By Carla PasternakWhen house prices were rising sharply, New Century (NEW), a sub-prime lender, attracted home buyers with weak credit histories to take out loans. A booming housing market made these loans less risky, since the borrower could refinance an existing mortgage by using a rapidly appreciating house as collateral, if necessary.
The problem - what goes up must come down. Since the housing boom has faded, investors now worry that default rates will increase, the firm's loan base will dry up, and profits will suffer. New Century's share price, which is now trading near its 52-week lows, reflects these concerns.
No doubt the mortgage-lending market won't be as easy in 2007 as it was this past year, but many of the challenges ahead may be baked into New Century's share price.
Certainly, earnings are trending down. In the latest quarter, the lender posted a sharp drop in profits, to $1.12 a share, down from $2.04 a share last year. For the year, per share earnings estimates have steadily declined from $7.10 in September to $6.09 by the end of November. Next year's estimates tell the same story, with projected per share earnings falling from $6.73 to $4.18 in the past three months alone.
Lower earnings could affect dividend payouts. In its latest quarterly report, New Century's management committed to distributing at least $400 million to shareholders next year. That translates to about $7 per share -- roughly the same as this past year's trailing 12-month payout of $7.10 per share. The big difference is that management said the money would come either through dividends or else through share repurchases. In other words, a dividend cut could be in the works.
And yet, as a dominant player in the lucrative sub-prime mortgage market, New Century may continue to generate solid interest income and capital gains from its loan portfolio. Moreover, while the housing market is cooling, it's not crashing, and demand for sub-prime mortgages is widely expected to stabilize over the next few years.
As a real estate investment trust [REIT], New Century is required by law to distribute 90% of its taxable earnings to shareholders. Based on the 2006 and 2007 earnings estimates just given, we can expect the dividend to average about $5.00 a share over the next couple of years. That may not be as juicy as investors have come to expect, but it still provides a superior, double-digit yield at the current share price.
Trading at just 9 times next year's earnings, and roughly on par with its book value, New Century's shares are attractively priced for a stock that carries a yield of about 20%. Even with its reduced earnings picture and uncertain dividend outlook, the stock should provide steady income over the long term.
Action To Take: Like most mortgage REITs, New Century operates in a cyclical industry that's highly sensitive to changing economic conditions largely beyond its control. In other words, this stock is not for the faint of heart. That said, NEW could provide a solid income stream for risk-tolerant investors with a long-term orientation.
NEW 1-yr chart
Disclosure: Author has no position in NEW