Doral Financial DRL

Doral Financial (DRL) is a bank with two divisions, Puerto Rico and the USA. The company has had a slew of issues since 2004. The thought process behind examining this bank is simple: it's way to cheap if it's solvent enough to stay in business.

The table below shows just how cheap the company is compared to it's peers in Puerto Rico

Table 1. Silly Ratio Analysis

As the title indicates, the ratio analysis does little beyond tell you that the company is cheap. So let's look at the reasons it is cheap.

History

Like many fantastic organizations in the credit bubble, Doral took a very proactive stance to loan underwriting. By proactive I mean they would issue a loan to anyone with a pulse (and likely a few people without one).

Even better, the company was able to use creative gain-on-sale accounting to inflate income by almost $1 billion. The company also had managers who creatively valued interest-only strips. All this creativity caused the company share price to plummet.

All of this happened before 2005 and here we are in 2013 and the company is still dramatically cheaper than peers, who have all, in theory, improved their metrics. In fact, Doral ongoing struggles were even mentioned (not directly) in the Q4 2012 OFG Conference Call. Becoming a better bank rests on the belief that the newly created subsidiary, Doral Recovery, can manage the high number of non-performing assets and loans.

Doral Recovery

There are three main sections to Doral Financial. Doral Bank, Doral Insurance, and Doral Recovery. The corporate structure can be seen in the well-drawn flow chart below. My wife is an artist, I clearly am not.

Doral Corporate Structure

 

Doral Recovery was created in March of 2013 to manage

"The credit costs related to Puerto Rico TDRs and non-performing assets are the largest drag on our earnings. They need special attention, so we've established a special servicing capability; we call it Doral Recovery. The purpose of Doral Recovery is to isolate, manage, and resolve these assets." -Glen Wakeman Q4 2012 Earnings Call

 This isn't a new strategy, but what exactly are those assets?

Well from their Q4 presentation we can see that there is $699M of residential loans(43% of loans are performing), $525M of CRE, $127M of C&I, $111M of mortgage and Commercial OREO, and $147M of Construction and Land for a total of $1,609M in Recovery. The table below shows how they are performing. 

Doral Recovery Performing Loans

Therefore, there are at least $742M of non-performing loans in Recovery. On page 125/126 of their most recent 10K they list total non-performing assets and loans. Also on page 125 there are $111.9M of OREO NPLs. Grand total there are $894.8M of Non-performing Assets (NPA).

Clearly this is what the market is concerned about, and rightly so. But how much bad news is there?

Impact on Book Value

Book value was $835M at the end of the year. The allowance for loan and lease losses was $135.3M (pg 63 10K). Adding that non-cash figure back we get an pre-allowance BV of $1.011B. 

Let us assume that all non-performing assets are worth exactly zero. 

$1,011M - $894.8M = $116.2M (conservative) BV

That is BV to equity though and there is $352M of preferred shares out there (current liquidation value found on F-3 2012 10K). So in order for common equity to have any value the preferred needs to be made whole. Which means that Mr. Market thinks there is more than $236M ($352M-$116M) of value in those non-performing assets since the common shares are not a zero.

Just two weeks ago FBP announced a sale of loans to Lone Star Funds where they received 38% of their unpaid balance. This was for commercial and construction loans. Below I've shown a brief recovery analysis for Doral's NPA. 

Currently the common is $0.81/share, which implies a market cap of  $104M (128.44 shares outstanding). So Mr. Market believes that those loans will be able to recover $340, or 38%, of the NPA balance ($236M of preferred liquidation to make up and then $104M of common equity).

To me that says the market is pricing this well on the equity side and poorly on the side of the preferred, which are all trading below liquidation value. Next steps include understanding the preferred structure and determining a fair value for Good Bank Vs. Bad Bank.

Miscellaneous Thoughts

-Out of their $4.56B of deposits $2.12B are brokered deposits. I'm not a fan of it being this high.