Although short selling -- the practice of selling borrowed shares with the hope of repaying the loan by buying back the shares at a lower price -- goes against the American belief that stocks always go up, I have long been fascinated with it. Short Stories discusses what works, what doesn't, and what some of the leading lights in shorting stocks think about its opportunities and threats. I describe possible short trades and seek your comments and questions for story ideas. I don't offer any investment advice and I don't trade on any of the posts I write.
Last night Bloomberg News reported that American Home Mortgage Investment Corp (NYSE: AHM), which catered to borrowers with good credit, would file for bankruptcy -- possibly August 6th -- a few days after it shut down most of its operations. This week American Home stopped making loans and fired 90% of its 7,000 employees after a surge in borrower defaults prompted investment banks to quit extending credit.
This suggests that NovaStar Financial (NYSE: NFI) which I suggested shorting last December at a split-adjusted price of $116 could soon follow suit. That's because on Friday, according to Reuters, NovaStar -- which specializes in subprime mortgages -- announced to brokers that it would stop funding certain mortgages "temporarily." This is a less extreme version of what American Home did earlier this week.
So despite receiving a $150 million equity infusion last month, NovaStar's bankers may decide not to throw more good money after bad and pull its credit just as American Home's bankers did.
If NovaStar does file for bankruptcy, it will make itself into an object lesson in how to short a stock successfully. The basic lesson is to look for a company that owes more money than it can pay back. In NovaStar's case that looked like a good bet last December.
If an acquirer steps in at Friday's after-hours price of $5.74, then the short position -- though up 1,921% -- will be a bit less valuable than if NovaStar files for bankruptcy.
Update: This morning's Kansas City Star reports that Friedman Billings Ramsey analyst Scott Valentin cut his target price for NovaStar to zero -- it is currently trading at $4.39. So if you covered a short position initiated last December, you could realize a 2,542% return on your investment.
Peter Cohan is President of Peter S. Cohan & Associates, a management consulting and venture capital firm. He also teaches management at Babson College and edits The Cohan Letter. He has no financial interest in American Home or NovaStar.
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Reader Comments (Page 1 of 1)
8-07-2007 @ 9:22AM
Marisol Cantina said...
What would happen is Novastar goes into bankruptsy will the previous home loans be paid off?
8-08-2007 @ 4:17AM
NFI/HomeView said...
As a former employee of NFI, under HomeView Lending (for 2 months), it almost seems like they are trying to gain captial just to keep the stock from going to ZERO and filing for a B/K. Almost like they want to get the price back above a certain amount so they can sell it back to the company. The executives of NFI it seems are doing this. Though I was just a grunt on the sales floor, the executives could be seen taking very long lunches and pretty much just drifting around the office in Lake Forrest as like they had nothing better to do. This partically went on for the 2 months when I was there. March to end of May. I decided to resign from the company because of the confusion and inexperience of it's operations and management. The underwriting staff is fairly inexperienced and overly paranoid. The mindset is we'll do loans, but want to do 80% LTV deals with high FICO, good credit depth. Which I cant blame them, but the rates they are offering the homeowner through the brokers is plain out sad. It's as close as you can get to a HARD MONEY rate without calling it a hard money loan. So greed and poor managament and direction have caused NFI and all it's sister companies its doom. Im still confused on how Wachovia and MassMutual would even consider investing in NFI, unless it wanted to get into the mortagage industry and basically clean NFI, HomeView, and Acceleron out and start it up again with new entire staff of management, sales, and operations people. Oh ya and most importantly a new name =)
8-10-2007 @ 11:01AM
Debra said...
I am in the proc of refinancing, but in Pre forclosure on my home. If Novastr files BK can they continue with the forclosure on my home?
9-05-2007 @ 4:05PM
Thomas Martin said...
We have the National Mortgage Complaint Center & we would like to hear from any former employee.
9-05-2007 @ 4:07PM
Americas Watchdog said...
We have the National Mortgage Complaint Center & we would like to hear from former employees about this company.