NCT is organized as a REIT, but unlike most REITs does not purchase actual buildings, but instead invests in mortgage loans and securities, primarily backed by subprime commercial (the majority of assets), residential, and mobile-home loans and loan securities. They just reported a whopping Q4 loss of $106.2 million, or $2.01 per share. Their stock price has dropped from $31 in April 2007 to about $11 today.
Book value per share fell between Q3 and Q4 from $12.66 to $5.59, a decline of $7.07 per share. NCT says Generally Accepted Accounting Practices (GAAP) understates their book value because it does not allow them to write down their limited-recourse liabilities at the same pace as the assets securing them.
That argument isn’t entirely without merit, but strikes me as a very fine one to make. If GAAP book value drops another $7.07 a share in Q1 2008 it would fall to -$1.48 per share.
Would you invest in such a company, or offer it loans, given (1) a negative book value, (2) rapidly depreciating assets, (3) regular massive losses, based on the assurance that essentially amounts to “don’t worry, while we may be insolvent according to the standards of most US accountants, but once we default on debt we owe to other people we’ll have plenty of assets to pay the loan we want from you.”?
Also, many lenders use GAAP accounting in making loan decisions, and even if NCT’s more creative non-GAAP accounting were used, their books still look weak and getting weaker, and there are plenty of prime borrowers out there who are having trouble getting loans.
But wait, it gets worse! The biggest part of NCT’s huge writedowns have come from its subprime portfolio.
It also owns $542 million in mobile home loans. How well do you think those will do in a recession? A writedown of 30% of the value of the that portfolio would create a loss of $162.6 million. And remember, GAAP book value is a mere $295.1 million as of 12/31/07. Mobile home loans were the downfall of Conseco, once a giant financial company. They are especially vulnerable to foreclosure, since they retain their value very poorly in foreclosure auctions, and because they are usually low-value units, the fixed costs of foreclosure take a much larger bite from their value that SFHs and condos.
Commenter David Free notes that NCT paid off much of its short term debt in so far in Q1 2008, and wonders if that is a good sign. I say no. Given the market situation I am not sure that NCT had the ability to roll over this short term debt. And it didn’t pay off the debt with earnings, it has lost tons of money in 2007 and so far in 2008.
Instead, NCT sold one of the few assets that anyone would want to buy, namely its AAA-rated GSE securities, which made up 60% of its Q1 asset sales. The remaining 40% of the assets it sold in Q1 ’08 were lower quality RE loans/securities that nonetheless were rated higher than its overall portfolio. The other two big sales were $254M of REIT debt rated BBB, and $248M of CMBS rated A-. By contrast, the remaining REIT debt and CMBS are both rated an average of BBB-. So it dumped (at a loss) its A- and BBB assets, while keeping the BBB- assets. NCT is thus taking on more credit risk at a time when defaults are rapidly increasing.
So how are BBB–rated CMBS that are still on NCT’s books doing these days? Compare the chart at the end of Q4, when spreads were at 950bps, to today they are at 1,650bps. (Remember, on this chart up is down.)