Catching Javelins
By Tom Dyson
February 22, 2007

Dave Hennigan is a real estate broker in Southern California. He helps people sell their houses. A sale generates a 6% commission, which Hennigan splits with the buyer's agent.

I've heard there are 400 realtors on the small Floridian island where I live. Competition is brutal, and, to make things worse, no one is buying houses right now. I gather the situation in California is similar: Last year, 80 agents worked out of Hennigan's office. Now there are only 50... and half of them are inactive.

Here's the thing about Hennigan. While all his buddies sit around twiddling their thumbs and waiting for the phones to ring, Hennigan trawls through public records looking for people who are behind on their mortgage payments. Lenders usually start seizing houses after six months with no payments. Hennigan looks for people who are three months late, so they still own the house, but they're really starting to feel the heat.

When he's figured out their addresses, he pays them a visit. And he takes a buddy with him to sit in the car and keep the engine running in case someone comes out with a shotgun. Then he explains their options. They could refinance... and push the problem into the future… Or sell the house, pay back the loan, and move somewhere more affordable.

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"Why don't you make a fresh start?" he pushes them. "And I'll take care of the sale."

But there's one desperate character Herrigan won't touch... the guy whose house is worth less than the value of the loan. It's called negative equity. This guy has no incentive to sell his house or refinance. The best these guys can do – provided they don't care about their credit record – is walk away from the house and refuse to pay their loan back. Then the lender eats the loss.

Anyway, five months ago, Hennigan didn't even know what a default was and had only seen a couple of foreclosures. Now he's doing better than ever. "I'm giddy because I'm going to be so busy," he says.

In late 2004, Riverside, California – where Hennigan works – saw about five foreclosures a week, according to the Medford (Ore.) Mail Tribune. Now, there are 73 per week and rising.

So who's holding the bag? The over-leveraged homeowners, for one. They bought houses that were too big, using too much debt, and now they're drowning in interest payments.

But there's another big bagholder I'm interested in: The lenders. 

Bloomberg says 20 mortgage-lending companies have gone out of business in the last two months. Last night, another one got hammered. NovaStar Financial reported bad news after market close last night. Today, it's down 41%.

Subprime lending stocks tend to pay out enormous dividends, as many of them are structured as REITs. Since their stock prices have fallen so far, their dividend yields are among the largest you'll ever see... assuming current dividend payouts are maintained. For example, New Century (NEW) pays a 40% dividend yield. NovaStar (NFI) pays a 32% dividend yield. Last night, I found two others that pay more than 20%.

I suspect some of these lenders may go bankrupt. But where there's crisis, there's usually opportunity, too. Could there be a contrarian trade in this carnage, or are mortgage investors playing catch with javelins?

I intend to find out... and I'll report my results in these pages over the next few weeks.

Good investing, Tom Dyson