % • Money center bank • JP Morgan Chase (JPM) 4.73 % • Money center bank • Goldman Sachs (GS) 3.54 % • Investment brokerage • Citigroup (C) 1.75 % • Money center bank 21.52 %

  5. Recommendations • Sell all JPM ~ 4.75 % • Weakest of the three money center banks • Sell some BAC ~ 2.00 % • Fairly valued, but more potential sub-prime risk • Buy more C ~ 1.75 % • Fairly valued, well positioned, strong stock in sector • Buy some SFI ~ 2.00 % • Not a MCB, undervalued, low sub-prime risk exposure • Keep all Brk-A & GS ~ 9.9 %

  6. General Strategy • Reduce Sector Weight by 2 % • As determined last presentation • Reduce Money Center Bank Exposure • Three similar MCB’s, constituting 12 % of the SIM • Concentrate on Favorite MCB(s) • At least one of the three has to be weaker • Diversify within the Sector • Too much domestic MCB, little foreign banking, no REIT • Avoid Risks from Sub-Prime Crisis • Don’t sell just to buy back into the crisis

  7. Current Holdings • Property and casualty insurance 6.00 % • Berkshire Hathaway (BRK.A) • Money center banks 12.00 % • Bank of America (BAC) • JP Morgan Chase (JPM) • Citigroup (C) • Investment brokerage 3.50 % • Goldman Sachs (GS) 21.50 %

  8. 1. Reduce Money Center Bank Exposure • Bank of America (BAC) 5.50 % • Pros: size (#1 credit cards, #1 on-line banking) • Cons: sub-prime, expansion to date via M&A • JP Morgan Chase (JPM) 4.73 % • Pros: credit cards, broad customer base • Cons: sub-prime, inefficiency of M&A • Citigroup (C) 1.75 % • Pros: size, diversity, foreign exposure • Cons: sub-prime, economy (investment banking)

  9. Money Center Banks

  10. Money Center Banks

  11. Citigroup (C)

  12. Bank of America (BAC)

  13. JP Morgan Chase (JPM)

  14. Money Center Banks

  15. Money Center Banks

  16. 1. Reduce Money Center Bank Exposure So . . . Reduce MCB’s from 12% to 7% . . . OldActionNew C 1.75% + 1.75% = 3.5 % BAC 5.50% - 2.00% = 3.5 % JPM 4.75% - 4.75% = 0 % Total 12.0 % 7.0 %

  17. General Strategy • Reduce Sector Weight by 2 % • As determined last presentation • Reduce Money Center Bank Exposure • Three similar MCB’s facing, constituting 12 % of the SIM • Concentrate on Favorite MCB(s) • At least one of the three has to be weaker • Diversify within the Sector • Too much domestic MCB, little foreign banking, no REIT • Avoid Risks from Sub-Prime Crisis • Don’t sell just to buy back into the crisis

  18. 2. Concentrate on Favorite MCB(s) • Eliminate more JPM than necessary to reduce 2.0% and allow room to diversify • Add to C, as the favored MCB • Reduce BAC, to put in line with C

  19. General Strategy • Reduce Sector Weight by 2 % • As determined last presentation • Reduce Money Center Bank Exposure • Three similar MCB’s facing, constituting 12 % of the SIM • Concentrate on Favorite MCB(s) • At least one of the three has to be weaker • Diversify within the Sector • Too much domestic MCB, little foreign banking, no REIT • Avoid Risks from Sub-Prime Crisis • Don’t sell just to buy back into the crisis

  20. 3. Diversify within the Sector Add 2.0% = iStar Financial, Inc. (SFI) • Primary business is lending and corporate tenant leasing • Web-site: http://www.istarfinancial.com/home.html • Part REIT and part financial services • Business is high-end commercial real estate financing • But, it pays dividends like a REIT (i.e., taxed like a REIT) • Market Cap: $4.45 B (mid-cap; $1 - $10 B) • Shares outstanding: 128.2 M • Average volume: 1.2 M/day • Beaten down by the sub-prime crisis, even though its not a sub-prime player and has little sub-prime exposure

  21. Compare to Money Center Banks

  22. iStar Financial, Inc. (SFI)

  23. Money Center Banks

  24. Money Center Banks

  25. Money Center Banks

  26. Money Center Banks

  27. Money Center Banks

  28. SFI’s Story Market Psychology: • Price has been falling in concert with sub-prime residential lenders, due to the overall sub-prime risk. • Fell further when REIT sector was downgraded in June, on fears of a slowing economy, increasing interest rates, lack of investor confidence, and prospect of decreasing dividend yields.

  29. S&P 500 Index (3-year)

  30. Financial Sector (3-year)

  31. MCB’s = e.g., JPM (3-year)

  32. iStar Financial (3-year)

  33. SFI’s Story Market Psychology: • Price has been falling in concert with sub-prime residential lenders, due to the overall sub-prime risk. • Fell further when REIT sector was downgraded in June, on fears of 1. a slowing economy, 2. increasing interest rates, 3. lack of investor confidence, and 4. prospect of decreasing dividend yields.

  34. Deebo

  35. iStar Financial (3-year)

  36. SFI’s Story • “iStar Financial is one of those guilt-by-association companies.” • “[T]he company has very different risk exposures from those of subprime residential lenders such as Countrywide and American Home Mortgage.” -- Emil Lee, TheMotleyFool.com (July 31, 2007)

  37. SFI’s Story • More conservative lender, and uses less leverage D/E • iStar (SFI) 2.93 • Countywide (CFC) 5.40 • American Home Mort. (AHM) 8.96 • Annaly Capital Management (NLY) 11.24 • Redwood Trust Inc. (RWT) 12.91 • Has not increased reserve for potential loan losses this year (still anticipating 6%)

  38. SFI’s Story • May 22, 2007 Acquired Fremont General’s commercial real estate division for $1.9 B (immediately changed compensation structure from volume-based to profitability-based) • July 2, 2007 Announced an increased dividend = 5% increase on dividend 5 years in a row • July 31, 2007 increased 2007 earnings expectations from $2.74 to $2.90 per share • August 1, 2007 Reactivated stock repurchase program, up to 2.7 M shares (open market) • Current Price $18.31 (35%) off 52-week high

  39. General Strategy • Reduce Sector Weight by 2 % • As determined last presentation • Reduce Money Center Bank Exposure • Three similar MCB’s facing, constituting 12 % of the SIM • Concentrate on Favorite MCB(s) • At least one of the three has to be weaker • Diversify within the Sector • Too much domestic MCB, little foreign banking, no REIT • Avoid Risks from Sub-Prime Crisis • Don’t sell just to buy back into the crisis

  40. Recommendations • Sell all JPM ~ 4.75 % • Weakest of the three money center banks • Sell some BAC ~ 2.00 % • Fairly valued, but more potential sub-prime risk • Buy more C ~ 1.75 % • Fairly valued, well positioned, strong stock in sector • Buy some SFI ~ 2.00 % • Not a MCB, undervalued, low sub-prime risk exposure

  41. Proposed Holdings OldNew • Berkshire Hathaway (BRK.A) 6.00% 6.00% • Property and casualty insurance • Bank of America (BAC) 5.50% 3.50% • Money center bank • JP Morgan Chase (JPM) 4.75 % 0% • Money center bank • Goldman Sachs (GS) 3.50 % 3.50% • Investment brokerage • Citigroup (C) 1.75 % 3.50% • Money center bank • iStar Financial, Inc. (SFI) 0 %2.00% • Credit services 21.50 % 19.50%

  42. Questions

  43. Bank of America

  44. Citigroup

  45. JP Morgan Chase

  46. iStar Financial

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