AAMC - Altisource Asset Management

[thepupil]

 

No idea.  If you believe that the accounting isn't crooked (and I like Altisource's accounting), then AAMC has done a really good job as an asset manager.  If AAMC really does generate high returns without taking on excessive risk, then they're really good at asset management.  If that's true, then they will over the long run attract a lot of AUM.  Even if RESI leaves they may be fine.

 

The contract does punish RESI for firing its asset manager.  It would shrink AUM at RESI and make it difficult for them to raise capital, so I think the board of directors are incentivized not to do it except in extreme circumstances.

 

Do you like RESI's accounting? 

 

A lot of your posts on mining and oil and gas talk about company's inflating reserves and boasting of bullshit IRR's. I enjoy them and think they are well reasoned.

 

Do you see any parallel between what RESI does and the junior miners do? RESI buys pools of illiquid assets, sells or leases up a small percentage of them for high returns and then in turn writes a portion up (unrealized gains) which comprise the majority of revenue. The economics on buying the whole pool of assets will not be known for several years (like buying a massive acreage position and selling a small portion for a giant implied gain,  a la CHK in the McClendon era).

 

It's not perfectly analogous, of course.

 

I think RESI has tremendous incentive to fire AAMC and don't see how AAMC survives without RESI. The fees! Plus RESI may have issues bidding on pools of loans while the regulators tear through Ocwen Empire companies like shit through a goose. 

 

How do you think about the Luxor's preferred in terms of valuation? I see it as making the story all the more binary.

 

As long as AAMC is a going concern and below $1250, the preferred does not require any thought with respect to dividend requirements or dilution; it is a worthless liability in the base and bull case where radical change does not happen to RESI/AAMC.

 

But if there is a windup or change of control, then the preferred is entitled to par ($250mm) + all previous divvies paid to AAMC. Also the preferred is puttable to the company in 2020 (there is a line that Luxor can have the co redeem at 5 yr intervals starting in 2020). So if AAMC were to lose RESI, it would have debt and something senior to it in liquidation preference and in my opinion would be a zero.

 

My other thought is RESI stock needs to go up fast! Or they need to lease up/monetize their portfolio in a big way to earn the dividend. They are levering up the portfolio via securitization but borrowing to pay the dividend will be just more of the same and I don't know how a market that is pretty panicky wrt Erbey entities will tolerate that.

 

They need to get their stock up above book to issue equity to pay the dividend, but how long can they do the quasi-ponzi dividend dance?

 

I find it hard to ask questions or state opinions about these two co's in any objective way. They both just seem absurd to me. But if RESI goes down further, I think it will be pretty damn interesting. You'd be buying a moderately levered portfolio of NPL's for a big discount to book with the upside optionality that they can fire the parasitic GP that charges it huge fees. But it's hard to get comfortable at all with RESI given the accounting.

[ItsAValueTrap]

 

No idea.  If you believe that the accounting isn't crooked (and I like Altisource's accounting), then AAMC has done a really good job as an asset manager.  If AAMC really does generate high returns without taking on excessive risk, then they're really good at asset management.  If that's true, then they will over the long run attract a lot of AUM.  Even if RESI leaves they may be fine.

 

The contract does punish RESI for firing its asset manager.  It would shrink AUM at RESI and make it difficult for them to raise capital, so I think the board of directors are incentivized not to do it except in extreme circumstances.

 

Do you like RESI's accounting? 

 

A lot of your posts on mining and oil and gas talk about company's inflating reserves and boasting of bullshit IRR's. I enjoy them and think they are well reasoned.

 

Do you see any parallel between what RESI does and the junior miners do? RESI buys pools of illiquid assets, sells or leases up a small percentage of them for high returns and then in turn writes a portion up (unrealized gains) which comprise the majority of revenue. The economics on buying the whole pool of assets will not be known for several years (like buying a massive acreage position and selling a small portion for a giant implied gain,  a la CHK in the McClendon era).

 

Reserves can get wildly, wildly inflated.  You can't really do that with real estate.

 

Of course there are some Ponzi REITs that you can look at.  I don't believe any of them have been able to fake cash flow.

 

RESI has negative cash flow, which is potentially a red flag.  Because of what they do, I believe that their NPLs are cash flow negative in the early stages.  They will only start being cash flow positive once the NPLs are worked out.

 

It's not perfectly analogous, of course.

 

I think RESI has tremendous incentive to fire AAMC and don't see how AAMC survives without RESI. The fees! Plus RESI may have issues bidding on pools of loans while the regulators tear through Ocwen Empire companies like shit through a goose. 

 

How do you think about the Luxor's preferred in terms of valuation? I see it as making the story all the more binary.

 

As long as AAMC is a going concern and below $1250, the preferred does not require any thought with respect to dividend requirements or dilution; it is a worthless liability in the base and bull case where radical change does not happen to RESI/AAMC.

 

But if there is a windup or change of control, then the preferred is entitled to par ($250mm) + all previous divvies paid to AAMC. Also the preferred is puttable to the company in 2020 (there is a line that Luxor can have the co redeem at 5 yr intervals starting in 2020). So if AAMC were to lose RESI, it would have debt and something senior to it in liquidation preference and in my opinion would be a zero.

 

My other thought is RESI stock needs to go up fast! Or they need to lease up/monetize their portfolio in a big way to earn the dividend. They are levering up the portfolio via securitization but borrowing to pay the dividend will be just more of the same and I don't know how a market that is pretty panicky wrt Erbey entities will tolerate that.

 

They need to get their stock up above book to issue equity to pay the dividend, but how long can they do the quasi-ponzi dividend dance?

 

I find it hard to ask questions or state opinions about these two co's in any objective way. They both just seem absurd to me. But if RESI goes down further, I think it will be pretty damn interesting. You'd be buying a moderately levered portfolio of NPL's for a big discount to book with the upside optionality that they can fire the parasitic GP that charges it huge fees. But it's hard to get comfortable at all with RESI given the accounting.

 

It comes down to whether or not they're playing games with the BPOs (broker price opinions) on their properties.  It doesn't seem like that's the case, though I'm not 100% sure about it.  Certainly it makes sense that property prices have gone up given the changes in case-schiller and other home price indices.

 

Their BPOs may be based on the price of the property before renovations.  Future renovations/cleanup can greatly increase the value of the property; the BPOs may not take this into account.

For example, many potential buyers of a home may have difficulty financing the purchase if the water does not work, etc. etc.  Because the home hasn't been repaired, a lot of buyers will be unable to get financing to buy the home.

 

The RESI 10-Q states:

 

During the three months ended September 30, 2014 and 2013, we transferred 1,113 and 43 mortgage loans, respectively, to REO at an aggregate fair value based on broker price opinions ("BPOs") of $189.9 million and $6.2 million, respectively. Such transfers occur when the foreclosure sale is complete. In connection with these transfers to REO, we recorded $38.4 million and $1.8 million, respectively, in net unrealized gains on mortgage loans.

 

On the other hand, BPOs can be a little wishy washy.  A BPO is cheaper than an appraisal.  The person estimating the value of the home may not even drive by it (let alone step inside the home).  An appraiser might walk around the inside of the home and test the water after the home has been de-winterized.  A BPO will not go to that level of detail.

 

If the BPO is crooked, the BPO can easily overestimate the value of the home and overlook expensive repairs.

[thepupil]

yep, so they

 

1. buy the NPL portfolios

2. foreclose on some of them

3. as part of the foreclosure they get a BPO on the individual properties

4. When BPO > cost allocated to that property, an unrealized gain is booked

 

Do you agree with that sequence? When it says "foreclosure sale" I'm not taking it to mean these loans are sold to a non-RESI party because it takes a very long time for these unrealized gains to be realized; they are staying on the books, for the most part.

 

For example:

three months ending 3/2014, they had $65MM unrealized gains

 

In the next two quarters there were $10.8MM (2Q) and $13.7M (3Q) realized gains, and the unrealized gains keeps rising as they move NPL to REO.

 

So I just want to be clear they aren'r actually "selling" them as they are moving them to REO and then sell them or lease em up. They could fudge the BPO's or the BPO's could overstate value and not account for repairs and all that stuff you pointed out (which would make the earnings overstated). But in my opinion there are many other, more evil ways to juice those unrealized gains. The first one that I could think of is how they allocate costs to an individual property.

 

Frankly, I don't know how the whole bidding process works for a pool of 1000's of loans. I'm assuming you just put one bid in on the pool (i.e. you say "hey bank, I'll pay 60 percent of the loan balance for that $1B NPL's"). So do you just allocate 60 cents on the dollar of cost to each loan? Probably. That seems like the right way of going about it. But if I was a super evil cayman islands based fraud committing organization, I might allocate 50 cents to the ones that I was able to foreclose on and 70 cents to ones to be dealt with years down the road, in order to show I was making a lot of money. That would be fraud and is solely conjecture.

 

I'm not saying that's what they do. I'm more just illustrating that this is an opaque pool of illiquid assets where the vast majority of earnings are non-cash. In the hands of an evil smart person, it's open to abuse. And juicing earnings is highly incentivized because the manager receives a giant percentage of dividends / earnings because of the high incentive fee.

 

 

They  can also just mark up their loans. Not all of the unrealized gains are from moving to REO. They can more or less just say "hey this is getting close to being worked out, it's worth more". Earnings are an interesting concept at RESI.

 

ii. Net unrealized gains from the change in fair value of loans. On a monthly basis we adjust our loans to fair value by evaluating the fair value of the underlying property, the expected timeline and probabilities of loan resolution and expected market yield. We employ various loan resolution methodologies with respect to our residential mortgage loans including loan modification, collateral resolution and collateral disposition. The manner in which a sub-performing or non-performing loan is resolved will impact the amount and timing of these net unrealized gains. We expect the timelines for each of the different processes to vary significantly, and final resolution could take up to 24 months or longer from the loan acquisition date. The exact nature of resolution will be dependent on a number of factors that are beyond our control, including borrower willingness, property value, availability of refinancing, interest rates, conditions in the financial markets, the regulatory environment and other factors.

 

After mortgage loans are acquired, the fair value of each loan is adjusted in each subsequent reporting period as the loan proceeds to a particular resolution (i.e., modification, or conversion to real estate owned). As a loan approaches resolution, the resolution timeline for that loan decreases and costs embedded in the discounted cash flow model for loan servicing, foreclosure costs and property insurance are incurred and removed from future expenses. The shorter resolution timelines and reduced future expenses each increase the fair value of the loan. The increase in the value of the loan is recognized in net unrealized gain on mortgage loans in our consolidated statements of operations.

 

With respect to termination, the fee is high, but not that high. Paying 3 yrs of incentive fee to get back the 50% of your upside that AAMC takes would be well worth it. If someone like Blackstone bid for RESI, they could easily say "we'll charge a fixed fee" or costs + 20% rather than the cost +50%. RESI's board would have to consider it. Is the Ocwen advantage worth that much?

 

 

b]We may not terminate the asset management agreement without cause during the first 24 months of its term. Following such 24-month period, we may terminate the asset management agreement without cause upon the determination of at least two-thirds of our independent directors that (i) there has been unsatisfactory performance by AAMC that is materially detrimental to us, or (ii) the compensation payable to AAMC under the asset management agreement is unreasonable, unless AAMC agrees to compensation that at least two-thirds of our independent directors determine is reasonable.

 

AAMC may terminate the asset management agreement without cause by providing written notice to us no later than 180 days prior to December 21 of any year during the initial term or a renewal term, and the asset management agreement will terminate on the December 21 following the delivery of such notice.

We will be required to pay AAMC a termination fee in the event that the asset management agreement is terminated as a result of (i) a termination by us without cause, (ii) a termination by AAMC as a result of our becoming regulated as an “investment company” under the Investment Company Act, or (iii) a termination by AAMC if we default in the performance of any material term of the asset management agreement (subject to a notice and cure period).

The termination fee will be equal to three times the average annual incentive management fee earned by AAMC during the prior 24-month period immediately preceding the date of termination, calculated as of the end of the most recently completed fiscal quarter prior to the date of termination. In the event the asset management agreement is terminated: (1) the Ocwen servicing agreement, the support services agreement and the trademark license agreement will terminate within 30 days; and (2) if the asset management agreement is terminated without cause by us, the Altisource master services agreement may be terminated at Altisource’s sole discretion.

 

 

Anyways, that was long, at 70 odd percent off tangible, I'm still too sketched out to buy RESI. But if it gets to 50%, greed may takeover fear. I think AAMC is still priced for tremendous growth at RESI. At $452MM, that's 30 ish % of AUM not counting the preferred. Still the most expensive asset manager. Its fees are the highest of any asset manager. But those can change (RESI could also try to renegotiate rather than fire).

[ItsAValueTrap]

Is the Ocwen advantage worth that much?

AAMC generated excellent performance, crushing index ETFs.  They charge high fees.  I don't see what the big deal is.

 

Coca Cola charges ridiculous prices for sugar water compared to say Cott.  KO's Dasani branded bottled water is even more ridiculously priced.  Most people would not consider Coca Cola to be a huge scam.  I don't see what the big deal is.

 

They  can also just mark up their loans. Not all of the unrealized gains are from moving to REO. They can more or less just say "hey this is getting close to being worked out, it's worth more". Earnings are an interesting concept at RESI.

Yes, anybody can commit fraud if they really put their mind to it.  At any kind of business.  Even a business that sits on a pile of cash (some Chinese reverse merger scams have faked their cash).

 

But just because they can doesn't mean that they are.

 

----

As a sanity check, compile a list of companies and rank them all based on scamminess.

 

Let's say you compare AAMC to the GPs (general partners) of MLPs.  I would rate AAMC near the top in terms of integrity in the same tier as Kinder Morgan.

 

Certain MLPs like LINN and ACMP would be in the bottom tier.

[thepupil]

Is the Ocwen advantage worth that much?

AAMC generated excellent performance, crushing index ETFs.  They charge high fees.  I don't see what the big deal is.

 

What excellent performance has AAMC generated? We could measure RESI performance in a few ways:

 

1) cumulative total return since spin-off and since secondary offerings against some benchmark, like SPY and VNQ.

 

I'm seeing the opening price on December 24 2012 as around $15. The stock is currently $17.60 so capital appreciation of 17% + divvies of 2.38 (15%), so a total return since spin of 32%. Not bad. VNQ and SPY are up 32% and 40%. I wouldn't say RESI has crushed them, unless yahoo finance is wrong and the spinf price was lower.

 

As for the unfortunate souls who participated in RESI secondaries at $18.75, $21, and $34, I believe the ETF's are crushing them.

 

If you were talking about AAMC's appreciation, I don't think LP's/clients care about their GP's management company's stock appreciation. It's not evaluated at the year end review

 

 

2) net income / ROE

 

Judging AAMC by stock performance of RESI alone may not be the right thing to do. After all as yadayada said "why the hell am i on this message board" if I take price to be = value. Judging by the ROE and net income at RESI, so far AAMC is doing well, but as this discussion started out, NI and ROE are almost all determined by AAMC's loan marking model and the BPO's.

 

3) Growth in TBVPS

 

they've done very well with this given the high ROE and net income and their ability to sell loads of stock at big premiums to book.

 

So what are you basing your "excellent performance, crushing index ETF's". I don't see it. As for AAMC's ethics. How would I judge the ethics of an asset manager that decides how much it makes using a model and then pays itself 50% above a low hurdle in cold hard cash raised from stock and bond offerings? I would not put that in the top tier of ethical GP/LP arrangements.

 

 

[thepupil]

 

 

Let's say you compare AAMC to the GPs (general partners) of MLPs.  I would rate AAMC near the top in terms of integrity in the same tier as Kinder Morgan.

 

 

Why? I really don't get the veneration of AAMC. What is the basis of AAMC is the top in corporate integrity? Is that mark to model earnings? The CFO turnover? The Chairman resignation? The highest in industry fees?

[thepupil]

the big deal with the fees is that

 

a) they are objectively very high; I'd challenge you to find a hedge fund or PE vehicle or investment product that charges (costs + 50% over 4% of tangible book<---may be a little off on the hurdle, my memory is a little fuzzy, just remember it was low) or more. I posit that AAMC is in the top 1% of all asset managers in its fees.

 

b) for the accretion model to work, you have to get people to buy that you can make a high enough sustainable ROE to justify a premium to book. The fees are a giant headwind wrt that. A rational person may say: "why would I ever pay book for a levered portfolio of NPL workouts and give 50% of my upside on such risky activity to the manager?" "Why give the manager the free option?

 

c) the immediate realization of fees when we don't know the economic of the business. Whenever there are illiquid assets and incentive fees, the GP can abuse the LP's without the proper protections. You may want to look into what Polygon did with Tetragon Financial and Leon Cooperman's lawsuit. They, according to Cooperman, took control of Tetragon ( a very undervalued stock btw) and realized incentive fees as they marked the book up and down.  Hedge funds don't have this problem, since the market marks their assets and there is a high water mark. Many real estate PE or venture capital or other illiquid vehicles wait until the LP has been paid back to realize incentive fees or have clawbacks or some other measures. The majority of RESI's earnings are unrealized. 100% of AAMC's pay is realized.

 

here is the Tetragon thing, sound familiar?

http://www.reuters.com/article/2011/07/12/us-tetragon-polygon-lawsuit-idUSTRE76B4L620110712

 

that's why i don't like the fees.

[ItsAValueTrap]

My bad, I spoke too soon.  I would look at their returns on equity.

 

They paid 31.45M in dividends last quarter.  Annualized over $1317M in book value, the ROE is 9.6%.  (31.45M * 4 / 1317M)

The 9.6% yield is taxable based on the REIT rules.  A stock index ETF might do 6-10% over the long run.  So they aren't crushing the index ETFs.  (Depending on how taxes are done and how well you think a stock index ETF will do over the long run.)

 

*Without the incentive fees they'd be crushing the indices.

[thepupil]

Okay, so even if we believe RESI's revenue and earnings (the vast majority of which are non-cash), RESI's agreement with AAMC gives the vast majority of excess returns to AAMC. Most would conclude this is not fair. You invest in someone to make excess returns net of fees, not for them to make a lot of excess and then pay themselves it, renting your capital for free and having you take all the downside. It would be like a HF manager saying "I charge 0 and 50% of performance above the index". You could say "hey that's fair, only paid for outperformance," but at the extremes and as that inccentive fee % gets higher, it just doesn't make sense.

 

In response to your whole "anyone can commit fraud but that doesn't mean AAMC is", I agree, but I would just point out that you just seem so forgiving of Erbey and the empire with respect to the yellow and red flags. In my opinion it contrasts sharply with the Glenn that is

a) skeptical of all promotional managements

 

b) wrote this when I pitched an illiquid yield vehicle that marks its assets up and down called ACAS (ACAS and AAMC are similar vehicles in that management more or less makes up the earnings)

 

 

I learned the hard way that integrity matters.

 

Sometimes management will do crazy things and shareholders will see their money vanish.  For example, I got burned on QXM/XING where the CEO ran off with the operating business and the cash.

There are non-Chinese companies that decide to fake their cash (e.g. Refco, Satyam, etc.).  Cash being the easiest thing to audit.

 

So I don't think I will ever invest in shady people.  Ever.  Sometimes they end up doing something that's really messed up.  Take Bernie Madoff for example.  He is a smart guy who made a lot of money legally (it was sleazy but market making isn't considered illegal) and didn't need to run a Ponzi scheme.  But he did it anyways.

 

So when you said they were crushing the index. That is now "crushing index if you use their own earnings, not stock performance and if you measure the gross of fees performance, rather than the net of fees performance.

 

In terms of the other claim, that AAMC is in the top tier of GP's and asset management co's in terms of ethics and integrity, that is a lot harder to measure than performance (which can be quantified with ROE and stock performance). But can you help me with what metrics or value judgements you are using to say that AAMC is full of integrity? I am blind, emotional, and have already passed judgement on Erbey and AAMC. Convert me to the faith of Erbeyism and help me see the light!

 

I just see high asymmetric fees, CFO turnover, a disgraced and dethroned chairman, rapid raising of capital at big premiums to book (smart, but some would say selling expensive stock is not ethical, Singleton and Watsa would say it is, Buffett  would say it isn't, I'm with Singleton and Watsa). I see an externally managed yield product that is designed to funnel the most money possible to the manager, not unlike an externally managed REIT (Portnoy RMR empire, see tickers: SIR, old CWH, GOV, etc. or Gladstone's REIT's like LAND) or an externally managed BDC that has lots of discretion in marking its assets and pays unsustainably high dividends not backed by recurring cash flow (see the old Allied Capital, Fifth Street Finance, etc.).

 

When I look at AAMC I see sketchiness and signs of lack of integrity. I see the shady people that you say you will never invest with. So what metrics inform your idea that AAMC is high class/ethical/top tier etc?

 

 

[ItsAValueTrap]

First you figure out which road is the high road and what isn't the high road.

 

Fees:  Erbey has a duty to AAMC shareholders and some fiduciary responsibility for RESI shareholders.  If the fees are too low, then AAMC shareholders are getting a raw deal.  Too high, and that's bad for RESI.

The way I see it, the fees are based on performance.  High performance leads to high fees and vice versa.  If AAMC did a bad job it would be paid very little.  This seems reasonable enough.

RESI shareholders consented to the fees.  The spinoff was more or less consensual.  If you held onto both AAMC and RESI, then you pretty much aren't paying fees.  Anybody who bought in on the secondary consented to the fees.  They should've known what they were buying.  Clearly the secondary investors know what the fee structure would be like.

 

I honestly think that RESI is one of the higher-quality secondaries out there.  I see it as the NPL/real estate version of the old Kinder Morgan KMI/KMP/KMR.

 

Mortgage origination:

Only Ocwen is really involved in origination.

The unethical way of doing mortgage origination is something like Household.  You gouge consumers on hidden costs such as points, prepayment penalties, etc. etc.

The ethical way of doing mortgage origination looks a lot like Quicken Loans (which did the NCAA bracket thing with Berkshire).  They use technology to bring down costs.

The Ocwen way of doing mortgage origination is more like Quicken than Household.

 

Servicing:

Coming out of the subprime crisis, the big banks' servicing departments were very understaffed.  So, because of the situation they were in, they were trying to foreclose as quickly as possible rather than spending the time on doing loan modifications.  I believe Ocwen behaved better in pushing harder for loan modifications.

 

Ocwen/Altisource definitely do servicing more efficiently via technology and offshoring and little things like the shared appreciation program, psychology, sending informational DVDs, etc.

 

Non-performing loans:

If the borrower wants to give up the home, then Ocwen will push for a deed in lieu of foreclosure.  They will pay people money to leave the home.  This is a win-win for the borrower and Ocwen.

With Hubzu, Altisource is trying to create efficiencies by making the process of selling a home less expensive than the traditional MLS/real estate agent system.

 

In this area, you mostly cannot get ahead by being dishonest or by cheating people.  You get ahead by creating value.

 

Kickbacks:

To be fair, Ocwen/Altisource seemed to have gotten involved in kickbacks on force-placed insurance.  These kickbacks are avoidable by the borrower if they maintain their insurance.  Not quite as bad as kickbacks that are unavoidable (e.g. retail brokerages selling out their clients via payment for order flow).

 

Cross Country:

A scam where Ocwen is an accomplice.

 

Accounting:

Unfortunately some things are difficult to value and creates the potential for abuse.  But that is no reason to avoid a stock.

Berkshire Hathaway underwrites insurance and derivatives.  Both insurance and derivatives are difficult to value accurately.  Is that a reason to avoid Berkshire Hathaway?

 

I like the accounting for the companies in Erbey's empire.

 

Treating shareholders:

I think that Erbey treats shareholders more fairly than Malone.  Malone tricks shareholders into making sub-optimal moves.  Erbey does not do this.

[thepupil]

Thanks Glenn. Appreciate all the thoughts.

 

I'm going to more or less  concede this part of what you wrote to you. I don't know too much about the OCN/ASPS part of the equation. I'd just point out that you, who hold the Erbey empire as some paragon of corporate integrity and ethics, point out that they are "accomplice to a scam" and admit there were some shenanigans going on with the forced place insurance. I recall you also saying that "eventually the number of co's in the empire would cause conflicts of interest to get out of hand". 

 

 

Mortgage origination:

Only Ocwen is really involved in origination.

The unethical way of doing mortgage origination is something like Household.  You gouge consumers on hidden costs such as points, prepayment penalties, etc. etc.

The ethical way of doing mortgage origination looks a lot like Quicken Loans (which did the NCAA bracket thing with Berkshire).  They use technology to bring down costs.

The Ocwen way of doing mortgage origination is more like Quicken than Household.

 

Servicing:

Coming out of the subprime crisis, the big banks' servicing departments were very understaffed.  So, because of the situation they were in, they were trying to foreclose as quickly as possible rather than spending the time on doing loan modifications.  I believe Ocwen behaved better in pushing harder for loan modifications.

 

Ocwen/Altisource definitely do servicing more efficiently via technology and offshoring and little things like the shared appreciation program, psychology, sending informational DVDs, etc.

 

Non-performing loans:

If the borrower wants to give up the home, then Ocwen will push for a deed in lieu of foreclosure.  They will pay people money to leave the home.  This is a win-win for the borrower and Ocwen.

With Hubzu, Altisource is trying to create efficiencies by making the process of selling a home less expensive than the traditional MLS/real estate agent system.

 

In this area, you mostly cannot get ahead by being dishonest or by cheating people.  You get ahead by creating value.

 

Kickbacks:

To be fair, Ocwen/Altisource seemed to have gotten involved in kickbacks on force-placed insurance.  These kickbacks are avoidable by the borrower if they maintain their insurance.  Not quite as bad as kickbacks that are unavoidable (e.g. retail brokerages selling out their clients via payment for order flow).

 

Cross Country:

A scam where Ocwen is an accomplice

 

I have more well developed opinions on the fees and ethics of the fees part.

 

I think your justification of the structure and the fees is weak. I don't know what you mean by RESI consented to the fees. They were spun to shareholders. I agree that the original shareholders were treated well because they got to participate in both RESI/AAMC's upside, but my perspective is one of a new investor, how it is set up today and how might an activist make his case to fire AAMC.

 

The secondary participants definitely knew what they were getting into. I've spoken to several of them (my job gives me access to a number of money managers). They went in with eyes wide open and thought the fee structure was terrible. They were counting on the economics of the operation to justify the parasitic fees and they were trying to front run retail and real money adoption of a popular NPL/SFH theme.

 

In short they were playing a game of greater fool (at least those I've spoken to). Also a lot just bought the secondaries to flip immediately since this was such a popular story and allocations were scarce. In all parasitic fee yield vehicle stories there is a mix of smart money who thinks they can get away with it and a mix of retail people who just see yield and nothing else. Yield is a drug. It makes people invest in things they wouldn't, like succumbing to a 50% of profits fee! 

 

I personally think that the most ethical way of doing things would be to either charge a low fixed fee (this is a permanent capital vehicle), have a stronger hurdle on the incentive fee (rather than one that becomes a lower percentage of tangible book as time passes and RESI grows in value) or better yet just have RESI be internally managed.

 

The only reason Erbey had "a duty to AAMC shareholders" is because he made the structure. He could've just made RESI an internally managed vehicle that participates 1:1 in upside and downside. AAMC has 5 employees, it's not like its some massive operation that had to be a separate company.

 

Internal management (or lower fees with external management) would be far more likely to achieve a premium to book. Single Family REITs trade at or above book/NAV and according to you and others RESI bought cheaper NPLs so the market should award RESI with a higher rating. Either the market is dumb (a possibility) and will correct or it is applying a discount to RESI because of the fees/uncertainty of the NPL model.

 

I think the fee structure of AAMC / RESI is "short term greedy" and actually has impaired the ability to grow value (because the market is applying a fee/Erbey taint discount to RESI). But that's a subjective interpretation

 

I think the comparison the Kinder empire is particularly relevant because my interpretation of the events of why they had to consolidate all the vehicles was that KMP shareholders started to apply a fee/IDR discount to KMP as they realized KMI would start to eat all their growth once they went into high splits (sound familiar?). I realize they also did so to have the ability to retain earnings and be less dependent on capital markets but high splits IDR's definitely played a role. Wasn't KMP yielding more (trading at a discount) than other  high quality midstreams when the transaction occurred? Look at KMP compared to MMP. The market loves MMP because it has no IDR's / GP take.

 

RESI just took a shorter period of time to get to high splits because Erbey and crew set such a low hurdle and were so successful at the outset of growing TBVPS by accretive issuance.

 

http://www.wsj.com/articles/kinder-morgan-to-consolidate-in-70-billion-deal-1407704960

 

Analysts also have cited the hefty payments—about 46% of its cash—that the partnership has been making to the publicly traded company that runs it, Kinder Morgan Inc. Mr. Kinder owns 23% of that company, though his stake will decline to about 11% after the consolidation.

 

I don't find the comparison to Buffett and insurance relevant. Buffett's insurance operations have a VERY long history of underwriting profitability and few hidden surprises. Buffett is never selling product and telling a growth story. The Ocwen empire has a short history full of (so far) negative surprises. RESI exist to sell equity and funnel money to AAMC. I just think they are completely different.

 

I think we may just have to agree to disagree because we interpret the same stuff so differently but I wanted to air my thoughts on your thoughts. A lot of ink has been spilled on this thread by people who are neither long nor short LOL.

[ItsAValueTrap]

I personally think that the most ethical way of doing things would be to either charge a low fixed fee (this is a permanent capital vehicle), have a stronger hurdle on the incentive fee (rather than one that becomes a lower percentage of tangible book as time passes and RESI grows in value) or better yet just have RESI be internally managed.

 

The only reason Erbey had "a duty to AAMC shareholders" is because he made the structure. He could've just made RESI an internally managed vehicle that participates 1:1 in upside and downside. AAMC has 5 employees, it's not like its some massive operation that had to be a separate company.

 

Regarding AAMC shareholders, Erbey is supposed to create shareholder value for them.  If the asset manager is acting like a charity, then that is unfair for AAMC shareholders.

 

Fixed fees versus performance-based fees:  You can make an argument either way.  Fixed fees create incentives for the asset manager to act as a 'AUM whore' where their prime focus is on growing AUM.  Performance-based fees encourage skill (and also volatility/risk-taking).

 

Skin the game: If I remember correctly, Erbey actually bought shares of HLSS and RESI so that he would have a little more skin in the game and his interests wouldn't be so misaligned between OCN vs HLSS and AAMC/ASPS versus RESI.  The sums of money weren't that substantial though they weren't that low either.

 

Anyways:

1- I don't have a ethical problem with ultra-high fees or products that aren't great value.  Extended warranties aren't good value.  But some people actually want to buy them.  I don't have a fundamental problem with pawn loans.  I don't have a problem with bottled water.

2- IMO, deception is unethical.  If the company is playing accounting games then that is unethical.  Hidden fees are unethical.

3- If the other party consents to a deal, they are fully informed, and there was no deception involved... then I would say that it is ethical.  (Often this isn't the case with extended warranties.)

 

I guess we'll disagree on #1.

 

 

I think the comparison the Kinder empire is particularly relevant because my interpretation of the events of why they had to consolidate all the vehicles was that KMP shareholders started to apply a fee/IDR discount to KMP as they realized KMI would start to eat all their growth once they went into high splits (sound familiar?). I realize they also did so to have the ability to retain earnings and be less dependent on capital markets but high splits IDR's definitely played a role. Wasn't KMP yielding more (trading at a discount) than other  high quality midstreams when the transaction occurred? Look at KMP compared to MMP. The market loves MMP because it has no IDR's / GP take.

The structure became unwieldy.  For KMP acquisitions, KMI started forgiving some of the IDRs so that the economics on the deal would work out well for KMP shareholders.  However, I don't think that this is why they made the deal.

 

It kind of made sense to do the deal for tax reasons.  The acquisitions and capex throw off a lot of tax losses.  Capex can be depreciated over ?15? years even though a pipeline will last >=60 years.  Consolidating the empire means that the tax writeoffs can be applied to KMI, which had been paying taxes for a while.

 

AAMC is structured in a tax-efficient way because it is based in the US virgin islands.  Those tax breaks have the blessing of the US government.

[ItsAValueTrap]

I'd just point out that you, who hold the Erbey empire as some paragon of corporate integrity and ethics, point out that they are "accomplice to a scam" and admit there were some shenanigans going on with the forced place insurance.

 

If you look hard enough at any company, you can probably find some flaws.  Berkshire Hathaway for example was arguably involved in finite reinsurance shenanigans.  Stated differently: they may have helped others commit a massive fraud.

 

But at the end of the day, they have done more good than bad.  I personally think that Berkshire is one of the most ethical companies out there.

[thepupil]

 

Fixed fees versus performance-based fees:  You can make an argument either way.  Fixed fees create incentives for the asset manager to act as a 'AUM whore' where their prime focus is on growing AUM.  Performance-based fees encourage skill (and also volatility/risk-taking).

 

 

With such low hurldle, AAMC incentive fee is a management fee and RESI is an AUM whore. This is my main issue. The combination of an incredibly high incentive percentage, 50%, and such a low hurdle (and the accounting which allows AAMC to more or less decide how much it gets paid).

 

The lower percentages start even lower but the 50% starts at a mere 4.3% of tangible equity (50% over quarterly distro's above 25 cents = $1.00, $1/$23 tangible = 4.3%). So if the gross ROE of RESI is 11%, AAMC takes at least (50% * 6% = 3%).

 

Ignoring the ethics or fairness part of the fees, I think the fee structure is going to hold RESI and AAMC back and that's what I think is the main risk to AAMC. RESI gets sick of trading below book and not being able to raise capital accretively (they're almost done levering up the current portfolio so they probably need equity in the next few q's to fund their dividend).

 

It is incredibly NPV positive to fire AAMC unless you think what AAMC brings to the table is worth a very big % of sustainable outperformance.

 

RESI could still retain ASPS and work with OCN (the supposed advantages) without the help from the 5 employees that work for AAMC, right?

[ItsAValueTrap]

The lower percentages start even lower but the 50% starts at a mere 4.3% of tangible equity (50% over quarterly distro's above 25 cents = $1.00, $1/$23 tangible = 4.3%). So if the gross ROE of RESI is 11%, AAMC takes at least (50% * 6% = 3%).

 

When it was first spun out, BVPS was $12.84.  Because RESI raised capital at higher/accretive prices, BVPS went up.  Effectively that lowered the hurdle.  By purchasing shares at high prices, the secondary offering shareholders consented to the higher fees.

 

It is incredibly NPV positive to fire AAMC unless you think what AAMC brings to the table is worth a very big % of sustainable outperformance.

I doubt the directors would do it because it would get in the way of AUM and piss off a major shareholder (Erbey).  But maybe activist investors get it done... who knows.

[thepupil]

just to quantify the upside to RESI and downside to AAMC here, let's try to figure out how much RESI would have to pay to fire AAMC.

 

The termination fee will be equal to three times the average annual incentive management fee earned by us during the prior 24-month period immediately preceding the date of termination, calculated as of the end of the most recently completed fiscal quarter prior to the date of termination.

 

Using the below, it looks like 2014 AAMC incentive should be around $70 or $80MM ($50+$20MM trailing q run rate). So that's $70MM in 2014 but I'll throw in $10MM for fun. 2013 was negligible.

 

So the average annual incentive fee paid for the two years ending 12/2014 should be around $40MM ($80MM/2). 3 X $40MM = $120MM.

 

So RESI could fire AAMC for $120MM. The yield on that $120MM would be huge since AAMC is taking such a high % of upside. An activist could team up with a PE firm with experience managing NPL vehicles (Starwood, Colony, Oaktree, etc.) to help manage for a less rapacious fee. Let's say someone would do it for costs + 1.5%. How many additional points of gross ROE must AAMC provide to make i better for RESI to retain AAMC? I haven't built the model, but I'll hazard a guess it's pretty high.

 

Another way to put it is: is there someone out there who will accept less than a growing $70 or $80MM / year of pure profit (all costs are reimbursed or outsourced, $10MM / AAMC employee  :o) to manage $1.3B equity of NPL's? I'd wager there is someone who'd do it for less. You could hire all AAMC's full time employees for $3mm / year guaranteed and save $60MM / year (50% yield on the $120MM termination). That way you'd keep all that AAMC dream team. Even grant em generous RESI options and it would still work out.

 

Like you said "who knows if it happens", but anyone buying AAMC is making a clear bet that RESI will allow AAMC to take a big % of its upside and Erbey is no longer on both boards to facilitate the transfer of wealth from AssetCo to ManagerCo.

 

I can't be the only one who sees this potential activist opportunity. There is high demand for NPL's and supposedly RESI's were bought at good prices. You can buy them, pay 9% of equity to get rid of AAMC an own all the upside. A fund with the right resources could probably make a nice trade of it. And make Erbey and Luxor poorer in the process, which would please some. 

 

From RESI's financials

Related party general and administrative

21,530 3 month ending 9/2014

2,039

51,629 9 months ending 9/2014

4,474 

 

From AAMC's Financials

Management incentive fee

19,503 3 months ending 9/2014

44,129 9 months ending 9/2014

 

 

[ItsAValueTrap]

Most of the shareholders in RESI got their shares via a secondary offering.  Presumably they really  like AAMC as the asset manager.

 

[ItsAValueTrap]

I think AAMC handles the purchase of NPL pools.  They bid on stuff from FHA/HUD, Ocwen, etc. etc.

[thepupil]

Can you not say the same of about any REIT? Commonwealth REIT raised all its money via common stock offerings and secondaries.

 

When an activist stepped up to get rid of the high fee, poorly incentivized external management structure  with lots of related party transactions (wait, doesn't that describe RESI/AAMC???), a very large percentage of shareholders forced out the Portnoy's and RMR even though they had likely acquired their shares via secondary offerings.

 

Shareholders are fickle creatures and as a I pointed out earlier, I think you may have an overly idealized vision of why people participate in secondaries or IPO's or own a stock for that matter. They often do so to try to flip on the bump up from the secondary discount, sell to someone they consider more dumb, or ride a theme. Just because they subscribe to a secondary, doesn't mean they believe the stock to be undervalued, or the compensation fair, or anything. It just means they put in for some shares because they heard XYZ fund is doing so or there are a scarce number of "housing recovery stocks" and they read they should own those, or they think retail will bid it up on the yield even though they know that yield comes from equity and debt offerings for now. For many a investor ownership does not mean endorsement of what that company does or its management. Hell on Thursday I bought a little ASPS as a speculative position and I definitely don't side with Erbey.

 

When it doesn't work out, all the sudden it becomes management's fault. Most shareholders also bought when Erbey was chairman. What's AAMC without the cult figure / genius behind it all? It's a tainted brand.

 

Neither of us knows what will happen but there is a very strong quantitative cost savings case to be made for firing AAMC. Like immediate 50+% yield on cost strong.

 

Plenty of Private Equity outfits or distressed investors could handle the bidding on NPL's. Who do you think are the other bidders? RESI doesn't need to pay $80MM / year to put in some bids.

[ItsAValueTrap]

RESI (managed by AAMC) hires another company to handle servicing.

 

http://www.sec.gov/Archives/edgar/data/1555039/000155503915000005/resi8-kservicingagreement.htm

On January 24, 2015, Altisource Residential Corporation (the “Company”) entered into a servicing agreement with Fay Servicing, LLC (“Fay Servicing”). Under the servicing agreement, Fay Servicing will subservice and provide certain administration, management, modification and disposition services for residential mortgage loans and REO properties acquired by the Company and its subsidiaries from time to time.

[Guest roark33]

This seems to strike right at Altisource's business, no?  Looks like without Erbey, the companies are starting to go outside the fold. 

[ItsAValueTrap]

This seems to strike right at Altisource's business, no?  Looks like without Erbey, the companies are starting to go outside the fold.

 

Yes.  Right now, AAMC accounts for a very, very small part of Altisource's revenues.  It's disclosed in the 10-Ks.

 

What Lawsky wants is for these companies to act more independently so they don't collude to increase fees to borrowers.  (Though they may collude anyways.)

 

It could be the case that Altisource isn't very good at repairing REOs and renting them.

[thepupil]

 

Like you said "who knows if it happens", but anyone buying AAMC is making a clear bet that RESI will allow AAMC to take a big % of its upside and Erbey is no longer on both boards to facilitate the transfer of wealth from AssetCo to ManagerCo.

 

I can't be the only one who sees this potential activist opportunity. There is high demand for NPL's and supposedly RESI's were bought at good prices. You can buy them, pay 9% of equity to get rid of AAMC an own all the upside.

 

 

People are starting to do the math

 

(Bloomberg) -- Altisource Residential has “meaningful” upside potential as portfolio value could be in low $20s (or higher) without issues surrounding William Erbey-related cos., and/or if Altisource Asset Mgmt advisory agreement ends or is reworked, JPMorgan’s Anthony Paolone writes in note. Increasingly convinced board will step in, bolstered by timing: RESI, AAMC agreement opened for termination without cause on Dec. 21; sees cost of terminating immediately <$2/shr vs waiting another yr est. ~$6/shr JPM still has long-term RESI business model questions including financing, competition in NPL mkt Keeps neutral, PT $22; RESI 4 buys, 2 holds, 1 sell, avg. PT $24.64: Bloomberg data RESI down 44% in past 12 months NOTE: Yday, RESI NPL Servicing Move From OCN May Be L-T Positive: Compass Pt

[thepupil]

 

 

Capstone Says RESI Should End AAMC Servicing

By Felice Maranz

(Bloomberg) -- Altisource Residential holder Capstone sends board demand letter requesting termination of asset mgmt agreement with Altisource Asset Mgmt for cause, without paying any termination fee. Cites Section 11 of asset mgmt agreement Also requests termination of servicing agreement with Ocwen unit Requests board investigate any claims RESI has against AAMC, OCN, officers and directors Sees actions adding significant value for RESI holders; values RESI at $28.10/shr; if RESI terminates AAMC for cause, hires new asset manager at market rates, est. worth $34.10/shr

 

NOTE: Mitigating AAMC Deal Key to Getting RESI Back on Track: JPMorgan: Link

Statement:Link

 

[ItsAValueTrap]

 

 

Capstone Says RESI Should End AAMC Servicing

By Felice Maranz

(Bloomberg) -- Altisource Residential holder Capstone sends board demand letter requesting termination of asset mgmt agreement with Altisource Asset Mgmt for cause, without paying any termination fee. Cites Section 11 of asset mgmt agreement Also requests termination of servicing agreement with Ocwen unit Requests board investigate any claims RESI has against AAMC, OCN, officers and directors Sees actions adding significant value for RESI holders; values RESI at $28.10/shr; if RESI terminates AAMC for cause, hires new asset manager at market rates, est. worth $34.10/shr

 

NOTE: Mitigating AAMC Deal Key to Getting RESI Back on Track: JPMorgan: Link

Statement:Link

 

Their argument strikes me as a little dubious since all servicers have technically broken the law.  If a servicer makes a mistake it can accidentally break the law.  Servicers make mistakes all the time.

 

*I'm not a lawyer.

**I have a very small long position.