Ocwen/Altisource: What went wrong

Lessons learned:

1. Regulators are difficult to predict.
2. Don’t underestimate the amount of damage that a regulator can do.
3. Use small position sizes for companies with potentially nasty regulatory risk.

While I was always aware of #1, #2 is what really got me into trouble.  Due to the actions of the NY DFS, I do not see the subprime mortgage servicing industry as an attractive one.  Lawsky may succeed in regulating away the industry’s profitability and crippling the growth of subprime servicers.

Advertisements

Private placement pitfalls / Pinetree post-mortem

Some publicly-traded companies regularly participate in private placements.  One subtlety about private placements is that the buyer receives shares at a discount to the market price.  Participating in private placements can generate immediate mark-to-market gains.  This can make short-term performance appear better than it actually is.

In the long run, I think that private placements are a bad idea for investors for the same reason that secondary offerings are a bad idea.  It is difficult for the incoming shareholders to make money given the conflicts of interests (existing shareholders prefer to sell shares at inflated prices) and the extreme fees (typically several percent or higher).  An alternative to a private placement is a rights offering.  Rights offerings are considered to be fair to all shareholders and can potentially have very low fees.  However, very few Canadian juniors actually go that route.  Most companies choose to dilute shareholders and to generate massive fees for brokers, underwriters, lawyers, accountants, etc.

The mortgage servicing game

This lengthy post covers different ways in which mortgage servicers can get ahead.

Liberty Broadband rights: Don’t trade deep-in-the-money derivatives

Liberty Broadband is issuing warrants in its rights offering.  Personally, I would be very careful/hesitant about trading those rights.  There is an arbitrage between the rights and the common stock.  This is the kind of arbitrage that high frequency trading is really good at exploiting.  Suppose that the common stock moves 30 cents in less than a second.  Any limit orders for the rights might be trading at the old price 30 cents away.  Somewhere in that time window, it is possible for somebody with a very fast trading system to calculate the correct value of the rights (which is a deep-in-the-money warrant) and pick off any old orders trading based off of slower quotes.  If very few investors trade that particular deep-in-the-money derivatives, there will be adverse selection.  If your order fills, you will likely be trading with a market maker or HFT who is ripping you off.  For good order execution on derivatives, you want to be trading with other investors and not HFTs.

My rule of thumb is to never trade deep-in-the-money options/warrants.  The way I would avoid being on the wrong side of the arbitrage is to trade the common shares instead of the rights.

Avoiding bullsh**ers

I try to avoid management teams that deceive their investors or make excuses for their performance.  Usually, it is because:

1. Management is trying to promote the stock.
2. Management is not very good at their job and don’t want to be fired.  Or, the CEO earned his position due to skill in office politics rather than operational skill.
3. Management is delusional.
4. Management knows that the future is not bright but doesn’t want to admit it.

Money managers and their ability to spot scams

Looking at the ability to spot scams is one way to figure out which money managers are skilled or unskilled.  Warren Buffett has invested in surprisingly few scams.  I believe this is because he looks for integrity and invests in businesses that he understands.  His ability to avoid scams is especially interesting because he does not perform traditional due diligence when buying private businesses.  He does not hire accountants to comb over the books of businesses that he buys.  Nor does he have a team of analysts to perform due diligence.

On the other side of the coin, unskilled managers tend to get burned by scams on the long side and to miss out on opportunities in shorting scams.

Risks to Ocwen and Altisource

I apologize for the high volume of Altisource posts.  Altisource is by far my biggest position so I need to make sure that I’m not goofing this one up (especially because I have been doubling down on Altisource).

As far as the risks go:

•  Ocwen’s future earnings will likely be hurt as I do not see it taking kickbacks on force-placed insurance.
• Regulation can theoretically be very ugly for Ocwen and Altisource.
• Declining delinquencies could slow or reverse growth at either company.