Delta Financial Corporation Reports Third Quarter 2007 Results

Just bought for childs roth ira at $2.28 . Great stock buy if you arent hasty .

amo3 - I don't get this one. This company has a $7.6billion loan portfolio left on its balance sheet that it probably cannot sell, even at a loss. They did manage to get off a securitization for $900 million but they took a loss on the sale. This had to be the last batch of higher quality loans they have, otherwise they would have sold more. Therefore they are left with a portfolio of loans of the poorest quality they orignated and now have to run them off. The credit performance of this portfolio is a disaster. They have only a 1% reserve against 9% of non-performing loans and they took a $12.5M charge off in the quarter, which is 17% of their reserves. If they keep going at that rate they will wipe out their equity of $115M in 9 quarters. But the bad news is that the loan loss provision is just an estimate of future losses. We have just begun to see the collapse of sub prime and other mortgages. From my personal experiance I can tell you that when a loan portfolio starts to fall apart, you have no idea where it will end and it generally ends up a lot worse that you originally prediceted. But they did raise $70M. However, that will likely go to fund actual operating losses they have until they can fire enough people. I suspect that those investors significantly diluted existing share holders.
In conclusion
- you have a company that is leveraged 63/1 and has $4M in cash, so there is no equity or working capital cushion here.
- the credit quality is undefinable at this point. We are just at the beginning of the collapse of sub prime and this portfolio is experiancing huge problems. 9% of the portfolio or $684M has not paid for 90 days or longer, which is a HUGE problem. We don't know where it will end and neither does management.
- furthermore, the company is experiancing operating losses and needs cash at any price to have a chance at keeping going. The company's continued existance is far from certain. You can bet the new investors took whatever remaining security the company had so the common shareholders will be toast.
I though value investing as about buying safe and cheap companies. This is sure cheap. Safe it is NOT!
Please explain to me what I am missing.

If I understand the situation correctly the fact is that the 7.6billion loan portfolio, is not their risk.

DFC securitizes loans using portfolio accounting (where both the mortgage loans [assets] and the non-recourse securitization bonds [liabilities] are kept on the balance sheet.

The majority of the the real risk of these loans is on the shoulders of the past buyers of DFC securitization bonds.

If that is correct then the remaining question is how to sell future securitizations for a minimum loss.
If they can figure out this they are safe.

amo3 - Thanks for your comments and insight. I have browsed their 10Q, which does a pretty good job of explaining their business. I have 2 areas of comment: first, securtizations and second, opertions and liquidity.
Securitizations are very complex financial structures. Yes the majority of the debt is not recouse to the seller/borrower; however, they are not 100% non-recourse. A lender gets comfort to make the largely non-recourse loans by advancing only a portion of the value of the loans in a pool, say for example 90%. The seller/borrower has to come up with the rest of the capital. As long as the underlying mortgages are paying within predetermined delinquncy rates and the securtization does not fall below certain interest coverage thresholds, the excess cash flow from the mortgages flows through the waterfall back down to the seller/borrower each month. But, if the underlying mortgage portfolio breaks through the interest coverage and delinqueny thrsholds, then an early amortization event is triggered. Then all the cash flows that would go to the seller/borrower go to the lender to accelerate principal repayment. Therefore, while the seller/borrower is not liable to repay the loan, they have NO CASH FLOW from the securitization. As I pointed out earlier, 9.1% of the whole $7.6B is delinquent 90 days or more. You will also notice that they have warehouse lines to accumulate mortgages into large enough batches to securitize. If the lenders feel that the underlying value of the mortgages in the warehouse line have fallen, then they can require addtional collateral or cash, a margin call. There have received "substantial margin calls during the 3erd quarter".

The company is losing money on its oerpations on a cash basis. They do not have enough cash to cover expenses. They have minimal cash in the bank and minimal equity. To turn around the operations, they have to originate mortages and reduce overhead. You will notice that actual SGA went up in the 3Q. It is far from certain that they will return to profitability even if they do not have an early am event on their securitzations, more maring calls on their warehouse lines or other call on their cash. So your point that the remaining question is how are they going to sell future securtizations for a minimal loss is a little short of the mark. The real question is whether they will be able to sell any securitizations at a profit. They need the upfront cash.

So, in conclusion, the company is unprofitable operationally, the credit of its securitizations are declining which may tirgger a loss of cash flow from them and their volume is going down. Why invest in a company with so many things that can go wrong that will kill the business. I know Mr. Parbrai is a very smart guy. I am sure he sees a path to a positve outcome but I'll be damned if I see it. I am no great statistician but I know for certain that when a lot of things can go wroing at least one will. And this case almost anything can kill this company. If your goal is to buy low in bad environment, there have to be better places than DCF. I would be trying to find the best companies in the space that will survive the downdraft and come out stronger after the weak companies fail. For me, DCF is too weak to place a bet on. I try to find companies where it does not take a lot for things to go right.

If anyone knows what the original thesis for investing in this business is I would appreicate seeing it. I could have missed something.