Dear Fellow Shareholders:
Welcome! This is the first Annual Report of the Third Avenue Fund, Inc., (TAF). TAF was established to follow the same general investment strategies as Equity Strategies Fund, Inc. under the aegis of the same Board of Directors and the same management. The crucial difference between the two funds is that TAF makes a continuous offering of new shares. Equity Strategies, on the other hand, is closed to new investors. As the accompanying audited financial statements show, TAF had made no securities investments, as of October 31, 1990, the close of TAF’s first fiscal year. At October 31, 1990, the net asset value was $10.00 per share.
TAF commenced its investment operations on November 1. We anticipate that TAF will be close to fully invested by calendar yearend. At December 19, 1990, net asset value was $10.18 per share. The Fund’s unaudited portfolio consisted of the following securities as of that date:
|$400,000||Louisiana State Agricultural Authority 8.25% Bonds due 10/1/96|
|$1,000,000||Adams County (Colorado) IDR Bonds 9.00% due 11/1/96|
|$2,000,000||AmBase Corp. Senior Subordinated 14 7⁄ 8% Notes due 7/15/98|
|15,000 shares||Home Insurance Company $2.95 Series A Preferred Stock|
|7,000 shares||Elders IXL (Canada) Retractable Preferred Stock|
|20,000 shares||Presidential Life Corp. Common Stock|
|20,000 shares||Broad, Inc. Common Stock|
|177,000 shares||National Asset Bank Common Stock|
|50,000 shares||National Loan Bank Common Stock|
|70,000 shares||First Constitutional Financial Corp. Common Stock|
Management believes that most of the securities owned by TAF are selling at prices that appear to reflect panic on the part of the sellers. Indeed, we don’t think prices have been this attractive since 1974 for the types of securities of most interest to TAF. Low prices ought to reflect both reduced risk and large appreciation potentials for TAF. Of course, while we believe these holdings are appropriate for TAF, given its investment program, the following discussion should not be read as a general recommendation to other investors. A brief review of the rationale for each of TAF’s holdings follows:
The Louisiana State and Adams County Industrial Revenue Bonds are backed by Guaranteed Investment Contracts, or GICs, issued by Executive Life Insurance Company of California (“Executive Life”). TAF acquired both securities at an approximate 50% yield to maturity and a 37% current yield. Executive Life’s parent, First Executive Corporation, appears to be hopelessly insolvent. Executive Life, though, appears reasonably solvent, able to meet its obligations, in part, because its junk bond portfolio seems to be materially less junky than average. An issue has been raised that these GICs would be subordinate to other policy holder claims in the event that Executive Life ever is placed in conservatorship, (i.e., an insurance equivalent of Chapter 11). It is unlikely that a subordination claim can ever be perfected because, in our view, there appears to be little legal basis for any such claim. In any event, we expect Executive Life to stay out of conservatorship and that these bonds will continue to pay interest and principal without a money default. On the other hand, if Executive Life is ever taken into conservatorship, we expect that the ultimate rehabilitation of Executive Life would result in a workout for these issues at prices that would give TAF a quite satisfactory return on its investment.
AmBase Corporation (“AmBase”) is the parent of Home Insurance Company (“Home”), owning 41% of Home Preferred Stock outstanding and 100% of Home Common Stock outstanding. AmBase has announced an agreement to sell its entire Home position to a group headed by a subsidiary of TryggHansa, a large Swedish insurance company. The Indenture governing the Bonds owned by TAF requires that if AmBase is no longer a “substantial owner” of Home, AmBase is required to tender for these bonds at a price of 100% of par, and that condition cannot be waived without each bondholder’s consent. We believe that, in the event AmBase does not honor this condition, it will be either because the acquirer of Home can succeed in assuming these Notes despite the plain language of the Indenture, in which case the Notes will become a performing loan yielding about 47%; or AmBase seeks relief under Chapter 11. We feel in that case, this issue still ought to work out better than TAF’s cost basis of less than 23% of par. This issue is only subordinated to $400 million of bank debt and $102 million of 113/4% Debentures, a relatively small amount compared to the value of the Home position. Most of the other claims against AmBase are for employee compensation, which in Chapter 11 may be subordinate to TAF’s position under theories of equitable subordination. It has been hard for bankruptcy courts to allow claims for equitable subordination in the past. In the AmBase case, however, we believe there is a strong claim for equitable subordination (and voidable preferences) given the AmBase management and their compensation packages.
Home Insurance is operating well, and does not appear to be infected with the AmBase disease. Home Insurance Preferred Stock is senior to AmBase Bank Debt, and may, in fact, be comparable to securities rated Baa or maybe A. At TAF’s cost, the Preferred held by TAF offers a 25.1% current return. If a buyer of the Home desires to refinance this high dividend preferred, say in two years, the buyer would have to call the issue at $20. If that were to occur, the yield to maturity for TAF would be about 53%.
Elders Preferred is ratably secured with the bank debt of the parent company, Elders IXL Ltd. (Australia) (“Elders”). At TAF’s cost, the yield to maturity at the 1992 redemption date is about 30%. Elders is a wellfinanced, profitable brewer with interests in beer operations in Australia, the United Kingdom and Canada. Presidential Life (“Presidential”) is a New York domiciled life insurance company. TAF acquired its position at less than two times earnings and at above a 57% discount from net asset value.
Presidential Life has a junk bond problem. We believe that problem has been vastly overblown in the marketplace. Indeed, we think Presidential is a conservatively capitalized company. However, if we are wrong, the ultimate downside for TAF’s position in Presidential Life Common is much greater than would be the case for the other insurance investments discussed above, Executive Life, AmBase, and Home Insurance.
The TAF position in the equity of Broad, Inc. (“Broad”), a financial services company, was acquired at less than five times earnings and at 57% discount from net asset value. We haven’t figured out what is wrong with Broad, Inc. Common Stock, other than a general malaise toward financial institution equities in the financial community. After two face-to-face visits with Broad management, we remain highly impressed with them.
National Asset Bank and National Loan Bank are debt free companies which are continuing to liquidate portfolios of troubled Texas bank loans. TAF acquired its positions at prices which appear to be discounts of at least 50% from conservatively estimated present values for those bank loans. We remain particularly impressed with the management at National Asset Bank. That management is attempting to convert the company from a liquidating bank to a nonbank going concern. If they succeed, they may be in a position to build premium values, well in excess of liquidating values, into the company.
At September 30, 1990, First Constitutional Financial Corp. (“First Constitution”), a unitary savings bank, had a net asset value of $13.16 per share, was in capital compliance for all regulatory purposes, and was suffering cash losses from operations of perhaps $1 million per year. TAF’s cost basis for its First Constitution position is $0.94 per share. We believe that First Constitution may be one of the few survivors among banks doing business in southeastern Connecticut. Practically all the other banks appear to be basket cases. If First Constitution proves to be a survivor, it might well take over a substantial amount of profitable business from competing banks, starting in 1991. It appears as if the appreciation possibilities for First Constitutional Common Stock may be huge, although there may be some risks.
We suppose that many people who read this letter will conclude that the TAF portfolio is speculative. Certainly all the conventional thinkers believe TAF is speculative. We disagree. Unconventional, sure. But given the prices at which the various securities were acquired, and given the extensive, in-depth research that went into the decision making process for each investment, speculative versus conservative ought not to be measured only by what is cosmetically acceptable, and what rating services say. Rating services and conventional thinkers pay no attention at all to price. From the TAF perspective, we believe that there ought to be, at the least, a price component in measuring whether an investment is either speculative or conservative. There also ought to be a quality of research component. TAF will try to stay conservative by these measures even though the portfolio is unlikely to ever be cosmetically correct.