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By Tiddman
August 22, 2007

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Okay if your experience with DFC did nothing more than whet your appetite for sub-prime boutique financial companies, let me introduce you to CCRT. And to make sure that you're sufficiently interested, let me point out that sub-prime nuevo-afficionado Pabrai made CCRT one of his largest positions in Q2... at about 35% above current prices. CCRT was also Tom Brown's presentation at the value investing congress last fall.

CCRT is primarily a credit card investor and servicer, up to 2006 they derived about 80% of their revenues that way. They have recently expanded into other lines of business that would make any loan shark proud -- retail micro-loans (i.e. payday loans), used auto loans (i.e. "buy here / pay here"), and buying and working off portfolios of previously charged-off receivables (i.e. AACC and PRAA). They have also expanded their credit card business to fee-based credit cards for the "underbanked" (i.e. ultra-low FICO scores and people with no credit).

You might wonder why a company would engage in these sketchy activities. One simple explanation may suffice -- their net interest margin has been between about 18-26% over the past couple of years. Compare this to your typical bank that might run a net interest margin of 2-4%. While the company deals with the dregs of the credit world, it's very profitable.

CCRT got mixed up in a hedge fund last year, much to its dismay. John Devaney runs a hedge fund named United Capital Markets that evidently plays with sub-prime CDO's and CMO's. Additionally, at the end of 2006, he owned just over 10% of CCRT (5,364,028 shares), and CCRT is one of his investors and significantly increased their investment in Sept 2006.

Devaney took heavy losses in Q2 2007 due to sub-prime problems, and prohibited investors (including CCRT) from redeeming their money. In Q2, CCRT revealed about $25M of losses related to this, and said the rest of their investment had an equity value of $45M. Further, on July 26 filed an amended 13G showing that his stake in CCRT was down to 2% of the company (now 1,186,449 shares). Apparently some of this was sold back to the company (one report said 2.8% of the company's shares). As of Q2 the company had bought back 5.5% of their stock. This hedge fund tango seems to be their total direct exposure to sub-prime mortgages, all of the rest of their assets are non-mortgage.

The financials are a blizzard of different segments, accounting treatments, one-time events, and partial ownerships, and are hard to get a handle on. One interesting figure is that the company has generated $482M cash from operations so far in 2007, compared to a market cap of $1.1 billion. This cash is exclusive of various provisions for loan losses which, while non-cash, certainly can't be ignored.

The delinquency rate on their assets is around 14%, up from 10% a couple of years ago. They say the reason for this increase is a shift in assets towards higher-margin, higher-delinquency products, such as the fee-based cards for the unbanked. So far they haven't shown any spikes in credit problems as a result of the general turmoil in sub-prime lending, but it will be interesting to see what they report in Q3.

Reported earnings are suppressed by non-cash provisions for loan losses, which again the company says are high because of both new assets coming on the books that require higher provisions, and a general trend away from securitized assets and towards on-balance sheet assets. They are showing accounting losses for 2007 so far despite the cash that has been generated. Basically, the accounting losses for certain assets are front-loaded, and as these assets become a greater portion of total assets, current earnings are distorted.

For anyone interested in any of these sub-prime or "unbanked" product categories, I think that CCRT is an interesting way to play the trend since they are active in all of them and have a pretty decent track record and growth trajectory. Management also owns a lot of stock.

Most of these stocks are trading off significantly, but so far it isn't clear that these companies will be negatively impacted by the current environment, and some may even see some benefits as there are increases in charged-off assets and sub-prime borrowers have fewer other sources of financing.

Here is a link to Tom Brown's presentation which gives a good overview:

http://www.bankstocks.com/images/valueinvestorBKS.ppt

T