Walk Away From Your House by Jim Cramer

[mrbaseball]

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Walking away will cause people to 'lose their deposits'. Even though the market has already taken many people's deposits

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Well? This is exactly what happened in the early 90's. The house was worth less than they paid for it. They owe more than the current worth. With a small down payment coupled with teaser rate/exploding mortgage waalking away is often a prudent strategy. Of course this just puts more pressure on the loaners.

[gull]

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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.

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

[Phone Booth]

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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

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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.

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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]

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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.

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Absolutes are beyond retarded. There are more sub prime mortage lenders that are going to fail. The survivors will profit from the shakeout. There are some that are hugely overvalued because they aren't trading at zero. There are some trading near zero that are clearly worth much more. Do your homework individually and find out.

I hate absolutes, but if I had to say one about this situation I would have to say that "subprime mortgages written before the second half of 2005 are solid" is more true than not. I'll leave it to you to figure out why.

[DesertCat]

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Why would you be buying into a falling market? If valuations look good by your analysis then wouldn't it be more sensible to wait for some confirmation from price action that an upward move is more likely?

Bottom fishing can prove profitable if you make the right calls at the right time, but I doubt it provides a good risk:reward

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Are you suggesting I'll make a bigger profit if I wait until it goes up so I can pay more?

To answer your question, I think the current price is idiotic, the remaining excess cash flow is clearly going to be more than the current trading value. I don't know when the price will stop being idiotic, but when it does it will quickly move up by around 100%. I can't predict when that will happen, certainly by year end, or by early next week. So I buy when I can.

And in this case, the company is going to dividend those cash flows directly to shareholders. So I really don't have to care what the market price is once I've bought. I expect to have my basis returned to me by years end.

[DesertCat]

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

Catching a falling knife.

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We've had enough exchanges that you should know that I specialize in catching falling knifes. It's how I make my living and it's treated me very, very well. I understand why wall streeters who don't understand how to estimate value, or cannot commit to value investing, grow cold when their "picks" drop in price, and assume they made a mistake or that someone else knows something they don't and rush to sell.

I guess Eddie Lampert isn't one of them.

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The audacity of his Kmart investment put Lampert on the map. With Kmart in Chapter 11 in 2002, he scooped up its debt as creditors fled. But his investment swooned as the retailer got even sicker. So Lampert doubled down and bought yet more debt, enough to give him control of the bankruptcy process.

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[Phone Booth]

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I hate absolutes, but if I had to say one about this situation I would have to say that "subprime mortgages written before the second half of 2005 are solid" is more true than not. I'll leave it to you to figure out why.

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I assume this has to do with home price appreciation and the fact that a lot of 2/28's from then have already reset. On the other hand, underwriting standards already became comical in late 2004 and early 2005. Add that to the locality effect (bad loans tend to be clustered in neighborhoods which can change RE fundamentals by making those areas less desirable) and that most of those subprime borrowers are simply not ready for the payment shock.

But this is all moot as small lenders shouldn't have a lot of exposure to performance of loans in the 2004-2005 vintages. Where they are going to make money going forward (and how creditors view their prospects) is a much bigger concern. What lenders are essentially engaged in is an arbitrage between the price of mortgages in the primary market (what borrowers are willing to pay) and in the secondary market (what investors are willing to pay). There is no real arbitrage at a volume that can keep very many lenders in business.

[DesertCat]

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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.


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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.

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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.

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