Alesco Financial Inc. Q3 2008 Earnings Call Transcript

Alesco Financial Inc. (AFN)

Q3 2008 Earnings Call

November 4, 2008; 10:00 am ET

Executives

Jay McEntee - President, Chief Executive Officer and Director

John Longino - Chief Financial Officer and Treasurer

Analysts

Greg Walker - Bear Stearns

David Trumble - Wachovia

Lee Carter - Private Investor

Arthur Burns - Deltek

David Taylor - David P. Taylor

Lee Cooperman - Omega Advisors

Joseph Vagda - Private Investor

Robert Knapp - Ironside Partners

Presentation

Operator

Good day ladies and gentlemen and welcome to the Alesco Financial Inc. third quarter 2008 earnings conference call. Before we begin Alesco Financial would like to remind everyone that information provided in the earnings release and during the call contains forward-looking statements, which involve a number of risks and uncertainties.

Alesco Financial cautions readers that any forward-looking information is not a guarantee of future performance and that actual results could differ materially from those contained or implied in the forward-looking information. Factors that may affect future results are contained in the Alesco Financials filings with the SEC which are available at the SEC’s website at www.sec.gov.

(Operator Instructions) I will now like to turn the call over to Jay McEntee, President and CEO. Sir, you may begin

Jay McEntee

Thank you operator and good morning everyone, thank you for joining us. Also representing the company with me this morning is John Longino, our Chief Financial Officer.

On the call today I would like to focus on a few major areas, first I’ll explain the steps we have taken to continue to enhance our liquidity and financial position, second I will provide a brief overview of our asset performance through the end of the third quarter; finally I will make some observations on the possible alternatives for the future direction of the company. Then I will hand the call over to John Longino who will provide certain details about our results from the third quarter.

The significant turmoil in the marketplace provided us with an opportunity to dramatically enhance our liquidity and financial position by buying back 80% of our convertible debt. This debt which totaled $140 million at June 30, could have been put to us in May 2012 at par. As of the end of the third quarter we have bought back $8.8 million at an average price of $0.42. We recorded $43.9 million net gain in the quarter on these purchases.

Early in the fourth quarter we bought back an additional $32.5 million of bonds increasing the total net gain on the convert purchases to nearly $60 million. This entire gain is offset by tax losses and does not give rise to additional distribution requirements relative to the maintenance of our REIT status.

As of today, the outstanding balance of the convertible debt is only $28.7 million; while our restricted cash balance is approximately $80 million. With respect to our asset performance, we continue to experience significant challenges. Through today we have had a total of 21 banks representing a total of $328 million in trust preferred securities deferral payments to us. We have also had four banks total holding $162.5 million of TruPS and our deals actually default.

As of September 30, the aggregate principal amount of trust preferred securities in deferral and default is $490.5 million representing approximately 9.5% of AFN's consolidated trust preferred securities portfolio and an aggregate of $6.2 million in quarterly interest payments to the eight CDOs in which AFN invested.

These deferrals resulted in over collateralization failures in all eight of our TruPS CDOs. We are assuming a zero recovery on all defaulted and currently deferring securities, we expect two of the eight CDOs to cure over collateralization failures and recommence making equity distributions within two to three years, while the other six may not cure from anywhere from 5 to 15 years. These estimates could change if there are additional deferrals or if some of the differing banks would begin making payments.

With respect to the middle market loan business, as of September 30, we had $172.6 million of middle market loan assets on a warehouse facility, secured by $40 million of cash from AFN. This warehouse facility expires in May of 2009. The warehouse is non-recourse to AFN beyond posted cash equity. It is not subject to margin costs and AFN has no liability with respect to this line beyond the posted cash collateral.

Middle market loans held as of September 30 including those on the warehouse totaled $882.5 million. While we continue to believe that the middle market loans that have been acquired through our Emporia platform will provide an attractive return on investment for Alesco, the ongoing problems with the economy have certainly played some stress uncertain of these loans. We have increased our loan loss reserves in this portfolio to $20.6 million as of the end of the quarter.

Now I will discuss the possible alternatives with respect to the future direction of the company. We have reviewed various business strategies and investment opportunities over the last two quarters. However, given the tremendous uncertainty in the markets none of these transactions have met our investment qualifications.

The past year has been a very frustrating time for us and for most financial services companies; however, in hindsight it is clear that the actions we have taken to strengthen our balance sheet and to maintain adequate liquidity starting with our CDS positions and including the recent convert buy backs represented the best course of action for us. We believe our strong cash and liquidity positions would provide various options for moving the company forward in a positive way.

We may acquire another company or business platform we also might invest a portion of our unrestricted cash and distressed our undervalued assets which provide significant upside potential to us. We intent to monitor all viable opportunities and pursue only those, which are accretive and which can provide long-term value to shareholders. What we won’t do and frankly do not need to do, is rush into any plan for the shake of having a plan, but there are opportunities for us.

I will now turn the call over to John Longino, our Chief Financial Officer who will discuss the company’s financial results.

John Longino

Thank you Jay. I would like to provide an update on each of the following key areas. Our cash and liquidity positions, the New York Stock Exchange de-listing notice, REIT status and our book value and investment portfolio summary.

As of June 30, we had $136 million of unrestricted cash. During the third quarter we paid out $15 million related to the second quarter dividend and $35 million to buyback convertible debt. We also generated $10 million of positive cash flow net of interest G&A and other costs, leaving unrestricted cash of $96 million as of September 30.

Early in the fourth quarter, we used an additional $18.6 million to buyback more convertible debt. The convertible debt balance was $140 million as of June 30; as of today that balance total just $28.7 million. The only other recourse indebtedness we have, is the $48 million of TruPS debt, which has 30 weighted average years to maturity. We have no other short term or even near term recourse indebtedness, which could place demands on our current $80 million unrestricted cash positions.

As we indicated in our press release and 8-K filing on October 16, we were notified by the New York Stock Exchange that we were not in compliance with their continued listing standard, which requires the average closing price of any listed security not to fall below $1 per share for any consecutive 30 trading day period. Under the NYSE rules, we have six months or until April 10, 2009 to cure this condition of noncompliance. We’ve revised the NYSE that we fully intend to cure this condition and maintain our listing on the exchange.

The NYSE continued listing standards also require that our average market capitalization be at least $25 million over any 30 consecutive trading days and that we maintain our REIT status. With respect to maintaining REIT status the Kleros Real Estate one, two and four deals continue to provide us with REIT qualifying assets and income. Therefore, we believe maintaining our REIT qualification through December 31, 2008 should not be issue.

Even if the remaining Kleros deals were to fail and be liquidated, there are a number of options available to us for maintain REIT status in 2009 and beyond, if that is our desire course of action.

GAAP book value at September 30 was $267.8 million or $4.53 per diluted share based on 59.1 million shares outstanding. As compared to $203.4 or $3.41 per share based on 59.6 million shares outstanding as of June 30, 2008. The breakdown of GAAP book value by asset class is set forth in a table on page 1 of our earnings press release.

At this point, I would like to turn the call back to Jay McEntee

Jay McEntee

As discussed over the last few months the realized tax losses we have experienced during 2008 are expected to significantly offset or eliminate our taxable income and any REIT required additional dividend distributions through the 2008 year. Decisions regarding future dividends will continue to be made based upon projections regarding our taxable income and liquidity and are subject to the review and approval of our Board of Directors.

As a result of our strong cash position and our strong liquidity position we continue to believe that we have the ability to be patient and to manage through these difficult times. We believe there are viable business acquisitions and other options available to us as solid investment opportunities, which we intend to pursue vigorously, but at the same time cautiously.

So, I would now ask that the operator to open the floor for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Greg Walker - Bear Stearns.

Greg Walker - Bear Stearns

I just want to be clear; in terms of dividend generation and dividend distribution, at this point you are not generating a dividend, nor plan on paying one; is that correct?

John Longino

Well, we haven’t made a final decision with respect to the balance of the year. Obviously, terminating the dividend for a prior quarter is telegraphing a desire to retain cash, but that decision’s not been finalize yet and I’m certainly not giving dividend guidance for the balance of the year at this point.

Operator

Your next question comes from Robert Knapp - Ironside Partners.

Robert Knapp - Ironside Partners

Seems like those purchases of the bonds workout very well, good job. One thing about the income statement that’s always been tough for me to kind of understand is what’s actually coming through to Alesco, because you have to consolidate everything and I appreciate it that you sort of made it a little bit easier for us saying that you spent 35 buying the bonds and you had net $10 million of positive cash flow. Can you kind of just give us a little bit more detail, what’s actually providing cash flow up to the pattern, up to the AFN level this point?

John Longino

Yes, the majority of the positive cash flow is coming from Emporia portfolio between the warehouse as well as the Emporia deals, which continue the cash flow. We are also generating cash from the residential mortgage portfolio on an income statement basis, the loan loss provisions are significant, therefore those are driving off losses, but from a cash flow prospective they are driving off cash.

Robert Knapp - Ironside Partners

Okay. So, the TruPS portfolio though now has stopped providing any cash up to AFN at this point?

Jay McEntee

We had $458,000 worth of cash this quarter from that and then that will be virtually zero. We have some on-balance sheet TruPS to continue to provide us with some nominal amount of cash.

Robert Knapp - Ironside Partners

Right, but the previous quarter if I remember, you have eight of them, six had stopped cash flowing and now all the eight have stopped; is that correct?

Jay McEntee

That is correct.

Robert Knapp - Ironside Partners

Okay and then on the Emporia portfolio, can you give us a little bit of an idea what kind of leverage loan those are, not the names necessarily, but just --?

Jay McEntee

Sure, we focus in the middle market space. So, we’re looking at companies with EBITDA of $50 million and less, let’s call it. Typical aggregate loan size, of which we participate, it might be $100 million, because obviously there’s quite a bit of variability there, but that’s smaller of the non-broadly syndicated loan spaces where we focus our interest.

Robert Knapp - Ironside Partners

Okay and can you give us an idea, if you show us the statement here that says that it looks like the leverage loan investments are $75 million; if that’s producing $10 million a quarter, then is it a 14%, 15% yield that it’s growing?

John Longino

It’s not producing $10 million a quarter. I said, the significant cash flow are really from the Emporia and from the residential mortgages and they were roughly $5 million each and if you don’t mind, we’ve been receiving some complaints that we end up having conversations with people in the earnings release, so if you have other question, you can get back in the queue.

Robert Knapp - Ironside Partners

Okay. Sorry about that. I thought these were just basic questions that everyone would like to know the answer to?

Jay McEntee

Yes, but we would like to limit everyone to one question, one follow up and then other questions that others have.

Robert Knapp - Ironside Partners

Fair enough. I’d just encourage you please to go see your investors at some point see it. I know it’s been hard, but it’s been months since you’ve down on the road or even presented at a conference. So, thanks for answering the questions.

Operator

Your next question comes from Joseph Vagda – Private Investor.

Joseph Vagda - Private Investor

I was looking over the CDO projections in last quarter, the CDOs are valued at $106 million and you stated previously that there was $2 million a quarter coming in an income. Now there is no money coming in and they’re valued at $140 million; how is possible?

John Longino

Yes, the GAAP table reflects the fair value of the assets less the fair value of the liabilities and so realistically that is the GAAP accounting that we live with under FAS 159, we’re measuring fair value of assets and liabilities. They move in the same direction, but they don’t move completely in sync. So, you are going to see variations like that from a GAAP perspective.

Joseph Vagda - Private Investor

What accounting firm is coming up with number?

John Longino

We are coming up with that number, our auditors are actually, but we come up with those numbers.

Joseph Vagda - Private Investor

And one last question, when you guys said that you have TruPS, I just want to make sure, because I asked this last time. It’s any unrestricted cash and others TruPS publicly traded TruPS that you have outside of the CDOs?

John Longino

Yes, on-balance sheet trust preferred are predominantly private; are there any of them public traded?

Jay McEntee

No, they’re all private.

Joseph Vagda - Private Investor

And they’re in unrestricted cash?

John Longino

No, there are not unrestricted cash, there in TruPS investment top line.

Operator

Your next question comes from Lee Cooperman - Omega Advisors.

Lee Cooperman - Omega Advisors

I want to make sure on a couple of numbers. We had $96 million of cash unrestricted at the end of the quarter and you said you spent $18.6 million in buying some additional securities back, I guess the converts, so we now presently have $77.4 million?

John Longino

Yes. We actually have about 80. We had a few other loan sources.

Lee Cooperman - Omega Advisors

So, we have roughly $80 million in cash and the converts that we have left to 28.7?

John Longino

That’s correct.

Lee Cooperman - Omega Advisors

Okay and then the TruPS you went with 30 year maturities and like that had about $48 million?

John Longino

That’s right.

Lee Cooperman - Omega Advisors

And you’ve just started to investigate the best ways of investing that cash on behalf of your shareholders presently?

John Longino

Correct.

Lee Cooperman - Omega Advisors

Okay. If I can ask you a kind of quantitative question; you guys have a stock repurchase program and it looks like you paid roughly $1 a share what you bought back; what’s behind that decision? Do you guys have view of the value of the business and that you think the stock market’s mis-pricing the residual value of the business?

John Longino

Well, we do. At least the paramount concern that we had, is one of liquidity. So, we’ve really just barely tipped our toe to the stock repurchased program in contrast to the convert repurchase program, which is very relevant to our liquidity because of that 2012 put right over hang that the convert represented. So, we do think and would be interested in continuing to look at the stock as an attractive investment for the company, but so far we’ve been very, very careful to monitor and maintain liquidity.

Lee Cooperman - Omega Advisors

Okay; you guys have a view of the economic value of the business? I know the book value is kind of ridiculous as a result of a lot of the accounting assumption, which are probably dubious, but do you guys have a view the economic value of your business?

Jay McEntee

Well. We’ve gotten away from that economic value calculation, because…

Lee Cooperman - Omega Advisors

I mean economic in the real world?

Jay McEntee

Yes. There’s just so many subject of elements to it and it’s very difficult to sit here today and project what the impact of the trek will be on the underlying banks that we have differing and so many others. So, the liquidation value of our company is not equal to the GAAP book value today, to tell you I’m a little bit reluctant to start terming numbers around frankly.

Lee Cooperman - Omega Advisors

I assume you think it’s in excess of the price of stock, you would be buying back stock?

Jay McEntee

That would be correct.

Operator

(Operator Instructions) Your next question comes from David Taylor - David P. Taylor.

David Taylor - David P. Taylor

I was a little standard frankly given all the black inline that we’ve seen in the financial area recently, that you have a $30.4 million gain relating to changes in the fair market of financial instruments, do you want to elaborate on that?

Jay McEntee

Yes, it’s just simple accounting. When you purchase back your own debt at less than par you have a gain.

David Taylor - David P. Taylor

No. That was a $43.9 million gain. In addition to that you have a $30.4 million gain relating to charges in the fair value of financial instruments according from your release.

Jay McEntee

Yes, the issue there is, again we’re valuing all of the consolidated assets and all the consolidated debt that’s in our balance sheet, and the reality is that in the current environment the liabilities have actually suffered more, because their securitized liability. They’ve actually suffered more than the assets. So, we’ve actually written down the liabilities by a larger amount then we’ve written down the assets which generates a gain in our income statement

Operator

Your next question comes from Arthur Burns - Deltek.

Arthur Burns - Deltek

I’m just seeing if I heard you correctly in trying to understand the difference between the deferral on a TruPS preferred issue and a default on a TruPS preferred issue; was there a difference?

Jay McEntee

Yes. The trust preferred instrument, provide for a five year deferral future that’s really required in order for the underlying banks to get to tier-1 capital treatment for them. So, when a bank notifies us that they are in deferral it doesn’t necessarily mean that the bank is going away, but in contrast if a bank is taking over by the regulator it pretty much means that that security is no longer worth anything and there’ll never be recovery on it. So, a deferred institutions is one that has notified us, “hey, we are going to take the payment basically and try and work through our issues” and a defaulted one is on that’s gone.

Arthur Burns - Deltek

And the deferral does pick, I mean accrues?

Jay McEntee

That’s correct

Operator

Your next question comes from Lee Carter – Private Investor.

Lee Carter - Private Investor

Am I correct in assuming that it’s the same management for RAS as AFN?

Jay McEntee

No, I mean the AFN, the correlation between rate RAS and AFN is that the CEO of RAS is the Chairman of AFN, but there are no other crossovers if you will of people.

Lee Carter - Private Investor

On March 10, ‘08 you issued a statement that said approximately $2.7 billion or $45 to share, recognized an increase in stockholders equity; is that disappear or have you recognized whatever was in that amount?

Jay McEntee

That related to the, adoption of 159. If you remember we had a GAAP book value of $2.4 billion coming into the year. All that really did was get us to a more realistic GAAP book value.

Lee Carter - Private Investor

Okay, a 453 correct to date and GAAP?

Jay McEntee

267.

Operator

Your next question comes from Joseph Vagda.

Joseph Vagda - Private Investor

Yes, I was wondering, you guys kind of caught me off guard with the REIT statement; is the NYSE not going to allow you to list unless you remain a REIT?

John Longino

The requirements change. As a REIT we need a market cap of $25 million. If we were no longer a REIT then the market cap requirement would jump. We’ll have to qualify as new company effectively and we would have to have $100 million market cap. So that changes the game a little.

Operator

Your next question comes from Greg Walker - Bear Stearns.

Greg Walker - Bear Stearns

My question is somewhat similar to the last question. As I understood your comments, you are likely to remain a REIT through ’09; can you comment on what other avenues you considered in terms of structure or is that too preliminary at this point?

Jay McEntee

Sure, we’re not projecting that we’re likely to be a REIT though ‘09 we are quite confident with our REIT status through ’08 and I think our position on ‘09 is kind of a wait and see. If there are no changes at the company, there are some hurdles to ‘09 status, although it’s not a follow on conclusion that we would not be a REIT in ‘09.

In terms of our public status there are alternative to NYSE listing and we’re certainly focused on those and watching that over the next couple of months. We have about five months left in the NYSE grace period for de-listing and will consider alternatives and do our best to maintain a public listing. I’m confident that we can do that.

Greg Walker - Bear Stearns

To interpret that, is the NASDAQ a possibility?

Jay McEntee

AMX is probably a better possibility.

Operator

Your final question comes from David Trumble - Wachovia.

David Trumble - Wachovia

I’m interested in the expense line; both the related party management compensation and G&A were up over the last year. Can you explain that related party management compensations and where it’s expected to go?

Jay McEntee

Yes, first of all with respect to the G&A, what we are looking at a three month period back to September ’07 versus September ’08. G&A is flat quarter-over-quarter September of ’08 to June ‘08 and that’s a function of how many CDO’s were in etc, so G&A is flat.

With respect to the related party management comp, the asset management fees being paid by the underlying CDOs are actually down quarter-over-quarter. There is a one time the center fee payment to the manager related to the $44 million gain on the debt buy back and in terms of contract that earns an incentive fee, so that’s why there is a one time comp there.

David Trumble - Wachovia

So you would expect see some of that in that fourth quarter since you bought back more debt.

Jay McEntee

Well that depends, because we have to hit a certain level of gain before it even trips over the hurdle rate. So at this point in time, based on what we purchased in the fourth quarter not necessarily. It’s a function of also of what other income we have from regular operations; whether there’s any additional referrals that result in realized losses, there’s other factors that could enter into that, but the underlying asset management fees are clearly down most of the subordinated; most of the subordinated, not always subordinated fees have turned off, it’s just the senior fees and frankly even at that point, we required to continue to accrue some of those fees in our financial statements even if they are not being paid to the management by the underlying CDOs.

Operator

And we are showing no more questions in queue at this time. I would now like to turn the call over to Mr. Jay McEntee for closing remarks.

Jay McEntee

Thank you everyone and we look forward to talking to you next quarter.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect and have a good day.

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