Amid present subprime mortgage carnage Delta Financial performance is impressive.
Sticking to their strategy to focus on the fixed-rate loans niche (87% of their loans in 2006), the seasoned and conservative management reached amazing results:
1) Profits per share increased 22% compared to same quarter of last year while virtually all other subprime mortgage lenders reported losses in 4th quarter 2006.
2) They originated a record $4 billion loans, 5% more than 2005 volume.
3) They reached a truly outstanding low cost to originate (1.6%). According to the information we have in our hands we believe that in the 4th quarter they were the low origination cost leader in the subprime mortgage universe despite they spread their fixed cost on much smaller volume compared to their bigger competitors. The secret here is that are using their in-house origination platform which sports very low 1.1% origination costs against the 2.2% supported by the broker channel.
4) Their underwriting profit that is still near record highs.
| period | Q3 2005 | Q4 2005 | Q1 2006 | Q2 2006 | Q3 2006 | Q4 2006 |
| gain on sale of whole loan sales | 1.4% | 1.4% | 1.1% | 1.3% | 1.8% | 1.6% |
Regarding the outlook, the company CEO Hugh Miller is positive. He has not seen so far the usual seasonal decline in loan volume during the first quarter of the year and he plans to hire new loan officers to grow retail origination platform.
Loan losses are within expectations and 90+ days delinquent loans reached 5%, about half of what we believe to be the industry average.
At the current quote of $9.58 the company trades at 1.51 x book value, 7.5 x 2007 expected earnings and pays a 2.2% dividend.
Though company evaluation is richer than the other distressed subprime distressed competitors like New Century, Accredited Home Lenders or Novastar Financial which are currently fetching a fraction of their tangible book value, we believe that the company superior business model and management deserve the premium.
Disclosure: the author is long Delta Financial and Accredited Home Lenders Holding Co. at the time of posting
6 comments:
Are you still long DFC?
From the March 7, 10K p 113, the SFAS No. 197 fair value analysis is set out. I attempted to update the fair value calculation: Mark-to-market estimated fair value at 12.31.06 adds $153.377 million to the carrying value of mortgage loan assets. Estimated fair value of financing liabilities is reduced from carrying value by $41,875 million, for a total of $195.25 million in excess of book carrying value. That I calculated to equate to an additional $8.387 of fair value in excess of book value, based on 23.278mm shares. GAAP book equity is $149.576mm, or $6.425 per share. Added together that is $14.812 per share fair value [pretax, $11.4 after tax]. At $9, DFC is selling at .60x fair value pretax.
Did I miss anything in that calculation?
Your calculation of fair value per share seems correct though the purist may argue you may have used 23,490,812 as outstanding share number (as stated in 10K page 83).
The difference in fair book value per share would be immaterial in any case.
Yes I'm still long Delta Financial.
Based on the new 10K, securitizations, etc., have you attempted to calculate a fair value that breaks out the value of the mortgage platform over and above its carrying value within the fair value that I calculated?
I am also long DFC
Many thanks for all your posts on DFC, which, along with the VIC write-up, has been the most helpful for me in understanding this company.
Some questions remain:
1. A key point made in the VIC write-up is that DFC, by issuing NIM bonds, is able to issue non-recourse debt in excess of the principal balance of the mortgages it securitizes. In other words, the loans on a "real" balance sheet are held at a value below the amount of debt securitized against them. How do we know this? (All we have in the 10K is the GAAP balance sheet which shows mortgage loans in excess of the financing for those loans. Even the Fair Value statement in the footnotes show the loans in the assets are in excess of the financing liabilities.)
2. DFC's 10K speaks of their securitizations containing an overcollateralization (O/C) provision as a credit enhancement. If the NIM bonds are in excess of the associated mortgage principal balance, then this portion of the securitization is an "undercollateralization." Why would anyone want to buy such a thing? (Granted, more power to DFC if they are able to sell these!)
3. Assuming a doomsday scenario in which the default and loss rate is 100%, DFC's book value would hold up, but the earnings would take a hit as the net interest income dries up. Am I correct?
Comments to the last two Anonymous readers:
Sorry for late feedback but in my day time job I've been fighting with chinese shipyards and banks these last weeks and did not have the time to have a deep look at 10K.
Value of origination platform: last weeks turmoil showed that origination platform value can be worth 0 if the platform originates bad loans. That's not the case of DFC.
Overall still think that origination platform + loan portfolio are worth something around $14 per share.
NIMs questions: lack the accounting background to provide an accurate reply to your questions. However in the overall analysis the NIMs points are not that important.
The turmoil in subprime lending world and its effect on even the lenders with the best reputation (like Accredited Home Lenders) showed that the first point to focus is on quality of underwriting standards. Next post on DFC will focus on the leading indicators of future loans default.
Doomsday scenario: correct.
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