Altisource exits force-placed insurance “brokerage” business

Today, Altisource stated that it is discontinuing its lender placed insurance brokerage business (press release).

The discontinuation of this business line is expected to reduce Altisource’s quarterly diluted earnings per share by an average of approximately $0.50 – $0.65 for the period October 1, 2014 through December 31, 2015.

My guess is that Altisource was involved in taking kickbacks for force-placed insurance.  It is Ocwen that should decide whether or not to take kickbacks and it is Ocwen that would get to keep such kickbacks.  However, it could be the case that Ocwen took its kickbacks as a lump sum fee when it sold Beltline Road Insurance to Altisource.  See this Associated Press article which explains how it works.  The article quotes a source that argues that what Ocwen/Altisource are doing is wrong.

Currently, Erbey wants Altisource to get out of (kickbacks on) force-placed insurance due to “uncertainties with industry-wide litigation and the regulatory environment”.

Profitability

Let’s take a look at the EPS decrease due to discontinuing this business.  For the 5 quarters from Q4 2014 to Q4 2015, it expects an EPS decrease of $0.50 to $0.65.

In the last two quarters, earnings plus amortization of acquisition-related intangible assets (net of tax) was $2.63 for Q2 and $2.18 for Q3.

slide-13-adjusted-earnings

The press release for Q3 2014 comments:

Compared to the second quarter of 2014, we believe a portion of the lower service revenue in the third quarter of 2014 is not lost, but will be shifted to future periods.

Here’s a quick and dirty calculation for Altisource’s current P/E ratio.  The average EPS (minus amortization of intangibles) of the past 2 quarters is $2.41.  Subtract $0.60 from that to account for the discontinuation of the insurance brokerage businesses.  Adjusted EPS is now $1.81/quarter or $7.24 annualized.  Altisource’s current share price is $60.50.  Adjusted P/E is 8.36.

Other minor adjustments

If Altisource were to capitalize some software development costs, its profitability would be somewhat higher.  It is currently working on its next-generation REALAnalytics technology, which will be available to the broader market in 2015.  Because it is currently in its startup phase, it is almost certainly losing money so that it may become profitable in the future.

Going forward

There are different areas where Altisource may see earnings growth from:

  1. Ocwen’s revenues will eventually start growing if Ocwen resolves its regulatory issues and starts buying mortgage servicing rights (MSRs) again.
  2. Growth in servicing-related revenues from non-Ocwen customers.
  3. Hubzu may start driving up volumes of non-Ocwen homes.
  4. REALAnalystics.
  5. Compliance-related services for Ocwen.

Altisource’s old Q2 2014 presentation provides a slide showing example service revenue scenarios:

service-revenue-scenarios

Things I don’t know

I did not figure out how the brokerage business was so profitable.  Presumably, Altisource is exiting the business because it is doing something that regulators would frown upon.  It may potentially face a future liability from lawsuits or regulators.  My old post on force-placed insurance gives a few examples of previous settlements.  If they were not doing anything wrong, I don’t see why Altisource would exit a highly-profitable business.  (I also don’t see why the brokerage business would be highly profitable unless they were doing something grey or questionable.)

The bottom line

I still think that Altisource is incredibly cheap.  Currently, the regulatory environment has increased costs for mortgage servicers such as Ocwen.  Altisource’s costs have also gone up considering that it does not want to deal with force-placed insurance going forward.

As far as MSRs go, the increased compliance and regulatory burden on mortgage servicers reduces the value of MSRs.  In the short term, this is bad for Ocwen.  However, there will be a huge opportunity for the non-bank mortgage servicers to acquire a lot of cheap MSRs.  In the long run, regulation is good for the non-bank mortgage servicers as it will grow their market.  Increased regulation will create higher fixed costs for everybody, creating economies of scale for the biggest mortgage servicers and creating barriers to entry.

Erbey will likely continue to find ways to create value.  While not all of Altisource’s new ventures and adjacent businesses will work out, some of them will become incredibly successful.  While the share price has performed terribly this year, I don’t think that the fundamentals are impaired.  Altisource will presumably buy back even more shares given the drop in share price.

*Disclosure: Long ASPS.

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23 thoughts on “Altisource exits force-placed insurance “brokerage” business

  1. how does this event change your view of management’s ethics?

    were you surprised that forced insurance premium represents such a large part of the company’s earnings?

    Does it bother you that management really didn’t point this out to investors earlier? it would seem this is a key fact that management somehow forgot to emphasize.

    Does this indicate that Erbey is too promotional previously with his revenue growth projections?

    • I feel like ASPS took the least amount of kickbacks, though I’m not really sure. So far, they haven’t had to pay out big settlements over force-placed insurance. I think what they were doing could be considered grey. Though I never fully understood what that part of Altisource did.

      2- I feel like Erbey’s shareholder communications are fair. If you think that actions speak louder than words, then Altisource’s increased buybacks are saying that the stock is undervalued. There is an incentive for him to not explain to shareholders that Altisource has a bright future ahead. But they’ve told investors about every money-losing startup venture (e.g. Altisource Labs / REALAnalytics, Hubzu) and highlighted the amortization of intangible assets. While the businesses are complicated, they’ve done a fairly good job at investor transparency.

      3- In general, Altisource was average or above average in terms of servicing quality. They actively pushed for loan modifications where allowed by their servicing agreement. They tried to give homeowners money to give up the title to their home. I think in general they behaved more ethically than the industry average (by being good at what they do).

      4- I think you do have a point in that management did not highlight the risks in a business that made up a big chunk of Altisource’s profits. I can’t figure out if the EPS reduction mentioned in the press release includes or excludes impairment.

  2. It seems the cheapness is pricing in little or no growth.

    What are your thoughts on chance of settlement? That seems to be the main catalyst, not that it’ll happen anytime soon.

  3. Glenn, I have enjoyed your thoughts. I think one of the biggest issues for me with this investment idea is more fully understanding the revenue streams. I am most worried that the work being billed is not actually being done or marked up multiple times as it flows from one entity to another within the Erbey empire. If you read this report from the GAO on the VA’s contract with Ocwen (before Altisource was spun out), you wonder if the profit margins are so high because the work just isn’t being done. The revenue streams regarding the homes in foreclosure are so opaque that I have a hard time getting my head around whether this is just a messy industry in which regulatory issues are always going to be present (i.e. typical debt collection) or whether Ocwen/Altisource is somehow participating in shady activities.

    In its former iteration, Ocwen bought non-performing loans when it was a thrift. It settled with the Office of Thrift Supervision (link below) and agreed to no longer buy any more loans, which effectively end their business model (put them in run-off) until Ocwen shed the thrift (thereby escaping the settlement decree and moving on to its current form where it is now able to operate in the servicing industry.

    If you read the settlement with the OTS, one of the major issues discussed is forced placed insurance. This settlement was in 2004. Ocwen agreed to change its practices regarding this issue (not stop it), but curtail it significantly. Ten years later, they are no longer under the supervision of the OTS and they are back at it again with forced placed insurance (until yesterday, that is). This strikes me as suspect.

    Your continued thoughts are appreciated.

    http://gao.gov/assets/270/269348.pdf

    http://www.occ.gov/static/ots/enforcement/93606.pdf

    • Looking at the office of thrift supervision document, their issue with force-placed insurance was something else. The document doesn’t talk about kickbacks or insurance commissions.

      I don’t think that the industry is that shady. The real bad actors are the people who made all the subprime mortgages in the first place. (And the ratings agencies, investment banks, lobbyists, people who irresponsibly bought toxic assets, etc.)

      In terms of servicing quality, most third parties say that Ocwen is average or above average (Fannie Mae, ratings agencies, etc.). Ocwen does make mistakes like everybody else. Unfortunately, such mistakes hurt homeowners. Homeowners do have some legal recourse against their mortgage servicer. Sometimes they win big lawsuits against a mortgage servicer that made mistakes.

      The kickbacks on force-placed insurance are avoidable for homeowners. (However, it can be extremely frustrating if the servicer force places insurance due to their mistake or a third party mistake.)

      You largely cannot get ahead in the mortgage servicing business by being shady. You do need to keep your costs down. Call center workers with little experience (due to churn) and Indian accents are annoying but not particularly harmful to society. Some mortgage servicers have hurt homeowners with their incompetence. However, this incompetence is just as damaging for the mortgage servicer.
      The mortgage servicer can be evil and find ways to rape the mortgage investors, e.g. by taking excessive kickbacks on force-placed insurance. It’s up to the mortgage investors to sue, which they largely have not done. The ratings agency give good grades to Ocwen for servicing quality.

      Altisource and Ocwen seem to have largely gotten ahead by finding efficiencies: offshoring labour, automating processes, using technology, working on consumer psychology, convincing homeowners to keep paying their mortgage, reducing delinquencies, encouraging loan mods, etc. etc. From a societal standpoint, Ocwen is one of the better mortgage servicers around because they make less mistakes than their peers and make more modifications.

      • The storyline at OCN/ASPS is efficiency. However, I am not sure that is actually accurate. You could imagine a scenario where efficiencies are harmful to their business. Two different points here:

        1. Between the onset of a delinquency and the resolution, there are a variety of fees, BPOs, property inspection, property preservation, late fees, forced placed insurance, etc. Each day the process grinds on, fees accumulate. Some fees are paid by the homeowners (added back in during a loan modification), some are paid by the bondholders, but there are fees at each stage. Ocwen/Altisource benefit more through a lack of efficiency here.

        2. Ocwen and Altisource are fair more profitable than NSM and Walter. Most assume that this is due to the above-stated efficiency. However, unlike a typical consumer-facing transaction, it is tough to compare the pricing. We can all compare the pizza prices at Domino’s and Pizza Hut and if the pricing is the same, but the margins are different, the one of them is more efficienct with its costs. However, can anyone tell me how much NSM charges for a BPO vs. how much Ocwen/ASPS charge for a similarly situated BPO or various other aspect of the process? Is Ocwen more efficient at the process or are they just billing their customers more.

        I am still doing research, but I appreciate your thoughts. Tomorrow is going to be an interesting day for the entire group of companies.

        I would be curious to hear your thoughts on the Wells Fargo deal being cancelled.

      • 1- Ocwen benefits from lower fees, because it has to finance advances. It normally doesn’t get kickbacks on services.

        Ocwen strongly benefits from loan mods. Keeping the MSR revenue going is a big win for them. It’s probably where Ocwen creates the most value. If a mortgage goes into foreclosure, Ocwen has to eat the cost of financing advances. It also loses the 25-65 basis points of UPB in servicing fees.

        2- Unfortunately I did not go through reports to MBS investors because I don’t have access to them. If you invest in MBS, you have rights to get certain information about how your investment is doing and what the servicer is doing.

        3- Wells Fargo deal seems like a good thing. They got their deposit back and they don’t have to buy the MSRs at the old price. The new prices on MSRs should be lower because regulation is raising costs, lowering the NPV of MSRs. I suspect that Ocwen will get higher IRRs when buying MSRs now.

  4. Have you looked into Hubzu? The revenue they are generating from Ocwen homes increased from 2.5k in 2012 to 5.9k in the most recent quarter. The number of homes sold on Hubzu has materially increased too. I think the 4.5% fees they generate from Ocwen homes vs 1.5% for 3rd party homes isn’t going to sit well with regulators. This could be a larger hit to revenues than exiting the force placed insurance biz.

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  6. interesting that they continued to buy back stock at ASPS knowing the exposure they have with Forced Placed Insurance…any bullish and bearish theories?

    • In the past, Erbey said something to the effect of:
      1- Invest in the existing business first.
      2- Invest in adjacent businesses if it meets their hurdle for IRR.
      3- Buy back shares.

      He’s allocating capital based on the highest rates of return. Now that the share price has changed, the priority between 3 and 2 might switch places. Certainly Altisource has been buying back more shares than its excess cash flow. Altisource may eventually start using debt to buy back shares.

  7. Glenn,
    In response to your above post:

    1. The benefit of the higher fees income far outweighs the financing costs of the servicing advances. If those fees were externalized to an unrelated third-party, you might be right, but in keeping it in house, there is substantial incentive to increase these fees, despite the financing costs. Through HLSS, Ocwen has even lowered these financing costs. If a loan goes into foreclosure, my understanding was that Ocwen stood first in line to recoup those servicing advances after the foreclosure was settled, i.e. the proceeds from the foreclosure sale would first flow to the repayment of Owen’s servicing advances and second to the principal (and incurred interest) on the outstanding mortgage balance. In fact, Ocwen makes a point in almost every presentation to state that they have a 90% cushion of the value of the real estate collateral beneath the servicing advances.

    2. As for Wells, I think that is a good spin on the outcome, however, I wonder if it points to something much worse, insofar, as Ocwen may not be able to go out an acquire further MSRs. I don’t think anyone should take it as a fiat accompli that Ocwen will be able to continue to buy MSRs. Without a replenishment of the MSRs, we might actually get to see if all the calculations regarding run-off value of Ocwen turn out to be accurate….

    Imagine you are JPM, or a regional bank and you are thinking of selling your MSRs. You can either sell them to M&T Bank or Ocwen or retain them. I think Ocwen will have a much harder time winnig these bids because of the deal closure risk unless NYS DFS explicitly comes out with a statement saying that Ocwen is open for business again.

    • Ocwen doesn’t get ANY of the fees. (Unless it receives kickbacks.)

      If a home turns into REO, the mortgage servicer is incentivized to spend as little money as possible renovating it and to sell it as quickly as possible. Which is bad for investors.

      2- The idea that companies will be blocked from buying MSRs seems silly to me. It’s fundamental to how the lending system works in the US.

  8. The fee income I was mentioning in the above post was for ASPS, not Ocwen. Sorry for not being more specific. I think there can be an incentive to drag out the process.

    As for companies not being able to buy MSRs. Just because “companies” will be able to buy MSRs doesn’t mean that Ocwen will be able to buy MSRs in the future. There is nothing structural to the US mortgage market that requires letting Ocwen continue to buy MSRs. In fact, I just attended a sales pitch from a MSRs broker wherein they described their recent MSRs activity in the past quarter. Roughly $65B in UPB had been sold, but Ocwen was not a buyer because they are effectively out of the market.

    You could imagine a settlement where Ocwen agrees not to buy any future MSRs until X, Y, and Z are done to reform their internal practices to prevent any future issues.

    My point is merely that Ocwen may not be able to replenish its tank of MSRs and I think some investors think it is a question of when and not if. I will dig up the 10K that puts a stop to Ocwen, as a thrift, buying any future delinquent loans, and I worry that another similar possibility is in the cards here…

  9. Matt, your theory on the settlement where OCN agrees to not buy any MSRs until some things are fixed is probably the most likely scenario.

    in fact, sellers will probably look for NY DFS approval before selling MSRs to OCN.

    I think the market already expects this, and the stock trades as if there is no more MSR purchases..

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