360 Degrees of Subprime Lending

True Book Value

To calculate this, I start with Sept. 30 numbers and then adjust for writedowns. Stated equity in the third quarter was $2.06 billion. Subtract $95 million of goodwill, which is an intangible asset. Divide by the fully diluted share count of 56.5 million for $34.82 per share. The company stated it is making two major adjustments.

First, it is writing down its residual assets. For New Century, these are retained interests in its securitizations. Its valuation is based on the assumptions it made when the loans were originated and packaged. Default rates, prepayment rates and the like factor into the equation. We all know the market has worsened, so I estimate a 50% writedown. (This is more punitive than most sell-side analysts have estimated, but I think it is prudent.) This results in an after-tax writedown of $1.19 per share.

Second, it needs to record a reserve for early payment defaults. In the second and third quarters of 2006, it misapplied an accounting rule and did not adequately reserve for these defaults. Some have speculated that as many as 10% of loans originated are or will be in early payment default status -- that is, missing one or more of the first three to six payments, triggering a repurchase request from the warehouse lender and/or securitizer to the originator.

On a Feb. 14 conference call, Accredited Home Lenders (LEND Quote), a well-run company that makes similar loans, said it was conservatively predicting 2% of loans originated would be in early payment default. If we take 2% of New Century's 2006 originations and write them down by 20% (remember: New Century itself does not lend 100% of home values), that results in a writedown of $2.18 per share. Adjusted book value is $31.45.

I want to be more conservative, though. Tighter underwriting guidelines, less origination going forward (it said it would originate at least 20% lower in 2007 than in 2006) and possible litigation reserves for shareholder lawsuits could take another $1.45 off book value after tax. Therefore, I use $30 for adjusted book value.