Great editorial in Tuesday's paper from Wesbury about the Fed's job. He does some interesting math suggesting that subprime in a worst case scenario is worth around $73, which would hurt anyone that owned those bonds on leverage but shouldn't impact the overall economy. I see 3 main problems right now:
1. too many houses and too much capacity to build new homes, to sell new homes (realtor's) and to mortgage them (mortgage brokers). This makes the home builders troublesome.
2. too much origination capacity in mortgages -- figure 40% of origination volumes will drop over the next couple of years as the industry adjusts to new realities. That essentially means no more sub prime, alt-A and or jumbo mortgages.
3. too much leverage on the part of investors buying mortgage pools and other exotic, illiquid, hard to value/trade debt instruments. The problem is not in the securities but who owns them and what condition their balance sheet is in. Too many investors used leverage at the wrong time -- the peak instead of the bottom. at the peak leverage means wipe out. at the bottom leverage magnifies the gains.
So the editorial goes over an extreme example where by 50% of subprime loans default and recovery rates (forced sale of homes) amounts to only 50% of the loan values. That works out to a 73 value for the bonds yet most of these securities are no longer trading -- even if a buyer could be found that would accept that "emergency" price, the hedge funds and other leveraged participants couldn't sell at that price because that would wipe out their equity thanks to the leverage amounts.
none of the 3 reasons above is really impacted by the credit worthiness of the borrowers -- its more the creditworthiness of the lenders that has mattered.
Great article on Tuesday at the realmoney.com site (pay part of cramer's world) written by Howard Simons. He points out that any time we have had problem markets in the last couple of years (may 06, feb 07, jul 07) you can usually point to the BOJ doing something stupid -- this time is no exception. The bank of japan has been reducing global liquidity by way of allowing investors to unwind the carry trade of borrowing cheap yen to buy other higher yielding currencies. The Chinese are working to offset this folly so that we can continue to buy their exports. its a fascinating article that basically says who cares what the fed does its the BOJ that matters.
Thursday, August 23, 2007
Wednesday, August 22, 2007
latest news (DFR and others)
Sorry about the delay in posts -- still having computer troubles with the Internet access. One of these days I'll get around to trying to fix them.
DFR - certainly nice to see the stock run up to the $8.70 area. Good and bad news this week -- first TMA sells down a bunch of their portfolio -- sounds like they couldn't do a repo rollover and decided to sell instead -- that shrank the portfolio by $20 bill and the book value by over 1/3 since the end of June. That would equate to some where around $9 for DFR so we are near 1X book value which is where the stock generally traded except for the couple of times it spiked to $17. Why assume DFR's book value has dropped too? because the value of all mortgage securities have dropped even those of the highest quality. Leverage that DFR is using magnifies the drop in assets.
H&R Block had trouble with their funding and had to use their line of credit. another sign that liquidity is not there.
On the good news front -- BAC buys a big stake in countrywide financial through a convertible preferred stock which they got on great terms -- they earn 7.3% yield and they get to convert at a price that was a discount to where the stock was trading (most converts are done at a premium to the current stock price). That provides them with $2 bill in new capital and gives a vote of confidence in their survival.
There is always the chance that DFR could do a similar deal -- raise equity from the Dart family or some other big investor that provides liquidity at a steep price. If DFR was smart, they sold some of their AAA non-agency mortgages and reinvested in agency mortgages but I doubt they did. collateral requirements are lower on agency so that would give them breathing room. But they would have to be able to sell their non-agency mortgages at a price that is not too big of a discount from their previous value otherwise DFR would struggle to pay off the repo's used to finance the purchases. all speculation at this point. Got 6 days to go before the dividend is actually paid -- wish us luck.
I still have no idea what the next dividend will be -- depends on liquidity, how much the portfolio has dropped in value and changes in the interest margin they are earning. we know that short rates are dropping and that mortgage rates are rising -- means their spread should be widening unless their repo's are costing them more due to the liquidity issues in the market.
I am still digesting the MDT quarter so I'll comment on that in the next couple of days.
AB -- only concern is where the hedge funds they manage now stand on year to date performance -- are they still eligible for a big incentive fee or not? quant funds have taken a hit so its possible they won't see the almost $2 in earnings in Q4 that is part of guidance. worst case is that the quarter is $1 instead of $2 so when the stock is near the low $70's its full discounted -- near the mid $80's and not so much.
CME -- first we get concerns about growth in derivatives but now its concerns about buying the NY merc. certainly possible. the company has a pretty good track record of doing what is best for the business. CME is already clearing the electronic trades for NY Merc so they have pretty good knowledge of the situation.
I used factset recently to do Greenblatt's screen based on the little book that beat's the market that was published a few yeas ago. He looks at valuation (price to cash flow) and return on capital. I saw several of my stocks on that list -- LH, TSRA, GGG, UEPS, which was pretty cool.
UEPS -- another week before results come out for the June quarter plus any day we can hear what happened in the welfare tender in south africa. I believe pricing will hold up at least in line with expectations and they will earn new business that no one is really expecting now. if the tender turns out favorably and the quarter goes well, this could be a low 30's stock -- easily.
EPD and MMP. MLP's that have been hurt by recent hedge fund trading (need for liquidity) more than any concerns specific to the companies.
ILMN -- should take some profits given the stock is up 50% since purchase but I still think the product cycles have a long way to go in terms of driving upside to results. translation -- I have decided to stand pat so far, which based on history is generally the wrong call. ABI is going to have a competing product in another few months so its possible ILMN's growth will be impacted then and that makes it harder to blow out epxectations.
DFR - certainly nice to see the stock run up to the $8.70 area. Good and bad news this week -- first TMA sells down a bunch of their portfolio -- sounds like they couldn't do a repo rollover and decided to sell instead -- that shrank the portfolio by $20 bill and the book value by over 1/3 since the end of June. That would equate to some where around $9 for DFR so we are near 1X book value which is where the stock generally traded except for the couple of times it spiked to $17. Why assume DFR's book value has dropped too? because the value of all mortgage securities have dropped even those of the highest quality. Leverage that DFR is using magnifies the drop in assets.
H&R Block had trouble with their funding and had to use their line of credit. another sign that liquidity is not there.
On the good news front -- BAC buys a big stake in countrywide financial through a convertible preferred stock which they got on great terms -- they earn 7.3% yield and they get to convert at a price that was a discount to where the stock was trading (most converts are done at a premium to the current stock price). That provides them with $2 bill in new capital and gives a vote of confidence in their survival.
There is always the chance that DFR could do a similar deal -- raise equity from the Dart family or some other big investor that provides liquidity at a steep price. If DFR was smart, they sold some of their AAA non-agency mortgages and reinvested in agency mortgages but I doubt they did. collateral requirements are lower on agency so that would give them breathing room. But they would have to be able to sell their non-agency mortgages at a price that is not too big of a discount from their previous value otherwise DFR would struggle to pay off the repo's used to finance the purchases. all speculation at this point. Got 6 days to go before the dividend is actually paid -- wish us luck.
I still have no idea what the next dividend will be -- depends on liquidity, how much the portfolio has dropped in value and changes in the interest margin they are earning. we know that short rates are dropping and that mortgage rates are rising -- means their spread should be widening unless their repo's are costing them more due to the liquidity issues in the market.
I am still digesting the MDT quarter so I'll comment on that in the next couple of days.
AB -- only concern is where the hedge funds they manage now stand on year to date performance -- are they still eligible for a big incentive fee or not? quant funds have taken a hit so its possible they won't see the almost $2 in earnings in Q4 that is part of guidance. worst case is that the quarter is $1 instead of $2 so when the stock is near the low $70's its full discounted -- near the mid $80's and not so much.
CME -- first we get concerns about growth in derivatives but now its concerns about buying the NY merc. certainly possible. the company has a pretty good track record of doing what is best for the business. CME is already clearing the electronic trades for NY Merc so they have pretty good knowledge of the situation.
I used factset recently to do Greenblatt's screen based on the little book that beat's the market that was published a few yeas ago. He looks at valuation (price to cash flow) and return on capital. I saw several of my stocks on that list -- LH, TSRA, GGG, UEPS, which was pretty cool.
UEPS -- another week before results come out for the June quarter plus any day we can hear what happened in the welfare tender in south africa. I believe pricing will hold up at least in line with expectations and they will earn new business that no one is really expecting now. if the tender turns out favorably and the quarter goes well, this could be a low 30's stock -- easily.
EPD and MMP. MLP's that have been hurt by recent hedge fund trading (need for liquidity) more than any concerns specific to the companies.
ILMN -- should take some profits given the stock is up 50% since purchase but I still think the product cycles have a long way to go in terms of driving upside to results. translation -- I have decided to stand pat so far, which based on history is generally the wrong call. ABI is going to have a competing product in another few months so its possible ILMN's growth will be impacted then and that makes it harder to blow out epxectations.
Monday, August 20, 2007
Stocks: FDS, IHS, CME, etc.
Factset -- this is a wonderful business -- one of the best ever -- they have had sequential (as in quarter over quarter) revenue growth for some ridiculous number of quarters in a row -- say 100 or more. That is a record of consistency unmatched by I suspect any other company out there. FDS also has very high free cash flow margins, very high return on assets and big barriers to entry. I have been an extremely loyal user for most of my 12 years in the business (only exception was when my firm was too small to afford a Factset subscription).
Factset has expanded from providing analytical tools and access to data to evaluate individual stocks to tools to evaluate portfolios; to evaluate potential M&A deals; to help companies perform investor relations functions; and many many other functions.
But I don't know the odds of them maintaining their revenue growth record in this coming environment -- too many investment bankers, too many hedge funds, etc. only good news is that they don't have much exposure to fixed income so that could be a new growth area. I don't want to panic given their track record but as the firm grows it gets harder to maintain growth patterns.
IHS -- is this the Factset of the energy and defense and aerospace industries? similar subscription based model offering access to critical info but I just don't know how critical the info is -- as a user of Factset as well as some of Factset's competitors, its very easy for me to know where Factset fits in and how they compare to their competition. FDS is the gold standard by which all customer service/support should be judged. They are expensive though so not everyone can or is willing to pay up for it. cheaper solutions that are not as robust exist -- those cheaper solutions probably meet the needs of many users but for some its not enough -- they need the power and flexibility that FDS offers.
The neat thing about IHS is that they are exposed to other areas than finance -- energy and aerospace and defense. They also have much higher percent of revenues from International clients -- 47% vs. 28% for FDS. They also have lower margins than FDS as well as several other similar business models. IHS's profitability has been improving, which boosts earnings growth above that of revenues. stock is not cheap however. will be doing some more work on this one.
CME -- some are arguing that volumes will drop based on the idea that the cost of using derivatives has increased and that anything with a rising price ends up with less demand. Its quite possible but I'm skeptical that the growth rate of derivatives will slow -- just too flexible and too many advantages to using them. I still like this one.
Others I have done some reading on this weekend include: ACM, MSM and MIC. So far I have been less interested with them for various reasons. Will continue to keep reading and reporting. hope you are making money this year.
Factset has expanded from providing analytical tools and access to data to evaluate individual stocks to tools to evaluate portfolios; to evaluate potential M&A deals; to help companies perform investor relations functions; and many many other functions.
But I don't know the odds of them maintaining their revenue growth record in this coming environment -- too many investment bankers, too many hedge funds, etc. only good news is that they don't have much exposure to fixed income so that could be a new growth area. I don't want to panic given their track record but as the firm grows it gets harder to maintain growth patterns.
IHS -- is this the Factset of the energy and defense and aerospace industries? similar subscription based model offering access to critical info but I just don't know how critical the info is -- as a user of Factset as well as some of Factset's competitors, its very easy for me to know where Factset fits in and how they compare to their competition. FDS is the gold standard by which all customer service/support should be judged. They are expensive though so not everyone can or is willing to pay up for it. cheaper solutions that are not as robust exist -- those cheaper solutions probably meet the needs of many users but for some its not enough -- they need the power and flexibility that FDS offers.
The neat thing about IHS is that they are exposed to other areas than finance -- energy and aerospace and defense. They also have much higher percent of revenues from International clients -- 47% vs. 28% for FDS. They also have lower margins than FDS as well as several other similar business models. IHS's profitability has been improving, which boosts earnings growth above that of revenues. stock is not cheap however. will be doing some more work on this one.
CME -- some are arguing that volumes will drop based on the idea that the cost of using derivatives has increased and that anything with a rising price ends up with less demand. Its quite possible but I'm skeptical that the growth rate of derivatives will slow -- just too flexible and too many advantages to using them. I still like this one.
Others I have done some reading on this weekend include: ACM, MSM and MIC. So far I have been less interested with them for various reasons. Will continue to keep reading and reporting. hope you are making money this year.
Sunday, August 19, 2007
Friday and the coming week
Well that was a nice surprise! Nice to be able to say you owned the strongest performing stock on the NYSE -- DFR -- of course still down quite a bit for the year. What effect will the Fed have on DFR and the markets in general?
At the margin, more firms will make it with the fed cutting than if they don't cut so that definitely improves the odds for DFR. That said, the Fed can't do anything to fix the balance sheet problems of so many players in the debt markets. They are overleveraged already -- that is the problem -- so reducing the cost of more leverage can't really help them.
Think back to 2000-2002 when the Fed was cutting rates from 2001 on and at first many tech and telecom stocks rallied hard but over time everyone realized there was no fixing what was broke without a massive decline in value and a large reduction in capacity -- my thought is 40% decline in mortgage origination between peak levels and the trough. think about how many brokers both mortgage and realtor will be unemployed in the shakeout. People like Countrywide or IndyMAC that keep talking about taking market share and growing are missing the big change.
Within that world is there room for a conservatively managed mortgage portfolio that can still allow the firm to operate as a REIT that also owns a management company and some alternative assets? I think so and that's why I still own it -- the biggest issues are with investors owning the wrong securities (credit risk or overly leveraged) and with origination volumes, which don't impact DFR.
Dividend on DFR -- some one on the message boards (yahoo) was making the buy case based on 42 cents for 2 more dividends this year -- its possible I guess but I wouldn't hold my breath. I have no idea what the dividend will be but it seems like a crazy question to ask when faced with survival as the primary goal.
I expect the rally will last a bit longer but I don't know where DFR will end up. longer term, if they survive, this is a big opportunity but that's a big IF right now.
At the margin, more firms will make it with the fed cutting than if they don't cut so that definitely improves the odds for DFR. That said, the Fed can't do anything to fix the balance sheet problems of so many players in the debt markets. They are overleveraged already -- that is the problem -- so reducing the cost of more leverage can't really help them.
Think back to 2000-2002 when the Fed was cutting rates from 2001 on and at first many tech and telecom stocks rallied hard but over time everyone realized there was no fixing what was broke without a massive decline in value and a large reduction in capacity -- my thought is 40% decline in mortgage origination between peak levels and the trough. think about how many brokers both mortgage and realtor will be unemployed in the shakeout. People like Countrywide or IndyMAC that keep talking about taking market share and growing are missing the big change.
Within that world is there room for a conservatively managed mortgage portfolio that can still allow the firm to operate as a REIT that also owns a management company and some alternative assets? I think so and that's why I still own it -- the biggest issues are with investors owning the wrong securities (credit risk or overly leveraged) and with origination volumes, which don't impact DFR.
Dividend on DFR -- some one on the message boards (yahoo) was making the buy case based on 42 cents for 2 more dividends this year -- its possible I guess but I wouldn't hold my breath. I have no idea what the dividend will be but it seems like a crazy question to ask when faced with survival as the primary goal.
I expect the rally will last a bit longer but I don't know where DFR will end up. longer term, if they survive, this is a big opportunity but that's a big IF right now.
Friday, August 17, 2007
dfr not able to get financing
not a good sign of their liquidity position. Maybe some will be happy that the deal may get canceled and bid the stock up. In that case I might sell half to recognize my losses and protect some capital.
when it rains it pours has never been more true -- so far at every turn the last month or so every thing has gone against them.
Interesting day in the market to say the least. I think we are near a short term bottom -- talk on real money today was about whether the right analogy is 1931. Also had lots of bears gloating about how they saw this coming and have warned about it forever and they see much more pain ahead. at the same time I could not access my schwab account for most of the trading day -- temporarily unavailable -- I presume due to heavy volume of trading. Also heard some high net worth managers talk about panic calls from clients worried about their money market assets and other stuff.
As far as stocks go, financials certainly got a bid (except for DFR of course) but a lot of other stocks were down even after the afternoon bounce.
I would urge you to go through your stocks and ask the following types of questions:
how strong is the balance sheet -- do they have any debt that may need to be refinanced? can they easily cover the interest expense?
are they a beneficiary of the growth in debt the last several years? this includes everyone from brokers to rating agencies to private equity related stocks to mortgage brokers, lenders, homebuilders, etc. -- the list could be long but anything on it could struggle to grow earnings in the future as the mortgage and housing industries shrink 40% or more vs. volumes from last year.
are they a supplier to anyone on the above list? I would include potentially FDS on the list because they sell to investment bankers and to hedge funds and those markets will struggle.
is their valuation reasonable using reasonable earnings assumptions?
do they have a growth strategy or is growth just cost cutting?
its late again -- will have to think of other options tomorrow.
when it rains it pours has never been more true -- so far at every turn the last month or so every thing has gone against them.
Interesting day in the market to say the least. I think we are near a short term bottom -- talk on real money today was about whether the right analogy is 1931. Also had lots of bears gloating about how they saw this coming and have warned about it forever and they see much more pain ahead. at the same time I could not access my schwab account for most of the trading day -- temporarily unavailable -- I presume due to heavy volume of trading. Also heard some high net worth managers talk about panic calls from clients worried about their money market assets and other stuff.
As far as stocks go, financials certainly got a bid (except for DFR of course) but a lot of other stocks were down even after the afternoon bounce.
I would urge you to go through your stocks and ask the following types of questions:
how strong is the balance sheet -- do they have any debt that may need to be refinanced? can they easily cover the interest expense?
are they a beneficiary of the growth in debt the last several years? this includes everyone from brokers to rating agencies to private equity related stocks to mortgage brokers, lenders, homebuilders, etc. -- the list could be long but anything on it could struggle to grow earnings in the future as the mortgage and housing industries shrink 40% or more vs. volumes from last year.
are they a supplier to anyone on the above list? I would include potentially FDS on the list because they sell to investment bankers and to hedge funds and those markets will struggle.
is their valuation reasonable using reasonable earnings assumptions?
do they have a growth strategy or is growth just cost cutting?
its late again -- will have to think of other options tomorrow.
Thursday, August 16, 2007
What do Mortgages/housing have in common with Telecom from 2000?
1. Special financing terms used to expand demand to those who can't afford it otherwise -- ie. if I don't ask for payment would you be willing to buy one? (Nortel Networks from the telecom equipment side, mortgage brokers/home builders from the housing side)
2. highly leveraged buyers that couldn't borrow another buck to buy any more -- (CLECs vs. home buyers especially sub-prime)
3. Huge over capacity from too much building on spec -- (16 national fiber optic networks vs. investment homes, beach front homes, downtown condos, etc.)
4. The fed will cut but it won't help the mortgage industry just like it didn't help the telecom industry in 2001. A brief rally and then a return to the steady decline.
5. there are more but its late....
So what does this mean -- expect the mortgage market to drop 40-50% similar to how telecom shrunk post 2000. Lots of companies will go out of business -- I assume Countrywide is a goner (absolutely no knowledge of their actual liquidity situation) -- why? because they don't get it.
They are still in growth mode hiring more loan officers from american home mortgage when they should be completely focused on survival. They don't realize the future is a much smaller industry. Back in 2000 half of all high yield bonds issued were for telecom -- now? no where close to that share.
Now comes the important question? Who cares besides those in the mortgage industry and investors to own mortgage related investments? Well, there is the chance that all this liquidity stuff impacts the rest of the economy. I've been saying for awhile that it wouldn't and then I thought of the analogy to 2000 and realized we got a recession then why not now? Interest rates were a lot higher then although much less of a liquidity crunch occurred. Markets require access to capital -- especially debt capital to grow -- no capital, no growth. Credit is the lifeblood -- the oxygen that the system lives on. Simple as that. Previous credit crunches -- 1998, 1990, 1981 and a couple of times in the late 60's and early 70's.
I'm still not convinced yet of pending doom and gloom but I probably believe more now than before.
Stocks:
CME -- volumes are huge but worries about liquidity in their customers holding it back. I still like this one because the earnings will beat by a lot.
FDS -- had the chance to sell some in the low $60's last couple of days after the sharp bounce form the dive to $52 and didn't sell. Realized now that with fewer deals they could get pressured with service cancellations within the investment banking areas. Plus the death rate on hedge funds must be pretty high and that could mean fewer customers. Post bubble burst they were able to replace shrinking long only customers with hedge funds and investment banking -- what will they do now? Hard to bet against a company that has never had a down quarter in revenues sequentially across 25 years of operations. That said, nothing wrong with taking a little off the table either.
NVT, ILMN -- still have strong momentum in their business but valuations are high so some are probably selling to lock in profits. On a rally, which we should have starting a week or so from now, I will trim unless they go up sooner.
AB -- their model is heavily influenced by quant models so I suspect their performance could be impacted by the recent troubles. The only issue that matters for the stock though, is what is going on with the hedge fund area's performance -- the incentive fees expected as of a month ago would equate to $2 in earnings in Q4 but what happens if they have lost that money and will no longer earn incentive fees? yep lower estimates and lower price. For me, this is a keeper because they are in all the right spots for the future -- I have weathered many a bump in the past with this one so I'm not about to skip town now but as the market goes, so goes this stock.
being that it is almost 3am -- that's enough for now.
2. highly leveraged buyers that couldn't borrow another buck to buy any more -- (CLECs vs. home buyers especially sub-prime)
3. Huge over capacity from too much building on spec -- (16 national fiber optic networks vs. investment homes, beach front homes, downtown condos, etc.)
4. The fed will cut but it won't help the mortgage industry just like it didn't help the telecom industry in 2001. A brief rally and then a return to the steady decline.
5. there are more but its late....
So what does this mean -- expect the mortgage market to drop 40-50% similar to how telecom shrunk post 2000. Lots of companies will go out of business -- I assume Countrywide is a goner (absolutely no knowledge of their actual liquidity situation) -- why? because they don't get it.
They are still in growth mode hiring more loan officers from american home mortgage when they should be completely focused on survival. They don't realize the future is a much smaller industry. Back in 2000 half of all high yield bonds issued were for telecom -- now? no where close to that share.
Now comes the important question? Who cares besides those in the mortgage industry and investors to own mortgage related investments? Well, there is the chance that all this liquidity stuff impacts the rest of the economy. I've been saying for awhile that it wouldn't and then I thought of the analogy to 2000 and realized we got a recession then why not now? Interest rates were a lot higher then although much less of a liquidity crunch occurred. Markets require access to capital -- especially debt capital to grow -- no capital, no growth. Credit is the lifeblood -- the oxygen that the system lives on. Simple as that. Previous credit crunches -- 1998, 1990, 1981 and a couple of times in the late 60's and early 70's.
I'm still not convinced yet of pending doom and gloom but I probably believe more now than before.
Stocks:
CME -- volumes are huge but worries about liquidity in their customers holding it back. I still like this one because the earnings will beat by a lot.
FDS -- had the chance to sell some in the low $60's last couple of days after the sharp bounce form the dive to $52 and didn't sell. Realized now that with fewer deals they could get pressured with service cancellations within the investment banking areas. Plus the death rate on hedge funds must be pretty high and that could mean fewer customers. Post bubble burst they were able to replace shrinking long only customers with hedge funds and investment banking -- what will they do now? Hard to bet against a company that has never had a down quarter in revenues sequentially across 25 years of operations. That said, nothing wrong with taking a little off the table either.
NVT, ILMN -- still have strong momentum in their business but valuations are high so some are probably selling to lock in profits. On a rally, which we should have starting a week or so from now, I will trim unless they go up sooner.
AB -- their model is heavily influenced by quant models so I suspect their performance could be impacted by the recent troubles. The only issue that matters for the stock though, is what is going on with the hedge fund area's performance -- the incentive fees expected as of a month ago would equate to $2 in earnings in Q4 but what happens if they have lost that money and will no longer earn incentive fees? yep lower estimates and lower price. For me, this is a keeper because they are in all the right spots for the future -- I have weathered many a bump in the past with this one so I'm not about to skip town now but as the market goes, so goes this stock.
being that it is almost 3am -- that's enough for now.
DFR -- no margin for error
David confirmed today that margin requirements in the repo market have doubled -- that removes the cushion from DFR in terms of that unencumbered cash they talked about on the last call.
They do not have a repo refunding to do until the end of August and it will only be on a portion of their repo base but that is the next risk point -- will be interesting to see if they decide not to pay the dividend to conserve cash and increase their cushion of unencumbered cash. Assuming the deal for the management company closes, that might provide another source of liquidity -- or even a value even if the REIT portfolio becomes insolvent.
One interesting aspect, in addition to the potential for the management company to help, is that if the mortgages get wiped out in a margin call (see below on the math), then what happens to the alternatives portfolio? does that disappear too or does that survive. must admit to not knowing.
If DFR does go under, it will be a shame that they didn't react quick enough or didn't take survival seriously enough. Its always best to know the right question to ask -- they said it on the call and I am hoping they meant it -- they are focused on liquidity and will do yield optimization in the future. Right now I am standing pat -- hard to say what the right call is here.
Best way to think about it is would I buy it now if I didn't own it? no way too risky. Why not sell? I like David's comment on real money today -- there are stocks left for dead -- best to ignore those and focus on the walking wounded. To me DFR is in that situation. I won't commit new capital to it but rather than sell it, I will take the chance that they make it because the rewards will be great.
How does this work? If before they borrowed $985 mill to buy $1 bill in agency mortgages, now they can only borrow $970 mill to buy agencies. For AAA prime mortgages the borrowed levels would be $950 mill and now $900 mill. So to own the same level of mortgages going forward that they did at the end of July, they will need an extra $ 50 mill in capital for each $1 bill in AAA mortgages (they owned about $2.3 bill at that time) and an extra $15 mill in capital for each $1 bill in agency (they had around $5.5 bill end July). So as you can see that $229 mill they had then will be encumbered as the repos get refunded over the next couple of months. Will they pay the dividend -- can't know for sure until the money is in the account. if they are able to line up the next repo without any more issues, then yes I think they will.
A smaller cushion means almost any decline in the value of the mortgages and they will have trouble meeting margin calls.
I must admit fixed income trading is not my specialty so I'm somewhat flying blind.
I will lay out some thoughts on the market in the next note.
They do not have a repo refunding to do until the end of August and it will only be on a portion of their repo base but that is the next risk point -- will be interesting to see if they decide not to pay the dividend to conserve cash and increase their cushion of unencumbered cash. Assuming the deal for the management company closes, that might provide another source of liquidity -- or even a value even if the REIT portfolio becomes insolvent.
One interesting aspect, in addition to the potential for the management company to help, is that if the mortgages get wiped out in a margin call (see below on the math), then what happens to the alternatives portfolio? does that disappear too or does that survive. must admit to not knowing.
If DFR does go under, it will be a shame that they didn't react quick enough or didn't take survival seriously enough. Its always best to know the right question to ask -- they said it on the call and I am hoping they meant it -- they are focused on liquidity and will do yield optimization in the future. Right now I am standing pat -- hard to say what the right call is here.
Best way to think about it is would I buy it now if I didn't own it? no way too risky. Why not sell? I like David's comment on real money today -- there are stocks left for dead -- best to ignore those and focus on the walking wounded. To me DFR is in that situation. I won't commit new capital to it but rather than sell it, I will take the chance that they make it because the rewards will be great.
How does this work? If before they borrowed $985 mill to buy $1 bill in agency mortgages, now they can only borrow $970 mill to buy agencies. For AAA prime mortgages the borrowed levels would be $950 mill and now $900 mill. So to own the same level of mortgages going forward that they did at the end of July, they will need an extra $ 50 mill in capital for each $1 bill in AAA mortgages (they owned about $2.3 bill at that time) and an extra $15 mill in capital for each $1 bill in agency (they had around $5.5 bill end July). So as you can see that $229 mill they had then will be encumbered as the repos get refunded over the next couple of months. Will they pay the dividend -- can't know for sure until the money is in the account. if they are able to line up the next repo without any more issues, then yes I think they will.
A smaller cushion means almost any decline in the value of the mortgages and they will have trouble meeting margin calls.
I must admit fixed income trading is not my specialty so I'm somewhat flying blind.
I will lay out some thoughts on the market in the next note.
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