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  • Buy Western Asset Mortgage Capital Now As The Entry Point Is Low [View article]
    No--90% of the prepays don't have to be paid out as divvies. Only earnings have to be paid out. They're free to reinvest the run-offs as CPRs tick up. The real problem is that with agency mbs at all time highs, the spreads they'll earn from reinvestments are materially lower.

    Anup's pivot into non-agency is looking smarter by the day....
    Jan 23, 2015. 10:54 AM | 2 Likes Like |Link to Comment
  • What Went Wrong At Ocwen, And What Happens Next? [View article]
    Way I typically look at things is EBITDA. Here EBIT is prob the better measure, as you say. So the question is: how does their EBIT cover their debt service and fixed expenses, and is there anything left over as truly "free cash." By my calculations (admittedly back of the envelope for now) the answers seem to be adequately, and some.

    I come out at +/- 500-550M, or $4-5 a share, on a very stressed case liquidation value (write off all intangibles; 350M settlement and costs; 10% haircut on MSR liquidations). This completely discounts the possible upside on the carrying value versus current market value of MSRs, as well as the possibility that the settlements may be less onerous. Bond market agrees with you, however, as the senior unsecureds are trading (144A) around the 80s.

    Not sure about their total capacity, but several of the mreits have been setting up licensed servicers as subsidiaries so they can buy these up and service them (via the subsidiaries). There's also Nationstar, Walter, etc. to pick up the slack. There are buyers.

    Why did people get into this at higher prices? Cuz they assumed what the 2 and 20 lemmings always assume: that everything would go swimmingly. After all, everyone was talking it up. What'd it, like double or treble after Ira Sohn. What could possibly go wrong? But now that door looks pretty small when everyone is trying to get out at the same time and avoid looking stupid. Only one I really put any weight on is Seth Klarman. When he gives up, I know I've missed something.

    Put it in a drawer, come back in 2 years, and this'll either be at 0 or 25. On that happy note, GLTA!
    Jan 20, 2015. 01:39 PM | 2 Likes Like |Link to Comment
  • What Went Wrong At Ocwen, And What Happens Next? [View article]
    Re: FCF, read point (a) in my first long post above. I'm well aware that the amortization expense of the MSRs is indeed a "quasi-cash" expense given the liquidating nature of MSRs. Their current annualized expense for amortization is $250M. As I note in point (b) above, there is the related question of whether this expensing is sufficient given higher than anticipated run-off rates, about which I'm dubious...

    But assume for a second that the amortization expense isn't just a rosy accounting projection and that it matches the actual run-off. In one sense (and subject to the caveats I identify above), it's a moot point if--like the MLPs--they can continually replenish their supply of MSRs by acquisitions. The "free cash" from MSRs gets recycled into new rights. That particular daisy chain seems to have ended for the time being, so we're in run-off.

    But what's striking is that even if you DON'T add-back the $250M annualized in amortization expenses, you're still left with some serious FCF. Don't have the numbers in front of me, but assuming 750M in unadjusted FCF, minus the 250M for amortization, it still looks like nearly $500M (or 1/2 the current market cap) in a run-off period. Pretty sure that will cover debt service and keep the lights on for a year or two while they get the reg stuff straightened out.

    Happy to be corrected on any of these figures and assumptions. The reason I'm boring everyone to tears with these calculations is I hope to have them falsified.

    Also, agree that liquidation value makes more sense as a worst case.

    Still, think of the coincidence of things that have to go wrong for this to be a zero. (a) they need to be completely put out of the servicing biz, via a revocation of their license and a forced divestiture; (b) upon liquidation, the value of the MSRs and reverse mortgage portfolios turns out to be severely impacted by "legacy issues" (25% haircut); and (c) the recoveries upon divestiture need to be extinguished by a legal settlement in excess of $300M (spit-balling).

    I can envision one or two of these things coming to pass. It's almost certain that they'll be burned by at least one of these. They get shut off and have to liquidate, or they get hit by a big settlement but are allowed to continue operating, or they get gigged by the market in a partial divestiture. Still, I think the coincidence of all three of these negatives is less likely than the market seems to be pricing in.

    My 2 cents, and I'm done on this one for now...
    Jan 20, 2015. 11:11 AM | 2 Likes Like |Link to Comment
  • What Went Wrong At Ocwen, And What Happens Next? [View article]
    All great points/ sticky questions...

    On unloading the agency MSRs. In addition to their major competitors, there are loads of smaller players (including several of the mreits) who've been staging to get into this biz. TWO, MTGE, WMC, and several of the hybrids have been positioning themselves and getting subsidiaries licensed to service these.

    It's not that there's no market for them; the real question is current value. Looks like there are a couple of large BWICs coming up that might establish a market price. But even absent a true "market" price, you can kind of reverse-engineer the pricing on these off of current pricing for agency IOs. And not surprisingly, these have gotten pounded as rates have dropped. There will also be new marks (12/31) from other players as this earnings season rolls around.

    If I'm right about the material effects of falling IR on the value of the MSRs, you could actually look at the aborted Wells Fargo deal in early 2014 as a blessing in disguise. It stopped them from buying a boatload of MSRs at prices that were undoubtedly top of the market--not reflecting today's obscenely low rates and a faster burn-off rate. Remember that when the Wells deal was hatched, everyone was expecting rates to blow through the roof and mtg refis to be muted. Now, presumably, when they get the greenlight to begin acquiring again, the pricing will reflect current expectations about prepayments.

    I actually think they have more leverage in the CA situation than the media seems to be allowing. CA borrowers are scattered in every single mbs pool; you can't just divest (sell-off) the CA mtgs from the rest of the servicing rights. Conceptually, OCN services deals (entire pools, for the mbs trustees) not discrete individual loans. I can't foresee every single mbs trustee simply firing OCN outright and throwing the whole mtg payment system into chaos. They send some boxes of docs, do a mea culpa, pay a couple hundred million to the states, and bride some affordable housing advocates: done deal.

    Bottom line: there are so many ? here that it's a fool's errand to try to pin down an exact value. It's impossible with so many moving parts. For me, though, the question is does the current price allow for a sufficient margin of safety to account for some of these risks, even in something approaching a worst case. I'm getting comfortable with a price in the $6-8 range that's like 1.5-2 times FCF on a going-forward basis, and probably considerably less than the bust-up or run-off value. Think about how cheap is 1-2 times forward EBITDA. Know any other biz selling that cheaply? That price leaves a lot of wiggle room for the "unknown unknowns." Still, not denying that the downside risk here is a zero.
    Jan 20, 2015. 10:00 AM | Likes Like |Link to Comment
  • 16 Investing Lessons From A SuperInvestor The World Forgot [View article]
    Truly one of the best!

    And I'll give him a free pass on #15 ;)
    Jan 19, 2015. 07:19 PM | Likes Like |Link to Comment
  • What Went Wrong At Ocwen, And What Happens Next? [View article]

    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.

    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