Marketgems Earnings Trader- Trading Strong or Weak Earnings Growth

[Joe Stocks]

NextBank- Doug Noland writes an interesting essay that includes the rise and fall of NextBank. Here's the excerpt about NextBank from this site.
http://www.prudentbear.com/archive_comm_article.asp?category=Credit+Bubble+Bulletin&content_idx=...
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The fragile underpinnings of contemporary consumer lending were brought to light this week, as the American Banker reported on the escalating cost of the failure of pioneer Internet credit card lender NextBank. It is now estimated that this failure will cost the bank insurance fund between $300 million and $400 million, rather shocking news (although I don’t believe it was covered in the Wall Street Journal). When the Office of the Comptroller of the Currency closed this bank on February 7th, it’s assets totaled only about $700 million and insured deposits were $554 million. Just a few months ago (April 17th), a spokesperson from the FDIC stated that losses were expected to be about $25 million. This proved an especially poor estimate. The ugly fact is that this bank was closed down only 30 months after NextCard acquired it. At the time, it had only $3 million of assets. NextCard proceeded to aggressively market insured jumbo CDs that enabled it to easily raise more than one-half billion of deposits. We live in an exceedingly dangerous financial environment.


The NextCard fiasco is pertinent today on many levels. For one, the company and investors believed that the company had developed a “better mousetrap” for lending – that its systems and credit scoring allowed it to capture quality borrowers through its 30 second approval process and aggressive Internet marketing. It is now clear that the Internet model of aggressive lending was an unmitigated disaster. This leaves us deeply concerned about the continuing boom in Internet mortgage lending, and how quickly enormous future credit losses can be created in the contemporary environment.

From the American Banker: “Since the FDIC took over NextBank (Feb. 7, 2002), the value of the bank’s $2 billion of credit card loans has dropped 40%, to $1.2 billion, and put the agency into a quandary. It missed its self-imposed goal of finding a buyer within three months, and now chargeoffs in the securitized portion of the portfolio – which holds the lion’s share of the damaged receivables – are about to trigger an early amortization clause, which would effectively prevent NextCard’s credit card holders from making any more purchases on their cards...NextCard, which stormed onto the scene in 1998 with a Visa card that could be obtained only through the Internet...had prided itself on selecting only the most creditworthy customers and screening out marginal or subprime applicants. However, the FDIC discovered that, because of either fraud or a failure in its screening methods, the company had customers who defaulted on their loans. Predicting that the FDIC would be left holding the bag for NextCard’s bad loans, both Standard & Poor’s and Moody’s...last week lowered their ratings on the securitized portion of the portfolio.”


Interestingly, the FDIC and the rating agencies initially expected a relatively quick sale of NextCard’s interest in its securitizations. S&P stated in March “that a purchaser will be found within the next two months.” However, things have deteriorated significantly for NextBank’s receivables, as well as the general Credit system, over the past few months. At 11.56%, charge-offs were high in January, but still provided sufficient cashflow to service the holders of the asset-backed securities. By June, charge-offs had surged to 16.61%, with the trusts now having reached the point where they no longer received sufficient cash to meet requirements (negative “excess spreads”). A negative “excess spread” over a three-month period would trigger a “breach” and force an “early amortization.” From S&P: “...if the base-rate trigger associated with each series is breached and cardholder collections are passed through to investors, [this would make] them unavailable to finance new receivables...principal collections will be passed through to the certificateholders in sequential order. Consequently, these collections would be unavailable to fund new purchases made by the cardholders.”

Let there be no doubt, when borrowers are informed that they will not be able to use their NextCard visas for new purchases, defaults will skyrocket (with rising servicing costs) and the value of card receivables (and related securitizations) will plummet. It is no mystery why there is little interest in acquiring NextBank trust assets. The NextCard experience (with loss estimates as high as 70% of deposits) does not bode well for the FDIC’s exposure to other troubled lenders. Metris ended the first quarter with deposit liabilities of $1.725 billion and managed card receivables of $11.78 billion. Providian ended the quarter with deposits of $14.4 billion and a “managed consumer loan portfolio” of $22.1 billion. How could it have ever made any sense to allow subprime lenders to finance reckless lending with insured deposits? It is also worth mentioning that Internet mortgage king Countrywide Credit ended March with over $2.2 billion of deposit liabilities.


It is interesting to observe the timeline of the NextCard fiasco. From the company’s website: “NextCard was so-founded on June 6, 1996 by Jeremy and Molly Lent…The first NextCard Visa was issued on December 23, 1997. Although many applied, only the best consumers passed the strict credit quality guidelines we established… The NextCard team is “not afraid to take chances.” The company’s founder (Jeremy Lent), CEO and president all learned their trade at Providian.

May 14, 1999: NextCard issues 6 million shares in a public offering at $20, with the stock trading as high as $40.75 before closing its first day of trading at $37. Donaldson Lufkin & Jenrette (DLJ) was lead manager.


June 9, 1999: NextCard shares surge 37% to $44 on buy recommendations from DLJ, U.S. Bancorp Piper Jaffray, and Thomas Weisel Partners.

June 17, 1999: NextCard announces that its loan portfolio has grown to $150 million and is increasing $1 million daily. The stock gains $4 to $39.


August 16, 1999, Bloomberg headline: “NextCard Buys Bank to Gain Access to Cheaper Funding.” NextCard purchased Textron National Bank with assets of less than $3 million and renamed it NextBank. From Bloomberg:“ ‘This transaction will allow us to further diversify our funding sources,’ John Hashman, NextCard’s chief financial officer, said in a statement. Gaining access to the Federal Deposit Insurance Corp.-insured ‘deposits market will further enhance our liquidity position and funding costs.’” Also from Hashman: “We expect to begin originating FDIC-insured deposits soon, and we will focus on developing a unique Internet-based experience for these consumers.”

December 9, 1999: NextCard’s secondary offering of 8 million shares at $35.94 raises $287.5 million. The company sold 4.5 million shares with selling shareholders liquidating 3.5 million shares ($125.79 million). The offering was co-managed by DLJ and Goldman Sachs.


February 22, 2000: NextCard announces $500 million of customer receivables. CEO Jeremy Lent: “We are very pleased to reach these major growth milestones ahead of the market’s expectations. Even more important, we continue to beat our aggressive growth targets while maintaining very strong parameters in the other core elements of our business model…The reason for our continued success is that we are the leaders in applying credit card target marketing techniques to the Internet channel. Our real-time profile-based pricing system, which encourages high credit quality consumers to transfer balances to us from their other credit cards, has been one of the reasons why we have been able to achieve dramatic and sustainable growth with high average balances and good credit quality.”

March 20, 2000: A Bloomberg story has company insiders filing to sell $28 million of stock, part of a record $23.4 billion of insider filings to sell shares during February 2000.


November 2, 2000: Business Wire: “Nextcard, the leading issuer of consumer credit on the Internet, today held its first annual Investor Day, during which the company provided an update on several exciting growth strategies. At the meeting, NextCard announced that it expects revenues of $1 billion in 2003, implying a three-year annual revenue growth rate of 75%. Further, NextCard initiated earnings guidance of $150 million…in 2003 and increased guidance to $75 million for 2002. The company also announced it expects that assets under management will exceed $6 billion by the end of 2003… From company President John Hashman: “We are very excited about our Company’s long term vision and growth prospects. NextCard has built the foundation for a very successful company… The opportunity in front of us is as big as ever. There is no question this works on the Internet. It is fundamentally a better way to provide consumer credit.”

But Mr. Hashman’s words were anything but the truth. From the San Francisco Business Times (Ron Leuty, Feb. 25, 2002): “In the four years since it introduced nearly instantaneous online approval for Visa cards, NextCard grew to 1.2 million accounts with $2 billion in credit card loans. It bulked up on risky subprime customers… Problems started to appear soon after the company bought the former Textron National Bank in September 1999. A routine examination by the OCC in second-quarter 2000 revealed ‘deteriorating’ credit quality… At the OCC’s request, NextCard and NextBank entered into an agreement Oct. 26, 2000, to ensure that the bank’s total capital…stayed above 12 percent of assets.”


July 25, 2001: “NextCard Reports 144 Percent Growth in Second Quarter Operating Revenue; Company Reaffirms Guidance for Fourth Quarter 2001 Profitability... Total managed loans rose over 115 percent to $1.789 billion...”

August 3, 2001: “Lent Family Trust Files to Sell 415,000 shares.” John Hashman files to sell 17,900 shares.

October 31, 2001: “NextCard, Inc. announced today that its Board of Directors has retained Goldman, Sachs & Company to explore opportunities for the sale of the Company to a larger, more established financial institutions with the resources necessary to support the Company’s continued growth. The company’s decision resulted from its belief that, given newly imposed regulatory limitations on its business operations, as well as the current market environment, it can best enhance shareholder value through a transaction with a larger and better-capitalized entity. From CEO Hashman: “NextCard has established a strong leadership position in the Internet channel, which is the fastest growing channel in the credit card business. We believe we have created tremendous value in our business model, and we should be in a better position to unlock that value for our shareholders through a transaction with a larger entity.” The stock drops to 87 cents.


February 7, 2002: NextBank closed down by the Office of the Comptroller of the Currency. “NextBank’s unsafe and unsound practices were likely to deplete all or substantially all of the bank’s capital, and there was no reasonable prospect for the bank to become adequately capitalized without federal assistance.”

February 11, 2002: FDIC mails $525 million of checks to NextBank’s depositors.


April 17, 2002: FDIC spokesman estimates loss to insurance fund at $25 million.

July 3, 2002: American Banker runs story stating FDIC now expects NextBank-related losses to the insurance fund of between $300 million and $400 million.

While off the radar screen, we view the collapse in the value of NextBank’s securitization interests as an ominous portent for the aggressive consumer lenders and their mountains of asset-backed securities. Combining the more than $400 million raised in the equity markets with the $400 million potential FDIC loss is a frighteningly large sum compared to the $2 billion of outstanding receivables. With troubles for the likes of much larger Metris, Providian, Americredit, and others, we would expect a risk-averse marketplace to move away from riskier consumer asset-backed securities. This trouble at the margin will mark a key inflection point for consumer lending generally, with reduced Credit availability at the fringes of subprime Credit cards and autos. That this sector will join the impaired corporate sector only exacerbates already significantly heightened systemic risk. It is no hyperbole to aver that the risk market is today in complete disarray.

It is today especially important to appreciate how quickly things turned sour for NextBank when it was forced to reduce its aggressive lending – how quickly the “better” mousetrap was exposed as ultra-reckless lending (and pretty close to financial fraud). Earlier in the week, it appeared that the U.S. Credit mechanism was sinking quickly into a state of systemic crisis. While a stock market rally does help to stabilize the Credit system, we unfortunately in no way believe the risk of a serious dislocation has dissipated. At the same time, we remain petrified of the disastrous financial and economic consequences that mount from the runaway mortgage finance Bubble. We suggest the Federal Reserve, bank regulators, and the Office of Federal Housing Enterprise Oversight take a cold, hard look at the NextBank Meltdown.