ITS TIME AGAIN FOR NCANS BASHER MYTHS ABOUT NFI AND THIER DEBUNKING:
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The Most Common BASHER MYTHS MYTHS.
And Their Debunking
These are the most popular whoppers that you will see from the BASHERs. All are easily debunked. Variations on the theme abound, but these are the primary MYTHS you’ll encounter as you peruse the message boards. And for fun, here's a link to a list and description of the most popular dishonest forms of argument they use.
The Most Common BASHER MYTHS MYTHS.
And Their Debunking
These are the most popular whoppers that you will see from the BASHERs. All are easily debunked. Variations on the theme abound, but these are the primary MYTHS you’ll encounter as you peruse the message boards. And for fun, here's a link to a list and description of the most popular dishonest forms of argument they use.
1) Myth: "Rising Interest Rates/10 Year Treasury will crush NFI's business"
Fact: Rates increased on the retail loan side from August through November of 2003, rising by over 1% from their lows in July. This is the exact same effect that the BASHERs postulate a rising Fed rate would cause. Their problem with that theory is that NFI's business and profitability increased during that period, establishing new highs in both origination growth as well as in earnings. So rates did rise, and the effect was the opposite of what they had been predicting up until then. Did that change their sentiment or theory? Absolutely not. They simply ignore the facts and continue to post their debunked theory. Here's the truth of the matter with respect to the retail/long side interest rate story: The 10 year Treasury has little or no impact on NFI's segment of the market. The 10 year yield myth is an argument that as yields rise, so do MORTGAGE lending rates, and the extrapolation is fewer customers will want loans with higher interest rates. True of AAA conforming and jumbo originators, where a quarter point is cause to refi for their customers, not of NFI. An interesting sidenote is that NFI’s target segment of sub-prime and alt-a paper actually increases as 10 year yields and 30 year MORTGAGE rates rise, as originators are more interested in investing time in the slightly more demanding (in terms of time and effort) NFI segment once the “easy money” AAA paper deluge slows. We saw this from August-Nov. 2003, when rates increased by 1%, and NFI's business continued to increase dramatically. In terms of the Fed raising rates, whenever it happens it is likely to be in a measured and reasoned fashion. When and if they do start increasing, three things happen, exactly like 2003 Aug-Nov: The portfolio increases in value as the ARM's adjust up, originations increase as more borrowers fall into the subprime area that might have been marginally conforming in a lower rate environment, and the rate of paydowns decreases as fewer folks refi their loans (few refi to a higher rate than their current loan), resulting in a dramatically higher profit from the same loans - the accounting treatment that allows NFI to write the loans down in 2 years based on an average life assumption of 3 years goes out the window with lower paydowns. With a 4 or 5 year life, more of the income has to be taken as profit rather than to write the loan down in 2 years, resulting in higher booked profit. Example - $7 face value loan, pays in $3.50 per year real cash, company writes it down in 2 years, so first $7 is expensed. If life extends to 5 years due to very low paydown due to rising rates, company has to write it down over 3 or 4 years meaning a portion of the $3.50 annually has to be taken as profit now (about $1.25 per year more TI.) Now, in the event there is a radical increase in rates, say, 200 Bp in 12 months, earnings will be negatively impacted by 7.5% (4.1% for 100Bp). Contrast that to the monthly growth in the portfolio of 5+% per month so far in 2004 - it doesn't take long for that decline to be outweighed by the growth. The net net is that even in a 200Bp rate increase environment, the worst that will happen is that earnings growth will slow a bit - not stop or reverse.
2) Myth: "NFI lends money to deadbeats at the bottom of the credit ladder".
Fact: NFI's loans have a weighted average FICO score of 622. They have a mix of loans at different levels of the credit ladder that provide the best risk adjusted return given the coupon and the score. Click here for September 2004's distribution of loans by FICO and by program type. They have an extremely conservative loan-to value, so the borrower has left a ton of money in the property as collateral for the loan. This is hardly fugitives and felons, rather just below AAA. The “sweet spot.”
3) Myth: "Rising defaults and delinquencies will crush NFI".
Fact: Defaults are not rising as a percentage of the portfolio, and neither are delinquencies. As you see more volume, the absolute number is expected to grow, but it is the percentage, not the absolute number, that is important. And with MORTGAGE Insurance (MI) in place on the majority of the portfolio and 82% loan to value on homes forecasted to increase in value by 7% this year, in most cases NFI actually breaks even or makes money on defaults once the home is sold, so it is a non-issue.
4) Myth: “The dividend is in jeopardy”.
Fact: The dividend comes mainly from the “portfolio”—something like 88% gets paid from the interest only (I/O) portion of the income stream and the proceeds of the bond sales generated from the roughly $12.5 billion (+/- 10%) of loans that the company has securitized by Dec. of 2004—the “portfolio” of loans. While the company essentially sells the principal on that loan portfolio via their securitizations (they split the loan into 2 parts—principal and interest, and create and sell bonds which are collateralized by the principal portion for the life of the loan), they retain the rights to the income from the interest only portion (I/O), which they collect until the loan pays off. They sell the first 18 to 24 months of that I/O income at a discount (a NIM, which is an IOU for the first 18-24 months of I/O income collateralized by the I/O stream), and then once that NIM expires, it’s free and clear income from then on. Even if income from originations declined by 50%, the portfolio would continue to grow for years, and so would the dividend. The only variable would be how fast the dividend grows, not whether it gets paid at all—that is locked in, and any supposition to the contrary is an outright falsehood, barring defaults at a level above those which occured during the Great Depression.
5) Myth: “High short interest means the smart money know something is wrong”.
Fact: Every year several hedge funds blow up because of mismanagement, bad bets, fraud, etc. In NFI’s case, high short interest is a function of a dangerously bad bet placed in July, 2002, when the conventional wisdom was that the economy would turn around Fall of 2002, resulting in increased Fed rates, resulting in shrinking housing market. Coming up on 2 years later, that bet turned out to be the worst of all possible bets—economy still in the dumps, Fed rates near historical low, housing robust with 2004 looking to be as good or better than 2003. The hedge fund that placed this bet is in danger of becoming the 2004 implosion in the hedge sector as a result of this bad bet. So much for “smart money.”
6) Myth: “They must be cooking the books, or using funny accounting”.
Fact: The company uses extremely conservative GAAP accounting standards, and in fact writes down the value of its assets far faster than is required. If anything, they are overly conservative. Whenever you hear this old chestnut, it means the BASHER in question has nothing factual at all to say, and is just trying to instill fear based on general, non-specific anxiety in the wake of Enron and Worldcom. Use your head—if there were a negative, the BASHER would cite a specific. 15 quarters of consecutive greater performance should stand to dispel doubts based on non-specific anxiety.
7) Myth: “A slowdown in Refi’s will crush NFI”.
Fact: Much of NFI’s business comes from folks restructuring their high interest rate debt to low interest rate debt, i.e. 18% credit cards to 7% home loan. This segment is not that interest rate sensitive, not like the folks who refi every 90 days to trim ¼ point. So a reduction in the “point trimming” refi’s has nothing to do with NFI’s business, any more than a reduction in Serbo-Croatioan refi’s has to do with U.S. refi’s—two different animals.
8) Myth: “Gain on sale accounting is a scam/fraud/Ponzi scheme”.
Fact: Gain on sale is a legitimate and conservative accounting treatment used by thousands of public companies. It has been abused in very rare and well-documented instances where the gain on sale was much higher than fair market. NFI uses an approach where they book their gain on sale at the lowest/most conservative market value allowed. This argument is sort of like saying “accrual accounting is bad.” It relies on your ignorance of the term, and of accounting principles.
9) Myth: “The growth trajectory can’t last.”
Fact: These same shorts were saying that last year before the company almost tripled in size and in earnings. They are saying it this year as the company more than doubles. They will be saying it next year when it likely doubles again. At some point they will be right. That point has yet to arrive. And if growth does level off in a few years, paying yearly dividends at an estimated rate of $20+ per share, current holders, and new investors today, will have been well rewarded for their investment acumen. The fact is that as long as they take market share successfully, they will continue to grow. They have a long way yet before they are saturated.
10) Myth: “The stock is falling/flat/rising for a reason, and that reason is ______.”
Fact: Between July 1, 2002, and end of that month, NFI shed 45% or so of its market value. It went from $35 and change to $20. Wild assertions of the company’s demise were posted almost daily, along with every imaginable scenario of doom. In retrospect, the stock plunged because a large hedge fund sold more than half of the float short in a 30 day period. Simple. More supply than demand. Since then, the stock has swung around a lot. Sometimes dropping as much as 35% off its highs, only to regain those highs shortly thereafter. Many reasons have been postulated. More often than not, the stock moves because that same hedge fund is up to more antics, either short selling, or covering, or creating swings to play on momentum. None of this has anything to do with the company’s business or its market. The fundamentals and the market remain solid and promising. Nothing has changed.
11) Myth: “They pay out more than they earn in dividends. That’s impossible.”
Fact: This relies on your ignorance of GAAP vs. Taxable Income. NFI pays out 100% of “Taxable Income”, which is a calculation using IRS rules for allowed deductions. GAAP is more conservative, in that it allows you to reduce GAAP earnings with expenses that Taxable Income won’t allow (IRS doesn’t want you paying “too little” tax). So, for example, GAAP lets you write off expenses for employee stock options. Let’s say 25 cents per share. If GAAP earnings are $1.00, those option expenses reduce GAAP to 75 cents. But the IRS says you can’t deduct those expenses, so Taxable Income is still $1.00. And that means the dividend is $1.00, based on “Taxable Income”, when GAAP earnings are 75 cents. Now, maybe $1.50 came through the door in actual cash, so neither number accurately reflects actual cash, but that’s easily computed off the company’s cash flow statement. Suffice it to say that there’s plenty of cash to pay the dividend several times over.
12) Myth: “The dividend is unsustainable, it will be going down, not up.
Fact: One of the most confusing things for investors is understanding where the dividend comes from. Roughly 88% of the dividend is paid from the interest only (IO) income and bond proceeds generated from the portfolio, and the rest comes from the other various profit centers (servicing, outright sales of some wholesale loans, retained loans). The portfolio was roughly $11.3 billion as of 2004. The company is currently writing about $38 million per day in originations, and about $300 million of the portfolio “drops off” per month due to prepayment. That means at the current run rate NFI grows the portfolio roughly $500 million per month, or roughly $6 billion per year. Even if we stay flat from here on out, the portfolio will grow by that amount, which will mean roughly $12 - $13 billion by end of 2004, $19 billion by end of 2005, etc. That doesn’t assume any growth in new paper, which incidentally is growing at an over 60% rate year over year as of September, 2004. If the worst predictions of the BASHERs comes true, and we drop by 50% in new paper, the portfolio will “only” grow by $225 million per month ($325 mil - $100 mil “drop off = $225 mil growth), or only $2.6+ billion per year. Still great growth, and still an increasing dividend for the foreseeable future.
13) Myth: “They use derivatives. Derivatives are bad, or risky, or whatnot”.
Fact: Derivatives are a way of hedging risk from interest rates rising. Derivative hedges act like insurance; if rates go down, their cost turned out to be unnecessary, and NFI could have made a larger profit. If rates go up, they insure that NFI will still earn a favorable profit, regardless of how high rates rise. Derivatives are a very conservative way of eliminating risk to the greatest extent possible in interest rate sensitive environments. Those that don’t in this business have gone BK recently or are in severe credit jeopardy. This is an argument from ignorance, that hopes to frighten by using the “D” word out of context.
14) Myth: “Increased competition will crush NFI.”
Fact: There are plenty of competitors already in the same market NFI is in. New entrants come and go. Like any area of business, NFI’s niche is highly specialized, and there are companies that excel, that are mediocre, and that are poor performers. NFI tripled their market share in 2003, and will likely continue to increase market share for some time to come. They are one of the companies which are excelling in their niche, and in fact have created several key proprietary innovations — their branch strategy, their principal/IO securitization strategy, and their proprietary web-based approval system for their originators. Simply put, they are doing this better than their larger competitors, hence the increase in market share. Arguments and hypothesis notwithstanding, the growth numbers are the fact, and so far they are growing at a 60%-80% rate year over year from 2004 over 2003. Everything else is speculation by those who would color everything in the most negative possible light. So far they have been dead wrong on every count. Don’t be fooled.
15) Myth: “Big Institutional money isn’t jumping in, they must know something’s wrong.”
Fact: There are quite a few institutions which hold NFI. 39.9% as of the last report (6/30/04). Vanguard, AXA Rosenberg, Goldman Sachs, Barclays, etc. One of the challenges for NFI is that they have a relatively small number of shares outstanding, and relatively light trading volume. This means that anyone taking a meaningful position has to do so over a long period of time, or they will run the price up. Institutions want liquidity, and there isn’t enough stock in the float to take a meaningful position without creating huge swings when you either buy or sell. So the likleihood of a large change to the upside is limited until the company increases its float.
The idea that institutions “know something” or have better visibility would imply that the performance of institutional entities should outperform the indexes. Most don’t. When NFI traded in the $9 range in October of 2002 (split adjusted), many posters implied that the institutions must “know something”, or they would be jumping in with both feet. Wrong then, wrong now.
16) Myth: "This last big drop in the share price wasn't a short attack, it was XXX."
In July of 2002, NFI's share price dropped by almost 45% on massive volume. No one knew why at the time, and many panic sold to avoid losing their savings. It turned out that this was a massive short attack. We know this because the short interest went from essentially 0 to almost 2 million in a matter of several months. In August of 2003, NFI's share price dropped from $74 to $48 on massive volume and on no news, immediately after raising the dividend by 11%. At the time many explanations were thrown about, however in retrospect it was a large short attack, as evidenced by the trading data captured in the Suspicious Trading section. March 23 and 24, 2004 NFI's share price dropped from an all time high of $70+ to $57 dollars in two trading days on massive volume on no news. The drop was achieved in the same manner that August's drop was engineered, with massive selling out of the Pac Ex and Midwest exchanges, and a walkdown in pre-market on the 24 by the Pac Ex followed by a massive dump on the NYSE, just like in August. In fact exactly like in August. The data is captured again under Suspicious Trading. So again, we have a massive short attack. On April 12, 2004 we saw a 30+% drop on the issuance of a WSJ article riddled with inaccuracies and mis-statements (like not even getting the dividend amount right!), and short interest as of that day's reporting increased by over 1 million shares! Interestingly, the BASHER traffic on the message board spiked to unseen levels in conjunction with the sell-offs, almost as though coordinated teams were put into service at the exact time the attack commenced - yet another unmistakeable giveaway. The BASHERs would have you believe that this is anything else besides what it so obviously is - the reason is because they don't want you understanding the game they are trying to play, as understanding converts panicked sellers into buyers, and that is not their goal. Anytime you hear that "this time it's different, it's because someone knows something, or the market is panicked, or whatnot" it is likely that the simplest explanation is the best - it is another short attack to trick weak hands out of their shares.
Page Created/Last Updated: October 1, 2003 / July 25, 2005
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