Delta Financial Corp. announced on 12/06/07 that they were unable to economically securitize their portfolio of fixed-rate subprime loans in time to forestall bankruptcy. Equity shareholders likely regain nothing as Delta's business model relies upon large short-term leverage, and because their portfolio of subprime loans are unlikely to price well.
So what happened? Mohnish Pabrai came out earlier this year with a thesis that DFC could make $5 per share when the credit market stabilized. Whether or not you agree with his estimates, DFC did stand out among subprime lenders for their unwillingness to overweight ARMs. At around $7 a share, even if housing fell into the pre-2002 trend line, DFC would still have been cheap...if they survived.
As it turns out, the credit crunch was not a subprime problem, but the result of a credit big bang. As housing prices marched up, weak borrowers refinanced, resulting in better credit ratings. Lenders looked at their low default rates and decided to lower their covenant and LTV requirements. Then the securitization markets stepped in, and lenders turned their eroding risk management ethic into a mass loan production focus. Securities ratings agencies gentrified it; PE shops boosted it; and banks abetted it.
After a few years, capital swapping between financial firms obscured the true quality of borrowers. When the housing market slowed, the markets realized how much leverage had been built, and now here we are.
So the upside thesis may have been correct, but the downside thesis needed some tweaking. It's true that a value investor focuses on the company, but when a company doesn't have a capital pool to sustain macro down trends, a macro analysis is also necessary.
Still a Pabrai fan though.
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