And, I would look at their balance sheet in the following light. Take their 115 million in equity and add the 75 million in allowance for loan losses, giving you 190 million in "adjusted" equity.Now, they have 6,630 million in securitized loans plus 62 million real estate and 32 million trustee receivables, adding up to 6,724 million. The debt balance that these loans secure is 6,510 million. That leaves approximately 214 million in "at-risk" capital in their securitizations, which counts on their balance sheet towards equity. You can judge how at-risk it is based on their current delinquency numbers:
The 214 million is only about 33% of 90 day + delinquencies, meaning there is a strong likelihood that most of this capital be wiped out. The only hope would be that some of the earlier securitizations will perform better than others, leaving some capital to be returned to Delta.Meanwhile, Delta also has 480 million in pre-securitized loans which are backed with about 475 million in warehouse facilities and other borrowings. If the conditions in the market have not improved since the end of the 3rd quarter, then Delta will probably also take a further hit in capital from the sale of these loans. We saw in that in the 3rd quarter they were taking 10% losses on these loan sales.
Delta has been increasing the interest rate on its loan, and they just cut a quarter of their staff to lower their costs and loan production. So we can hope that fairly soon the ongoing business can stabilize. But the very poor delinquency performance of their securitizations this quarter show two things. One, their equity is in danger of being wiped out, and that another cash infusion at very unfavorable terms will probably be necessary. Two, Delta's niche underwriting in the sub-prime market might not be as good as they made it out to seem.
3 comments:
I don't think their underwriting should have been part of your thesis.
DFC uses insured automatic valuation models to appraise a big chunk of their loan collaterals. AVMs are getting better, but they still overstate home values, in some cases by ridiculous levels. And the AVMs are supplemented with an "exterior" evaluation, which is about as thorough as it sounds. Plus their loan process is geared towards speed, not conservatism. Almost any loan can get past the Click and Close requirements, and the mortgage analysts have very little time to read over the terms (sorry, I haven't seen the #s in some time). But the strength of DFC's underwriting "values" primarily lays in the fact that they avoided ARMs and the sunbelt states, not in the underwriting process itself.
I might need you to clarify where I was supporting their underwriting. Perhaps you misread the final sentence?
"Two, Delta's niche underwriting in the sub-prime market might not be as good as they made it out to seem."
Anyways, you are right that Delta has often boasted it has avoided ARMs and frothy markets, but the fact is they were still loaning to people with very high Debt to Income ratios. In an environment of easy credit and rising home prices, the true value of these loans is distorted because instead of defaults, you have refinances or home sales. I think now we are starting to see what the real value of these loans might be like. (See Delinquency chart in the post)
My mistake, but my point was that they never really gained an expertise in underwriting subprime; they gained an expertise in marketing to, and quickly funding, subprime borrowers.
DFC is such an interesting company because they have a business model that flexes from good to terrible depending on market perceptions. But when people are spooked by any security related to subprime, DFC collapses. It's rare that you see reflexivity play such a fundamental role in a company.
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