A Short Update on My Four Short Ideas 33 comments
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So far I have written four “Short Ideas” for Seeking Alpha, and my track record has been stellar.
My article on Crystal River (CRZ) was submitted when the stock was around 3.5, and as I write it is now at 2.18, down nearly 40%. In it I predicted that the company would in Q2 write down its book value from $5.33 per share in Q1 to either 2.38 or 2.44 per share in Q2, depending on whether there was a second write down on a defaulted junior loan to a Portland condo development.
As it turned out, the company reported book value of $2.46 per share, so I was off by just 2 to 8 cents in my estimate of a massive write down of almost $3 per share. Importantly, I predicted that this write-down would cause the company to be in default on certain loans by causing its equity to decrease below $100 million, which is what happened. It will be interesting to see what actions CRZ’s creditors will take now that it is in default on its loan. I also predicted the company would “drastically cut (for the second time) its regular dividend, if not suspend it entirely.” Recently the company announced that it is cutting its dividend from 30 cents to 10 cents. My prediction of a suspension or drastic cut was accurate. You heard it here on Seeking Alpha first.
Though CRZ reports book value at almost the exact level I predicted, it is important to realize that my prediction was using CRZ’s accounting methods, which do not write down all of its assets to market value. At my market value estimates for all of its assets, CRZ is completely worthless.
My prediction of Redwood Trust’s (RWT) write-down was also on the money. I made my prediction of Q2 write-downs a few days before the quarter was even over, but I was still correct that RWT would be forced to report a substantial write-down.
Specifically, I predicted an $82 million write-down of assets, and the company reported a $60 million mark to market write-down. RWT stockholders took a write-down of their own. When I submitted my article RWT was around 30, now it is around 20.8, a decline of more than 30%. During the same period the S&P 500 increased by a little under 1%.
Right now FirstFed Financial (FED) is at 8.9, down from 15.5 when I submitted my FirstFed Financial article. In my article I listed 9 reasons why shorting FED was a wise play, noting that “FED would need to fall another 50% from current prices to reach the same relative valuation of these two negative-amortization peers.” Those peers are Downey Financial (DSL) and Bank United (BKUNA).
The stock hasn’t quite dropped 50% since late June when I wrote my article, but its 42% drop so far is pretty close.
Lastly, Maguire Properties (MPG) has fallen only slightly since my article appeared on Sunday. This surprises me, because of all the companies I’ve covered, MPG may be the worse.
If the company valued its assets fairly, it would report book value of well under $0.00 per share, perhaps as low as -$10 per share. Its stock should be trading near 0 right now. As I noted in my article, the company has been burning cash at an incredible rate each and every quarter, and recently had to take out a $20 million loan at 13%, a rate befitting a credit card for someone with really bad credit.
This presents an incredible opportunity for patient short sellers, as the company’s demise becomes more certain each quarter as it loans mature and it is unable to renew accept on ruinous terms. As for MPG longs, all I can think is that they are still holding on with the desperate hope that a buyout will somehow happen. It won’t. Two years ago the buy-out rumors had substance to them, but now there are no “next suckers” left to buy a company with negative book value and extremely heavy exposure to Orange County office buildings.
With all of these companies, things are only getting worse from the time I wrote my article. Recently JP Morgan announced that it was going to write down the value of its mortgage portfolio by another 1.5 billion after Merrill Lynch sold its similar portfolio of toxic mortgage securities for 22 cents on the dollar.
RWT and CRZ are loaded to the gills with these same types of toxic mortgage bonds. FED is full foreclosed and delinquent mortgages, especially “liar loans” and the option-ARMs that are quickly turning out to be even worse than subprime mortgages. These are the mortgages that back many toxic mortgage bonds. And most of MPG’s portfolio was financed with low-interest loans that banks were only able to make because they could package them into mortgage securities. Those loans are steadily maturing, and MPG already in April showed that it did not have the ability to refinance its loans as they mature at anything close to the favorable terms that it originally took them out at.
Disclosure: Author is short MPG, RWT, CRZ, DSL, BKUNA, and FED
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This article has 33 comments:
1) You stated book value would be less than $1.44 a share -
"CRZ reported equity of $132.6 million as of 3/31/08, or $5.33 a share. As of 6/30/08, the probable mark-to-market of the MBS securities portfolio will reduce that to $61.6 million, or $2.48/share. Another $2.5 million write-down on the defaulted condo loan in Portland would nick another 10 cents a share off book value, to $2.38/share. If the value of the CRE portfolio is just 10% lower than CRZ’s Q1 estimate, as I think it is, book value falls to a mere $1.44. Mark to market those high-risk junior loans (probably by 20% or more to reflect current conditions), and we are well under $1 a share."
2) You state in this article that you previously said they would pay no dividend or have to drastically cut the dividend - in actuality you stated
"That swing has already happened, or very nearly so. I do not even think the company will be able to pay its next quarterly dividend [Editor's note: The author refers to the September 2008 dividend]. The market largely agrees, which is why stated dividend, if paid, would result in the stock having a yield of 34%. If the company does not announce that it is suspending its next dividend, its creditors will probably either issue margin calls or file a suit against the company to enjoin the dividend payment."
I closed my position on CRZ (having sold Aug 2.50 puts immediately after your article helped tank the stock) so have no vested interest at this time. However, I think before you pat yourself on the back too hard you should at least stick with the facts of what you said.
I think i recommended Potash as a buy when it was at $150, up from single digits a few years ago, but it's now at $180 or so, guess I'm the next Buffett too.
Nada !
It will probably violate this new covenant by the end of the current quarter. CMBX junior tranches have fallen to new record lows lately, and suffer from much higher spreads than in the close of Q2.
SBG: I made a variety of estimates based on different accounting assumptions. This estimate you reference was of -reported book value ex income from continuing operations-. And this makes sense, because I did not attempt to estimate earnings from operations.
User: Some of these stocks it is mostly too late for anyone to ever go short because of transaction costs. So some of my article was intended for those in my situation of considering when to cover.
For current shorts with higher entry points (like me), there is no reason to cover, because the stock will almost certainly go lower.
Shorting a stock that goes down is no more or less profitable whether the stock had been going up or down before you made your trade. So I don't understand what point you are trying to make. My articles are not attempts at expose, they are attempts to analytically value companies and make informed near-term and long-term estimates of their future value using the best available data.
Or you can short some of the larger financials, But profits may be lower since they are pretty well covered by independent sources, and there is always the hard to value premium they may have from potential too big to fail bailouts.
The smaller near-dead financials are a great way, however, to make a large profit just if current trends continue, and even bigger if they get worse.
I wouldn't recommend buying puts right now on many of these "walking dead" financials as the options have already priced that in. Even if they go to zero in the next 6 months the reward isn't worth the risk, IMO.
Shorting the calls on the stocks when they have their random bear market rallies, however, has worked quite well for me.
Greg, since you are an attorney but I'm a mere layman, I defer to your linquistic expertise.
However...
Isn't it more accurate to say that CRZ "breached loan covenants" rather than saying that CRZ [was] "in default"?
After all, though "default" can and does mean "failure to fulfill an obligation" breaching a loan covenant is NOT the "obligation" that's key - repaying the money is.
On any debt, there is NEVER any more of an affirmative duty to do anything other than pay the amount specified when due.
But at the same time, since there is certainly a provision for some sort of breach/demand notice, it's only AFTER such a notice is sent and not abided by, that a loan (or credit line) defaults.
Please don't try to puff yourself up here -"see, I was right, blah, blah blah". Such talks bores the readers and makes you appear to be bragging.
And if you have to mischaracterize a breach as a default so as to make yourself look smart, it's all the more obnoxious.
Isn't it more accurate to say that CRZ "breached loan covenants" rather than saying that CRZ [was] "in default"?
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No, it would not. *In default* is more precise, because a breach may be minor or immaterial. There is no such thing as a *immaterial default.*
You don't have to be a lawyer to know this, I would expect these terms to be familier to anyone in finance.
Forgive me if I am belaboring this point, but "default" means you are not paying when due, right?
But loan covenant(s) could cover many things, including minimum equity, maxium debt, etc. which are not specific to the payment schedule itself, right?
When one breaches a covenant (such as dropping below minimum equity) it dosn't always follow that the loan itself won't be paid, right?
For example, an auto loan might require that you not use your vehicle for hire. However, if you do use it for hire, but continue to pay the loan payments, you have breached a covenant, but you have not defaulted on the loan, right?
So then, how do we end up calling a "covenant breach" a "default"?
What am I missing here?
Steve: My financial short calls have fallen a lot more than the average financial stock. You are wrong, my number is correct, and comes right from the mouth of the company:
"This loss includes $60 million (negative $1.84 per share) of net negative market valuation adjustments."
Go to the section (usually) labeled: "Events of Default" of any corporate loan agreement. They are often filed as exhibits to 8-Ks, 10-Qs, and 10-Ks.
Lots of things can trigger an Event of Default. Not making timely payments of interest and principal as agreed is certainly one, but there are many others.
Probably the best thing you can do to learn about options is open up a "practice account" using Yahoo or Google's "portfolio" option (other sites have this too) and see how you do.
Or perhaps open an options account with just a few thousand of real money.
Like MBIA and ABK, the market seems to have decided for the moment that FED is going to survive after going up 4-fold in the past 6 weeks.
Can you give any further analysis on why the market might believe this, and why the market is wrong in that belief? Certainly your article on FED paints a devastating picture for the bank's future. I keep trying to borrow shares with my TDA account, no luck yet. . . Maybe on Monday if the squeeze goes on again.
Bottom line, if you breech a covenant or miss a payment there is typically a cure period before a formal default can be declared. You can sometimes obtain waivers to certain events but if in breech outside of the cure period and in need of a waiver you're at the lenders mercy as to whether its granted or a formal default is declared that allows to proceed with their remedies available under the loan agreement. At this point the lender is attempting to maximize the amount of their recovery, whatever that direction is.
Matt: Bear market rallies are to be expected.
As for the reason why, I am no good at explaining short term market movements, which is why all of my articles deal with fundimentals.
That said, FED is one of the most heavily shorted stocks on the market, so short squeezes can always happen. I think current prices are a great opportunity to short FED.
While I was not fond of your June article, I must say you were correct about at least the near term direction of RWT stock. If the RTC II is launched, which I am certain it will be in one form or another, what does this do to your prediction for these mortgage reit stocks?
"My prediction of Redwood Trust’s (RWT) write-down was also on the money"
Inaja: "I must say you were correct about at least the near term direction of RWT stock"
Its interesting to come back to these articles after a month or so and take another look. Greg: don't break your arm patting yourself on the back for RWT. Anyone that takes the time to look at the specific components of the "analysis" you did can see that each individual component of your forecast write-off was way off. You are "close" on the total ($80 million vs an actual of $60 million) but only because RWT wrote-off $12 MM ($80 million vs $48 million doesn't look so close) on assets acquired during the quarter, not part of your analysis at all. This company is just too complicated for your simplistic analysis to capture.
And what about the forecast of a $4 stock price? Seems like a lot of buyers disagree.
A drop in the stock price from $26 to $24 doesn't seem worth the stress of a short position. Of course I'm sure you got out at a much better price - without telling anyone before hand.