Irvine’s New Century Financial Corp. has a card up its sleeve if its stock price continues to languish: split the company in two.
The subprime lender talked of a possible split during an investor conference earlier this month in New York. For now the idea is just an option, though it would be the second big change after New Century converted to a real estate investment trust late last year.
During the conference, New Century executives sought to convince analysts and investors that their stock is worth more than its recent $2.4 billion market value, which is off by about 30% this year.
The company could spin off its mortgage subsidiary, Ed Gotschall, vice chairman of finance and a cofounder, told those at the conference.
New Century now has a dual structure.
Its mortgage arm funds loans from brokers and gets business directly from borrowers. The mortgage unit has fueled the company’s growth in the past few years.
The parent company is a real estate investment trust that holds loans as investments and pays dividends to shareholders.
“We’d like the market to understand that there are two entities here, a REIT and an origination subsidiary, and to value the two separately,” Gotschall said. “If the stock value doesn’t at some point in the future get to that level, we have the alternative that we could flip the two apart to get full value out of it.”
Now isn’t the right time for a split, Gotschall said. The company declined to comment further for this story.
It’s unlikely New Century would split so soon after becoming a REIT, analysts said. But a breakup would be a viable option, they said.
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A spinoff has been suggested before, according to Richard Eckert, senior research analyst with Newport Beach’s Roth Capital Partners LLC.
New York’s Greenlight Capital Inc., a hedge fund manager and dissident New Century shareholder, could be pushing for a spinoff, Eckert said. In April, Greenlight faulted New Century’s management for the company’s slumping stock.
The big issue for New Century is its value on Wall Street, according to Eckert. New Century’s complaint that investors only are valuing the REIT and its dividend appears to be true, he said.
The mortgage subsidiary could see a market value of $1.5 billion or more, based on its current volume and profitability, Eckert said.
“It would be a way of unlocking value,” he said of a spinoff.
New Century last year became one of a handful of mortgage companies to adopt what’s known as a hybrid REIT structure. Newport Beach’s Impac Mortgage Holdings Inc. became a hybrid REIT in 1995.
New Century’s parent company gets a tax break in return for paying out at least 90% of its taxable income to shareholders. Unlike traditional REITs, New Century’s mortgage unit keeps some profits for operations. Hence the hybrid.
Subprime lenders, which make loans to people with imperfect credit, have seen loan volume skyrocket in the past few years, even as more traditional lending has dipped.
The sector is concentrated heavily in Orange County. Along with New Century, the county is home to five of the top 10 players: industry leader Ameriquest Capital Corp. of Orange, 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.
New Century continues to make a lot of loans. It did $6.1 billion in loans last month, nearly double a year earlier and up 33% from July. Its loan portfolio is $18 billion.
But two analysts downgraded the company’s shares last month. The worry: narrowing profits.
New Century and other subprime lenders are getting squeezed with rising short-term rates. The lenders sell their loans as bonds, with pay outs based on short-term rates. As rates go up, so do payments to bondholders. That cuts into profits as interest income from mortgages stays the same.
Subprime lenders have upped the rates they charge to borrowers in recent weeks, but not enough to keep pace with rising costs, according to Bose George, vice president of equity research with Keefe, Bruyette & Woods in New York.
George downgraded New Century’s stock last month to “market perform” from “outperform,” based on competition for loans and a potential correction in the housing market.
“At some point this cycle has to end and lenders have to learn to live with lower volume,” George said.
New Century executives have other reasons for believing their stock is undervalued, and not all have to do with the mortgage unit. Executives said they plan to increase their annual dividend of $6.60 per share by more than 10% next year.
At New Century’s current stock price, the dividend works out to a yield of 15%.
Company officials also point to their acquisition of Royal Bank of Canada’s U.S.-based RBC Mortgage Co., which was completed earlier this month.
New Century got a “very low price” for RBC Mortgage, according to the company’s Gotschall. Terms of the deal were not disclosed.
Gotschall said the deal stands to expand New Century into loans to borrowers with better credit and boost subprime lending via RBC branches.
New Century also said its cutting costs by lowering its commissions to brokers and plans to keep its support staff at 3,000 workers. It may add to its sales force of 2,000 workers, according to officials.
In 2007, New Century plans to move to a 20-story office tower being built at Park Place at Michelson Drive and Jamboree Road. The company, which is based a couple blocks over now, signed a lease for 190,000 square feet at the planned building.
“Over the next year or two as we see this cycle unfolds and unwinds, we believe that the value will come back to the company and to the stock value,” Gotschall said. “We’ve got I think a lot of options available to us over time to unlock shareholder value. We’re open to looking at any and all of those options.”
