When Mohnish Pabrai increased his bet on Delta Financial Corp. last summer, taking part in a $70 million bailout of the troubled mortgage lender, he did so thinking that Delta had a floor. “The mark-to-market value of its assets exceeded its stock price, and it had an earnings engine,” says Pabrai, a value investor who has fashioned himself after Berkshire Hathaway chairman and CEO Warren Buffett. Unfortunately for Pabrai, in December the lender crashed through its floor.
Alpha first chronicled Pabrai’s investment in Delta last fall (“The Oracle of Irvine,” October 2007). At the time, it remained uncertain how his 28 percent ownership of the Woodbury, New York–based lender would play out. Pabrai had already stepped up once to defend his position — which at more than 4.6 million shares of Delta represented roughly 10 percent of his portfolio — as the subprime crisis took its toll on the company. In August, instead of dumping his stake in Delta when its shares fell to $5 — close to half what he’d paid — Pabrai joined New York–based hedge fund firm Angelo, Gordon & Co., Delta’s second-largest shareholder, in a rescue effort. Pabrai bought $10 million in convertible notes, which he soon after converted into 2 million shares at $5 each, while Angelo Gordon purchased $60 million in warrants.
But the emergency cash infusion only prolonged the inevitable. In November, Delta fired most of its 1,395 employees; the following month it filed for bankruptcy. Pabrai sold the bulk of his shares for 26 cents or less, amounting to a loss of roughly $50 million.
Pabrai had believed that Delta would be able to escape the carnage because it made only fixed-rate subprime loans. It didn’t offer adjustable-rate products, which triggered most of 2007’s delinquencies and foreclosures by its competitors. But investors made little distinction. When the market for repackaged subprime home mortgages disappeared, so too did investors willing to buy Delta’s loans.
Pabrai says the shutdown of the subprime mortgage market was totally irrational and that it was a logical assumption to think it would return.
“It made perfect sense for me to make that bet,” says Pabrai. “The odds were overwhelming that I would beat the dealer.” He adds that any stock has the potential to fall to zero. “The market is a game of probabilities,” he explains. “We make bets when the odds are in our favor.”
Pabrai would not give specifics about his overall 2007 performance but says losses in Delta had little impact on his portfolio and that he has received only two e-mails from worried clients — a group comprising mostly relatives, friends and business associates. According to regulatory filings for his Irvine, California–based Pabrai Investment Funds, which manages one domestic and two offshore hedge funds, the firm’s assets declined 3.5 percent from $469 million in 2007’s second quarter to $453 million in the third quarter.
