Alesco Financial: REIT Selling For Less Than Cash On Hand 13 comments
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Alesco Financial (AFN) is among the Specialty REITs that have been significantly affected by the disruption in the credit markets. The company was formed as a result of the merger between Alesco Inc. and Sunset Resources in late 2006, and evolved in 2007 as an investment vehicle for CDO pioneer Cohen & Company to invest in a hybrid type of debt instrument called a Trust Preferred (TruPS) issued primarily to medium size banks and insurance companies. The company also has a business that provides commercial loans to mid market companies in 34 industries and a business that generates income from a $1B residential portfolio of 740+ FICO borrowers.
Alesco was among the first of the Specialty REITs to set a 2Q 2008 earnings release date (Tuesday, August 5th ) and recently reported that it had $115M unrestricted cash as of May 15th. Moreover, the company recently declared a 25 cent dividend (see June 10th announcement). This begs the obvious question: Why is a stock which just declared a 25 cent dividend trading for a $1+ and for less than the cash it has on hand.
Blood in the Streets
Alesco stock price has declined from the $8 range in July 2007 to around $1.50 today. This decline is due primarily to three major factors:
- IndyMac’s (IMB) announced deferral of its Alesco TruPS beginning in 2Q2008
- The market for CDOs and the types of hybrid securities Alesco invests in have become stagnant, limiting the company’s opportunity for growth in the intermediate term, and
- Stringent credit markets and overall sector malaise have had a negative impact on every company in the space including Alesco.
Arguably, the IMB deferral has had the biggest impact on Alesco and is therefore addressed in more detail. IMB comprises approximately 2.4% of Alesco’s TruPS investment, spread across 8 CDOs. Alesco owns the first loss piece of these CDO stacks, and interest payments are diverted from Alesco and to the priority CDO tranches if approximately 3% - 5% of the obligors in a particular CDO defers or defaults on the payments. IMB’s total interest payments represented approximately $2M per quarter across the 8 CDOs, of which approximately $1.5M is Alesco’s share (2 cents per share per quarter). Prior to the deferral, Alesco earned approx $15M (25 cents per share) in recurring interest income per quarter.
IMB’s deferral triggered the failure of overcollateralization [OC] tests for 4 of the 8 CDOs. This means that Alesco does not receive income from 4 of the 8 CDOs until the OC deficiency is cured. The total impact of the IMB deferral therefore is $8M or 12 cents per share per quarter. Excluding the IMB related income, AFN still earns approx 13 cents per quarter (52 cents per year) from its existing investments. Alesco summarized the IMB deferral impact with the following the May 15 press release. Significantly, management noted that they expect the 4 affected CDOs to cure in 4 – 7 quarters and have the cash to pay the 25 cents quarterly dividend for the reminder of 2008.
Overview of Business Lines and Income Levers
Before discussing the investment thesis pros and cons, below is an overview of Alesco’s major business lines and sources of revenues. This excludes income from the Kleros RMBS investments, a business the company is deemphasizing, and Credit Default Swap gains is a non recurring item:
- TruPS income from banks $0.02 per quarter (Excludes 12 cents of IMB related diverted income) § TruPS income from insurance companies $0.04 per quarter § Commercial loan income from mid market companies $0.06 per quarter § Residential loan income from 740+ FICO borrowers $0.01 per quarter
- TOTAL (Excluding IMB impact, KLEROS & CDS) $0.13 per quarter
Investment Thesis - Negatives
- IMB deferral reduces income by 12 cents per quarter and lowers the threshold for other deferrals to shut off income from the remaining TruPS CDOs.
- REIT status may become an issue if Kleros assets are disposed of and REIT qualifying assets not found.
- As a REIT, AFN has to pay dividends on the deferred income until the OC deficiency is cured.
- Low stock price and significant disruption in credit markets prevents company from raising capital growing via historical methods Alesco is dependent on the banking sector for most of its income. The banking sector has been showing signs of stress in recent months.
Investment Thesis - Positives
- Excellent liquidity. As of May 15, Alesco had on hand approximately $125M of unrestricted cash, equal to approximately $2 per share.
- As of March 31, 2008, Alesco reported $88M of restricted cash. The $88M is primarily restricted for the following purposes: $43.7M at consolidated CDO entities to be used to acquire additional assets and $44.1 million of undistributed cash flows from operations at consolidated CDO entities.
- Almost all of Alesco’s debt is long term, non recourse thereby eliminating the risk of margin calls and fire sale disposal of assets. The company does have a $140M convertible due in 2012.
- The CLO/Leveraged Loan business (approximately 24 cents in annual net interest income) has performed very well with almost zero delinquencies and no deleterious credit migration. 90% of these 400+ loans are senior secured first-lien loans to companies in over 30 different industry sectors.
- At $1.50 per share, Alesco trades at less that 50% of its combined unrestricted and restricted cash balance
Alesco recently announced the formation of a special committee of its independent directors to review a number of going forward strategies for the company, including whether to remain a REIT. However, at $1+ a share, the market has priced in some draconian assumptions about the lack of viability of the business going forward.
The ultimate question is whether the market is wrong to value the company so low given the cash hoard, lack of margin recourse debt, and remaining income producing businesses.
Disclosure: Author holds a long position in AFN
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This article has 13 comments:
Thanks.
by Alesco after negative events. Even their website has little info.
If these guys utilized a public relations expert and released better
info the stock would be $6 or more.
Hello Franklin,
Yes, I am the author and I own AFN shares. I use a stock screener which filters out high yielding stocks where the yield is way out of whack. Then I do my DD and take my chances from there.
AFN first came on my radar when it dropped in the $2s in Aug 2007 after the AHM meltdown took down the entire sector. Since then I've added in the lows $2s and low $3s and received 4 dividends (including the one today) equal to $1.06. I'm usually a trader who likes to swing trade these companies for profit but chose to hold this one through all the ups & downs.
GL to you.
User,
Read the May 15th press release carefully. AFN said the CDOs would cure in 4 - 7 months even if IMB defaulted and didn't pay another dime. The key is that there are no other or minimal defaults/deferrals in the affected CDOs. AFN Mgmt suspected that IMB would eventually fail and that is why they put that caveat ("even if IMB does not resume making payment") in the press release. The key for AFN therefore are the other 300+ banks in its CDOs.
GL to you.
It would appear that those 300 or so banks in AFN's TRUPS may be in danger.
Thanks for the info Scotty. That would depend on which banks and whether they are in AFN CDOs. Other than IMB, ETFC was the only other large financial company in AFN TruPS at 2.4%. If the deferred/defaulted that would hit AFN. Multiple smaller banks deferring/defaulting would do the trick as well. One or two additional small deferrals would likely not have much impact.