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laterre

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  • What Went Wrong At Ocwen, And What Happens Next? [View article]
    Addendum:

    Many comments above have suggested that MSR valuations (assuming OCN is a forced seller) may be impacted by the liability issues/ requirements of a forced divestiture in CA. Don't want to minimize the "firesale" problem, but it seems to me that the issue of interest rates/ run-off is more material to pricing if/when it comes to divesting the agency MSRs. Besides the regulatory problems (which I think they'll eventually resolve) this is a different (and potentially additional) negative that most aren't focusing on.

    However, in looking over the 10/30 earnings presentation, OCN makes the interesting suggestion that rather than being OVERvalued, there may be some embedded upside when one considers book value versus market value (albeit as of 9/30/14).

    I take their numbers with a grain of salt, but they claim that the book value of their MSRs understates their "Fair Market Value" by $500M--or half the current market cap of the company (Shareholder presentation, p. 21)! They also provide some even more flattering numbers about "Internal Valuation" based on their "special sauce" (in which I place no confidence whatsoever, BTW), but which give an estimate of value of the MSRs of more than twice book value(4.5B!). Regardless of the degree of fluffing, there's some buried optionality here of an order of magnitude similar to the regulatory flack that's not being priced in by the market.

    Key question to consider in valuing a bust-up/ run-off scenario: what's the current market value for the agency MSRs? Interest rates have moved big-time since 9/30/14, and assuming the MSRs have strongly negative duration (crudely inferrable based on yields for IOs), I'd assume that an IR decline of the sort we've had in the past four months could shave more than 10% from the fair market value of the MSRs. How much of this decline might be offset by the reverse mortgage portfolio (whose duration would be positive, I think, but could vary considerably depending on whether they're floating or fixed) is another big question...

    Something to watch for when the mreits start reporting: how are TWO, MTGE, and others moving their marks on the MSRs they've acquired recently?
    Jan 19, 2015. 02:34 PM | 1 Like Like |Link to Comment
  • What Went Wrong At Ocwen, And What Happens Next? [View article]
    Still trying to get my head around this one. Even putting aside the litigation, the convoluted sub-servicing and securitization agreements make this a real mess to try to value.

    Taking the opposite tack of a worst case liquidation value, I'm struggling now on the free cash flow question, which has been a major selling point to date. On the surface, OCN looks like a FCF machine. Once you add back all the non-cash charges and financial engineering, they look like they're reliably throwing off 600-800M a year in free cash--a number that was greater than a $1B a year before they hit the rough patch. That kind of FCF takes care of a lot of problems, and would imply that the stock is being valued at an insane 1.5 times FCF. But among the largest of those non-cash "add-back" expenses is the amortization of the MSRs. This amounts to $250M a year of the "free cash." Without these, the FCF generation is still positive but less eye-popping.

    Two questions I'm pondering in light of recent events. Curious about how others reckon these. (a) in a typical distressed valuation, I've got no problem ignoring D&A on the grounds that it's a sunk cost and one can usually defer replacement indefinitely with negligible impact on cash flows. Add-backs for D&A=real FCF. But here, the D&A represents an actual evaporation of a cash-flowing asset. As these MSRs roll off, so does the cash flow. So I wonder whether treating these as add-backs for purposes of EBITDA doesn't misstate the true cash flow power here, esp. if they're prohibited from replacing them? (b) what's the relationship between their accounting measures of D&A expenses and the *actual* roll-offs of the MSRs? They list the projections/ assumption in the 10-K, but these look incredibly low given how far interest rates have fallen in the past year, and typical sensitivity of mortgages to prepayments. [I'd assume subprime are less sensitive, but in the current market you'd never purchase agency mbs using the rosy assumptions they're listing]. So my question: are they amortizing the run-off each quarter on the basis of the original book-keeping projections at purchase (the way mreits typically do for mbs)? If that's the case, then there could be an ugly catch-up charge at some point in the future if the empirical performance diverges from the projections? Or, alternatively, do they expense amortization based on actual run-off performance each quarter?

    Why this matters... In a model where they are in perpetual acquisition mode (like they were up until 2014) this is all kind of a moot point (and allows them to bury it in the accounting/ potentially exaggerate true FCF). But in run-off mode where they're not replacing the MSRs--and IR are suddenly much lower than anyone could have foreseen--the amortization of the rights can be a big deal, and it conceivably matters a lot whether it's accounted for based on empirical performance or rosy accounting assumptions...

    Make any sense? Thoughts?
    Jan 19, 2015. 12:56 PM | 1 Like Like |Link to Comment
  • What Went Wrong At Ocwen, And What Happens Next? [View article]
    Define "firesale prices"? Weren't these the very same MSRs that other would-be servicers, mortgage reits, and other FI players were queueing up to buy six months ago? The same MSRs that have the interesting qualities of negative duration and positive carry?

    To be clear, I don't have any specific "analysis" of OCN, and I'm not saying run out and try to catch a falling knife. But as far as valuing their ASSETS (as opposed to their EARNINGS, which may very well be good and screwed by the CA news...), I'd imagine that falling interest rates (and thus accelerating refis and runoff speeds) would have more of an effect on their ability to monetize those assets, should the need arise, than would a forced divestiture of their CA rights.

    Only one opinion among many, and quite different from the market's, obviously.
    Jan 13, 2015. 01:31 PM | 1 Like Like |Link to Comment
  • What Went Wrong At Ocwen, And What Happens Next? [View article]
    Agree 100% that the big "known unknown" as far as a liquidation is the future legal liability. Are we talking about $250M in future settlements, or 1B? If the latter, and an indefinite hold on new biz, then the equity is prob a zero. Still, given that the other assets should be relatively liquid, you can create a range of valuations for a best, base, and worst case for the legal liabilities.

    Also, not sure you'd face the same BAC/ Countrywide legacy issue in an asset divestiture, in or out of BK. Buying the MSRs gives you servicing rights in the future. Unclear why/whether purchasing these rights would carry the liabilities of things OCN did wrong while servicing those loans in the past.

    Fuzzy, agreed, but worth watching.
    Jan 13, 2015. 12:02 PM | Likes Like |Link to Comment
  • What Went Wrong At Ocwen, And What Happens Next? [View article]
    Ugly--and probably worse to come...

    Still, even if they go out of business, the MSRs and other assets on their balance sheet have cash value to buyers looking to built out these platforms. Someone has to service the loans, and it's not going to be the banks.

    Worst case and spit-balling (never looked at their numbers before 5 minutes ago): assuming a healthy (though indeterminable) charge for future settlements, and writing off all the goodwill and intangibles, I still get a margin of safety in the low to mid single digits in the case of a forced liquidation.

    Anyone know if/where the senior unsecureds trade, or was that a PP?
    Jan 13, 2015. 10:55 AM | 1 Like Like |Link to Comment
  • SandRidge: Playing The Endgame With A Hedged Position [View article]
    I've already said above that I don't think the author understands the capital structure in SD. His "arbitrage" trade would have you potentially losing on both sides in a typical BK scenario. But the covenants being discussed--by him and the mgmt--*are* (not "might be") with respect to the senior secured revolving credit facility--not the bonds. And the consequences of having your working credit line yanked are indeed every bit as "supremely adverse" as he says.
    Jan 8, 2015. 04:18 PM | Likes Like |Link to Comment
  • SandRidge: Playing The Endgame With A Hedged Position [View article]
    He's prob talking about the revolver, not the notes. Notes typically don't have these kinds of restrictive covenants tied to earnings or leverage. They're unsecured. But I'll let the OP explain for himself...
    Jan 8, 2015. 10:51 AM | Likes Like |Link to Comment
  • SandRidge: Playing The Endgame With A Hedged Position [View article]
    Your entire premise for this article is a howler. SXDRP is EQUITY, albeit preferred equity and convertible. The 2021s are senior unsecured DEBT. They're behind the senior secured revolver, as you say, but in front of all other unsecured debt, as well as all the equity.

    Re. SXDRP:"In regard to the payment of dividends and UPON LIQUIDATION, the preferred shares rank JUNIOR to the company's senior debt, equally with other preferreds of the company, and senior to the common shares of the company."

    Check the prospectus for the preferreds and the 2021s if you don't believe me.

    http://1.usa.gov/14iAKLu

    No opinion on SD one way or the other, but if you think a buyout is in the offing, just keep it simple and buy the debt in size, or hedge some of the risk by shorting the common. My guess is that at this stage of the game the trade is uneconomical.
    Jan 6, 2015. 01:09 PM | 3 Likes Like |Link to Comment
  • Fishing In The Oil Patch [View instapost]
    Hey Darren,

    Thanks so much for the detailed run-though on your numbers for recoveries/ liquidation. That's fairly conservative, I agree. And I hadn't factored in the compensatory value of the hedges, which is why I was coming up with worse numbers. Never paid these small E&Ps much mind before they suddenly all went on sale.

    The preferreds still scare me, to be honest, but I began a small starter position of .5% of portfolio. Will be monitoring closely and hope that mgmt can make good on their "worst case" scenario for 2015. The risk/reward on this is just too good to overlook completely, but still can't go as deep into the water as you guys.

    @ jpmist: hey, greetings, and happy new year! I didn't read all the original covenant docs on the senior and 2nd liens, but ran through the recent modifications/ waivers fairly carefully. There's nothing outlandishly bad, other than Apollo Inv is sticking them for 13-14% on the supposedly secured 2nd lien (which might give some indication about where the shotgun preferreds ought to be yielding). The only thing that's unusual (and maybe this reflects my general ignorance of the small E&P space) is that the lenders are literally telling them what wells they can drill. It's like someone adult needed to step into the boardroom and takeover their capex given all the cash that's been squandered lately on dry wells.

    The serial preferred issuance at the market is also weird, frankly, but I guess it was more cost effective for them than a true senior unsecured bond issuance with a real underwriter.

    Something here just doesn't smell right to me, which explains why I'm only treating this one as a lottery ticket...
    Jan 3, 2015. 04:39 PM | 2 Likes Like |Link to Comment
  • Gundlach: Bull market for Treasurys to continue [View news story]
    His brand new LONG duration bond fund (DBLDX) is a very interesting product, both for expressing this contrarian view on IR (which I share) and as a macro hedge.

    Using agency CMO derivatives (which most small investors can't access) allows him to express this directional view on IR and also to capture a much fatter coupon than just buying a bunch of long dated treasuries.
    Jan 3, 2015. 10:32 AM | 2 Likes Like |Link to Comment
  • Ditching The 401(k) [View article]
    Apologies for the candid reaction, but while generally well-reasoned, this comes off as a really smug portrayal of retirement planning.

    Ok, so the 3% employer match isn't great, and you may not stay long enough to collect the full benefit, but even 2% is something (assuming you leave early). True--the tax advantaging is contingent on your highest adjusted marginal bracket, so in your case it may be, say, 10%. And let's assume that your fund choices aren't great in terms of either performance of fees.

    Even so, you are conservatively leaving 12% on the table right off the bat by declining to participate. And if you're a true saver, as you say, and socking $ away (versus having cash in hand now in your paycheck) is a real priority for you, you can get a lot more money (up to 18K per year, plus the match) into tax advantaged accounts via the 401k than by means of individually managed accounts, and in many cases do a Roth IRA on top of the 18K. Maximizing the amount of $ that's shielded from the tax man every year has an ongoing benefit, as it's amazing how much taxes eat into gross profits, even for supposed "buy and hold" investors.

    Lastly, maybe you're right and your plan options all suck. This happens frequently as (gasp) employers put little thought into designing these things. However, as mediocre as the options may be, I would bet you dollars for donuts that over a 10 year investment horizon, even dollar-cost averaging into that crappy, fee-heavy large cap US equity fund they're offering you will still outperform your own attempts to beat the S&P by assembling your portfolio of dividend growth stocks. If it were so easy, everyone would do it, and beating it isn't the point so much as doing so on a risk-adjusted basis.

    But to each his own, and good luck to you, really ;)
    Dec 29, 2014. 08:51 AM | 21 Likes Like |Link to Comment
  • Fishing In The Oil Patch [View instapost]
    Thanks much for the detailed info on Mill-Pref. Wow, this one has some *serious* hair on it. If these prefs are your single largest position, I really hope you've gotten the sizing right... Vaya con Dios, my friend!

    How confident are you that they won't immediately hit the new covenants in the amended credit agreements? By my very quick reading (and without cross-checking against the originals) these waivers look like they were designed by the lenders as a stopper to put a brake on cash going out the door to the preferreds (or more stupid capex). Based on the current price of the Prefs, Mr. Market is assigning 100% prob of a dividend cessation in the immediate future. Wouldn't be the worst thing to preserve some cash.

    Not sure on your buyback theory, though, as I'm assuming the secured lenders would insist on any FCF going to paydown the senior and 2nd liens, no? That's more or less the demand they've made w/r/t the impending Alaska credit receivable. Why would they allow cash to go out the door beneath them in the cap structure, even if, as you correctly point out, it's more accretive than drilling?

    I'm also less sanguine than you on the margin of safety through the prefs. Given the huge write-downs to reserves in the last Q, don't you worry that another big chunk of their assets could vanish with the stroke of a pen? You've also got to haircut the rigs, equipment, etc. for a firesale liquidation. And with any further preferred issuance at a standstill, what's to stop them from issuing something else senior and secured to the prefs, leaving them with nothing? I notice the lenders ratcheted up to 90% their senior security claims on the assets. Doesn't exactly scream confidence in valuations.

    Pretty much the only truly positive signal I see on the prefs is that one of the Directors just ponied up to buy some in the open market.

    Mad props to these guys if they can make it to the other side of the mountain and carry the pref holders with them. Fantastic upside r/rw on these things. But thus far, this company looks like a well-oiled machine designed for taking money from the state of Alaska, drilling dry holes, and selling dodgy preferreds to the retail market.
    Dec 28, 2014. 01:38 PM | 2 Likes Like |Link to Comment
  • Seventy Seven Energy: Underfollowed Special Situations Gem Trading At A Deeply Distressed Valuation [View article]
    With 5 minutes of research, I get a conservative liquidation value of their assets at 1840M, over and against 2084 in curr liab and LT debt, for a stressed valuation of (200M). The equity is a zero in a bk.

    With the spin they issued 500M of unrated debt and...promptly paid it to CHK. Nice trick.

    As far as revenues, assuming a 2014 annualized base of 2B, over and against OPEX of 1600, SG&A of 110M, and Interest expenses of 100M, they are/were FCF positive to the tune of 200M as of the last Q.

    Stressing for a 25% reduction in revenues in 2015 and assuming some inelasticity of expenses, you get 1500-(1280+110+100)=or roughly breakeven for FCF.

    Anything more than a 25% decline in revenues and they're burning cash. 50% decline and they'll burn through the revolver in 12-18 months.

    Not the biggest POS in the dog park, but nothing to write home about.
    Dec 19, 2014. 10:14 AM | 2 Likes Like |Link to Comment
  • Seventy Seven Energy: Underfollowed Special Situations Gem Trading At A Deeply Distressed Valuation [View article]
    Ditto on the debt question...huge omission.

    You *absolutely* have to stress for debt coverage before concluding that this is worth more than zero.

    Moreover, and without even glancing at the 10-Q or other docs, I want to vent about a new favorite pet peeve of mine that I'm noticing more and more often from all the Joel Greenblatt fetishists around here. Namely, that not all "spins" are good opportunities, and many of them are outright scams intended to offload debt-ridden subsidiaries onto the gullible.

    I can name a dozen recent bankruptcies that originated as "spins," which were really thinly veiled dumps of debt. Case in point: many of the Sears divestitures such as Orchard Supply Hardware. Back when spins were underfollowed and misunderstood, the Greenblatt trick worked. But now that everyone knows that everyone else knows the trick, nudge-nudge, wink-wink, companies are mercilessly spinning off debt-laded subsidiaries that are designed to fail. To me, the fact that this was a top of the market spin is a red flag NOT to invest.

    No idea whether this is a bargain or not, but the fact that the senior unsecured debt is changing hands in the 50s is not a good omen.
    Dec 19, 2014. 09:38 AM | 1 Like Like |Link to Comment
  • Key Energy At $1: Priced Like An Option With Upside Potential To Match [View article]
    Thanks much, hoyt. Yep, it's conservative but also reflects what you might reasonably expect in a true liquidation. A solid % of current assets, moderate % of hard assets that have value only to another industry player, and writing off the intangibles. I prefer to build in a decent margin of safety. If anything, that's probably generous in terms of what some of these cyclical industry assets might bring in a fire sale.

    On the credit agreement: looks at a glance like Wells or the syndicate agreed to relax the covenants temporarily in recognition of the FCPA problems in exchange for lowering the amount. It's scheduled to decrease to 350M by July. They may hit the new covenants. Haven't stressed for those as I assume they'd get them waived.

    Not to say they can't refi and get more secured debt in front of the unsecured bonds, but I kinda like the fact that they're currently locked out of the capital markets. Rather than a long-drawn out chess game, what you see is pretty muh what you get in terms of the capital structure. They either make it to the other side of the mountain in the next 9-12 months, or they file. Equity is a call option, like hawk says.
    Dec 17, 2014. 01:03 PM | 2 Likes Like |Link to Comment
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