Cycle over for distressed asset plays?


"The business they sold investors as 'secular' is actually 'cyclical,'" writes a bearish analyst of Altisource Residential (RESI -0.7%) and Altisource Asset Management (AAMC -10.5%). "And the cycle is now over."

For RESI to work as a business, the company needs a continuing supply of distressed single family home portfolios to buy, needs to raise capital above book value, and then needs to repeat the cycle. And as Friday's HUD auction of distressed mortgages shows, an improving real estate market and a wave of capital entering the space has about ended the easy money.

RESI was paying a 34% discount to fair market value a year ago for these assets, but Friday's result (of which the company was shut out) showed just a 22% discount - a decrease in profit of nearly 60%.

Comments (10)
  • northgoingzax
    , contributor
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    and just who is this analyst?
    24 Jun 2014, 06:04 PM Reply Like
  • Abercrombie
    , contributor
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    Doesn't matter. He or she is spot on.
    If you look at what occurred during the RTC sale of assets after the S&L meltdown, the first few auctions offered great opportunities to make a lot of money (I was at a private equity shop bidding on these pools). But, within six months, many other players started bidding and we were all using pretty much the same assumptions regarding the time and cost to recover the asset or otherwise recoup our investment (it's not rocket science). Soon, $500mm deals were trading with the top three bids within 1% of one another. RESI and AAMC tried to convince the market that this was a secular business and that they had a proprietary pipeline, etc., which is nonsense. The sellers are anything but stupid and they know how to run auctions and achieve the highest prices (and lowest returns for the winning bidders). It's a race to the bottom in terms of what the bidders will accept as a return on investment and who's willing to use more aggressive recovery assumptions.
    The other related issue is that everything that RESI has bought to-date has also been in competition, which perhaps is one reason the firm is so dependent on illusory "Unrealized Gains" to generate the basis upon which it pays egregious fees upstream to AAMC. If RESI got such a great deal on what it has bought thus far, why are they unable to translate more of this into "Realized Gains" (i.e., cash money)? Marking to model is all too reminiscent of the 2008 meltdown, when the tide went out and the model was naked. Toto has pulled back the curtain and there is Mr. Erbey still pulling levers to no avail. The jig is up.
    24 Jun 2014, 08:21 PM Reply Like
  • Shadow Banker
    , contributor
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    Abercrombie - good luck with that. I've found that following advice from people who publish Hitler videos in their pump-and-dump schemes always works out for me.

     

    RESI's "mark to model" is correct accounting. Would you rather them buy at 75, wait a year, and then instantly mark it to 95 once it's resolved? If you don't trust Erbey, you should be more afraid of a non-accrual method since it would be much easier for him to screw investors that way. I suggest you read up on ASC 310-30 for a lesson on how things work in mortgage loans...it's not rocket science to see how buying a dollar for less than a dollar can make money for those with the lowest cost of capital...
    24 Jun 2014, 11:18 PM Reply Like
  • Jean Fonteneau
    , contributor
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    Shadow Banker, I think everybody agrees with your accounting point, but the issue here is that the opportunity to "buy a dollar for less than a dollar" which is the premise for the whole scheme to exist is quickly vanishing... And if you have to pay 77% rather than 64% where does that leave RESI model and valuation, much lower potentially?...
    24 Jun 2014, 11:51 PM Reply Like
  • Shadow Banker
    , contributor
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    Agree that pricing is most definitely what the market is concerned about here. It's a moot point for RESI though. RESI is trading significantly under where they can liquidate their current portfolio, excluding all of their financing options, rental income, or any other NPL acquisitions. BPOs are extremely accurate...this is not voodoo valuation.

     

    AAMC is more sensitive to the party being over for low-cost acquisitions. However, given the broader NPL pipeline, RESI's ability to generate more income than competitors via rentals, a buy-back program working as we speak at AAMC, and another REIT management contract coming up, the pair trade that Glaucus suggests is illogical and is very dangerous.

     

    25 Jun 2014, 12:21 AM Reply Like
  • Abercrombie
    , contributor
    Comments (32) | Send Message
     
    Shadow,
    Not sure what RESI being a bad investment idea has to do with Hitler but I guess when your stock plummets you need to throw something inflammatory into the mix to distract attention from the deteriorating fundamentals. "Look, Genghis Khan!!!" Actually, you might have tried, "Look, Benjamin Lawsky!!!"
    Seriousness aside, you're really missing the point. I am more than familiar with the accounting, just noting that you cannot fudge cash but you can play games all day long with what you think your loans are worth (see IndyMac for details). When you say that they're holding loans at 75 that are really worth par, then I'd challenge them and you to demonstrate that by selling a few hundred. The harsh reality is that they cannot. If you recast the loan and the borrower starts performing, then it will take at least a year of performance before another buyer will take it off your hands; obviously, if the loan was restructured and principal forgiven, then you'll get less than initial par. Moreover, even if you did not forgive principle, who is going to pay par for a 95% LTV loan? As for rental income, etc., where, pray tell, is RESI generating any of that? How many homes do they actually own now and rent out? What percentage of the portfolio have they resolved to the point that they have possession of the home? If the play is to eventually convert NPLs into performing loans, then there is a time value issue of taking it from owning the notes to eventually owning either a performing loan or the physical asset. Been there, done that, on billions of dollars of assets in my career. Right now RESI is cash flow negative because it needs to keep feeding the beast but the overwhelming majority of its income is "Unrealized," which is hard to pay the bills or dividends with.
    Mr. Erbey is an undisputed master of financial engineering and convincing everyone that he invented the wheel, discovered fire, and cured the common cold all while being the only guy in town who can service a loan. Good luck with that.
    25 Jun 2014, 10:16 AM Reply Like
  • Jean Fonteneau
    , contributor
    Comments (211) | Send Message
     
    +1 on that one.
    25 Jun 2014, 11:50 AM Reply Like
  • Badgold
    , contributor
    Comments (198) | Send Message
     
    Wait until some of the clowns who RESI has cut better deals to default again. RESI has these mortgages are marked at Par and they will go south!!!

     

    Not to worry AAMC will not give you back any money, as there is no high water mark.

     

    Shadow Banker-- This is the logical flaw in your bullish view. It can cut both ways. You may have to writedown the mortgage again and start over.
    25 Jun 2014, 02:07 PM Reply Like
  • Shadow Banker
    , contributor
    Comments (12) | Send Message
     
    This is not a new concept. What do you think Lone Star is going to do with that pool? Buy for 75% of property value, foreclose or mod, sell the loan/house a year later, repeat. The returns on their website seem to suggest that unrealized gains really can turn to cash, and they don't even have a rental option.

     

    Glaucus published a hitler parody video about AAMC and RESI. He is the author of this article. Good guy to rally behind.
    25 Jun 2014, 04:11 PM Reply Like
  • Abercrombie
    , contributor
    Comments (32) | Send Message
     
    Shadow, my friend, I saw the video but assure you I am not short RESI on the back of someone using that clip for the 29th time (Hitler complaining about ObamaCare was funnier). No, as you note, this is not a new concept, but it is absolutely, positively, cyclical and not secular...that's the point. NPLs can be bought for 50 cents on the dollar and generate 30% IRRs; well, Microeconomics 101 tells us that other players pile in and drive those IRRs down until no one will accept them. Do you really think that RESI, which pays underwriters about 10% or more all-in to raise money for them, and pays egregious fees to AAMC, has cheaper capital than Lone Star? Really? Lone Star and others are anything but stupid and they aren't sharing the upside with another Erbey entity.
    You need to understand that much of this sector, and Erbey is the master, is structured as "Stuffer/Stuffee." Think of it as "Asset-Light" vs. "Asset Heavy." Erbey makes most of his money owning big chunks of the "Stuffee" that sucks fees (think vampire squid) from the asset-heavy "Stuffee." Sure, Erbey owns enough of the asset-heavy "Stuffee," but he has a lot more dough at stake in the asset-light "Stuffer." As always, follow the money.
    In this case, you cannot rely on wash, rinse, repeat, in a cyclical opportunity. RESI only survives so long as it can access the capital markets to keep raising new money. They cannot monetize what they own fast enough to recycle the capital, so they keep raising more equity on the back of inflated projections of what their investments are worth (i.e., mark-to-model). The BDC industry has been playing this game for years; it works until it doesn't. As long as credit is improving, the BDCs run unrealized gains through the income statement, then do another equity raise to pay the cash dividend associated with all those non-cash unrealized gains.
    If you believe that what RESI owns is really worth what they say it's worth, then the simple response should be, "Show me the money." The only realized gains they generate are the few loans they can cherry-pick and sell, but the rest are works in process (at best).
    Finally, even if you suspend disbelief and accept the RESI valuations, why would you ever pay more than BV for a company that upstreams a huge share of the profits to AAMC? RESI was a trade, it's not a going concern. I'd be concerned about that...
    25 Jun 2014, 06:05 PM Reply Like
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