Description

Altisource Asset Management Corporation has a somewhat convoluted history, and its business has undergone some changes over the past few years. After a false start pursuing a business model as an asset manager for Front Yard, a residential REIT (AAMC’s asset management agreement was terminated in late 2020), the company created its Alternative Lending Group (ALG), which acts as an originator/acquiror of residential real estate loans, which the company holds and also sells to institutional multi-asset manager counterparties. Put another way, the company is, as CEO Jason Kopcak put it, “building a platform to originate private credit.”

The company has been written up on VIC several times, and we urge you to review these prior writeups, which will provide additional background - though, we do feel the thesis has changed significantly since those writeups, which we will outline. 

The Market Opportunity

The basic idea behind the creation of this platform is that the company believes that, on the one hand, private credit markets have been underserved for a long time, with trillions being raised in the alternative asset / fixed income space by insurance companies, money managers and hedge funds (think PIMCO, Met Life, Apollo, KKR, etc.), who are all looking for their targeted fixed income investments. On the other hand, there is an underserved market for owners of small and medium-sized businesses, who want capital for their businesses or real estate projects. Formerly, prior to the financial crisis, the alternative credit space was small, with big banks like Goldman, Morgan Stanley, and JP Morgan serving as intermediaries for the credit appetites of their clients. After the advent of Dodd-Frank regulations, these banks had to behave more like commercial banks, and it became harder for them to source, aggregate and manage alternative assets. As a result, institutional multi-asset managers, who had begun raising a lot of money in the space, were not able to access investments through their familiar channel with the banks, and they were not set up to source loans from, say, mom and pop real estate developers. Altisource’s Alternative Lending Group was created to meet this market need.

The Selling of Loans (Forward Flows)

One key to understanding the company’s new business model is that AAMC sources loans that are structured and documented to the exact specifications of the end buyer of the product. The company has fully developed underwriting and back office management systems that institutional buyers of the loans can rely on, so that these larger firms don’t need to develop entire new departments and dedicated employees for managing that process, which would take time and money to set up, as well as be a managerial distraction. Instead of going to the banks for deal flow, where the deal spigot has been turned off, now they can turn to Altisource.

The company announced about a month ago that it has entered into two such “forward contract” arrangements with large institutional counterparties of significant scale (consisting of two asset managers with $50 billion and $15 billion of AUM). We believe the company has already begun actively sourcing loans to these asset managers. The company is also working on additional forward sale agreements with five additional counterparties, and we believe finalization of some of these agreements are imminent. We will come back to this and try to give a sense for the scale and growth of the current loan volumes.

Low-Cost Back Office

An important cost advantage that AAMC can provide is that their team of underwriters is in India - this is a low-cost back office that has purchased, underwritten and managed 15 thousand residential homes as well as $4 billion in residential non-performing loans. Altisource had been keeping the team on standby while it formed the new origination business. This experience and lower cost structure are significant advantages over domestic competitors. As the business scales, this low-cost back office will provide a competitive advantage. Traditional underwriters in America would cost many times more than the outsourced Indian team. 

USVI Domicile

Altisource’s headquarters are based in the U.S. Virgin Islands, which provides a powerful tax advantage versus U.S. domestic competitors.

NYSE Listing Requirements

As discussed, AAMC’s business model is to source private credit for large institutions. Yet, they currently hold ~$97 million in loans on their balance sheet. Why should this be? It relates to NYSE listing requirements which, in part, state that a company must maintain a $50 million market cap, or total assets / revenue of $50 million. We believe the company holds these loans as a “belt and suspenders” way to protect its NYSE listing, in the event the market cap does not meet the standard. They are holding a block of loans on a semi-permanent basis for now, but not that, in general, the company will need to carry new loans on their balance sheet only for a few days or weeks in order to sell them via forward sales agreements.

https://www.nyse.com/publicdocs/nyse/markets/nyse-american/MKT_Continued_Listing_Standards.pdf

Additionally, due to the market cap requirements for the NYSE, we believe that the company will use its small float and repurchase authorization to defend a $50m market cap, in order to stay in compliance with NYSE rules. This provides a margin of safety given how low the float of the company is and how the company has many times that amount of money in current assets that could be pledged to its credit line for cash. 

Credit facility / Warehouse Line

The company has 2 credit facilities- both are for $50m dollars and they should be able to give the company the capital it needs (combined with the company’s assets) to execute a significant amount of loan origination and sales. Once the company demonstrates that it is buying and selling more loans, it will be able to get further credit lines to increase volume, in addition to the retained earnings it will keep and deploy back into the growth of the business.

Not a REIT

This is NOT a REIT, with their associated required payouts, which gives it more optionality than, say, RWT, SACH, or LOAN. As an example - the company is able to retain 100% of its earnings at the holding company, which will let it either buy and sell more loans OR buy back more common stock. REITs can get hamstrung when they do not have as much cash as is needed for various corporate purposes because it must be paid out to shareholders. AAMC does not have this issue, and as a result, was able to buyback roughly 14% of its common stock from a large shareholder for $10/share. 

Buybacks with a Compensation Aspect

In late 2022, the company issued a series of preferred stock to Jason Kopcak, whereby for every 3 shares of stock that the company repurchases, the CEO will receive 1 share, personally. See:

https://www.sec.gov/ix?doc=/Archives/edgar/data/1555074/000155507423000004/aamc-20221230.htm

This creates a HUGE incentive for the CEO to be a willing participant in buying back shares. Normally, if a board authorizes a share buyback, a CEO generally will view this as taking money away from the running of the business. Here, the quickest way for the CEO to make a million dollars is to have the company buy back $3 million in shares. We believe the company has approximately $35 million remaining in previously authorized repurchases. If you believe, like we do, that the management team will be successful in scaling this business, these stock repurchases are accretive to shareholder value.

Per the last 10Q: 

“At September 30, 2022, a total of $271.6 million in shares of our common stock had been repurchased under the authorization by our Board of Directors to repurchase up to $300.0 million in shares of our common stock. Repurchased shares are held as treasury stock and are available for general corporate purposes. As of September 30, 2022, we had an aggregate of $28.4 million remaining available for repurchases under our Board-approved repurchase plan.”

The company currently has authorization to buy about one third of its outstanding shares, and many times its float. We also believe that the board would readily increase the buyback authorization if needed. 

Lawsuit with Luxor

In 2021 and 2022 Altisource settled several of the preferred suits with Wellington, as well as Putnam for approximately 11 cents on the dollar. If this same amount is used for the $144m outstanding with Luxor, the settlement will be roughly $15.8 million. However, since interest rates have gone up since them, a higher discount rate could be used, which could take the settlement to as low as 7 cents on the dollar- this would equal a settlement amount of just $10.08 million. 

We believe that the summary judgment case in early December significantly de-risked the lawsuit risk with Luxor, as the judge very clearly told Luxor that the funds in dispute were not legally available. Currently, AAMC is appealing the case and has retained Orrick to represent them. The brief is done in plain language, and we believe will make sense to the appeals court to throw out Luxor’s suit, which would potentially cause settlement. 

Erbey, Black Rock Suit 

This is what we will describe as the “free call option/lottery ticket” that is attached to AAMC. The potential payout could be in the billions should AAMC win the suit, and if they settle it, the payout (of which AAMC would be entitled to roughly half) could be in the hundreds of millions. Ultimately, who knows where this will go, but with a board of directors that have influence in the US Virgin Islands, the main hope is that there will be an announcement in the near future that the case will be heard in the USVI. If that happens, then the home court advantage for AAMC could be a real game changer.

https://usvipublicaccess.vicourts.org/case/summary/d9975a06243f1bdb1b48916d48edfeb27d602d0dc480ab5f0832b5894ba6bf2e

Redleaf Suit 

As part of the lawsuit over the company’s preferred shares, AAMC found a string of emails in discovery where former director and Luxor employee Nathaniel Redleaf seems to have breached his fiduciary duty to the company by giving away material non-public information. There were many other instances where it seems illegal acts may have been committed. The company has brought suit against Mr Redleaf personally, and it is our speculation that this will ultimately help a settlement negotiation with Luxor. There is the possibility that if Luxor was trading its position while in possession of the material non-public information that Mr Redleaf was leaking, that AAMC would be entitled to short swing profits. 

We believe that this will help the company settle the preferred suit. 

See:

https://usvipublicaccess.vicourts.org/case/d9975a06243f1bdb1b48916d48edfeb27d602d0dc480ab5f0832b5894ba6bf2e

Cryptocurrency ATMs

Crypto Currency - this is not something that we will address, because the company only has the option to spend $2m on the rollout of crypto ATMs, which is less than 1.5% of the assets of the company. We do not believe that the company is seriously pursuing these ATMs at the time- but if they do, we take comfort that they would not be holding any crypto onto their balance sheet. Test ATMs have been rolled out by ForumPay, and the ATMS generate ROIs that are solidly double digit. 

Management

Jason Kopcak is a CPA and has been in the finance/real estate mortgage mortgage space for > 25 years, at Morgan Stanley, Nomura (where he built a $4 billion residential business from scratch), as well as at his own mortgage origination firm, and thus has relevant background in origination, trading, warehousing, and securitization. If Kopcak was able to build a multi-billion dollar business at Nomura, we think he has a good chance to do so at AAMC, as well. 

Here’s an interview with Jason: https://www.youtube.com/watch?v=AI5ZfxAPjXE 

We think he has great confidence and energy, and is a good leader for the business. We don’t think there will ever be a need for an activist here, because Jason is a significant owner and will be shareholder-minded.

Stephen Krallman, CFO, has a background in private credit at Ares Management (and the IPO of ACRE, which invests in CRE), and Diamond Resorts. 

Danya Sawyer, COO, who joined on February 1, has spent her career in mortgage origination and specializing in process and operations at mortgage banking and capital firms. 

We think these are good managers who can deliver on the business plan.

Valuation / a Path to > $10 EPS in 2024?

It’s difficult to assess the pace of new loans and how quickly the newly announced Forward Contract arrangements will come online and begin to generate loan volumes, but we have a few data points that might provide some insight. 

We spoke to a developer / builder who has been getting loans from AAMC. This developer had closed on a loan with AAMC in mid-January, and had another loan nearing a close in mid-February. Meanwhile, the two large Forward Contract arrangements were announced by AAMC on January 31. Interestingly, there were loan numbers associated with the developer’s transactions: 10000348 and 10000499. This suggests 499-348=151 loans in approximately a month. It’s unclear how many of these new loans might be associated with the forward sales agreements, but we believe probably not many, as these agreements were very recently finalized. Let’s say the average loan amount was $250k, which is reasonable for smaller residential mortgages. That suggests a monthly loan run rate of 151*$250k=$37.75 million, or $453 million yearly.

While we believe that Q4 (which should be announced soon) won’t offer much - with AAMC posting a loss - we believe that Q1 will be close to break-even. After this, we believe that the company will be profitable in Q2 and growing steadily from there. 

Taking a step back, we believe that due to the new forward sale agreements coming online, AAMC will be able to double this volume through year-end, to approximately $900mm in volumes, and we assume the company will forward sell all these loans to institutions. The company has stated they expect to earn an approximately 350 bp spread on such sales. 

We have spent some time thinking about how revenues and expenses might scale, although this requires a few assumptions. In sum, we believe the company can approach this $900mm run rate of in loan volumes at the end of 2023, and of $1.5 billion at the end of 2024, with net margins nearing 30% for 23 and 40% for 24, and associated EPS of approximately $5 and $11, in those years respectively. The implied base case forward P/Es based on today’s price are ~10x for 2023 and ~5x for 2024. If these estimates are accurate, today’s price is still quite cheap.

Summary

Altisource is addressing continued market demand by large institutional asset managers in the US for private credit products that meet their fixed income needs. The company formed its Alternative Lending Group, and has begun executing on its new business plan to become a platform for originating and supplying private credit products to these institutions. It has signed forward sale agreements with two institutional counterparties, and is working on five more contracts. We believe the company has begun sourcing loans and forward selling these counterparties. The company is not a REIT, providing it with flexibility in the use/distribution of earnings and profits, and enjoys competitive advantages versus domestic competitors in the form of a low-cost India-based back office, and a USVI domicile with favorable tax advantages. 

The company’s continued status as a NYSE-listed stock appears to be on a solid footing. 

The company has been repurchasing stock, and has instituted a compensation plan that incentivizes additional stock repurchases.The company has access to two credit facilities that will provide working capital and reduce its cost of capital. The company is involved in a law suit with Luxor, a preferred owner, that we expect to be settled on terms favorable to the company, and has brought suit against a Luxor employee for breach of fiduciary duty that is supportive of its position in the Luxor suit. The company is involved in a suit against Black Rock that may result in a lottery-like payout to the company. The management team is experienced with a deep background in real estate, loan origination, private credit, mortgages, and operations in this space. 

We believe the company has a path to achieving $900mm and $1.5 billion in loan volumes over the next 2 years, and has a reasonable chance to earn $5 per share for 2023, and $11 per share for 2024, which implies forward p/e multiples of ~10x and ~5x. At these prices and with a long growth runway in front of it, we think the company is still cheap. 

Catalyst

- Execution of ALG business plan

- Luxor Settlement