Delta Financial Delivers Strong Quarter, Looks Cheap

This morning Delta Financial (DFC), a subprime mortgage lender we analyzed in September, released its 3rd quarter earnings. Despite the housing slump, weak GDP growth and competitors' woes, the company did a rather good job this quarter.

In a worsening environment, Delta obtained satisfying results by sticking to its disciplined business model: originating mainly (87% this quarter) fixed rate mortgage loans sporting low pre-payment and default rates, in large part through their in-house cheap retail channel (for about 50% of their loans).

3rd quarter 2006 highlights:

* 3rd quarter net income: $0.33 per diluted share (+6.5% year over year),
* originated $2.9 bil. year-to-date (+6% year over year but 3% less sequantially),
* mortgage loans held for investment at the end of September 2006: $6 bil. ( $4 bil. at the end of September 2005) granting in the next 12 months about $87 mil. of pre-tax interest income,
* gain on sale margin on the $197 mil. loans sold on "whole-loan" basis: 1.8% ((1.4% Q3 05, 1.4% Q4 05, 1.1% Q1 06, 1.3% Q2 06),
* increased their weighted average coupon to 9.06% (20 basis points more quarter-over-quarter).

The final result is a nice 22% after-tax return on equity.

Though we are expecting a softening origination volume for next year, we are sticking to our long term price target price of $14 since (1) originating margins are above our assumptions and (2) default rates are still under check thanks to Delta's underwriting discipline.

The stock, which trades at 6.14 times estimated 2007 earnings, can be considered cheap.

DFC 1-yr chart:

Disclosure: Author does not have a position in the securities discussed in this article at the time of posting.