Journal Register Company's Conference Call

Journal Register Company (JRC) is a $96 million market cap newspaper publisher that owns 22 daily newspapers "strategically clustered in six geographic areas: Greater Philadelphia, Michigan, Connecticut, Greater Cleveland, and the Capital-Saratoga and Mid-Hudson regions of New York."

JRC caught my eye as a potential short for three reasons: dying business model (newspapers), dying distribution areas (the Rust Belt and especially Detroit), and troublesome financial metrics (high leverage).

The company has net tangible assets of negative $636 million, thanks to $650 million in long term debt and $726 million in goodwill from a string of acquisitions that don't seem to be paying off.

They were recently able to dump two daily community newspapers and five non-daily publications in New England on GateHouse Media for $70 million. The total daily circulation as of December 31, 2006 for the New England cluster was 56,779; a sales price of $1232/daily copy.

JRC presently has 559,000 daily circulation across all clusters, of which 132,992 is in the Michigan cluster. Assuming that all of the clusters could be sold for the same price/daily copy as the New England cluster would value the remaining clusters at $689M. That is below the current enterprise value of $743M.

On the call, the head of the Michigan operations volunteered that the Michigan economy is expected to improve in the 2nd half of 2008 and that this turnaround is "worth waiting for."

I wasn't the only one wondering just who is expecting a turnaround in Detroit, and when questioned about the optimism, the reason given was that "state leaders" are saying there will be a "turn."

I'm also not the only one who thinks that promising results in the second half of next year is just a less-embarrassing way of saying "I don't know."

When another analyst asked what will happen if Michigan doesn't "turn," the man in charge of the Michigan cluster said that it's "way too soon to be thinking about what to do" if Michigan doesn't turn around.

Keep in mind that the Michigan cluster is principally in the environs of Detroit, the city whose population peaked in 1950 at 1.850 million and is now around 900,000.

As Vinny Mattone, quoted in When Genius Failed, said about Long Term Capital Management,
"When you're down by half, people figure you can go down all the way. They're going to push the market against you. They're not going to roll your trades. You're finished."

Or, perhaps even more aptly, a cancer that causes a patient to lose the majority of their weight is inevitably fatal.

The mechanism for this is in a city is a kind of positive feedback loop: as factories and jobs disappear, so do people, and the city's tax revenue base contracts. This tax loss leads to neglect of infrastructure and higher tax rates, motivating more people and businesses to leave.

Also, the people, businesses, and institutions that are left in Detroit are negatively selected to be those that couldn't figure out how to leave. It's difficult to imagine them turning the ship around, especially since the state government just passed tax increases.

[If you have lingering optimism, do a Google search for "Detroit ruins" and see how the city is reverting to wilderness. Property owners default and the properties get quit-claimed from government agency to agency on down to the city, which demolishes the buildings. They plow the bricks and debris into the basement before filling it in with dirt - the land development equivalent of salting the earth.]

I discuss Detroit in such detail because it shows that management must be delusional or just biding their time if they believe it's "way too soon" to start planning what to do if Detroit enters its 58th year of decline.

You might think that the Michigan cluster was a legacy from a more promising time, but the boondoggle (the former 21st Century Newspaper group) was actually bought by the Company in 2004 for $415m. That was a total cost of $3,000 per paid daily subscriber. They sunk a further $23m in cap-ex into the four daily papers and 87 weeklies.

For the past several quarters, management has reported their advertising sales declines both with and without Michigan, because it is such a drag on revenue and profitability.

Speaking of sales numbers from management; they will no longer provide monthly revenue reports. Nor are they giving any guidance. Also, the dividend is being suspended.

If I was an activist investor, I would try to get management to sell the Michigan papers. It just seems like loss aversion to keep hanging on to them and deny the decline of Detroit.

Weekend Roundup: Standard Pacific, Dollar Lows, Phoenix Residential Stagnation

Quick facts before the weekend:

• Dollar index hit an all time low today. It has lost about 3% since the September rate cut. I am long Euros through FXE, which is yielding 3.36%.
  
• Someone from a Standard Pacific Homes IP address just did a Google search for "standard pacific bankruptcy." For those of you new to the site, Credit Bubble Stocks does offer continuing coverage of Standard Pacific. I have continually rated SPF a "sell" since March and still own the puts. The homebuilder stocks rallied today on the strength of a 12% rise in orders at NVR. Points:
  
• A 12% rise in orders is not that meaningful. How many will close?
• NVR is the best positioned builder. Their slight strength doesn't imply anything about SPF. They build in practically opposite markets. I bought puts into the SPF and Beazer strength today.
  
• Valley resale market enters holiday slowdown. Matches the projection from my October 3 post, meaning that Phoenix metro has a massive inventory overhang.
  

Downey Financial Pessimism Beginning to be Vindicated

Downey Announces Third Quarter 2007 Results

Here is a graph of the dollar amount of delinquent loans, which are loans less than 90-days past due. (And, therefore, still considered performing.)

Look how sharply the 30-59 day delinquencies are up this quarter. Expect the 60-89 day delinquency series to snap upward in coming quarters, as they lag the 30-59 day series.

This increase in delinquencies has been driving the increase in non-performing assets (NPAs).

The exponential trend appears to be continuing unabated.

As I have explained previously, NPAs are calculated as a percentage of total assets. But not all of a bank's assets are loans. So, to make the NPA statistic more easily comparable, you can back out Downey's cash, investment securities, FHLB stock, and other assets that are not loans from the calculation.

This graph shows NPAs as a percentage of only loans. It reveals that calculating NPAs as a percentage of total assets has been steadily understating the increase.

In my previous post on Downey, I mentioned my surprise at an analyst who thinks this quarter's loss provision is "being made to avoid having to make other large provisions in future quarters." In other words, he thinks this is a one-time-only increase in the loss provision.

But take a look at Downey's loss allowance as a percentage of non-accrual loans:

Their loss allowance is substantially lagging the increases in non-accrual loans. This is in an environment where the Southwestern U.S. real estate markets get worse every month.

In other words, I think that Downey will be posting loss allowances at least this big in quarters to come.

Two other pieces of bad news:

• an increase of $3.5 million in net operations of real estate acquired in the settlement of loans due to a higher number of foreclosed properties, including 113 single family lots acquired through foreclosure of a land loan during the quarter
• The amount of negative amortization included in loan balances increased $11 million during the current quarter to $388 million or 4.70% of loans subject to negative amortization. During the current quarter, approximately 26% of loan interest income represented negative amortization, down from 29% in the second quarter of 2007 and 28% in the year-ago third quarter.

I continue to be short Downey Financial (DSL).

Downey Financial (DSL) Warning Shouldn't Come as a Surprise

This morning Downey warned that it will suffer a third quarter operating loss. The cause:

• An approximate $82 million provision for credit losses, which will increase the allowance for loan losses to approximately $144 million or 1.22% of loans held for investment.
• An approximate $9 million valuation reduction to real estate held for development to reflect declines in the value of single family home lots in which the company is a joint venture partner.

As a result, single family loan delinquencies, as well as losses from foreclosures, rose significantly during the third quarter and led to this quarter's large increase to the allowance for losses.

The loss evidently caught analysts by surprise.

The ramping up of loss provisions is not much of a surprise, but the size and acceleration of the increase was greater than expected, RiskMetrics Group analyst Zach Gast said.

The $82 million provision is likely being made to avoid having to make other large provisions in future quarters, Gast said. Gast is forecasting Downey Financial's loss provision in the fourth quarter will be closer to first quarter provision, which were less than $1 million.

Previously on Credit Bubble Stocks, I noted that Downey Financial's Non-Performing Assets were Increasing Exponentially. (That's part of my continuing coverage of Downey.)

I can't see how any analyst could look at this graph and be surprised by the size and increase in credit loss provisions. You can see it is following an exponential function very closely: the number of months it takes for non-performing assets to cross a threshold keeps decreasing.

I disagree with Mr. Gast's forecast that there will be a negligible increase in loss provisions in the 4th quarter for two reasons:

• First, they are probably under reserving for loan losses. On Aug 31, their NPA's were 1.96% or about $282 million but their provision is only going to be 1.22% or $144 million. That's in the face of increasing foreclosures and decreasing property values.
  
• Second, there is nothing to indicate that this or any other piece of bad Downey news is an outlier. The exponential trend is consistent with worsening anecdotal reports and broader market statistics.
  

At this time, I would also like to point out that Downey is down 18% since I recommended selling it in March. Also, here is its performance since I released my analysis of exponential NPA trends on September 19.



If you are trading Downey, I recommend that you subscribe to this blog, as we have a regular early-warning report on Downey's non-performing assets. It has proven to be a great leading indicator.

Mr. Gast actually put it pretty well himself in February:

“When there is good home price appreciation, you can get away with a lot of mistakes, but home price appreciation has stopped.

No Bids for SoCal Land

This is an interview published on the OC Register site with Tom Reimers, executive VP at land broker O’Donnell/Atkins from Irvine.

What’s the market for raw land in SoCal and Orange County today? What’s the outlook?
Tom: In general, the residential raw land market is non-existent. Land values and deal flow for other types of product are more stable right now, but the credit/financing crunch is squeezing those values as well.

How are prices?
Tom: It’s hard to say. With few to no buyers, it’s hard to say what land is worth. There are no transactions to set a benchmark. In some tertiary markets, the land is worthless from a residential development standpoint due to costs to develop being higher than the land value.

Related: Homebuilders Liquidate Assets in Desperation Sales.

Hovnanian spokesman Jeff O'Keefe said the company offered discounts as high as 30 percent.

D.R. Horton also threw in a washer-dryer and $2,500 toward closing costs, Moran said.

``Adding a credit toward closing costs still allows them to show the highest selling price they can,'' Moran said.

Next, Mortgage Slump Hits Home Decor Industry.

At the Annual Furniture Mart, Worried Manufacturers See the Mortgage Slump's Effects.

HIGH POINT, N.C. (AP) -- Doug Schock shook his head in disbelief while gazing at the empty bank of elevators, typically full as they shuttle thousands of buyers between dozens of showrooms filled with the latest styles in sofas, bedroom sets, and dining room tables and chairs.

Phoenix Inventory Explodes in September

Bubble Markets Inventory Tracking (BMIT) reports that Phoenix has "officially reached beyond the prior population adjusted inventory record of 65,079 set back in 1995. Current inventory is at 66,229 SFR, condos, MFR, and land parcels." BMIT is an essential blog to read.

According to Housing Doom, Phoenix metro home sales were 3,176 as of September 29, with one day left in the month and probably a several day lag before sales are reported.

Key points:

• If September sales total 3250, that is a drop of 25% month-to-month and 46% year-over-year.
• Assuming those sales, that is over 20 months of inventory.

Las Vegas inventory is also 20 months. Orange County is 8.8 months.

Need I mention that these are Standard Pacific markets?

Debunking Another Absurd Stephen Kim Homebuilder Rally

Wondering why the homebuilders are up huge this week? Surprisingly simple explanation:

NEW YORK (AP) -- Housing stocks rallied for a third consecutive day Wednesday, as sentiment increased that the long-battered shares may have reached a bottom, even if the beleaguered housing market has not. With no industry data to guide them, investors appear to be taking their cue from an analyst who earlier in the week upgraded the entire sector.

Citigroup Global Markets analyst Stephen Kim wrote in a client report Monday he does not foresee the stocks falling much more. However, he does not expect conditions in the industry to improve anytime soon.

"We are not trying to suggest that trends in the homebuilding sector are about to get much better," he said. "It is precisely when things have gotten this bad that the stocks start looking good."

For a moment, I thought I had been transported back in time to December 6, 2006, date of a previous Stephen Kim research report.

Citigroup recommended that investors buy shares of homebuilders now as order trends are expected to turn positive in the first quarter of 2007. "While many wait for an improvement in fundamental data such as prices or inventory to signal an 'entry point' in the stocks, we urge investors to look back to prior cycles, when the group rallied far ahead of fundamentals," Citigroup analyst Stephen Kim said in a research note. The brokerage firm raised its price targets on the following companies:

Pulte Homes Inc. - $45 [now $16.25, off by 64%]
D.R.Horton Inc. - $48 [now $14.84, off by 69%]
Lennar Corp. - $88 [now $25.90, off by 71%]
Centex Corp. - $83 [now $29.28, off by 65%]
Toll Brothers Inc. - $42 [now $22.79, off by 45%]
KB Home - $92 [now $28.60, off by 69%]
MDC Holdings Inc. - $85 [now $43.52, off by 49%]
Ryland Group - $95 [now $25.5, off by 73%]
Beazer Homes USA Inc. - $80 [now $10.08, off by 87%]
Hovnanian Enterprises Inc. - $63 [now $13, off by 79%]
Standard Pacific Corp. - $43 [now $6.24, off by 85%]
Meritage Homes Corp. - $87 [now $16.62, off by 81%]
Technical Olympic USA Inc. - $18 [now $1.94, off by 89%]

Stephen Kim sounds like a guy you should listen to if you want to lose two-thirds of your money.

Here's how the builders have done since he called the bottom on December 6, 2006:


See that tiny blip upwards on the very far left? That was the effect of his report. The bullishness carried through until it became clear that the "spring selling (buying?) season" was never going to materialize.

I worked in the industry and I remember what people were thinking. They honestly thought that spring of 2007 would come and the real estate market would kick right back into high gear.

That didn't happen, and now there are key problems that make it even less likely that we have reached the bottom of the housing market.

• Lending is tight. Homebuilders do great when there is no-questions-asked lending.
  
• Prices are still too high. High relative to rents, high relative to median incomes, high relative to other goods' historical increases, high relative to building costs. They need to come down much further - and the Case-Shiller HPI futures markets are predicting it.
• Inventory is huge in absolute numbers and in number of months' sales, and keeps getting bigger by both measures.
  

Given these challenges, and the tarnished balance sheets of the builders (with high debt, loads of difficult to sell homes, staggering amounts of lots and land, and problematic off-balance sheet vehicles loaded with land and debt), it's unlikely that the builders' stocks have reached bottom.

Mr. Kim: We have not reached the end of the housing bust. We are only now reaching "the end of the beginning."