Alesco: IndyMac Failure Priced In

When news of the failure of IndyMac Bancorp (IMB) broke over the weekend, I feared that it would provide yet another opportunity for the shorts to pull down Alesco Financial (AFN).  I was pleasantly surprised though on Monday, when the stock finished down only a penny in a brutal market.  While the majority of the financial stocks in my investing universe were down around 5%, Alesco’s relative strength was rather surprising and revealed something that I had not expected given the current market conditions. 

I believe that Alesco’s strength on Monday shows that the market is finally pricing in all of the company’s issues both those that are real and those that are perceived, with the IndyMac failure being almost certainly priced into the stock price.   

I am not going to go into any detail on Alesco at this time, as there are already several great articles on the company out there.  The most recent one can be found here.  Brian King, the author of the piece does a great job of outlining the case for Alesco.  As we all know, IndyMac has been in trouble for sometime and Alesco with its small stake in financial securities tied to the mortgage bank’s trust preferred securities was viewed as being particularly risky, even though the direct impact of these securities was minimal.  As a result of IndyMac situation, the failure of Kleros mortgage backed securities and the general fear of financial stocks the share price of the company has fallen dramatically over the last year. 

The company is currently sitting on a little over 100 million dollars in unrestricted cash after paying out it’s most recent divided, has zero short term debt, a relatively strong leveraged and commercial loan portfolio and some of the best connections in the business.  As a result, the company is uniquely positioned to profit from the current turmoil in the credit market after it undertakes significant changes to its corporate structure. 

The future for Alesco will be interesting to watch.  As the Kleros securities deteriorate, the company will likely be forced to drop its REIT status and its current high dividend payout.  I am currently estimating that this will occur at the start of 2009, giving current shareholders two more dividend payments for a total of 40-50 cents a share.  Once these dividends are paid and the fiscal year is closed out, I would hope to see Alesco drop the REIT status and convert to a standard C-Corp. 

If this were to occur it would allow the company to invest its significant unrestricted cash, which would likely be somewhere near 85 million at the end of the year as well as its future free cash flow into investments capable of generating significant returns for shareholders.  Examples of such investments could be the purchase of commercial mortgage backed securities, leveraged loans and normal mid-size commercial loans that have been shunned by your typical commercial bank.  Such a change would allow the company to begin to develop into a pre-deposit CapitalSource (CSE). 

Another possibility for the company is to become one of the premier asset gathers in its field of expertise.  The company’s large and diversified collection of trust preferred securities could potentially allow them to raise and manage investment partnerships that invest and lend money to smaller community and regional banks in either the form of a direct equity or trust preferred investment by their managed portfolios.  As the trust preferred market is currently nonexistent, any Alesco managed funds could likely garner significantly higher interest rates on their investments then the rates available before the credit crunch.  If the company were to find this too difficult, they could become an asset gather specializing in the management of leveraged loan portfolios.  Such a shift in company focus would eliminate much of the risk from the company, as it would have no direct exposure to the portfolios that it would be managing for its clients.  It would instead begin to receive management fees tied to its assets under management.     

If the company wanted to ratchet up returns and was willing to deal with increased regulatory oversight the company could purchase a deposit-based institution such as an Omni Financial (OFSI).  Such a deposit base would allow the company to fund its leveraged and commercial loans at lower rates then would otherwise be available to it.  There are quite a few community banks with large deposit bases and low market capitalization that the company could purchase to expand its funding base with relative ease, such an action would be the most positive in my opinion as it would symbolize management’s commitment to the company of the long-term.  If the purchase were to resemble that of CapitalSource’s and follow the CapitalSource model, it would be particularly positive for shareholders.

The final possibility for the company would be its sale to RAIT Financial (RAS).  The company’s are related through their ties to the Cohen Family and their sharing of the same office complex so such a deal would likely be positive to both groups of shareholders, especially if it were an all stock offer.  RAIT Financial shareholders would own a company with a stronger balance sheet while Alesco shareholders would join a company with a much stronger dividend platform.

Any of the above scenarios would be beneficial for Alesco’s shareholders and while they all involve the elimination of the dividend after this year’s payments, the long-term benefit of changing the nature of the business will be more then enough to offset the dividend elimination.  The failure of the stock to collapse on the headline provided by IndyMac’s failure is a sure fire sign that the stock has reached bottom and now offers decent value and potential upside to investors willing to take on the company’s speculative nature. 

For Further Review:

Brian King's Article on Alesco

Disclosure: Long AFN

Comments

[copesetic]

Why is it that any mention of AFN in any particular day seems to be the "kiss of Death" ? down 7% at this moment :(

[Smooth Jazz]

Great article Prudent and thanks for the plug (I'm Brian King). You eloquently laid out some great ideas to grow the business and leverage their core competencies. Hope Mgmt and the "Special Committe" are reading SA and consider some of you excellent advice.

I dont see the stock getting any traction in this market where good financial names are getting 10% - 20% haircuts daily. Hopefully, this "crisis" in the sector will pass and folks will see the value in AFN that you described. Unfortunately, I don't see any let up until we get through C, BAC, MER, etc earnings reports the next few weeks, and the REITs start reporting in early August.

Nice job!

[opposablethumbs]

I couldn't agree with you both any more than I do. For over one year now, I have considered AFN an unbelievable bargain 'hidden in plain sight.' You two have done a great job making the case and summarizing my own reasoning and conclusions. I have been more or less "day trading" AFN, -- especially around the dividend payment periods, -- but now I am going to simply "Buy and Hold" at these price levels @ $1 -- $1.30.

Thanks Brian for the great article!