Fixing some reasoning behind DFC:
I was recently interested in finding out whether the overcollaterization provision made by Delta Financial would be a source of potential earnings boost for the company. Simply speaking, if Delta wanted to securitize 100 million in loans, they would only issue 97 million worth in asset-backed securities. The 3 million extra would serve as a cushion in order to add more security for the asset-backed securities and to obtain better credit ratings. So is there anything important here? My conclusion was yes, but for the wrong reason.
At December 31, 2006, the loan principal balance that is backing securitizations stood at 6.16 billion, while the debt balance was at 6.02 Billion. That's 140 million that is considered equity on Delta's balance sheet, but in fact is not free for them to use until these securitizations start to expire. So, my judgement that DFC had 100 million in "excess capital" is false. In reality, as these securitizations start to expire, this will increase the amount of freed and clear equity that DFC holds. But this is also important because now two things change:
1. I believe excess capital to be between 10-25 million, substantially lower than 100 million.
2. A doomsday scenario could wipe out practically all of the equity.
It's always important to note when you are wrong. The margin of safety has largely been taken away. Now, my thesis involves simply owning the highest quality company with high insider ownership in an industry in danger. The price is very cheap at 7 times earnings. And over the past few months, hundreds of billions of underwriting capacity has come off the market, leaving the potential for Delta to become choosier and perhaps more profitable. But most this capacity coming off wrote mostly very poor loans, which Delta has chosen to avoid.
Normally, I start a position small and build it up as I get a better understanding of the company. Delta currently consists of 3% of my portfolio. At this point, I would choose to not add to my position due to a lack of a definitive margin of safety.