New Century Financial's 19% Yield from its Option ARMs Mortgage Business

Mea Culpa-- what we originally cobbled together and wrote about NEWs business was JUST WRONG. In our search for worts on NEW's stock price and high yield, we were mislead to conclude they write many interest only mortgages. I thought the risk in NEW was Option ARM related, but it clearly is not. It's 19% yield is not subject to the Option ARM lending issues (which are being addressed in Congress).

NEW is not in the Option ARMs mortgage business to any large degree, and so our conclusions about its massive yield were off base in this respect. As the company's Media Relations Director pointed out, NEW's Option ARMs business is less than 1% of its business which is much less vs. companies writing mortages.

However, Businessweeks published a list of subprime lenders, companies with a high level of Option ARM business, and guess what-- NEW is not on the list.

See, the list here.


We are in the process of contacting the company to get the facts straight, and sort out the risks (if there are any) of getting paid 19% yield on NEW shares.


Original, mistaken report:

At first look, New Century Financial (NEW) may look TGTBT (or "Too Good To Be True" as we like to say here at The Yield Hoe). And if you read the cover story in Businessweek (Sept. 11, 2006 issue), you may find plenty of reason to just walk away from the temptation of NEW's it's massive, juicey and otherwise wopping 19% yield.

Since it's October 1, 2004 move up from the NASDAQ to the NYSE, it's price has faced a bit of a drop, well below it's 50 and 200 day moving averages, which is generally a sign of a good place to buy if the company's is not in deep stuff.

Turns out the NEW sells something not so new in subprime mortgages. What is new is that massive roll out of these exotic mortgages to folks who don't have the best credit rating. (WRONG) These Option Adjustable Rate Mortgages, ("or Option ARMs"), as they are called are often sold with contract clauses that you might see in a Contracts law book as an example of an one sided deal, where courts see a deal written by a big bank with a lot of smart lawyers as something that can be modified when the consumer is in a poor position to negotiate anything (such as refinancing fees). Businessweek's Mara Der Hovenesian rightly point this out with examples of several cases, including a hardworking Police officer in California who can not afford to refinance but for the fees that his Option ARM mortgage contained.

There are several companys making hay packaging, selling and laying off these notes to hedge funds and other investors. A lot of NEW's earnings come from these Option ARM sales. (WRONG AGAIN) Some experts think it may be a good idea to buy NEW and hedge with options. Stop limit orders are another way to plan your exit before a drop in NEW that could knock that 19% yield down to earth.

For example, if you read options reporter Kopin Tan's view in "The Striking Price" section of Barrons, you'll find a different slant. Tan looks at the pros and cons of NEW as an investment, weighing the outsized yield against the bad news, and rough ride subprime lenders have faced as the Fed has raised rates almost 20 times over the last two years. Tan asked around, and a few options bookies (not Option ARMs (not relevant), but the other kind-- the right, but not the obligation to buy or sell an underlying security at a given price) even think writing calls on NEW is a good way to collect more rent for parking your money here and give you downside protection, as they say. Maybe even a few Puts to offset your downside risk on NEW, in the event maybe Congress goes democratic this fall, and they start cleaning up this profitable little mortgage lending nook to release hardworking people from loans they can not refinance without paying way too much. Many think the risk to NEW's dividend is factored into its price, which makes sense. Maybe an careful investor may want to buy NEW, write the calls and collect the premium, and use it to buy puts, for further downside protection against the risk of rising rates, and do good democrats.

As a REIT, NEW stands out among it's comps in a few ways, including a outsized total debt to total capitalization ratio, which tops 75%, verses it's very respectable Return on Equity, which tops 20% .. These include. Profit margins seem steady for NEW over the last five years, verses it's last 12 months, which is so so. On the plus side, NEW has both high revenue growth (almost 50%) and high earnings yield when looked at next to its peer group. It's peers include other real estate investment trust, such as H, SLG , AIV, SFI and more, which The Yield Hoe will be covering in upcoming episodes.

What's the bottom line on NEW? As always, that is up to you, but if you are looking to load the boat on NEW, in spite of its big debt ration, we'd keep those stop limit orders tight like a drum, to protect that downside from taking back what NEW offers via it's great big return from its offbeat dividend yield.


See, Feb. 7, 2007 posting for an update on NEW's massive drop.