Vindication of Indymac’s Alt-A and a Quantitative Take on 2007 EPS
Robert Craig-Stephenson submits: It is not often for an analyst to be vindicated within one week of publishing his opinion on a particular stock. But I am not an analyst, which probably explains how I got these things right in the first place! Let’s gloat over some of my previous writings on Indymac (NDE). I will use the American Home (AHM) press release made Monday (April 9) to show how close those predictions came true. Bear with me, as I will reward you all with a prediction of 2007 EPS for Indymac, and therefore a suggestion of where their stock should trade given the currently observed risk premium. 1. I wrote (Mar 30) “A more meaningful statistics would be the delinquency rate of the mortgages that they originate from 2005 onwards, especially the trend in the Q1 of 2007. ” AHM said (Apr 9): “the Company’s first quarter results will be adversely affected by ongoing high delinquency related charges due to the Company establishing additional reserves for increases in non-performing loans. While high delinquency charges were expected, their impact on quarterly results continues to be significant. ” 2. I wrote (Mar 30): “The capital market trades Indymac loans efficiently in the sense that changing expected performance are immediately reflected in the price that the loan will trade at. Right now, for stated income loans with adjustable rates, in the Alt-A sector, the market implies 50-300 basis points of default cost, depending on several other variables such as credit score and other borrower attributes. This cost alone will eat up most, if not all, of Indymac’s expected credit revenue. ” AHM said (Apr 9): “The Company’s first quarter results will be adversely affected by lower gain on sale margins. As March progressed, loan pools offered for sale by the Company received relatively few bids at lower than expected prices. As a result, those loans originated by the Company in late February and during March earned lower gain on sale revenues than were anticipated.” 3. I wrote (Mar 30): “The good thing is that most likely Indymac will not go under ala New Century - the losses won’t kill and Indymac does not depend on Wall Street financing. The bad news: Indymac will not make any money for several quarters as these costs adjust upwards and profit growth suffers.” AHM said (Apr 9) : “While the market may recover, and while we will attempt to restore our gain on sale margins by raising interest rates charged to consumers, our working assumption must be that current market conditions will persist and that our gain on sale margins will not recover through the balance of the year. Consequently, I am disappointed to report that our Company is lowering its full year earnings guidance and its dividend policy.” 4. I wrote (Mar 30) : ” Finally, in good times the differences in Subprime, Alt-A, and Prime mortgage borrowers stand out. Their personal attributes make the difference: education, income, and personal resilience. In bad times housing and employment play much bigger roles than individual strength, such differences may be harder to spot.” AHM wrote (Apr 9) : “A disproportionate share of the Company’s non-performing loans are repurchased Alternate “A” loans. The Company has ceased offering those types of Alternate “A” loans that have resulted in a high proportion of its repurchases” In my opinion, even at the time I wrote my article, #1 - #3 were really foregone conclusions to me. What truly set me free was the confirmation of #4, that there is no difference of how their Alt-A loan play out versus what has been unravelling in New Century, Fremont, and Accredited who are all Subprime lenders. Now, I will take AHM numbers, and use that to forecase NDE’s earning, and use the current multiple to arrive at a price target for you all day traders out there: Here is what AHM said in different places of their Apr 9 statement:
Assumptions underlying the revised guidance include a) slightly lower gain on sale margins in the second quarter compared to the first quarter, and gain on sale margins in the third and fourth quarters similar to the first quarter. b) the absence of further write-downs of low investment grade and residual securities, and delinquency related charges similar to the first quarter through the balance of the year In short AHM simply took the earning reduction in Q1 of 0,60 and apply it to the 2007 earnings, assuming essentially unchanged Q2-Q4 earnings. Let me be cautious, but not overly conservative by reducing each quarter Q2 - Q4 by 0.60, which is consistent with my disagreements to their assumptions. The 2007 earnings would then be $2.20, give or take. Given this information, I just have to map some P/E requirements to assumptions regarding what 2008 and beyond look like, to arrive at fair price. This is essentially the risk premium / cushion, that I demand in case I am incorrect:
That is for AHM, the current $19 price seems to put it on the “fair” side of the world. I did the same for Indymac, and that’s done basically by scaling the numbers ala AHM, and arrive at NDE forecasted 2007 EPS of $2.80. Finally, these are what NDE is going to be, given conditions in 2008 and beyond:
It is exceedingly clear to me, given NDE current price of $29, that the market is still using only the best scenario to play out for NDE. The risk-reward is absolutely tilted for the seller, as the upward move is severely limited relative to the downward move. It is a shame, that even the CEO, who launched a PR campaign by accumulating the stock at $29, implicitly tells the market to only imagine the best possible scenario to play out. Sellers, the sky is clear. Disclosure: Author has a short position in NDE http://usmarket.seekingalpha.com/article/31166 originaly from source |
