New Century Readies to Go REIT
By MATHEW PADILLA
Shareholders of Irvine-based New Century Financial Corp., one of the nation’s largest and most profitable subprime mortgage lenders, are set to vote next week on transforming the company into a real estate investment trust.
Investors are likely to sign off on the change at the Sept. 15 meeting. For many, the prospect of getting more profits in the form of dividends is too good to refuse.
As a REIT, New Century shareholders are set to get at least 90% of the parent company’s taxable income as a dividend. Last year New Century paid $178 million in income taxes on its pretax profit of $423 million, cutting its net income to $245 million.
New Century could have distributed some $380 million in profits to shareholders last year as a REIT. But the total likely wouldn’t be that high: As what’s dubbed a “hybrid” REIT, New Century subsidiaries are set to retain some profits for their operations.
In the process, New Century will be shifting the tax burden on its profits from the company to shareholders, though the tradeoff is probably worth it for many.
The company last year paid a 42% tax on its profits. Shareholders will see the dividends taxed as income at up to 35%, depending on where they fall on the tax scale.
The big payoff: no more double taxation of profits at New Century and once investors receive them as dividends.
Institutional investors stand to see the most gain from the transition. New Century’s biggest shareholders are New York-based Greenlight Capital LLC at 10% and AXA Financial Inc., also of New York, at 7%.
If approved, New Century plans to swap each one of its shares for one in a newly created REIT parent company. New Century also plans a big offering as part of the process,$750 million worth of stock to bankroll expansion.
New Century executives declined to comment for this story in the runup to the offering.
As of last week, New Century counted a market value of $1.8 billion. The company’s shares are up about 20% from the day of the announcement in April.
New Century saw a 17% surge in late August alone, likely from investors looking to get in before the REIT conversion.
In a statement, the company said converting to a REIT could increase shareholder returns, be more tax efficient and help with long-term growth.
Subprime lenders, which make mortgages to borrowers with less-than-perfect credit, have boomed in recent years as home values surged and interest rates declined.
New Century and others are holding up with interest rates off their 2003 lows. In fact, while traditional lenders have been hit from a huge falloff in mortgage refinancing, subprime players saw their market surge in the second quarter after an earlier lull.
Subprime lenders made $157 billion in loans in the second quarter, almost double from a year earlier, according to National Mortgage News, a Thomson Corp. trade publication based in New York.
Subprime loans made up 19% of all mortgages in the second quarter, up from 7.7% a year earlier.
New Century did $12.3 billion in loans in the second quarter, making it the second largest subprime lender with a 9% market share.
Orange-based Ameriquest Mortgage Co. was the top subprime lender in the second quarter, doing an estimated $12.5 billion in loans, according to National Mortgage News.
The county counts five of the top 10 players including: Washington Mutual Inc.’s Anaheim-based Long Beach Mortgage Co., Irvine-based Option One Mortgage Corp., a unit of H & R; Block Inc, and Fremont Investment & Loan in Anaheim.
With the conversion, New Century is hoping to have its cake and eat it too. The company is seeking to cast itself as a growth stock with the predictable payout of a REIT.
New Century plans to keep in place its current subsidiaries, including the company that makes and sells mortgages. Those subsidiaries would be subject to standard corporate taxes and would retain some profits.
The units could keep some profits to fund growth or turn them over to the parent company to deliver to shareholders as dividends, according to New Century’s 250-page filing with the Securities and Exchange Commission last month.
Wall Street’s task will be to value the growth potential of New Century’s mortgage operation with the yield prospects of the parent REIT.
At least two other subprime lenders are making the same move. Los Angeles-based Aames Financial Corp. announced plans to go REIT earlier this year. Shareholders of Glen Allen, Va.-based Saxon Capital Inc. are set to vote next week on converting to a REIT.
One smaller subprime lender already is a REIT: Kansas City, Mo.-based NovaStar Financial Inc. It counted a recent market value of $1 billion and a price-to-earnings ratio of 7.9, versus 6.4 for New Century.
The REIT conversion fits with New Century’s strategy of becoming more of an investor in loans and less of an originator and seller of them, said Richard Eckert, an analyst at Newport Beach-based Roth Capital Partners LLC.
New Century makes mortgages based on leads from brokers. It makes a smaller amount of loans directly to borrowers.
Like other subprime lenders, New Century packages its loans in pools of $1 billion or so and sells them to investors as securities.
The company used to handle the so-called securitizations as a one-time revenue gain.
But in early 2003, New Century started accounting for the sales differently. Now they are treated as financing, with interest from borrowers and yields paid to pool investors recorded as they are incurred.
“It makes it more transparent,” Eckert said of the change. “It makes the income stream more predictable and transparent to analysts. They have something to anchor their estimates of future earnings.”
Declining home values are a concern for New Century, according to Eckert. Most of the company’s borrowers are refinancing mortgages and taking out money to pay off credit cards and other high-interest debt.
To be sure, gradual increases in mortgage rates aren’t likely to deter someone looking to pay off a credit card debt at 20% interest.
With home values in OC and elsewhere rising 20% to 30% annually in recent years, borrowers have felt comfortable about doing so.
But now the housing market is showing some signs of cooling and could give borrowers some pause.
Perhaps the biggest concern for New Century is a flattening yield curve, Eckert said. That’s where the difference in returns between long- and short-term debt narrows, usually spurred by rate hikes by the Federal Reserve.
When that happens, investors tend to move out of riskier long-term investments,such as bonds backed by subprime mortgages,and into less-risky short-term ones.
There are some signs of flattening: The spread between two-year and 10-year Treasury notes last month dropped below a 40-week moving average of 180 basis points, according to a recent Lehman Brothers Holdings Inc. report.
