AAMC update Aug 2015

I previously described AAMC as a “royalty on yield chasing“.  AAMC’s economics can potentially be extremely attractive because asset managers can generate extremely high returns on capital.  Currently, the stock is trading at very depressed levels.  Two explanations for the share price:

  1. Luxor capital and other major shareholders may be liquidating.  Luxor suffered a lot of losses on the Bill Erbey family of stocks.
  2. AAMC generated close to no fees in the past quarter.  Either you think that management screwed up or that there is a temporary hiccup in revenue recognition.  Rental revenue, selling the home/mortgage, and marking the asset to BPO value all generate GAAP profits.  There is a time period after a BPO (broker price opinion) and before a home is rented out (or sold) where the home will not generate any GAAP profits, which can result in less fees for AAMC.

The shifting opportunities (slightly negative for AAMC)

On the latest conference call for RESI, George Ellison (CEO of both RESI and AAMC) explains that the non-performing loan -> rental business is unattractive at the moment:

NPL prices have been driven to what we feel are uneconomic levels.

As RESI is currently in the process of shifting mortgage servicing away from Ocwen, the servicing transfers seem to be affecting the company:

Total revenue and net gain on investments for the quarter was $76.5 million, 14% lower than the prior quarter primarily due to lower unrealized gains of mortgage loans which was negatively impacted by servicing transfers.

In my opinion, having to shift servicing away from Ocwen is unfortunate.  There’s some value being destroyed as the new servicer has to put in time to integrate the mortgage data onto their IT platform.  The new servicer also has to carefully make sure that any loan modifications do not get lost in the process.  The transfer of servicing creates a lot of unnecessary work and opportunities for homeowners/homedebtors to be lost in the shuffle.  It’s not great for the consumer and it’s not great for business.  Ironically, the controversy over Ocwen’s servicing quality has lead to unintended consequences.  The unnecessary servicing transfers will hurt homeowners as servicing transfers are inherently bad for the consumer.

Objectively, Ocwen is one of the best servicers for consumers according to the CFPB metrics.  (Unfortunately the CFPB does not measure aggressiveness in granting loan modifications, which should be the most important issue for consumers.  It is a huge win for the consumer to receive tens of thousands of dollars in the form of a loan mod.)  Ocwen is tied with Wells Fargo for the least number of failed metrics (one).  The politics have been perverse as Ocwen has been punished despite being one of the best servicers for consumers.  It is unfortunate that AAMC’s profitability and business plans have been disrupted by politics and the drama over Ocwen’s servicing stability.

Purchasing homes directly

RESI is looking at other ways of building its portfolio of single-family residential homes.  RESI recently announced a deal where they would buy a portfolio of homes from Invitation Homes, which is privately owned (by Blackstone Group LP) and is likely seeking an imminent IPO.  Bloomberg has a good article on the shift in Invitation Home’s strategy. RESI is also looking at purchasing homes on an individual basis.

It looks like Ellison is aiming for unleveraged returns of 6% and hopefully 7% on home purchases going forward:

I think we all, I’m not saying we are all there, but I think we all whatever the eight or nine of us aspire to be in the 6s, it’s great, you’re killing it if you get to 7.  And then single-family buying, excuse me, single home buying one-by-one I think can be you get in at even a more attractive entry point, so hopefully stabilizing it, driving towards that magic 7 is a goal that we all aspire to.

Going back to the Invitation Homes deal, here are some details from RESI’s quarterly earnings presentation:

RESI-IH-economics

The cap rate seems to be around 6.0 – 6.6% if expenses and vacancy eat up 45-50% of rental income.  e.g. $848 monthly rent X 12 X 50-55% / $85,0000.

The price per square foot seems to be $54 / sqft.  This is extremely cheap as the replacement cost would likely be in the ballpark of $100/sqft.  There are probably reasons why these homes sell and rent at very low levels (e.g. location, the condition of the home).  They probably have above-average expenses as a percentage of revenue.  Because the rents are low, there will be some fixed-cost leverage that will decrease margins versus more expensive (and classier) homes.

EDIT (8/23/2015):  Replacement cost should be somewhere under $100/sqft.  Meritage Homes is selling new homes in the Atlanta area for $98/sqft.

The bigger picture

Suppose the underlying assets have yields/cap rates of 6%.  In the long run, RESI expects to use securitizations to finance its single-family homes.  (The CEO has extensive experience with securitizations and was the head of Bank of America’s most important projects surrounding securitized products.)  Suppose that the cost of securitization debt is 4%.  If the assets are financed half with debt and half with equity, then the returns on equity would be 8%.  Thus, AAMC would be able to meet its return on invested equity hurdle under its asset management contract with RESI.  If AAMC simply directs RESI to use lots of leverage, then it would also be able to meet its hurdle.

In the long run, the returns will depend on management’s ability to create value and find attractive risk/reward opportunities.  It will also depend on macro factors such as home price appreciation/depreciation, rent controls, interest rates, appetite for securitizations, etc. etc.

So far, my opinion is that AAMC management has largely been saying and doing the right things.  The actions:

  1. The renegotiated contract between AAMC and RESI is a little Machiavellian as RESI’s fees will go up in the future.
  2. The price paid for the Invitation Homes portfolio seems reasonable.

What management has been saying:

  1. Ellison is a little less promotion than previous management.  The investor presentations no longer talk about home price appreciation.
  2. RESI is a little less promotion than peers like American Homes 4 Rent (NYSE:AMH).  AMH presents its “FFO” metric, which in my opinion is a variation on the “earnings before expenses” shenanigan.  Their FFO metric excludes deprecation (which is a real expense) and recurring costs (acquisition fees and costs).  RESI does not do this.

But as always, do your own homework and come to your own conclusions about management.  For example, share buybacks right now would benefit RESI and hurt AAMC (AAMC would prefer to grow assets under management and to take more fees, not the opposite).

*Disclosure:  I am a little biased.  I own some shares of AAMC.

Links

Old AAMC posts:

AAMC revisited – A royalty on yield chasing

AAMC: A wonderful asset management company – With the benefit of 20/20 hindsight, it is obvious that I did not predict the AAMC/RESI contract renegotiation and servicing transfers away from Ocwen.

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3 thoughts on “AAMC update Aug 2015

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