H&R Bullet Proof and the Problems with Going Short

My two vicarious mentors, Warren Buffett and Charlie Munger have both strongly advised against shorting. ( betting that a stock will decline). Charlie has gone so far as to call it a miserable way to live, given the fact that an investor can be exactly correct that a particular company or management can be a complete fraud while being a very good fraud. All the while the investor that has shorted the fraud is paying dividends on the borrowed shares or suffering the eroding time premium associated with long dated put options



It is extremely rare that I ever short anything. The mortgage and real estate related space is the one area where I have made an exception due to my industry "insider" status and confidence I have in my insights.I have taken a few very small positions via some put options ( LEAPS) as a hedge to my mortgage income and to keep from sticking a fork in my forehead as things seem to unravel exactly as myself and my mortgage buddies have envisioned



Well, every once and a while the student has to learn by first hand experience, which is also a nice way of saying that the young wannabe needs to get his ass kicked to learn the lesson for himself. Although it has been a mild ass kicking, that is exactly what seems to be happening here with HRB and it's Option One Mortgage division.


I shorted Block for many sound reasons, which would all largely seem to have come to fruition....Yet, the stock has barely budged. At 12/31/06 it stood at $23. After a horrendous Q4 which has effectively wiped out the entire years worth of earnings...and after lowering guidance for 2008....it stands at 22.04 after today's close.


Here are a few highlights of this mornings pre-opening conference call which initially had me doing the happy feet thing:

• $960 mm Pre Tax Loss. $808mm after tax loss from all "discontinued operations". <$2.48> per diluted share


• Q4 Net gain on sale margin of -687 basis points (yes, that is a negative sign)


• Impairments charges and additional reserves galore due to loan repurchases and a highly unfavorable market for "scratch and dent" loans. They are experiencing higher loss severity on many foreclosure's


• The warehouse lines covenants have been breached, although they have obtained waivers due to the pending sale
• The $700 mm they had hoped to "redeploy" to share repurchases after the sale of OOMC has essentially evaporated
• H&R Bank has fallen below the minimum capital threshold guidelines of the OTS and will not be able to be in compliance until at least the end of Q4 2008
• Book value is very likely to be continuing to decline and the sale price is a moving target. The closing will not take place until Q2 2008 which ends 10/31/07.

The stock trades at 18x the low end of next years optimistic guidance after all of the above.

I have had more success with my other 'basket case' of real estate and mortgage shorts, but all in all it has not been worth the argeda or the time and effort. The satisfaction of my investment thesis being correct has been over shadowed by being on the wrong end of a manic depressive Mr. Market, who refuses to be pessimistic enough given the circumstances.

So there you have it boys and girls. Eat your spinach, don't race trains to the cross roads and pay attention to your elders wise advice.