20% maybe too high, what number do you suggest? I am sure 0% is not a good number since we know SFI is very likely to add more NPL in the coming quarters.
Most companies have increasing loss reserve last quarter, not just SFI, so the environment was not getting better in Q2.
If you start with the book value and book value per share, you can easily make a good case. Before lehman collapses, its book value is 30 bucks per share. The problem is leverage. If the book value per share is 100 buck per share and trading at 1 per share, is it a good deal? No if the asset is 10,000 per share.
Your value of $10 per share means $1 billion in equity. Since the performing portfolio + CTL + REO is a little bit over $9 billion, a 10% error is enough to wipe you out. Remember, you assumed there is 0% discount of the performing loan, which I think is unlikely and will dip into your 10% cushion.
Maybe 3%, or an additional ~$200MM. These are performing loans with some seasoning now and SFI has been watching them closely for 18-24 months. If 10% of the $5.8B of performers go bad and you have to reserve/writeoff 30% of the balance, that gets you 3% required reserve or $200MM.
I am hopeful that any additional reserves/losses (there will be some) are close to being offset by discounted bond purchases. We shall see.
I totally agree with your point about the high leverage. This is a high risk equity investment and because of the high leverage, small swings in performance have a big effect on the equity value. That's why a $3/sh. price is sometimes compared to $10/adjusted book, or in some eyes $15-$17/BV, or even higher for some folks. The leverage adds risk here but also contributes to potential reward. I try to get comfortable with the risk by watching the company closely, but there are disclosure limits and watching closely will only take you so far.
Lehman is an interesting comparison-- I think they flat out lied when they gave marks on big troubled parts of their portfolio (including commercial real estate) and that came home to roost when BV turned out to be unrelated to true equity value. I've been following SFI for a little while now and I don't think they are flat out lying about asset values.
Lehman was also 30x levered and short term funded.
One of the important aspects of the macro environment improving is that it facilitates the liquidity (at whatever price) of assets - NPL, REO and perfomring, that SFI might need to sell to accomodate uses.
When SFI bought the fremont portfolio, it gets a 3% discount and the portfolio looks awesome at that moment. If you apply the same 3% discount in current environment, it seems to be a little bit aggressive. Well, as long as you don't put substantial money on this, it's alright.
Btw, your initial number $17 per common share is probably wrong because while the book value is 2 billion, the preferred is 550 million. So the common book value per share needs to start with $15. After your calculation, the adjusted book value becomes $8 per share.
While SFI doesn't need to liquidate its whole portfolio, it needs to keep liquidating it until at least 2010 because of its funding gap. It's pretty reasonable to say it can only get 80 cents of a dollar for performing loan sale now. Of course, you can always argue that the loss can be offset by discount bond purchase. But then, the bond purchase needs cash and you need to further liquidate the portfolio. It's tough math!