Insiders giving themselves special pensions

Defined benefit pension plans give pensioned a defined amount of money each year for the rest of their life.  Unfortunately for shareholders, the risks on this liability are very difficult to estimate and can get out of hand.  Warren Buffett explains the relevant concepts in a 1975 memo to Katherine Graham.  Shareholders are likely better off if the company offered its employees a defined contribution plan rather than a defined benefit plan.

When reading a DEF 14A filing (I have a previous post on things to look for in a DEF 14A filing), it may be worth checking to see if management is giving itself a defined benefit plan while the workers beneath them are receiving a defined contribution plan.  I believe that this is an area where management can basically hide some of its compensation.  Intel and TJ Maxx are examples of companies that have defined benefit plans for management.  In the grand scheme of things however, this practice isn’t that bad compared to other ways that insiders compensate/enrich themselves.

*Disclosure:  Long TJX via calls.  No position in INTC.

What Ocwen and Altisource do

Erbey’s empire of publicly traded companies (OCN, ASPS, HLSS, AAMC, RESI) is a little confusing.  Here’s my understanding of what his companies do.

LMCA/LMCK share class arbitrage

LMCK shares have no voting power while LMCA shares do.  In theory, LMCA shares are worth more than LMCK shares and should therefore trade at a premium.  Right now, the opposite is true.

Class A:  Ticker symbol LMCA.
Class B: Ticker symbol LMCB.  These shares have the most voting power.  These shares are highly illiquid.
Class C: Ticker symbol LMCK.  Non-voting.

In theory, you can arbitrage these shares by shorting LMCK and going long LMCA.  I would not recommend that particular trade because I’m not a fan of share class arbitrage in general.  But if you enjoy risky arbitrage trades that may take years to work out, there are better share class arbitrage opportunities out there.  For example, the spread is dramatically higher with LEN and LEN.B (18.7% versus 0.6%).

Altisource recap

This is just my opinion, but I think that Altisource is pretty cheap despite being one of the fastest growing stocks around.  Here are the company’s historical earnings per share (diluted):

2008: $0.38
2009: $1.07
2010: $1.88
2011: $2.77
2012: $4.43
2013: $5.19
Trailing twelve months: $6.69

Despite this incredible growth, the current TTM P/E is 12.8.

(Ocwen/Altisource) Force-placed insurance

Altisource’s share price fell dramatically today following a letter by Benjamin Lawsky to Ocwen (PDF link) that finds problems with a practice called force-placed insurance.  Normally, lenders will require the homeowner to pay for hazard/property insurance.  Part of each mortgage payment goes into an escrow account that pays for insurance and property taxes.  However, there are some rare cases where the borrower pays hazard/property insurance separately.  Perhaps they already had insurance before getting a HELOC.  Or, they wish to exercise their right to choose their own insurance provider.  In those situations, a borrower who has run into financial difficulties may stop paying their hazard/property insurance because they have more important expenses to pay.  This exposes both the lender and the borrower to the risk of catastrophic damage to the home.  Mortgage contracts generally allow the mortgage servicer to obtain hazard/property insurance elsewhere on behalf of the borrower.

There are two issues with force-placed insurance:

1. It’s almost always significantly more expensive than the original hazard/property insurance policy.
2. The mortgage servicer can take kickbacks/commissions from the insurance company.

(Ocwen) RMBS arbitrage

(This post is about a new venture at Ocwen that will likely be immaterial.)

On the latest conference call, Bill Erbey commented that Ocwen will be pursuing a new RMBS arbitrage strategy:

I believe that Ocwen has substantial opportunities to leverage our strong servicing capabilities by exercising cleanup calls, call rights or investing in existing private label RMBS tranches that we service. Most of RMBS securities we service have cleanup call provisions that allows the servicer to call the deal at par, typically when it has been paid down to 10% of the original unpaid principal balance. Notwithstanding slower prepayments, we see a steady stream of deals maturing in the next several years.

The opportunity results from the arbitrage of the underlying loans in REO being worth more than the securities. In other words, the whole is worth less than the sum of the parts. A condition precedent to our investment is our belief that Ocwen’s servicing creates strong cash flows for the securities overall. We’re building out this program and expect to be in the market purchasing securities in the next few months.

Perhaps some enterprising hedge funds will try to front run Ocwen.