Altisource and being greedy when others are fearful

Let me clarify how I feel about Altisource… I am extremely bullish on it.  It has everything I want in an investment:

  1. Wonderful economics.  Historical growth over 30%/year with very high high returns on capital.
  2. Low valuation.  P/E less than 10.  As a bonus, Altisource has gone crazy buying back shares after the share price fell.  It has bought back more than its free cash flow.
  3. Talented management (see #1).
  4. Ethical management.

In general, I always try to look at both sides of an argument.  To figure out if I am right about something, I try to prove myself wrong (e.g. to figure out the short thesis and to consider it).  That being said, I think that the fears over Altisource have been overdone.

Is now the time to be greedy when others are fearful?  I don’t like being promotional on this blog but I will say that I have been buying more Altisource.

Integrity

Overall, I think that Altisource and Ocwen combined have behaved with integrity.  They lead the industry in terms of loan modifications and avoiding foreclosures.  This has created a lot of value for society.  The pair also focus on creating efficiencies via technology, which also creates value for society.  Their record is blemished somewhat by allowing Cross Country Home Services to scam Ocwen borrowers (see “Are mortgage servicers evil?”).  Nonetheless, the big picture is that Ocwen has behaved ethically.  Compared to its peers, Ocwen is above average in terms of compliance with the CFPB.

I think that Ocwen is an honest business with an overzealous regulator (the NY DFS / Benjamin Lawsky).  Let’s look at somewhat similar situations.  Berkshire Hathaway was an honest business that was targeted by the SEC due to the potential conflicts of interest in its cross holdings between Blue Chip Stamps, Berkshire, Wesco, etc.  In the end, Berkshire settled with the SEC in 1976 admitting no wrongdoing, paid a $115,000 fine, and moved on (according to this website).  Berkshire stock has performed incredibly well since then.

Microsoft ran into anti-trust issues with regulators in the late 1990s and early 2000s over ridiculous concerns that bundling Internet Explorer with Windows was stifling competition.  With the benefit of 20/20 hindsight, we can see that the bundling did not stop Google Chrome from overtaking Internet Explorer in market share (Wikipedia summarizes some statistics).  In any case, Microsoft continued to compound book value per share since its antitrust issues.  Honest businesses tend to overcome their regulatory issues.

In rare cases, regulators have managed to deal a huge amount of damage to honest businesses.  There are numerous instances of regulators investigating hedge funds and saddling them with legal fees and other problems (e.g. Ed Thorp’s Princeton/Newport Partners was shut down despite not being guilty of racketeering or tax fraud charges).  This effect is likely unique to the hedge fund industry as clients can pull money out of controversial hedge funds.  It is the AUM outflow triggered by regulators that hurts the hedge fund’s business model.  Mortgage servicers do not have a similar dynamic that magnifies regulatory damage*.

(*When Ocwen wishes to purchase MSRs, the transfer of servicing rights must be approved by the securitization’s trustee.  The trustee is theoretically supposed to perform due diligence on the new servicer and to protect the mortgage investors from bad servicing.  If there are concerns about Ocwen’s servicing quality, then Ocwen may face difficulties in purchasing MSRs and difficulties in its relationship with HLSS.)

It is unlikely that regulators will devastate the mortgage servicing industry

If regulators were to put many mortgage servicers out of business, the consequences would be severe.  Somebody still has to service the mortgages.  If servicers exited the business, then the servicing will need to be transferred to another company.  The act of transferring mortgage servicing from one servicer to another is inherently harmful to consumers.  Some paperwork will likely be lost in the process.  Loan modifications approved by the old servicer may not be honored by the new servicer.  There will inevitably be unnecessary foreclosures.  Rapid servicing growth among the remaining servicers will also create problems with servicing quality.

Regulators want to be seen as being on the consumer’s side.  They are often motivated by their political goals.  They do not want to be seen as pushing borrowers into foreclosure unnecessarily.

I believe that the CFPB understands the importance of not bankrupting the mortgage servicing industry.  On one hand, the CFPB has forced the servicers to increase their servicing quality to benefit the consumer.  While this hurts the servicers’ profitability, it was not so costly that it would push servicers into exiting the business.  On the other hand, The CFPB has allowed the servicers to continue with their existing practice of kickbacks on force-placed insurance (so far at least; I don’t know if this may change in the future).  The fines to servicers were rather small.  It chose not to deal a heavy economic blow to the mortgage servicing industry relative to the NY DFS.

The NY DFS has been a far more aggressive regulator than the CFPB.  The NY DFS extorted very large settlements from investment banks.  It has been quite aggressive in extracting fines from companies that it can hold hostage.  The NY DFS will likely extort a settlement from Ocwen that is equal to or exceeds $100M.  Ocwen will pay more to one state than it did in its CFPB settlement for 49 states (somewhere around $53.5M).  While the settlement has not happened yet and its terms are unknown, I just don’t see the NY DFS putting Ocwen out of business.  Ocwen is one of the lowest-cost mortgage servicers.  If Ocwen were to exit the business, it would imply that every other mortgage servicer would be exiting the business.  I don’t know who would be left to service all of the legacy subprime mortgages.  Any remaining servicers can walk away from the mortgage servicing business entirely if they cannot make a profit.  This seems like a scenario that would not benefit the people who are using the NY DFS to further their political careers (e.g. Benjamin Lawsky).

Altisource versus Ocwen

The CFPB consent order with Ocwen and subsequent changes force Ocwen into increasing its servicing quality to benefit consumers.  For example, consumers benefit if they have a single point of contact rather than explaining their situation over and over again to several different employees.  Ocwen’s appointment system helps it achieve the CFPB’s single point of contact requirements.  The CFPB consent order also required Ocwen to build an online portal/website and to send lots of mail to inform the borrower about certain things (e.g. impending force-placement of hazard insurance).

While Ocwen’s expenses have gone up due to the new requirements, some of the changes increases Altisource’s revenues.  Altisource builds the web portals, automated mail systems, and the software to handle the appointment system.  Ocwen’s settlement with the NY DFS could saddle Ocwen with more expenses and may help drive higher revenue at Altisource.  While Altisource has been hurt by some of the changes in the regulatory environment (e.g. it exited the force-placed insurance business), regulation may not be that awful for Altisource.

My expectations

Next quarter, I expect Altisource to take a huge one-time impairment charge relating to Altisource exiting the force-placed insurance “brokerage” business (see “Kickbacks on force-placed insurance revisited“).  If this does not happen, then I really screwed up my analysis of the company.  I would need to reconsider what I’m doing.

Within the next 2-3 quarters, Ocwen should announce a settlement with the NY DFS.  With the CFPB, Ocwen announced a settlement 2 quarters after it recorded a charge for the impending settlement.  It is possible that a settlement takes longer.  If Benjamin Lawsky leaves the NY DFS as rumoured, then it is possible that there would be delays.  Maybe his successor has different political goals.  In any case, I expect Ocwen to settle and move on.  I don’t expect the end of the world.

Given low share prices, I see OCN, ASPS, and AAMC continuing to buy back shares at a high rate.  OCN may be more conservative on its buybacks depending on:

  1. How harmful its NY DFS settlement is.
  2. The rates of return on purchasing more MSRs.

I expect Altisource to buy back shares hand over first like it did in the previous quarter.  It spent $128.1M on share repurchases versus net income of $43.1M (I did not adjust net income for amortization of acquisition-related intangible assets).

In the long run, I expect Altisource to grow its earnings at very high rates (e.g. above 20%).  Its earnings growth will depend on Ocwen’s ability to buy high-delinquency MSRs.

*Disclosure:  Most of my portfolio is in ASPS and a much smaller portion of it in OCN.  I did not diversify my longs; my lack of diversification could be a mistake.

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37 thoughts on “Altisource and being greedy when others are fearful

  1. >If this does not happen, then I really screwed up my analysis of the company. I would need to reconsider what I’m doing.

    Can you elaborate on this? I read the kickback article.

  2. Here are some counterpoints:
    – You bring up examples where government regulation didn’t cripple the industry. However, it seems the for-profit education industry has seem some firms go under due to government crackdowns (COCO, CECO, ESI..). Perhaps the same could happen here.
    – OCN has been around for a long time. For most of its history, it’s been at best an average company in terms of profitability, shareholder returns, etc. In the past few years, there’s been explosive growth due to the transfer of MSRs from big banks. But that was understandable due to the high delinquency rates from the subprime fallout. Now that the economy and housing markets are recovering, and the government is scrutinizing MSR transfers, aren’t you worried that we’re ‘over the hump’, so to speak, in terms of MSR transfers from the subprime mess? Perhaps big banks would rather keep their existing portfolios than deal with the regulators. And OCN will go back to being a mediocre run-of-the-mill company. That’d be my biggest concern.

    • Thanks for the comment!

      The for-profit education industry had it coming because it was defrauding the government and causing harm to Americans. (I also think US healthcare has it coming. I don’t think mortgage servicers deserve to be punished horribly.) The government took away the subsidies that the colleges were abusing. The sector went from disturbingly profitable to slightly profitable (on average). Overly leveraged players got hurt. There was multiple contraction that hurt shareholders.

      I don’t see regulators pushing many mortgage servicers out of the business because that would cause a lot of harm to consumers. If they reduce profitability (e.g. not allow kickbacks on force-placed insurance… which seems like the future), then Ocwen should be hurt the least due to low costs and low leverage. And of course at some level, somebody has to service all the mortgages and somebody like Altisource has to provide the services in adjacent businesses.

      re: over the hump
      Yes declining delinquencies could be a problem for Altisource.

      re: banks keeping subprime MSRs
      I think it makes sense for them to sell them to Ocwen, which is what Wells Fargo wanted to do because the NY DFS blocked the sale. The subprime MSRs are a massive headache. Holding onto high-delinquency MSRs invites more regulatory scrutiny… the banks don’t want a colonoscopy because they have a lot of stuff they want to hide (e.g. all sorts of kickbacks in their other business lines). And originally the big banks got reamed by the CFPB. Ocwen can service those MSRs cheaper so there is a win-win situation in selling MSRs to Ocwen.

      Depending on the Basel III requirements, the banks may want to get rid of subprime MSRs because the risk/reward is not there. Originally people thought that MSRs were easy money. Then the cost of servicing shot up from delinquencies, they ran off faster due to prepayments, the servicers had to pay settlements with the CFPB and lawsuits regarding force-placed insurance. And then there’s Benjamin Lawsky. MSRs turned out to be far less profitable than originally thought.

  3. Have you looked at how fast the non Ocwen related parties revenues have been growing for Altisource? We may want to look at the worst case scenario where Ocwen is forced out of business and we just value Altisource as a stand-alone company.

    • I don’t see Ocwen signing a settlement where they are forced out of business or preventing from buying more MSR portfolios. It wouldn’t make sense for them to do such a settlement and I’m not sure if that’s what the NY DFS really wants. (It would also be perverse because Ocwen is average or above average in servicing quality, as well as fully compliant with every CFPB metrics.) Maybe the settlement will limit Ocwen’s UPB growth; I don’t know.

      The non-Ocwen revenues have growth roughly as fast as Ocwen revenues for Altisource.

  4. Glenn,
    I have been looking at their most recent quarterly filings and I’m wondering what’s your take on this:

    Transactions w/ related parties included above:
    Revenue 502,736
    Cost of Revenue: 27,904
    Selling,General and Ad exp: -464

    If I am reading this correctly of all their cost of revenue, 27,904 is related to Ocwen,etc and SGA is -464? That means if you back out the revenue, they are losing money hand over fist on 3rd party customers. That doesn’t sound right.

    • Never mind you can discard the message above. I just read further in the filing and see that Ocwen bills Altisource for contractor work. This makes sense now. Though I’m still curious to see how the ROIC looks for their 3rd party customers.

      • They don’t capitalize their software development costs and try to stay capital light so their ROIC numbers might look really high. If you manage to get a transcript of their investor day stuff, you will see that they clearly think about ROIC and being capital light. They compare the AAMC/RESI structure to the GP/LP structures in the MLP space.

    • I don’t think it’s important. The buybacks and leverage will magnify whatever happens.

      If Erbey is right, then the buybacks will magnify the gains.
      If the shorts are right, then the buybacks will accelerate the company’s demise.

      If it’s undervalued the buybacks are awesome.
      If it’s overvalued, the buybacks are awful.
      I worry more about whether Altisource is over or undervalued.
      (To a degree, you should also analyze whether Altisource is overleveraged or not because it’s smart to avoid Gambler’s Ruin.)

  5. Glenn…your conviction is rock solid….Against such a negative market I always wonder if I´m right……….specially if this is my biggest position………but I know this is the way big money is made.

    • Holding this stock is massive career risk for any money manager. Only gun slingers will be touching this or patient capital who knows the underlining business will continue. I’m trying to model an Armageddon scenario and see how Altisource looks without Ocwen.

      Basically I see a tech business making 50mm FCF growing at 20%/yr with a long runway. On top of that there are pretty high odds that Ocwen run off revenue is worth 400-500mm unless Lawsky shuts them down over night which I kinda doubt.

      Really wished there were multiple companies in this situation that are uncorrelated… then you can put big money and sleep well.

      • I just don’t see Ocwen being regulated away. Transferring their servicing to another company would cause a lot of harm to owners. The transfers inherently lead to missed opportunities for loan mods when borrowers get lost in the shuffle. Ocwen is also very good at doing loan mods.

        It seems highly unlikely to me that regulators would harm consumers. A more sensible solution is for them to make the servicers increase their servicing quality. This will saddle them with costs and decrease their profitability. They might also try to force the servicers to stop taking kickbacks on force-placed insurance for non-agency MSRs (Altisource/Ocwen looks like it has renounced this practice).
        That seems like a likelier Armageddon scenario… where Ocwen is not very profitable. Now Ocwen is a lower cost operator than its competitors. So, regulators have to be careful not to push its competitors out of business and to cause servicing transfers.

  6. So the risk you envision is Ocwen reverting back to earning low returns on capital? In that case the “show goes on” and Altisource becomes the winner?

    Yeah I don’t see regulators regulating Ocwen out of business since they would have done that by now. You think with the monitors examining every transaction for nearly a year they would have dug up some bodies, but I just see programming errors and some incompetency. I would throw in some sketchy business practices as well, but hey no one here is a saint.

    I’m just trying to see how you kill this company that’s very practical. The big money is made on betting heavily on high ROIC companies that’s plagued by high uncertainty and headline risk.

    Everyone likes to talk about how Buffett made his money by concentrating his bets, but each company that attributed vastly to his performance had real bankruptcy risks (Geico, Buffalo news paper) or a highly politicized environment (Washington Post). Now I’m just wondering if this is one of them.

    • The most likely scenario I see happening is that Ocwen and Lawsky reach a settlement. Lawsky wants some money (cuz NY has budget deficits) and wants the optics of the situation to make him look good. So I think Ocwen/ASPS will promise never to take kickbacks again… and they’ll gloss over the part where they didn’t take kickbacks in states that didn’t sign the CFPB consent order.

      Ocwen will pay at least $100M. It will agree to certain things that will benefit consumers. There will be some regulations to protect consumers from Ocwen growing too quickly. Their cost structure will go up; it’s unclear to me how much it will go up. The monitor will stick around and Ocwen will have costs relating to that.

      Ocwen pays Altisource for more technology to help them with compliance.

      Both buy back boatloads of shares. More so on the ASPS side. OCN should keep dry powder so that it can buy MSRs from competitors. Because everybody’s costs will go up, there will be win-win situations from Ocwen picking up MSRs from other servicers. Ocwen should have good rates of return on new MSR purchases… it will save dry powder for that. It will buy back shares if it can finance MSRs via HLSS and go capital light.

      Depending on how much MSRs Ocwen buys, it can be great times for ASPS once Ocwen starts buying again.

      Erbey gets back to creating value and driving very high ROICs. His stocks might become multi-baggers over several years, if not longer.

      • Yeah I don’t disagree much with you on that prediction. The biggest question is how you go about positioning? I got margin ready to grab stock once a settlement is announced and it looks acceptable, but how much you scoop up with cash before that day? I’m just looking for your thought process on it.

  7. nice post, though as a former shareholder I do have some counterpoints:

    1. The reason for the high roic is because asps is basically people and computers – it is basically a mortgage technology company that outsources nearly everything. Not unlike consulting companies such as Accenture, etc.

    2. True, relative to previous earnings it is very cheap. Will the earnings continue? Probably not at a such a high level bc of improving economy. However, the key thing is that the stock buybacks were so large that the company incurred debt to do so. Therefore, it has essentially reinvested in itself at higher prices and therefore is very largely levered to future earnings (i.e. ocwen). Therefore, I can’t help but think that losses by Ocwen will flow through even more strongly to ASPS.

    3 & 4. I’m not so sure about the talented management. It’s easy to have good economics when you have little assets and a captive customer/revenue. More importantly, take a look at glassdoor reviews “http://www.glassdoor.com/Reviews/Altisource-Reviews-E314037.htm” . Out of 200+ reviews, many many comments talk about micromanagement, cost cutting which destroys productivity & quality of systems. Sure, this is not a full random sample, but with dozens of detailed reviews…

    Now, from 1) , ASPS as a technology company is a people & computers (mostly). They’ve cut employee morale & management is literally out of touch (out of usa) and did not invest in technology.

    From that and other sources, it may very well be possible that ocn/asps’s competitive advantage was cutting large corners, not technology. When looking at customer reviews & satisfaction vs others, I’d never want ocwen as a servicer. If that “advantage” goes away because ocn needs to invest/train and its economics return to historical norms or those similar to the industry (which aren’t good to begin with), I’m not sure there’s an easy path forward.

    • 1- GAAP losses at Ocwen will not “flow through” to ASPS as far as I know. ASPS offers fee-based services. If the Ocwen business dwindles, then yes ASPS will be hurt.

      2- ASPS is in some ways similar to an asset manager. OCN and HLSS are vaguely like closed-end funds. AUM (assets under management) growth at OCN and HLSS are beneficial for ASPS. I think it’s reasonable to expect AUM at HLSS to grow.

      3- Glassdoor: I’ve found that employee morale doesn’t have too much of a correlation to how good the stock is.

      Regardless, all of the companies happen to have similar Glassdoor ratings:
      Ocwen – 2.3, Nationstar – 2.5, Altisource – 2.6, Green Tree Servicing – 2.3

      4- I believe that they have fairly good technology compared to their peers. Online web portals, automated mail, an appointment system to facilitate single point of contact, Hubzu, etc.

      As far as cutting corners go, Ocwen and Wells Fargo are fully compliant with the CFPB. Both are doing average or above average compared to their peers (some ratings agencies put Ocwen’s servicing quality from investors’ point of view as average).

  8. I know you’ve said nearly 50% of your portfolio is in ASPS (and OCN). If you don’t mind at what price and time did you initiate your position? What has your patterns of buying looked like as the stock declined? Just more curious than anything. I’m long ASPS.

      • is there any comparability to public companies like zillow, trulia? i might be completely off but in theory, if the “spun-off” entity could trade at even a fraction of what the public comps are trading at this presents a whole new angle. given limited scrutiny around a potential spin off of hubzu, i assume i am missing something major but was just wondering

      • They sort of compete against each other. Not everybody is looking to buy REO. People who are willing to buy REO will likely only buy REO because they’re trying to get a bargain.

        But yes if Hubzu were IPOed it could potentially fetch a very high valuation.

      • Hubzu will be really valuable if they can capture more 3rd party transactions. So far 95% of the homes sold are from Ocwen so it wouldn’t be worth much right now IMO.

  9. There seems to be more risks to the Hubzu platform from the latest round of investigation: http://www.bloomberg.com/news/2014-12-18/ocwen-said-to-have-stalled-home-sales-by-underwater-borrowers.html

    I’m pretty sure if Ocwen is stalling short sells they will do it to steer the borrowers to Hubzu in order to collect more fees. Maybe Altisource becomes the sacrificial lamb to keep Ocwen growing? Market seems to be agreeing since someone just blew out of their position.

    • It’s a short sale. The borrower essentially gets free money for the short sale. The lender has no legal obligation to agree to the short sale. The servicer is supposed to act in the mortgage investors’ (lender’s) best interests or act in a manner congruent with the servicing contract.

      The news article might be missing the point?

      2- The servicer is supposed to take certain steps to protect the mortgage investors from getting scammed. They shouldn’t allow short sales that are far below market value.

      • This issue was one of the main reasons I never pulled the trigger on ASPS and OCN. I spoke to some brokers that specialize in short sales and basically they informed me that even after getting good deals for their housing ASPS would essentially reject any deal that didn’t go through Hubzu and all the related companies. It’s not the price they had issue with, but rather the fact that the short seller wasn’t going through their related parties — which was “required”.

  10. Glenn what are your thoughts on the settlement? Sounds like Ocwen is a state run enterprise now. I’m trying to figure out how this impacts Altisource. It does say Ocwen may acquire more MSRs if they reach certain milestones, but Erbey stepping down hurts.

  11. Simply can’t believe that an immensely sophisticated person got trapped in such an awful stock… I will always keep this case in my mind while reading the usual clownish posts of the supposedly consistently profitable daytraders. I am afraid that blind luck is the only thing that really matters in the financial markets. Fudamental analysis is very timing consuming enterprise and seems like it is hardly payable at all.

      • The stock has been traded in a pure liquidation mode since the initial post from the 2th of November. Would be surprised if it finds a bottom tomorrow or this week.

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