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”.
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.
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.
There are different areas where Altisource may see earnings growth from:
- Ocwen’s revenues will eventually start growing if Ocwen resolves its regulatory issues and starts buying mortgage servicing rights (MSRs) again.
- Growth in servicing-related revenues from non-Ocwen customers.
- Hubzu may start driving up volumes of non-Ocwen homes.
- Compliance-related services for Ocwen.
Altisource’s old Q2 2014 presentation provides a slide showing example 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.