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NovaStar's nutty numbers
By Herb Greenberg 1/30/2004
Another quarter, another strange report from subprime lender NovaStar (NFI, news, msgs), whose stock has zoomed more than 200% in the past year.
While fourth-quarter earnings (after backing out accounting changes) appeared to beat estimates by a penny, they were actually smack in the middle of what the most bullish analysts were expecting.
And the quality of those earnings was as questionable as ever.
Once again, the quarter was aided by a gain on sale of mortgages, which is a discretionary item. What's more, the quarter-to-quarter growth in new sub-prime loans dropped to 6.4% from 18.4% a quarter earlier.
Here's where it gets really good, though: To get even that growth, following a trend I mentioned a month ago, the company has been forced to go downscale in loan quality. On the third-quarter conference call, NovaStar CEO Scott Hartman crowed about how "we continue to emphasize that we're not a typical subprime lender," with 83% of its loan production sporting a FICO score above 580.
His point, which the company emphasized in an investor presentation available on its Web site, was that NovaStar typically shoots for a higher-quality loan than other subprime lenders, such as Aames Financial (AMSF, news, msgs), New Century (NCEN, news, msgs) and Saxon Capital (SAXN, news, msgs). But last quarter, the proportion of loans with FICO scores above 580 slipped to 73%, with the biggest growth -- $106 million -- in the 540-to-579 bucket. The really low-grade stuff, with scores below 540, rose by $68 million.
Running harder and harder
"It shows they're running around faster and faster to keep the plates spinning," says one short-seller, who adds, "I love the fact that they're doing riskier and riskier loans, and they're keeping more and more of them on their own balance sheet." To be sure, mortgage loans on the company's balance sheet rose 113% over a year ago. That includes loans that can't be packaged as securities and sold, but instead are used as collateral against those that are.
Meanwhile, in recent quarters the company has been boasting growth of its branches. Last quarter Hartman said NovaStar would have "over 450" branches by the end of the year. According to its press release, the final tally was 432. Not to worry -- in its latest earnings release, the company bragged about how "branch originations again were a substantial driver of growth" of "wholesale" loans. Yet a closer look shows that most of the loans done by the branches are actually conforming or prime loans -- which took a steep dive -- and total branch production tumbled by 9.2%.
Competition intensifies
That's hardly good news, especially when NovaStar gets a fee on every loan each branch generates; as it stands, fee income dropped by nearly 17%. The branch performance is also an indicator of future loan origination.
If nothing else, says this short, "it tells you that every Tom, Dick and Harry loan originator is gonna be moving away from conforming and toward nonconforming loans." Not to mention the likes of Countrywide Financial (CFC, news, msgs), which like so many other large lenders has targeted sub-prime loans as the last frontier for growth.
Yet Countrywide, whose revenues are billions of dollars more than Novastar's, trades at 1.8 times sales vs. 7.5 times for NovaStar. And to think some people consider Countrywide overvalued! If it is, you can say this with certainty: NovaStar ain't cheap.
Of course, it wasn't at $15, either. Just remember: What goes up fast can go down faster. Thursday, the stock was down more than $2.30 at around $48.30.
Herb Greenberg writes regularly for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, though he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He welcomes your feedback and invites you to send any to hgreenberg@thestreet.com. Greenberg also writes a monthly column for Fortune.
© 2004 TheStreet.com, All Rights Reserved.
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