(ASPS/OCN) Kickbacks on force-placed insurance revisited

This is a follow-up to my previous post.  I suspect that the EPS decrease from Altisource shutting down its lender placed insurance brokerage business is largely not recurring and is more like a one-time charge.  If the EPS hit is one-time, it would mean that Altisource’s franchise is largely unaffected.

My theory

Over 5 quarters, the EPS drop will be roughly $59-77M.  This is a lot of money.  In the last reported quarter (Q3 2014), Altisource reported:

  • Net income of $42.3M
  • Insurance services revenue of $53.587M.
  • Related-party insurance services revenue of $14.801M.

A 50 to 65 cents EPS hit translates to roughly $11.82M to $15.266M per quarter.

Dividing $11.82M (50 cents/share) by insurance services revenue, the net income margin is 22%.  This assumes that the brokerage business accounts for all of the segment’s revenue, which is not the case.  If the brokerage business accounted for less than all of the segment’s revenue, then net income margin would be significantly higher.  The >22% margin is well above Altisource’s overall margin of 14.7%.  This leads me to believe that kickbacks on force-placed insurance are involved.  I don’t see how else the margins can be so high.

Now, Altisource does not own any MSRs.  It has no way of steering force-placed insurance business to any particular insurance company.  How did kickbacks manage to find its way to Altisource?

Beltline Road Insurance Agency

An 8-K/A filing from Altisource provides some information on Beltline and what appears to be kickbacks on force-placed insurance:

Deferred Revenue — Deferred revenue relates to a marketing services agreement made with an insurance company and insurance commission income on lender placed hazard insurance policies.  The revenue on the marketing services agreement is recognized on a straight-line basis over the life of the agreement, and the revenue on the lender placed policies is recognized on a straight-line basis over the life of the policy.  As of September 30, 2012, deferred revenue of $8.5 million comprised $2.2 million related to the marketing services agreement and $6.3 million related to insurance commission income on lender placed policies.  As of September 30, 2011, deferred revenue of $10.5 million comprised $3.4 million related to the marketing services agreement and $7.1 million related to insurance commission income on lender placed policies.  Beltline recognized insurance commission income of approximately $19.3 million, $22.4 million and $25.9 million for the fiscal years ended September 30, 2012, 2011 and 2010, respectively, included in Revenues in the combined statements of income.

“lender placed hazard insurance policies” is the same as force-placed insurance.
“Marketing services” and “insurance commission” may (or may not) refer to kickback payments.

In the past, Beltline was part of Homeward.  Later, Ocwen bought Homeward.  Then Altisource bought Beltline and other sub-businesses from Ocwen.  This could explain why Altisource is involved in kickbacks on force-placed insurance.

The structure may be setup this way because:

  1. Altisource can pursue some legitimate businesses relating to force-placed insurance as part of its marketplaces strategy.  All mortgage servicers (including Ocwen) legitimately need to buy force-placed insurance on behalf of the mortgage investors.  It’s the kickbacks on force-placed insurance that can be an issue.
  2. Ocwen wants to take kickbacks and wants to disguise these kickbacks.  A potential mechanism for doing this is to take a lump-sum cash payment for the sale of Beltline to Altisource.  Ocwen receives kickbacks upfront as a one-time cash payment (rather than getting the kickbacks as they come).  Presumably the agreement runs until a certain termination date (Q4 2015).  The Associated Press article linked to in my previous post essentially makes the argument that Ocwen is disguising its kickbacks.

Somehow, the contracts may have been structured in a way that Altisource is the bagholder.  Instead of having Ocwen force place insurance at inflated prices, it will presumably force place insurance at cost.  (Altisource could theoretically have similar deals with other mortgage servicers.)  Altisource presumably has no way of getting back the lump sum payments it paid out.

If my theory is right, then Altisource’s balance sheet will either have intangible assets or deferred revenue that correspond to lump sum payments.  Deferred revenues are inconsistent with my theory because they appear to be too low.  There was $13.5M as of 3Q 2014.  Altisource is saying that it will lose $59-77M after tax, which exceeds the amount of deferred revenue.  There is $250M in intangible assets.  If my theory is right, then we should see an impairment of intangible assets in the next quarter.

Of course, I may be completely wrong about all of this.

*Disclosure:  Long ASPS and OCN.

Links

Altisource exits force-placed insurance “brokerage” business

(Ocwen/Altisource) Force-placed insurance

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14 thoughts on “(ASPS/OCN) Kickbacks on force-placed insurance revisited

  1. if your theory is right, why would the “non recurring” charges take place over 5 quarters? according to GAAP, they need to write off the intangibles or other assets related to the discontinued business immediately…

    • The press release says “average of”.
      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.
      http://ir.altisource.com/releasedetail.cfm?ReleaseID=882365

      But my interpretation of the press release may be a little stretched. I do agree with you that the impairment will come all at once; so my theory doesn’t explain why it happens over 5 quarters unless there is some kind of deferred revenue going on.

      2- Another way of looking at it. Giving guidance for the next 5 quarters is a little strange for Erbey. IIRC Altisource doesn’t even provide earnings guidance. So it would make sense if there was some type of deferred revenue component in there that corresponds to a timeframe set out in contracts.

      3- All in all, I feel like the EPS hit is non-recurring. I don’t see how you can take kickbacks on force-placed insurance when you don’t own MSRs.

      • The 5 quarters thing can also be explained by a weird quirk in GAAP accounting.

        Suppose Altisource plans on closing down a technology platform it acquired when it bought Homeward/Rescap. In the meantime, it will keep the technology platform running if there is certain information that it needs to access from the old system. However, they’ve already moved all the loans and all of the business off of the old system. Altisource has to wait until it actually shuts down the technology platform before certain impairments and charges get recorded onto the books.

        This may have been discussed in one of the old conference calls.

  2. I think the easiest explanation is that ASPS was earning revenue without any costs, and now they are facing the prospects of losing this very lucrative revenue stream.

    There is a chance that your theory is right…but i think it’s small.

    IF i’m right, then you need to answer two questions:

    1) how well do you trust management now?
    2) why did they continue to buy stock knowing this significant risk? This is poor capital allocation.

    • If ASPS was getting a free ride from Ocwen, this would raise issues with the SEC because Altisource shareholders would be abusing Ocwen shareholders.

      2- I think Erbey is one of the more ethical CEOs around.

      3- Erbey has always been a good capital allocator. Now that the share price is depressed they have stepped up their buybacks. Makes sense to me.

      In the long run, regulation is good for the non-bank servicers. Perhaps this is perverse and unintuitive but I don’t think it makes sense to be overly fearful about regulation.

  3. Looking at the 10-K, Homeward brought 75,6M worth of intangibles (customer relationships). But not all of it should be related to force-placed insurance.

    I’m less optimistic than you regarding the nature of the earnings loss mentioned. I’ve begun to suspect shady business…
    Still, this is speculation: I’ll wait & see.

    (Long ASPS)

  4. Pingback: Misconceptions about Ocwen and Altisource | Glenn Chan's Random Notes on Investing

  5. Glenn, I noticed that the disclosure from this post (from 11/13/14) says you’re long both ASPS and OCN. You had another post earlier on 11/13/14 that disclosed only ASPS as a long. Does that mean what I think it does? 🙂

    By the way, thanks for sharing your insights!

  6. Pingback: Are mortgage servicers evil? | Glenn Chan's Random Notes on Investing

  7. Hi Glenn! I noticed that Seth Klarman loaded up on OCN recently. Any thoughts on why he chose OCN when you feel that ASPS is the better business and opportunity?

    Thanks!

  8. Pingback: ASPS conference call | Glenn Chan's Random Notes on Investing

  9. Pingback: Erbey complex update part 2: Lawsuit against Ocwen, BlueMountain goes after HLSS | Glenn Chan's Random Notes on Investing

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