Entrust
Financial Services Is A Potential
Cash Cow With Strong Growth Possibilities
by Richard Geist, editor
Richard Geist's Strategic Investing
We
continue to believe this is bottoming out. The internal dynamics
of the markets as well as the economy remains strong enough to
stimulate a recovery, which should become apparent in the second
half. While we can't predict the exact timing of a turnaround,
we believe strongly that as long as you keep plenty of cash on
hand now is the time to be picking up bargains.
I believe we've discovered
another unknown, undervalued bargain Entrust Financial Services,
Inc. (OTC BB ENFN www.entrustfs.com, a small mortgage-banking
firm that focuses on the non-conforming loan market. The Company
is a potential cash cow with strong growth possibilities.
Entrust is licensed
to do business as a mortgage banker in 40 states and has developed
ongoing relationships with brokers at more than 6,500 mortgage
loan broker offices. Currently they are doing active business
with about 300 400 of them, and therefore the company has substantial
room for growth.
Non-Conforming Loans
Entrust
specializes in non-conforming loans. These are customers who
have creditworthiness of the conforming borrower (those that
meet the Federal National Mortgage Association (FNMA) or Freddie
Mac underwriting guidelines, but for whatever reason may not
meet a particular criterion. For example, a typical loan might
be for a self-employed borrower with good credit, but he/she
runs expenses through the business and cannot prove with tax
returns that he really makes the money he does. What this means
for Entrust is that their clients are above the sub prime market
and nearly as good as conforming paper, but with much higher
yields to the company from a profitability perspective.
Because of the unique
circumstances of the non-conforming loan market clients, Entrust
writes loans at a significantly higher uptick from the conforming
market. Conforming markets work on a margin of 3/4 of a point
whereas Entrust works on a margin of about 250 basis points.
In addition Entrust concentrates on real estate transactions,
using mortgage brokers as their clients. These mortgage brokers
spend their marketing dollars to bring borrowers to the table
and Entrust funds the transaction. The Company's focus on real
estate transactions rather than refinancing means that they have
a more stable business relative to interest rate swings.
Automated Underwriting System
Entrust incorporates traditional marketing with a web based, proprietary automated underwriting system that allows mortgage broker clientele to process loan applications 24 hours per day, 7 days per week. Entrust has in essence created a rule based engine for the non-conforming market that is integrated with their loan origination system and sales prospecting system.
On the front end, mortgage brokers are able to meet with a client, get information from them, and within one minute realize whether they have a deal that's targeted for Entrust. On the back end, for Entrust the system filters out the loans that should never have been considered by the Company, thereby creating economies of efficiency so that the company's pull through on these loans is much higher than their competition, while the costs are lower.
Construction Loan Program
Because of management's experience in the manufactured modular home business, they have created a product that funds the construction process, including the purchase of the land, and then converts into a permanent financing that Entrust sells directly to Wall Street. While there are some construction to perm programs in existence, they are generally for stock built homes only, they have lower loan to value than Entrust offers, and usually do not include the purchase of the land. In most circumstances a borrower would have to be sophisticated financially with excellent credit in order to go through the process of buying the land, coordinating items, finishing the project and then securing permanent financing. Entrust bridges the gap by providing one stop shopping for such loans. The construction loan program is a retail direct product with no mortgage brokers. It is marketed to manufactured housing developers and manufacturers who then refer borrowers to Entrust. In addition Entrust's partner in the project has indemnified them against any buyback obligations. So the new program is essentially a customer direct type business with an insurance policy.
Industry
The United States has total outstanding mortgages exceeding $4 trillion, half of which is in the non-conforming market. Mortgage market growth has been driven by loan origination volume that is estimated to have been in excess of $1.5 trillion in 2001. The business is highly fragmented with over 20,000 mortgage loan originators operating in the 50 states and territories. In fact, the ten largest mortgage originators in the U.S. constitute less than 40% of the total mortgage loan market and no single originator holds a market share exceeding 8%. Independent sources project that the online mortgage market will reach $300 billion within the next five years in the U.S.
Competition
Entrust has a small piece of the $2 trillion non-conforming loan market, which leaves much room for growth. This is particularly true because of the fragmented nature of the market. The single largest competitor is Washington Mutual, which writes about $70 billion per quarter. Other large competitors include Greenpoint and Novastar. Management feels that they can compete on both service and technology. In addition they have a direct conduit to Wall Street, which has approved their guidelines. This means that anything the company writes within those guidelines is automatically purchases in the secondary market and securitized.
Revenues
Entrust's revenues are derived from three sources: fees, interest, and selling mortgages into the secondary market. The majority of revenues emanates from selling mortgages into the secondary market. With niche loan products such as no income verification loans with preferential interest rates and high loan to value mortgages, the company is able to sell its non-conforming mortgages in the secondary market at substantially higher prices than other mortgage lenders who market conforming mortgages. Unlike some of the other large mortgage bankers, Entrust does not manage or service a portfolio. All mortgages are sold.
Financials
Entrust
is approaching its fifth straight profitable quarter. For the
quarter ended March 31, 2002 Entrust reported revenues of $2.9
million, up 66% from the previous year's first quarter revenues
of $1.7 million. Net profit was $201,228 or $0.09 per share compared
to a loss of $137,105 or a loss of $0.07 per share. Management
is projecting revenues of approximately $20 million for 2002
with close to $1 per share in earnings. For fiscal 2003, the
company expects to double revenues to $40 million and increase
earnings per share to about $1.25 per share. Entrust currently
has approximately $2.7 million in tax loss carry forwards, which
will be used up in 2002. These figures are based on the company's
assumptions that they can do $40 million a month in loans by
the end of this year (double where they are presently) and $80
million per month in loans by the end of 2003.
The balance sheet at
the end of the first quarter included cash of $1.2 million, working
capital of $1.8 million, with a current ratio of 1.15. The company
has no long-term debt and stockholders' equity of $3.9 million.
Intangible assets were $1.6 million and include $1.2 million
for client contracts with the 6,500 brokers and the remainder
for state licensing. Assuming the company meets its target projections
for the year, their return on equity will be about 100%. The
high return on equity is a function of turnover of loans, so
the higher the volume the greater the return on equity. In addition,
because the company specializes in loans between $150 - $250
thousand, the high volume keeps their exposure against defaults
low. Forward 2002 P/E is a mere 2.5, and prices to sales is .37,
which makes this an extremely undervalued stock if you assume
the company can meet their 2002 projections. Insiders own approximately
36%. We also expect the company to make an application to a major
exchange within the coming months.
Risks
While
the current stock price offers you an excellent margin of safety
(based on current projections), there are risks you should consider.
First, this is a relatively new company, and we don't have a
long history of performance data to rely on. Second, despite
being partially protected against interest rate increases by
virtue of focusing on real estate transactions rather than refinancing,
a sharp increase in interest rates or a collapse of the real
estate market would affect the volume of loan applications. Third,
the company's growth depends on Americans' continuing their pattern
of changing addresses. Finally, management must be capable of
managing the rapid growth that we expect from this company. A
general risk for the industry is predatory lending legislation,
but because Entrust is not in the sub prime loan market, we don't
expect them to be affected by that legislation.
Entrust is growing
rapidly, occupies a niche that we believe will continue to expand,
has the potential to be a cash cow, and should be favorably impacted
by the market moving more to securitized mortgage backed securities
(because they are backed by hard assets). Given these considerations,
we believe the current stock price offers a solid margin of safety
in a difficult stock market environment.
Editor's Note: Richard
Geist is editor of Richard Geist's Strategic Investing, 1905
Beacon St., Waban, MA 02468. Monthly, 1 year, $157. Geist culls
through thousands of small-cap and micro-cap investment opportunities
to select only a few, each possessing those unique investment
qualities likely to propel a reasonable investment into a lifetime
fortune.
