Alesco Financial: Gem in the Garbage Pile

Apr.16.08 | About: Alesco Financial (AFN)

Alesco Financial (AFN) reports earnings on May 6. As a REIT it has gotten no respect from Mister Market for quite awhile despite very good performance. Basically it is a case of a story that sounds too good to be true, but in my opinion is in fact true.

Management has guided for a dividend this year of 25 to 30 cents a quarter. There is no reason to think they will not make it. A 25 cent dividend for Q1 has already been paid. At yesterday's price of 2.76 a share, 25 cents a quarter would be 36 percent for the year. Most investors look at a dividend like this and see a company in trouble.

Alesco has no potential liquidity problems. No debt is due until 2012. All investments are financed with non-recourse debt where the worst thing that can happen is that Alesco loses its investment. No margin calls can be issued to Alesco. The company has about 100 million dollars of unrestricted cash on hand which is about 1.67 dollars per share (as of 31 December). Liquidity is king right now and Alesco has it.

The frightening thing about Alesco is the huge losses it has reported in recent quarters. These have been due to an accounting technicality. Alesco lost its 30 million dollar investment in each of four Kleros CDO's. Although the loss was 120 million dollars GAAP accounting rules required Alesco to report a loss of over 1.2 billion dollars. This has resulted in a huge negative book value. SFAS 159, which took effect on 1 January, will correct this. The Q1 report will show a huge profit as the loss will drop from 1.2 billion to 120 million and Alesco book value will become a positive value around five dollars a share.

Alesco's major source of income is TruPS securities issued to over 300 banks and insurance companies, about 90 percent to banks and 10 percent to insurance companies. If you think large numbers of banks are going to fail in the next couple of years avoid Alesco. If you think the number of failures is going to be relatively small Alesco has a great risk-reward ratio. Even if the dividend is cut in half over the next couple of years the yield at the current stock price would be 18 percent. And the dividend may not be cut.

For what it's worth insiders have bought stock on the open market at higher than current prices but no insider has sold a share since the company went public.

Disclosure: Long