Despite housing slump, weak GDP growth and competitors woes company did a rather good job this quarter.
In a worsening environment, Delta obtained satisfying results sticking to its disciplined business model of originating mainly (87% this quarter) fixed rate mortgage loans sporting low pre-payment and default rates in large part through their in-house cheap retail channel (for about 50% of their loans).
3rd quarter 2006 highlights:
- 3rd quarter net income: $0.33 per diluted share (+6.5% year over year),
- originated $2.9 bil. year-to-date (+6% year over year but 3% less sequantially),
- mortgage loans held for investment at the end of September 2006: $6 bil. ( $4 bil. at the end of September 2005) granting in the next 12 months about $87 mil. of pre-tax interest income,
- gain on sale margin on the $197 mil. loans sold on "whole-loan" basis: 1.8% ((1.4% Q3 05, 1.4% Q4 05, 1.1% Q1 06, 1.3% Q2 06),
- increased their weighted average coupon to 9.06% (20 basis points more quarter-over-quarter).
Though we are expecting a softening origination volume for next year we are sticking to our long term price target price of $14 since originating margins are above our assumptions and default rates is still under check thanks to Delta underwriting discipline.
The stock, which trades at 6.14 times estimated 2007 earnings, can be considered as cheap.
Updated stock quote: $9.51 (+5.5% compared to 9/14/06 close, -0.83% compared to yesterday close).
Disclosure: author does not have a position in the securities discussed in this article at the time of posting.
8 comments:
I read your posting on "seeking alpha" board.
Small question. You note the fair value adjustment of $141mn as of year end 2005. Should this be tax-effected before adding to book value?
Regards
Thanks for your interest.
Excess marked-to-market book value is not directly taxable.
Of course you may make the case that in an actual liquidation income taxes would apply or that, in any case, the increased net asset value will create cash flows in the future that will be taxed somehow.
However:
- you take the risk of calculating income taxes twice, first on the excess book value then on your after-tax earnings estimates.
- the "invisible" book value most probably increased from Dec. 2005 providing some sort of cushion for a tax allowance.
Better to stick with a simple approach: the $143 mil. book value reported at the end of September 2006 is materially under rated (below liquidation value however you want to calculate taxes) while the company is solidly profitable (22% ROE in the last 12 months).
Moreover, if you look only at the asset side of the business in a liquidation, you should note that the pure book value approach doesn't give any value to the Delta in-house $2 billion-a-year origination platform.
Were you the author of the write-up of DFC, dated June 7, 2006, on the Value Investor's Club?
DFC seems like an interesting opportunity.
Thanks for your comment.
No, I was not the author of VIC write-up.
I agree that DFC seems attractive especially if the smooth landing thesis will prevail and job market will remain strong.
Interesting articles, thanks.
I'm curious as to whether you are waiting for a cheaper price or have another reason not to have "eaten your own cooking" and taken a position in DFC?
Also, given your industry experience, do you have any ideas as to a good shipping stock?
Thanks for you comment.
Delta Financial:
Yes, you're right, I'm waiting for a better price for two reasons.
1) Discipline trumps conviction: I usually buy a stock when it is below 10% to its 52-week high. Stock is presently around 8% below its 52-week high. I don’t like to pick up shares when many other investors already understood the true value of the company. In the case of Delta it may be a mistake.
2) I thought that the credit bubble in hot real estate markets would create a selling climate for the whole subprime mortgage industry with investors throwing the baby with the bath water. I’ve been wrong sofar. In the last 12 months the main two public listed pure player competitors did worse than Delta Financial (Accredited Home Lenders lost 30% and New Century breaks even). Delta Financial is still at +15% despite industrywide material and sudden increase in loan defaults.
For which reasons:
- Delta loan portfolio is performing much better than competitors;
- the whole business model is safer than competition and accounting is much more conservative and straightforward;
- major Wall Street brokerage houses are showing a strong interest in buying subprime mortgage originations platforms to feed their lucrative securitization business. It puts a floor below the stock. A few deals have been concluded already. I plan to write in the next few days a short column on which could the private market value of Delta origination platform. According my first estimates it should be a conservative $5-7 per share.
Shipping stocks:
If you are a long term investor with a 3-5 years horizon I have a tip for you. A stock quoted on Nasdaq with the ticker FATD (Forget About Those Dogs).
The rationale supporting such a strong opinion can be found in a long comment I wrote on Investing Ideas blog (an interesting investing blog written by Yaser Anwar).
Here is the URL:
https://beta.blogger.com/comment.g
?blogID=23127451&postID=11574291890
1145081
It doesn’t mean that you can’t make money on short term trading but on long term the odds are not in your favour.
I am studying DFC. Your posts have been most educational.
I am lost, however, concerning how you came up with the whole-loan GOS margins of 1.4 (Q3 05), 1.4 (Q4 05), 1.1 (Q1 06), 1.3 (Q2 06), and 1.8 (Q3 06). I cannot find these numbers in the Form 10Q. The latest 10Q has 4.91% as the net GOS margin for whole-loan sales in Q3 06.
You can find numbers in DFC quarterly earning releases.
Look at 3rd quarter 2006 for example (http://www.deltafunding.com/news.htm)
==
• Total cost to originate, as a percentage of total loan production, was 2.0% in the third quarter of 2006.
• Sold $197 million loans on a whole-loan basis for an average premium of 3.8% in the third quarter of
2006.
==
I like these numbers because they are a quick/handy way to measure underwriting profitability.
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