Too Late to Short Subprime

Because New Century's current financials will require restatement, it is likely in violation of covenants on those facilities, but there may be room for negotiation, as Wall Street probably wants to keep the major players standing. Surely, the eventual investors will want the ability to put defaulted loans back to their originator.

Generally, if a lender is to be shuttered, it happens quickly. This is intensely speculative, but I believe New Century has already passed the point where if it were to be closed, we'd know. I believe even plain survivability could prompt a rally in the shares.

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.