Bruce Berkowitz's 2013 Annual Letter

Our largest issuer position, at nearly 50% of assets, is in AIG common and warrants. Our second largest, at 15%, is in Bank of America common stock. Both are designated Global Systemically Important Financial Institutions. In other words, they are too important to fail, have significant value beyond their fortress-like balance sheets, and are capable of distributing healthy earnings to owners through dividends and/or buybacks of common stock. Yet, both trade at discounts to book value.

Headlines shout of Sears’ disastrous 2013 loss of $12 per share. A longer history shows that since the merger of Sears with Kmart, about 9 years ago, Sears has distributed over $66 of cash per share via buybacks and spin-offs and has paid down $27 per share of a pension liability that is no different, in our view, from debt. Fairholme research estimates that the fair value of Sears’ net assets exceeds $150 per share. If our research is accurate, we expect Sears’ market price of $38 to increase to this value over time.

Two of our best performers during the period were Fannie Mae and Freddie Mac. Both are absolutely essential for uniquely-American, affordable mortgages. If you disagree, try getting a 30-year, sub-5% mortgage outside of the United States. In 2008, both companies agreed to U.S. conservatorship and extraordinarily harsh terms and conditions during a time of global crisis. The plan worked. Fannie and Freddie saved the day, repaid nearly every penny of cash received from the U.S. Treasury, and can look forward to resuming a prosperous future based just on the aging of assets held. However, many believe Fannie and Freddie will be victims of a government-sponsored expropriation that brings our country closer to a future conceived by George Orwell in his novel, 1984 . We disagree.

On the macroeconomic front, U.S. fiscal responsibility and U.S. energy independence are on the horizon! Economic progress will eventually lift interest rates, which will depress asset valuations. However, our banks and insurers should more than counter this weight with a lifting of margins between earning assets and paying liabilities. Overall - a net positive.

The Fund’s portfolio prices remain a third below our growing estimates of intrinsic value... If history is any guide, expect these two measures to converge one day. For now, we believe, the difference between them to be a large margin of safety.