Thursday, March 29, 2007

Some Thoughts and Updates:

Hi readers, it has been awhile since my last post but I assure you I've been keeping busy. Here's what I've got.

I've been wrapping my mind more on different ways of looking at DFC. My newest perspective is to take the securitizations off the balance sheet to get a clear picture of what risk lies where.

At the end of 2006, DFC has:
489 million in assets + 45 million in Deferred Tax Asset
431 million in liabilities

Cashflow looks like:
-114 million in expenses
+147 million in net interest inflow
+33 million from non-interest inflow

There is 6160 mil in securitized loans with debt balance of 6017 mil off the balance sheet.

68 mil in equity +45 mil DTA+ 144 in overcollaterization.

In comparison, at 2005, there was 68 mil equity + 54 mil DTA + 50 mil overcollaterization.

This view is different because it ignores the provision for loan losses and other discounts which don't affect DFC's holding co. cash flow, but is expensed in the income statements. In reality, Delta Financial had 66 million in pre-tax cashflow come in for 2006. The deferred tax asset represents taxes they must pay upfront because the IRS does not recognize certain expenses, such as provisions for loan losses and gains on sale of older securitizations. I think it's better just to ignore this number as it will almost always exist (readers can correct me on this view if they disagree). What you clearly see though is two otherwise difficult to see facts.
1. Delta Financial generates a lot more cashflow than their financials show.
2. This cashflow is being used to fund further loan growth and ends up mostly in overcollaterization, which is equity that is at risk.

When analyzed in this perspective however, an investment in DFC at a market cap of 200 million seems a lot more compelling.

I guess it is standard industry practice to offer a 10% discount to listed prices for pulp. This negatively affects the assumptions made in our initial write-up. The overall effect drops my free cashflow estimate to 96 million. Still, with a market cap of under 500 million, SFK still makes for a very compelling investment. Just another one of the benefits of investing with a significant margin of safety.

Brick Income Fund (BRK)
I initiated a position in the Brick Income Fund. The Brick Group is a Canadian retailer of furniture, matresses, appliances, and electronics, and it has a market share of approximately 8.1%. The units have a distribution yield of 13.5% and the company arguably has a phenomenal Return on Investment of near 100%. With the ability to expand relatively cheaply and a growing franchise business, the company seems like a steal at these prices. Look for a further write-up shortly.

"Economist Thursdays"
Those devoted to reading the Economist know the new issue comes online on Thursdays (I've pinpointed it to 10:30 AM PST). Some notable quotes from this week's Finance and Business section:

"Loan securitisation disperses risk through the financial system and reduces the chances of a banking collapse. But it does have its downside, as has already been seen with American mortgages. In the old days, a bank was stuck with its loans and needed to worry about the long-term creditworthiness of the borrower. Nowadays, a bank will pocket an underwriting fee and get the loan off its books within weeks. In their eagerness to get deals done, argues Paul Watters of S&P, banks and investors do not differentiate sufficiently between good deals and bad."

"And remarkably, this lending free-for-all continues despite a sharp drop in credit ratings, says Martin Fridson, editor of the indispensable Distressed Debt Investor. No one seems bothered that 17% of senior, unsecured junk-bond issues are on the lowest possible rung, compared with 2% in 1990. "

I hope I can't get sued for that.

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