Subprime Lender Looks Cheap!!!

[squiffy]

Great deal on a sub-prime lender. Looks cheap!!!!

Sub-prime loan market shaken up
Stocks are hit after two lenders report big losses from defaults. Some borrowers may suffer.
By E. Scott Reckard, Times Staff Writer
10:40 PM PST, February 8, 2007



There's more trouble in the mortgage lending market — and that could mean problems for higher-risk borrowers who want to refinance their home loans.

An independent Orange County lender and Europe's largest bank both spooked Wall Street on Thursday by reporting huge losses on "sub-prime" mortgages to borrowers with bad credit, high debt loads or other risk factors.

The bad news from Irvine's New Century Financial Corp. and London's HSBC Holdings sent shares of sub-prime lenders tumbling by double digits, with New Century down 36%. The disclosures shaved smaller amounts off the stock price of HSBC and other lenders with broader operations.

The shakeout in the sub-prime industry began last year as housing prices leveled off and interest rates rose, curbing demand for loans. At first, some companies loosened lending standards to keep loan volume high, a tactic that has produced a wave of early loan defaults. More recently, companies such as New Century have tightened their loan policies to reduce their exposure to mortgages that could go sour.

As part of the fallout, marginal borrowers who snapped up loans with initial easy-money terms in 2004 and 2005 will find it impossible to refinance this year to avoid sharply higher payments, especially with home prices flat or lower in many areas, industry analyst Zach Gast said.

As much as $800 billion of adjustable-rate mortgages will reset to higher payments this year, and 1 of 11 home loans is both adjustable and sub-prime, according to the Mortgage Bankers Assn.

"There could be a good chunk of borrowers with nowhere to go to get loans," said Gast, who follows the industry for the Center for Financial Research and Analysis, a Rockville, Md., forensic accounting and due diligence firm with mutual funds, hedge funds and insurers as clients.

"It means a lot of people are going to lose their homes."

Gast said investors in mortgage-backed bonds, who for years demonstrated an unquenchable demand, had begun backing away from securities created from the riskiest pools of loans.

HSBC, which bought U.S. sub-prime lender Household International Inc. for $15.5 billion in 2003, said it would raise its provisions for bad loans by $10.5 billion, 20% more than analysts had expected. The action was taken mainly because adjustable sub-prime loans are driving delinquencies higher, Chief Executive Michael Geoghegan said in a conference call.

HSBC's New York-listed shares fell $2.44, or 2.6%, to $89.78. Washington Mutual Inc., Countrywide Financial Corp. and Wells Fargo & Co., all of which write sub-prime mortgages as well as conventional loans, saw their stocks slip by about 1% to 3%.

New Century is the second-largest sub-prime mortgage originator after San Francisco-based Wells Fargo, with HSBC just behind in the No. 3 slot. The Irvine company said late Wednesday that it had greatly underestimated the losses it would record as a result of loan buyers forcing it to repurchase mortgages that had quickly fallen into default.

It said it would record a loss of undetermined size for the fourth quarter, rather than the $1.08-per-share earnings Wall Street was expecting. New Century also said it would revise downward its financial results for the first nine months of last year.

New Century shares plummeted $10.92 on Thursday to $19.24, their lowest price in nearly four years. It was the sharpest decline for the stock since late 1998, when many sub-prime lenders were forced out of business by credit fears sparked by Russia's default on its debt.

Investors also dumped sub-prime specialists Novastar Financial Inc. of Kansas City, Mo., down $2.29, or 11%, at $18.31. Accredited Home Lenders Holding Co. of San Diego also tumbled as much as 11% during the day before closing down $1.75 at $27.25, a 6% decline.

Analyst Richard Eckert of Roth Capital Partners in Newport Beach had upgraded New Century to a "buy" in November because its shares looked cheap and Eckert had confidence in management.

Now, he said, the confidence factor among investors and analysts was "close to zero."

In a recorded message to analysts, New Century Chief Executive Brad Morrice sought to allay fears of a cash crunch at his company, noting that New Century "had cash and liquidity in excess of $350 million" at year-end. Company executives declined to elaborate on those comments.

Analyst Gast said New Century's cash and liquid assets were proportionally less than half of those at competitors such as Accredited Lending, with the $350 million in cash and liquidity at year-end down more than 20% from the $457.1 million that New Century reported three months earlier.

New Century is far from the first casualty in the sub-prime shakeout. Victims have included Ownit Mortgage Solutions Inc. in Agoura Hills, which filed for bankruptcy protection last month. Ownit had closed down after loan buyers on Wall Street demanded that it repurchase newer loans that had gone sour.

[Guppies]

Ok, let me take a crack at an analysis of this stock, I would appreciate it if someone could highlight what is good and what is not good about my analysis. Also, if I left out any important considerations one should take into account when analyzing a stock please let me know since I'm sure there are many things that I'm missing.

So, first off I assume the only stock mentioned that we should be considering based on its "bargain" price is New Century (NEW), most of the other companies mentioned in this article are much broader in terms of where they get their income from and as such their prices haven't dropped enough to make them a bargain (if they weren't already). So I'm going to restrict my analysis to New Century.

First of all, it's dropped roughly 45% in share price (From 30 to 17) since it announced its 4th quarter earnings. So it seems like it has the ability, albeit not immediately, to climb back up to a much higher price. My reasoning basically being that it's been there before, and the loan business isn't going anywhere, so they can get there again.

Their "Trailing P/E" (which I assume means their P/E based on reported earnings?) is 2.44, compared with 12.06 for Washington Mutual inc., 9.93 for Country Wide Financial Group, and 14.34 for Wells Fargo and Co. I was unable to get P/E information for HSBC. So their P/E ratio seems to be really low at the moment, which lends strength to a buy argument.

However the P/E ratios listed above are all for companies that have many other streams of income besides sub-prime loans. So maybe it would be better to compare New Century to the other, more sub-prime lending centric, companies listed in the article.

Novastar Financial Inc. has a trailing P/E of 5.10 and Accredited Home Lenders Holding Co. has a P/E of 4.06. These are much closer to New Century's P/E so it doesn't appear to be quite as undervalued as before, although it still has the lowest P/E of the bunch by quite a margin. So it still might be a buy.

However, there may be other reasons why its P/E is so low. Most notably, it is going to restate its first three quarterly reports of last year as their has apparently been some errors in its accounting practices. This is leading to some suspicion of fraud which may account for some of its low price and P/E.

Additionally, one can't overlook the fact that the housing market has slowed considerably and will likely remain that way for a good amount of time. This does not bode well for New Century as it would be much easier for them to recoup their losses in a bullish real estate market than the current one. As such it may be quite some time before they are able to post good earnings and growth.

Taking all of this into account here are my feelings on the stock. It does seem to be a bit undervalued since it looks like people are overreacting to its poor quarterly results and its need to restate earlier quarterlies as well. However, the stock does present a serious risk of price stagnation or descent as their business plan is not likely to generate a high revenue for at least a little while. Not to mention the fact that they are going to be coping with the fallout from all of their delinquencies for a while. So, I would hold off on buying the stock yet and wait for them to restate their quarterly reports. I assume these reports will be worse for the company than the originals and I would think this would drive the price down even further. Once this happens I would reevaluate the stock and if it seems like the company will be able to deal with its high delinquency rate I might invest in the stock hoping for it to regain much of its value over the next 5 years or so.

Ok, how was that? What did I leave out? What information did I include that was unnecessary or downright misleading? Do you agree with my conclusion?

[PairTheBoard]

Cramer talked about this sector a few days ago. His view was that a lot of the smaller players will not survive the bloodbath and your best bet is to go with Countrywide (CFC), the best of a bad breed in his words. His thought is that CFC is poised to take over the business left by its failing competitors.

I plan on following CFC and the rest of the sector to see what develops. CFC is still near its all time high and has yet to see the deteriorating subprime business impact its earnings. I'm not clear on why it has escaped trouble so far. But I suspect it will end up being impacted more than the market is now figuring in its price. It may fall to much lower levels in the next couple of years. If it does there may be a bargain there someday. I don't see it for now though.

Congress is looking at legislation this year to regulate the industry which may impact long term earnings prospects, or at least scare investors.

This reminds me of the bursting of the tech bubble. A lot of weak stocks went to zero and were never bargains at any price. Meanwhile, the best companies held up for a while but finally fell to levels that were almost unthinkable near the top of the bubble.

PairTheBoard

[DesertCat]

If you look at these companies their earnings are misleading at best, you simply can't use PE ratios at all with them. Almsot all of them securitize, i.e. they wrap up all their mortgages and transfer them into a special company (an ABS) to sell to outside investors. Theoretically they are off the hook for those potential mortgages after securitizing, but I'm not sure it's true (the wall street journal hinted today that some of the securitizers have been forced to cough up additional monies when ABS's have extra losses).

Companies like NovaStar & New Century have been huge battlefields between longs and shorts. To summarize a hugely complicated argument, shorts say the earnings are not reliable, even faked, the longs say "they pay a big dividend, the earnings have to be real". Right now it looks like the shorts might have been right.

So essentially your analysis is way too simplistic. You need to bury yourself in the financials of these companies for a week or so, build your own model, and then decide what their true value and future prospects are. I'm simply not willing to spend the time doing that because I think I'll end up with a <shrug> as my answer.

Remember, these guys are cratering because they could not assess risk on their loans properly. Defaults are skyrocketing. Who knows where it will end?

[Guppies]

Where would I get the kind of information you are suggested I need to look at? The company itself? Or is there a website or something that organizes a company's financial information and puts it all in one place?

[DesertCat]

[ QUOTE ]
Where would I get the kind of information you are suggested I need to look at? The company itself? Or is there a website or something that organizes a company's financial information and puts it all in one place?

[/ QUOTE ]

sec.gov, go to Edgar, that's the SEC's database of public company financials. You can read their last four quarterly statements and last annual report, just to get started. You might also find these financials on the company website.

[SMB]

I'd tread very carefully here.

Valuations on subprime mortgage-backed bonds are starting to falter. There are many better options with less risk than here.

[pig4bill]

Yup, NEW's debt was downgraded today.

You can look at filings for a lot of things, but for situations like this, that info is so old it may as well be written on the Dead Sea scrolls.

There's a reason it's called "catch a falling knife".

[jumbojacks]

So what about shorting sub prime lenders? Is there any opportunity in that?

[squiffy]

Brilliant new business plan. Why don't we loan money to people who have lousy credit and can't pay it back. The profit margins will be tremendous!!!!