EOS PREFERRED CORP EOSPN
February 24, 2012 - 9:53am EST by
jgalt
2012 2013
Price: 20.00 EPS $0.00 $0.00
Shares Out. (in M): 2 P/E 0.0x 0.0x
Market Cap (in $M): 30 P/FCF 0.0x 0.0x
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT 0.0x 0.0x

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  • Event-driven
  • Preferred stock
  • Mortgage REIT
  • Liquidation

Description

This is a straightforward event-driven idea that will likely return 25% in the next two 2-3 months. I believe downside is limited due to the massive overcapitalization of the parent and the fact that this issuer's parent must be “monetized” for the benefit of Lehman creditors.  In a worst case scenario you’re left holding a safe preferred currently yielding 10.6%.

The security recommended has the ticker EOSPN and is EOS Preferred Corp’s 8.5% non-cumulative exchangeable preferred stock series D. It currently trades at $20.00 or 80 cents on the dollar (~10.6% yield). For reasons I’ll explain below, the parent of the issuer must either be sold or liquidated in the next 2-3 months, meaning holders will likely get par ($25).

The issuer is EOS Preferred Corporation, a mortgage REIT wholly owned by Aurora Bank FSB. Aurora Bank is owned by Lehman Brothers (LBHI) and owns Aurora Loan Services, one of the country’s largest mortgage servicers. Like other banks embroiled in the mortgage fiasco of the last crisis, Aurora became undercapitalized and in September 2010 the bankruptcy court ordered LBHI to enter into a Capital Maintenance Agreement, pursuant to which it would inject capital into Aurora to bring it up to at least 11% Tier 1 capital and 15% total risk-based capital.

After the recapitalization, Aurora has been improving its capital ratios every quarter and today has 26% Tier 1 and total risk-based capital. The coupons on EOSPN, which had been turned off, have been turned back on. Last year, with the transition from the OTS (which, due to the Frank Dodd regulation, was abolished) to the OCC, EOSPN skipped a couple of coupons. The new regulators now have a grasp on the situation and realize that Aurora is massively overcapitalized and can afford to keep these coupons on. Therefore we should see one final Q1 ’12 coupon before receiving par.

EOS Preferred Corp shows a healthy balance sheet with $86mm of equity as of the latest 10-Q. There are 1.5mm shares of EOSPN outstanding, or $37.5mm at par. EOSPN has a liquid portfolio of securities (mostly non-agency RMBS) and could in theory be liquidated to pay EOSPN off at par.

 

Sale or Liquidation

In order to preserve value for the LBHI bankruptcy estate, the court ordered that Aurora be recapitalized and imposed a deadline of 18 months to get Aurora sold as a going concern to maximize a recovery for LBHI. That 18 month deadline is May 30, 2012.

If, however, after 15 months it appears that Aurora will not be sold, a liquidation plan must be submitted to the OCC. That 15 month deadline is Feb 29, 2012.

From Note 3 in the latest Q:

“Pursuant to a Settlement Agreement (“Settlement Agreement”) approved by the bankruptcy court and executed on November 30, 2010 (“Execution Date”), Aurora Bank, LBHI, LB Bancorp, and the OTS entered into a Capital Maintenance Agreement (“CMA”) in which, among other things, LBHI agreed that it will seek to sell Aurora Bank within eighteen (18) months from the Execution Date. If after a period of fifteen (15) months following the Execution Date, the OCC concludes a sale of Aurora Bank will not be consummated by the end of the eighteen (18) month period, Aurora Bank will prepare and submit to the OCC a plan for dissolution. The bankruptcy court will have the final review and approval of any proposed agreement for the sale of Aurora Bank.

“There can be no assurance that the sale of Aurora Bank will be consummated within the defined time frame. There can be no assurance that a potential buyer of Aurora Bank will come forward and tender an offer acceptable to the bankruptcy court, that the bankruptcy court will approve such offer, or that a potential buyer will meet all other conditions necessary to consummate the purchase.”

Therefore, whether Aurora gets liquidated or sold, this security should trade up as it currently yields 10.6%, has little risk due to the overcapitalization of Aurora, and has been subject to forced selling since certain brokers (such as Fidelity) put it on their restricted list last summer.

If you would like to read some background from the bankruptcy proceedings, head over to docket #11141: http://chapter11.epiqsystems.com/LBH/document/GetDocument.aspx?DocumentId=1257226

In LBHI’s disclosure statement for the third amended plan dated Aug 31, 2011, you can search for “Aurora” and note that LBHI expects to fetch at least book value (~$900mm) for Aurora, for the benefit of its creditors. While this may seem a drop in the bucket in the context of ~$43,700mm of plan assets (43 billion), it’s an additional recovery that the creditors certainly would like to have. See docket  #19629 (note: this is a huge PDF file):

http://chapter11.epiqsystems.com/LBH/document/GetDocument.aspx?DocumentId=1421319

 

From page 47:

“Aurora Bank operates a multi-asset loan origination, purchasing, and servicing business, with the loan origination business involving the issuance of residential and commercial mortgage, small business, large corporate, and consumer loans. Aurora Bank wholly owns Aurora Loan Services, LLC (“Aurora Loan Services”), one of the nation’s largest residential loan servicing operations. Aurora Bank is a federally chartered thrift institution subject to the regulatory authority of the Office of Thrift Supervision (the “OTS”). Based on their March 31, 2011 regulatory reports, the values of LBHI’s equity interest in Aurora Bank and Woodlands Bank were reported, on a fair value accounting basis, at $892 million and $896 million, respectively, for a combined value of $1.79 billion. See Exhibit 3 hereto for the Banks’ balance sheets as of March 31, 2011.

“Both Aurora Bank and Woodlands Bank are required to maintain minimum capital levels under applicable regulations. Failure to maintain required minimum capital levels would make Aurora Bank and Woodlands Bank susceptible to appointment of the FDIC as receiver to seize and liquidate its assets. In order to preserve the equity value of both Aurora Bank and Woodlands Bank and avoid the significant losses that could have resulted if the Banks were allowed to fail, since February 2009, LBHI has taken a series of actions to support the Banks’ capital levels and preserve the opportunity to realize the fair value of both Banks, each with the full support of the Creditors’ Committee. LBHI agreed to take steps as necessary to maintain the Banks’ capital at certain levels and to sell Aurora Bank and to sell or wind-down Woodlands prior to March 2012. If sales cannot be completed by that date, LBHI will within such period complete the dissolution and wind-down of the Banks by purchasing their respective remaining assets. Approximately $3.1 billion of claims of the Banks against LBHI were settled and expunged, and the Banks released certain collateral to LBHI.

“In total, LBHI’s support for the Banks allowed LBHI to avoid approximately $5.1 billion in losses, comprised of an unsecured priority claim of as much as $2.7 billion (as of February 2009 when LBHI made its first capital contribution to the Banks), and approximately $2.4 billion estimated by LBHI as (i) the aggregate liquidation value of both Banks plus (ii) the value of the collateral recovered and now held by the Debtors. The total investments made in the Banks by LBHI since February 2009 equal approximately $1.6 billion. As a result, LBHI’s support for the Banks has allowed it to preserve approximately $3.4 billion in value for creditors.”

Liquidity & Price

One last note: this is not an incredibly liquid security but I believe you can still buy at $20 if you're willing to stay on the bid. We were buying at 19.95 in the last couple of days and will likely add on any weakness.

Catalyst

Aurora gets liquidated, you get par ($25).
 
Aurora gets sold, securities trade up (currently yield 10.6%) as bankruptcy stigma is removed and security is taken out of broker restricted list (you can't buy this on Fidelity, for example).
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