Walk Away From Your House by Jim Cramer

[kyleb]

[ QUOTE ]
BTW, Wall Street has coined a term for this type of "value" investing.

Catching a falling knife.

[/ QUOTE ]

Oh, so people with poor credit will never need houses again, right? Gotcha.

[Phone Booth]

[ QUOTE ]
[ QUOTE ]
DesertCat, do you invest in subprime lenders and/or homebuilders? I think this is def. a good time to be buying with all the people predicting the apocalipse and all, everything is on 52week lows etc.

Where do you see the most value on these markets? I really trust your analysis

[/ QUOTE ]

I think there is some value in subprime, the problem is it's a lot of work to figure out where. I bought some DFC and made some nice profits and sold most of it before it replunged. I'm not going to buy it back until I do my homework on it in more detail now that I better understand these businesses.

The company I'm referring to in my first post is out of business and the market apparently thinks it's bloated corpse is worthless. It's been a great learning experience, I bought early before I really understood it and as it declined I've been constantly reresearching it and learning more.

Effectively what you need to understand is that most mortage/lending companies carry huge assets (securitizations) on their balance sheets that they don't own and huge liabilities are are totally non-recourse to them.

So you have to carve out a "pro forma" balance sheet of what they really own/owe. Then you look at the "stub value" of what cash they can reasonably get out of their securitizations. The securitizations are separate companies and you need to get their prospectuses and monthly reports to tease out how much cash flow they can generate and what collateral will be left over when it's closed. In some cases it's clearly nil, in some cases it's murky, and sometimes it's obvious that the parent company is going to get some cash.

Lots of work. But I think it's rewarding. I'm down $70,000 so far, but if I'm right I'll end up with a substantial profit by next year.

[/ QUOTE ]

I'm not sure what you mean by huge assets they don't own and liabilities that are non-recourse. If you mean term securitizations (as in most MBS/ABS transactions) that's not part of their book in any sense, except for three aspects - 1) They may or may not own residuals (equity tranche/first-loss position) and this may be what you're talking about in terms of the cash they can get. For most recent deals, the value of this will be close to zero. 2) The loans they sold into the securitization will have warranty for EPD (early payment default), fraud or other types of misrepresentation. This is a clear liability in this market. 3) They may or may not have retained servicing rights to the loans in the securitization (a fee for continuing to service the loans). This is another source of residual cashflow, though becoming less common for smaller shops.

All this is probably less of a concern (and easier to evaluate with reasonable amounts of disclosure) than loans in the pipeline that are held in a warehousing facility (which will generally be part of their book). Any serious mortgage market disruption can put the lender out of business because most of those credit facilities can be pulled on a moment's notice, in which case the lender won't have the luxury to wait to sell the loans into an appropriate securitization. In a liquidation scenario, you'll find that most lenders have very little value.

[DesertCat]

[ QUOTE ]


I'm not sure what you mean by huge assets they don't own and liabilities that are non-recourse. If you mean term securitizations (as in most MBS/ABS transactions) that's not part of their book in any sense, except for three aspects - 1) They may or may not own residuals (equity tranche/first-loss position) and this may be what you're talking about in terms of the cash they can get. For most recent deals, the value of this will be close to zero. 2) The loans they sold into the securitization will have warranty for EPD (early payment default), fraud or other types of misrepresentation. This is a clear liability in this market. 3) They may or may not have retained servicing rights to the loans in the securitization (a fee for continuing to service the loans). This is another source of residual cashflow, though becoming less common for smaller shops.


[/ QUOTE ]

Many securitizations are still held on balance sheets, even when totally non-recourse (i.e. well after any EPD liabilities have expired). I'm not an expert on the accounting reasons why, but I believe in the cases I've seen it's because the securitization is effectively owned/controlled by the parent company.

In the company I referenced, they have some residual interests in 2004 securitizations that are just held as assets at estimated fair value, but their 2005 securitizations are entirely on the balance sheet. I can't tell you why they are accounted for differently, just that they are.

[ QUOTE ]

All this is probably less of a concern (and easier to evaluate with reasonable amounts of disclosure) than loans in the pipeline that are held in a warehousing facility (which will generally be part of their book). Any serious mortgage market disruption can put the lender out of business because most of those credit facilities can be pulled on a moment's notice, in which case the lender won't have the luxury to wait to sell the loans into an appropriate securitization. In a liquidation scenario, you'll find that most lenders have very little value.

[/ QUOTE ]

I'm not talking about warehouse facilities. This company shut down theirs long ago.

[critikal]

[ QUOTE ]

I think there is some value in subprime, the problem is it's a lot of work to figure out where. I bought some DFC and made some nice profits and sold most of it before it replunged. I'm not going to buy it back until I do my homework on it in more detail now that I better understand these businesses.

The company I'm referring to in my first post is out of business and the market apparently thinks it's bloated corpse is worthless. It's been a great learning experience, I bought early before I really understood it and as it declined I've been constantly reresearching it and learning more.

Effectively what you need to understand is that most mortage/lending companies carry huge assets (securitizations) on their balance sheets that they don't own and huge liabilities are are totally non-recourse to them.

So you have to carve out a "pro forma" balance sheet of what they really own/owe. Then you look at the "stub value" of what cash they can reasonably get out of their securitizations. The securitizations are separate companies and you need to get their prospectuses and monthly reports to tease out how much cash flow they can generate and what collateral will be left over when it's closed. In some cases it's clearly nil, in some cases it's murky, and sometimes it's obvious that the parent company is going to get some cash.

Lots of work. But I think it's rewarding. I'm down $70,000 so far, but if I'm right I'll end up with a substantial profit by next year.

[/ QUOTE ]

And what if you're wrong? I personally have probably not done anywhere near the amount of research on the sub prime market as you have, but to paraphrase Keynes- the market can be irrational longer than you can remain solvent. You expect to make back your basis on dividends, but isn't it possible (and imo, likely) that this "crisis" will force your company to cut dividends? You've already said that one went out of business.

Perhaps I'm wrong but my view of the value investing strategy is that you make purchases with very little downside. You say you've already lost $70k, which is apparently significant to your portfolio. Dollar amounts don't actually mean much- what percent of your portfolio have you lost in these investments? What percent of your portfolio is in these mortgage related companies? Going against popular view can be quite profitable, but the view is usually popular for a reason. I'm by no means an expert on mortgages, but the experts sure seem to believe that a crisis is on hand.

When the S&P500 was trading in the 700s in 1997(?) Greenspan said that the market was far too optimistic, yet we had a huge bull run for the next three years. The market as a whole has only been showing weakness about the "lending crisis" for a couple of weeks. Reports that I've read on the housing markets seem to indicate that barring some sort of intervention, the downturn will extend into 2009. Are you planning on adding more and more money into your positions (which could be black swans) while they keep going down?

[DesertCat]

[ QUOTE ]

And what if you're wrong?

[/ QUOTE ]

I size my positions carefully based on risk and my portfolio size. I can afford for this one to go to zero and still have profitable year.

[ QUOTE ]

I personally have probably not done anywhere near the amount of research on the sub prime market as you have, but to paraphrase Keynes- the market can be irrational longer than you can remain solvent.

[/ QUOTE ]

Not sure what Keyne's specific point was, I can stay solvent forever because I use very little margin debt.

[ QUOTE ]

You expect to make back your basis on dividends, but isn't it possible (and imo, likely) that this "crisis" will force your company to cut dividends? You've already said that one went out of business.

[/ QUOTE ]

Many have gone out of business, including the one I'm investing in. It currently has about $43M in cash & equivilents, is pretty much a lock to receive $16M in cash flows in the next 4-5 months and has $51M in liabilities (some non cash that won't cost anything), so a net cash value of about $7M vs. a market cap of $18M. It also has $78M in securitization assets, loans, and real estate & a lawsuit worth up to $25M. So the market is saying those loans/real estate/lawsuit are worth about 10% of stated value (which has already been written down substantially).

The market is wrong here, mainly because there is no "market" for $18M market cap companies, i.e. wall street isn't looking at them. I think it's most likely that the company will end up being worth between $40M and $80M. And it's already committed to dividending all excess cash. And I think I have very little downside in this one.

[ QUOTE ]

Going against popular view can be quite profitable, but the view is usually popular for a reason. I'm by no means an expert on mortgages, but the experts sure seem to believe that a crisis is on hand.

[/ QUOTE ]

I'm not going against the popular view, I actually agree with it. Subprime underwriting standards did go loopy, real estate values were in a bubble, and the fallout is far from over. But clearly subprime loans will be made in the future, just on financially prudent terms. And every subprime loan written in the last 5 years isn't going bad, not even most of them. In the worst securitization this company has in 2005 has a loss rate of 2.9% in total.

Think about it this way. If 10% of loans go all the way to foreclosure and the company takes a 35% loss on each foreclosed loan, that's a 3.5% loss rate. It's a little more complex than that, but at that loss rate even if every loan went bad a basket of subprime loans would still be worth something like 65% of face value. The loss rate is of course depending of course on the value of the properties at auction and costs of the foreclosure process.

[ QUOTE ]

When the S&P500 was trading in the 700s in 1997(?) Greenspan said that the market was far too optimistic, yet we had a huge bull run for the next three years. The market as a whole has only been showing weakness about the "lending crisis" for a couple of weeks. Reports that I've read on the housing markets seem to indicate that barring some sort of intervention, the downturn will extend into 2009. Are you planning on adding more and more money into your positions (which could be black swans) while they keep going down?

[/ QUOTE ]

You seem to be macro focused. The housing market will have some impact on my positions value, but much of the value is already in cash, and even in worse downturn the remaining mortgage/reo assets will be worth a lot more than zero. Enough to pretty much guarantee a profit here. Every position stands on it's own.

[kimchi]

[ QUOTE ]
Video Link

[ QUOTE ]
is now telling people who "made a bet and lost" to not compound the error, and to simply walk away from the mortgage and default.

[/ QUOTE ]

[/ QUOTE ]

Sensational reporting by this guy is good for his ratings but I doubt many people will be able to walk away from their houses even if the valuations continue to fall.

People still need a roof over their heads and need to weight up the costs and benefits of defaulting and paying rent as opposed to remaining with their home and mortgage.

Walking away will cause people to 'lose their deposits'. Even though the market has already taken many people's deposits, it a near psychologically impossible thing to do - albeit prudent for certiain individuals in specific situations....a point Cramer fails to expand upon.

[jaydub]

[ QUOTE ]
[ QUOTE ]
Video Link

[ QUOTE ]
is now telling people who "made a bet and lost" to not compound the error, and to simply walk away from the mortgage and default.

[/ QUOTE ]

[/ QUOTE ]

Sensational reporting by this guy is good for his ratings but I doubt many people will be able to walk away from their houses even if the valuations continue to fall.

People still need a roof over their heads and need to weight up the costs and benefits of defaulting and paying rent as opposed to remaining with their home and mortgage.

Walking away will cause people to 'lose their deposits'. Even though the market has already taken many people's deposits, it a near psychologically impossible thing to do - albeit prudent for certiain individuals in specific situations....a point Cramer fails to expand upon.

[/ QUOTE ]

What deposit? His advice is aimed at the 100% LTV and neg am borrowers.

J

[gull]

[ QUOTE ]
Investing in sub prime mortgage lenders right now would be beyond retarded.

Real Estate market is going to crash, hard. Take that money and buy forclosure properties.

[/ QUOTE ]

Are you shorting them since it's beyond retarded? In other words, is your money where your mouth is?