Zeev's Turnips Patch-No Politics (ZEEV)

[TexasTech]

Barrons article debunked on NFI

http://www.nfi-info.net/news.htm

I've read it now, and seen the background of the fund manager. He has all the analytic depth of a typical equity analyst.

His thesis on NFI is based on three assumptions that have not been true in the past, but he thinks might be true in the future:

1) Capital markets will stop buying ABS
2) Credit performance at NFI will stop being better than the rest of the industry, and will significantly decline in the future.
3) That NFI will not be able to raise capital to continue to grow its portfolio (there's also the statement that they won't be able to originate enough, but a I see a disconnect there, becasue then they wouldn't need to raise new capital).

He also brings up the gain-on-sale "issue". Here's why he's wrong about that one: NFI does not, as he assumes, make optimistic assumptions about future cash flows when it books a gain on sale. It just books the sale at the wholesale market price, and assigns an earnings accrual rate that gives the future cash flows a present value equal to the real-world price derived from the wholesale value of the loan pool. He also misses the fact that using the sale treatment allows NFI to finance its investment via non-recourse NIMs.

Let's look at this in an analogy to another popular income investment, the CanRoys.... Imagine two forms for CanRoys... One only states its income when the sell oil at the spot price. The other enters long-term delivery contracts, and sells non-recourse bonds secured by those contracts.

Now, let's look at how the economics might work. Company A raises $30 million to buy a new field. It invests all the money, and pumps oil for the next ten years on a declining schedule, taking out $10 million in sales the first year, $9 the next, $8 the next, and so on, as long as the price of oil stays the same. Company B buys a similar field for $30 million and enters a contract to sell the next $28 million of production, conservatively projected at $9, $7, $5, $4 and $3, and securizes that contract to get $25 million today.

When both fields produce as expected, the 'conservative' company A realizes $25 profit over ten years on its $30 investment by receiving $55 over ten years. Company B ends up paying out only $27 to pay back the $25 million in bonds it issued because the money comes in quicker than the conservative projection, and debt is paid off in only three years. For its net investment of $5, it receives $28 starting in year four. The return on capital for Company B is more than twice the return of Company A.

The only way Company B fails to be worth more than twice as much per dollar of capital of Company A is if the oil fields do not produce as expected. Our NFI field has consistently produced *better* than expected, and tells us every month how it's going. While the past can be no guarantee as to future performance, it's generally a bad bet to assume that it's going to be the opposite of the past in the future, and risk your money on that being the correct view.