IMRichdad and I are looking at Doral Financial (DRL) as having the potential to make a significant recovery in its share price. Since a number of posters on this board also have an investment in Doral, or are considering one, I thought this might lead to an interesting discussion. Become a Complete Fool
In September, 2006, Doral announced it had settled with the Securities and Exchange Commission. The share price jumped from approximately 5.0 to almost 6.5. That is nice, but what can we really anticipate from Doral?
Doral Financial has been in serious trouble. Some of the major problems includes:
1. The company's credit ratings were severely downgraded.
2. The company was unable to file its annual and quarterly reports with the SEC.
3. Doral could no longer utilize the traditional funding source for the sale of non-conforming mortgage loans, and the unsecured bank and public debt markets.
4. The Office of Thrift Supervision ordered Doral to suspend dividends
In prior years, Doral earned "considerable revenue by selling pools of mortgage-backed securities (MBS) at fixed rate to investors." Doral retained the interest income on individual MBS's above the fixed interest rate owed to the investor. This interest income, known as interest-only strip (IOs), had been a significant source of revenue.
In 2005, Philip Durell examined Doral. He pointed out that the only risks are that a rise in short-term interest rates or another downgrade in Doral's credit rating may lead to a reduction in the IO's profitability." Unfortunately, both conditions occurred. In order to avoid going into bankruptcy the business had to be altered.
Since the beginning of the year, Doral has made major changes. A new senior management team was brought in and changes to the board members occurred. Different management implies a new business strategy. We decided to briefly examine the new business plan, and see its impact.
Doral Financial recently filed the Annual Report on Form 10-K for the year ending December, 2005. (The Quarterly Report for the quarter ending March 31, 2006 will hopefully soon be filed.) Page 11 of the recent annual report, Doral clearly states there is a new business strategy. Here are some of the key points:
1. Retention of more loans in portfolio to increase net interest income This was anticipated since the loans could no longer be easily sold to generate IOs.
2. Diversification of loan product offerings.
3. Continued emphasis on fee income
4. Diversification of loan sale and securitization channels for mortgage loans and a better balance between cash gains and non-cash gains on mortgage loan sales.
Rather than selling most of its internal mortgage loans, Doral Financial will become more of a traditional lending institution with less emphasis on trading and investment activities. The days of high revenue from selling loans will be over. If the business strategy is successful, Doral should perform similar to regular banks. This will not be bad. But we may not see a rapid return to a share price above $25. (Doral's initial profit levels will not justify the higher share price.)
Doral Financial has 56 mortgage banking offices in Puerto Rico, and one branch office in the New York area. (A very large Puerto Rican population has existed in the New York metropolitan area since the 1950's. This was an excellent marketing strategy for Doral to have a presence in New York.) The offices generate a large amount of loan applications which definitely will provide the company with sufficient opportunity.
Some mortgage loans may be sold. Conforming conventional mortgage loans may be sold to FNMA, FHLMC, or the VA. Previously Doral sold loans that did not conform to GNMA, FNMA, or FHLMC requirements. The latter activity will significantly decrease.
Please note we have not yet seen the first quarter's results from 2006 to confirm any of the results. Currently all we can do is speculate. Year ending 2005, indicated a net loss of income. But 2005 year end results includes many accounting changes. (Doral Financial had to bite the bullet with the last few years' revised reporting.)
The largest bank in Puerto Rico is Banco Popular, with 100 branches. Its net income per share has averaged $1.51 over the last 5 years. (2006 had a low of $0.75 per share. 2005 had a high of $1.97 per share.) Its share price is in the mid $20s. Doral has the potential to elevate itself to the level of Banco Popular. There may be some more setbacks. (There are still many legal suits for those connoisseurs familiar with Merck.) Over time, Doral still offers a significant improvement in the share price. But we should be realistic and not anticipate a return to the share prices prior to May, 2005.
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IMRichdad and I are looking at Doral Financial (DRL) as having the potential to make a significant recovery in its share price. Since a number of posters on this board also have an investment in Doral, or are considering one, I thought this might lead to an interesting discussion.
Become a Complete Fool