Citron Updates Home Solutions of America … The Bank Speaks.

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It is beyond debate that Home Solutions of America is facing a cash crunch. We have seen many public criticisms of their constant late or non-payment of subcontractors, while lawsuits and liens keep piling up.

http://pubrec3.hillsclerk.com/oncore/search.aspx?bd=10%2F4%2F2007&ed=10%2F22%2F2007&n=marshall%20investments&bt=O&d=10%2F22%2F2007&pt=-1&dt=ALL%20DOCUMENT%20TYPES&st=fullname

Its lifeline for survival its bank line of credit, collateralized by its receivables, as structured by Texas Capital Bank. Until last week, we were in the dark about the real status of the loan.

What we knew was that the loan was not in default; the company has made all of its interest payments without paying down any principal. We also knew that the company stated it was looking for a new credit facility. And most importantly, we had clues of behind the scenes disagreement with the bank about the company’s attempt to renegotiate terms of the loan, with regard to the company’s largest receivable – an insurance claim in the hands of a state agency (FIGA).

What makes this loan so interesting to assessing HSOA is that, beyond being the company’s only visible source of liquidity, it is a window into the quality of receivables, which has been in question since they started to balloon over a year ago. This uncertainty set the stage for a question during Texas Capital Bank’s conference call last week.

Takin’ it to the Bank

Well, it seemed that the one question on the conference call was enough to stimulate TCBI’s two main covering analysts to follow-up conversations with the bank about the risks to the bank from of this loan to HSOA.

On the conference call itself, TCBI’s CEO simply declined to discuss the HSOA loan in detail because Home Solutions is a public company. But that question was enough for their analysts to explore further. In a note put out by JP Morgan we read:

“TCBI arranged a $60mil credit facility to Home Solutions (a struggling restoration/rebuilding co. based in Dallas) … (TCBI could hold a 50% participation).”

“Struggling”? Who says they are struggling? Where does JP Morgan reach that conclusion, when Fradella and crew tell you business has never been better? It appears to Citron that the JP Morgan analyst must have scanned HSOA’s balance sheet for one second, before he assessed them to be struggling.

Furthermore we learn from this note that while the company is not in default on the loan, TCBI has already allocated a portion of reserve for potential loss on the loan.  As the analyst note states after speaking to management they feel confident that the credit will be resolved in the near future.  Resolved?  What is there to be resolved?  The line of Credit is good until November 1, 2009…why does it have to get resolved in the near future? 

 Why is this even an issue with the bank and why is it worth JP Morgan dedicating so much space in their note for one loan that we are to assume is in good standing? 

Where there is smoke, normally there is fire.

There should not be any risk involved with this loan.  If the receivables are all solid or if HSOA legitimately has several new $100m-plus credit proposals, then the bank should not be at risk for one penny loss on its loan.

The TCBI issues continued with a note from their analyst at Sandler O’Neill who on Friday put out this cautious note.

this paragraph has been deleted due to copywrite issues from Sandler O’Neill

Ok, so this analyst reduced his target by $1. With 26 million shares outstanding, this analyst believes that TCBI could be worth $26 million less due to one loan that they might only have total liability of $25 million….what does that tell you?
What it tells us at Citron is that the status of HSOA’s line of credit is indeed an issue. A big issue.

It is important to note that neither JP Morgan or Sandler O’Neill have any type of affiliation with Home Solutions.  They were simply commenting the business of Texas Capital Bank.

Backlog

In HSOA’s last 10-Q, the company states:

“These funds were used mainly to fund current projects related to the Company’s backlog which, at June 30, exceeded $300 million”.

What projects could possibly comprise a $300 million backlog? The company’s main announced future projects are related party transactions. They are in various states of lack of zoning approval and/or unfunded. One project, announced for a value of $100 million, exists only in the form of an option on some land.

But wait ….we have heard this tune before. Frank Fradella used to be the CEO of American-Eco Systems (predecessor company to HSOA)
In an SEC filing from March 7, 2000 Fradella’s company American-Eco Systems stated:

“At November 30, 1999, the Company had project backlog of approximately $280 million, substantially all of which it expects to realize within the next twelve months.”

http://sec.edgar-online.com/2000/03/07/16/0000950129-00-000968/Section8.asp

5 months later, on August 4, 2000, American Eco Corporation (the “Company”), and its subsidiaries filed for protection under the relevant bankruptcy laws in the
United States and Canada.

http://sec.edgar-online.com/2000/08/17/15/0000950120-00-000211/Section2.asp

Conclusion

Lets be crystal clear here. Citron does not believe that HSOA’s Line of Credit will cause any material threat to TCBI’s financial health. We raise the issue because the analysts’ concerns confirm that the loan is clearly a material risk issue to HSOA.
These analysts wouldn’t have put these notes out without confirming information. JP Morgan and Sandler O’Neill are respected Wall St. firms that don’t just shoot from the hip when they research banks. Most importantly, we are to assume that both firms had discussion with the CFO of TCBI and understood that what might be only a flesh wound for the bank, could be a death blow for Home Solutions. It is the opinion of Citron that Texas Captial Bank will attempt to collect all funds from FIGA thereby leaving the company with the same stack of mysterious receivables and no cash left for operating capital.

Cautious Investing To All.