Doral Financial Corp.: Bottom Fishing in Puerto Rico

Mar. 26, 2007 8:20 AM ETDoral Financial Corporation (DRL)
Chad Brenner profile picture
Chad Brenner
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One of the biggest disasters on the NYSE of the past few years has been Doral Bank (NYSE:DRL) of Puerto Rico. Can it now be one of the biggest winners of 2007? From a high of almost $50 in January 2005, the stock has fallen to a low of $1.19 about a week ago. It has since recovered to $1.91 on the back of sales of New York branches and some likely short covering. For investors who are not risk averse, this might be the time to consider DRL as the possible upside in the next few months and years is a multiple of today’s price.

Doral provides consumer financial services through its mortgage banking and thrift operating units. It is primarily engaged in a wide range of mortgage banking activities in Puerto Rico. Doral Financial has the leading share of the Puerto Rican mortgage market. In the past weeks, the press has mistakenly lumped it together with ailing subprime players. In fact, it seems to have a relatively healthy portfolio, at least when taking into account current weakness in the Puerto Rican economy.

Doral has been rocked by accounting scandals under the previous management. It still faces various shareholder lawsuits, regulatory issues and importantly refinancing of $625 million of floating rate senior notes in July. Analysts have largely abandoned Doral. Those remaining rate it a sell or weak hold. Morningstar switched from a 5 star rating to a 1 star rating overnight in the last months calling Doral “toxic waste”. Its price target is $1.50 which is simply the average of $0 or $3 in a good case scenario.

For bottom fishers, this all makes for a pretty attractive possible hunting ground. There are few stocks more hated than Doral. Relative strength is 1 which is pretty much bottom. The stock is oversold in technical terms, meaning a base might be forming. Compared to the subprime players, the restructuring of Doral is well underway.

Doral headhunted Glen Wakeman as new CEO already in May of last year. Under his leadership, settlement with the SEC has already been completed and the New York bank branch sale announced March 15 will free capital to the core Puerto Rico franchise. Refinancing and lawsuit settlement are not obvious, but resolution of these issues is something management and the Board has been working on for many months with leading investment banks and law firms. Such institutions are not paid to fail. The few analysts still covering, forecast a dramatic improvement in 2007 results to a small loss overall. It seems Wakeman has taken as many charges to earnings as possible in 2006. This is standard practice for a new CEO in a turnaround situation, but it makes 2006 ratios look very bad.

An educated investor, though, should separate one time charges from the future ongoing potential. What you believe about Wakeman is the key to this stock. He was a highly-regarded 20 year veteran of General Electric and most recently was CEO of their Latin American consumer finance operations. His compensation includes 200 000 restricted Doral shares and 400 000 options with a strike price of $7.60, almost 4 times today’s price. While rumors are that private equity might be coming in wiping out or even diluting current shareholders, that doesn’t seem so logical. Message board rumors of bankruptcy seem even more out of the question, even if not impossible. The questions, though, are: Would Wakeman really risk his reputation and agreed compensation at the cost of shareholders? Would he leave a very highly compensated and prestigious GE job to bankrupt a moderately-sized Puerto Rican institution?

Depending on how you answer these questions, you can choose to short or go long the stock. Message board short sellers constantly post deeply researched views such as “this puppy is going to zero” or “delisting next week”. Short sellers seem to currently be in full control of the stock. Fear and panic dominate. As of March 15, short interest was a recent record 19.5 million or an amazing 18% of all shares. There has been no good news on Doral for what seems like forever. ANY good news will likely leave the short scampering for the hills.

At the recent price of $1.19, the downside is to 0, while the upside is to even $5 or 6 short term. Those seem like pretty good odds, but not for short sellers. Shorts might try to take the stock down again in the next weeks if there is any bad subprime news anywhere in the U.S., even if totally unrelated to Doral. Such raids on the stock might prove to be great buying opportunities with the turbo fuel provided by shorts covering and new money coming in or back in. The message boards talk all about liquidation values, tax assets, lawsuit liabilities etc. Largely these posts are probably shorts trying to scare weak holders with seemingly credible downside arguments.

This whole discussion, though, misses what might be the main point. Doral gives any new owner access to a huge part of the Puerto Rican bankable market at potentially a quite reasonable price. S&P reports that Doral had over 500 000 accounts on an island with ca. 4 million people. This probably means that most families have a relationship with the bank either directly or through a relative. This can have very high future value, especially if you consider cross-sell of other products over time.

The strategic value is also very high as many institutions are retooling for the quickly growing U.S. Latino market and don’t want to be left out. There are probably at least 5-10 large global banks and various other players (regional banks incl. from Latin America, various private equity, hedge fund players, etc.) that would be happy to buy into such a deep penetration of this market. In an auction, this asset could yield a multiple of any liquidation value.

Possible sale discussions might be happening now in parallel to settlement negotiations on shareholder suits. Rumors of various banks being interested and even visiting Doral for due diligence are growing in volume. In any case, institutional investors are moving back in. After decreasing their stake over the past 2 years, in the latest Dec ’06 filing, institutional investors increased their stake 7.2% from the previous filing to 60.9% total. Among those increasing stakes were Barclay’s by 22%, Dreyfus by 13.5%, Franklin by 135% and UBS by 144%. Goldman Sachs is the now the 6th biggest shareholder. Fidelity remains the top holder, though it has reduced its stake.

These are not bad “smart money” names to co-invest with. The need for Puerto Ricans to bank will not go away. Global players know how to serve such markets profitably. As the yield curve eventually moves to a more normal shape, Doral can again become a profitable cash cow. It might also prove to be one of the best chances for banks lacking Latino exposure to leapfrog competitors. For investors, it might be a quick way to get a multiple on an investment in an otherwise tricky market.

DRL 1-yr chart


Disclosure: Author has no position in DRL

This article was written by

Chad Brenner profile picture
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Chad Brenner is a Seeking Alpha contributor.

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