October 11, 2010 - 8:52pm EST by
2010 2011
Price: 1.81 EPS $0.00 $0.00
Shares Out. (in M): 27 P/E 0.0x 0.0x
Market Cap (in $M): 49 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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As stated on its home page (www.origenfinancial.com), Origen Financial, Inc. ("ORGN") is an internally-managed and internally advised company specializing in the manufactured housing finance business that has elected to be taxed as a REIT.  ORGN no longer originates or services loans, but continues to manage its existing portfolio of manufactured housing loans and asset backed securities.  The site goes on to note that: "These loans were originated in the highest credit quality sectors of the manufactured housing finance industry using our proprietary credit scoring system and fully documented underwriting information.   Loan performance to date has resulted in lower than average default and delinquency rates and higher than average recovery rates compared to the manufactured housing industry as a whole."

ORGN was hit hard by the credit crisis.  It found itself forced to sell off at a loss the loans it had in warehouse in the midst of the crisis.  It also fire-sold its origination and servicing platforms.  ORGN required a rescue loan from a related party in Sept 2007 in order for the parent company to maintain liquidity.  Seven months later, the rescue loan had to be upsized from $15mm to $46mm and its maturity extended by several years.  This secured loan now has a 14.5% cash coupon and bears GAAP interest expense at closer to 20% after amortization of the associated warrants (2.6mm warrants struck at $1.22 per share).  It comes as no surprise that ORGN has not paid a regular cash dividend since 2007.

And yet, I believe ORGN common is an attractive long today, despite it being rather illiquid.  The company now trades on the pink sheets under the ticker ORGN.PK.  It no longer files with the SEC, but it files quarterly and annual financials on its website.  It continues to host quarterly earnings conference calls.

I view ORGN as a very slow-motion liquidation.  While ORGN has seen plenty of troubles in its life to date, I think that things are about to improve.  ORGN has been using the excess cash flows coming out of its securitizations to pay down the rescue loan slowly but surely.  This can be seen in the filings and is noted in the conference calls.  As of the end of Q2, the high cost rescue loan was on pace to be retired on or shortly after either Oct 15 or Nov 15.  At that point, ORGN would be in a position to restart cash distributions to shareholders.

It remains unclear if such distributions would be paid monthly or quarterly.  It also remains unclear if they will be restarted immediately upon retirement of the rescue loan, or if a few months of cash flow will be hoarded before restarting distributions.  In any event, the distributions should be coming soon.

ORGN has 7 different securitizations that were treated as financings.  ORGN holds the residual interest in each of the 7 deals.  Monthly servicing reports are available for each on ORGN's website.  Today, 3 of the 7 are currently cash flowing (2004-A; 2004-B; 2005-A) and 4 of the 7 are not (2005-B; 2006-A; 2007-A; 2007-B). 

While the consolidated income statement for ORGN reports losses, ORGN has been generating FCF and should continue to do so.  The GAAP income statement is rather misleading since the deals are far from homogenous and since ORGN simply holds residual interests in each deal.  Each deal is therefore effectively non-recourse to the others.  Economically, a given securitization may have $0 equity value left over for ORGN, but that should be as bad as it gets for ORGN -- even though for GAAP accounting purposes it could be generating large loss provisions, interest expense, servicing fees, and thus GAAP losses. 

On its conference calls, the company notes that it has been generating roughly $1mm of FCF per month at the parent company level.  It has been using that to pay down the rescue loan.  Once the loan is retired, that FCF can go to pay distributions to shareholders.  YTD, the 3 currently cash flowing deals have averaged distributions to the residual interests (held by ORGN) of $1.17mm per month.  That annualizes at $14.0mm, or $0.49 per FD share.  This would imply a "gross yield" of as high as 27% on the current stock price.  (Note that this is NOT all recurring spread income; a portion of this relates to principal payments on the underlying collateral).

Corporate overhead has been cut dramatically as the company is in run off.  Cash overhead appears to be running at a bit less than $4mm annualized.  And the May 2008 proxy projects cash overhead falling to closer to $2mm in 2012 and beyond.  Subtracting $4mm of cash overhead from the $14mm would suggest a $10mm distribution rate after overhead, or $0.35 per FD share.  This would imply a yield of 19% on the current stock price.

However, other income (unrelated to the residual interests owned by ORGN in the 7 securitizations) has apparently covered corporate overhead on a cash basis, so it may well be punitive to subtract it out like this.  I believe other income includes income on some mortgage bonds not held inside the securitizations, sublet income on office space, etc.

Also note that looking at the current distributions to ORGN's residual interests this year gives zero credit to the other 4 securitizations that are not cash flowing today.  In particular, 2005-B has cash flowed in the past and may very well do so again in the future.  At the end of Q2, securitzation 2005-B was over-collateralized by 18%.  2006-A is much less obvious.  It had 13% OC at the end of Q2.  2007-A and 2007-B are unlikely to ever cash flow in my estimation and will most likely be written off in time.

I would also suspect that for tax purposes any distributions to shareholders for quite a while would be treated as a return of capital (instead of as ordinary income) given ORGN's prior tax losses.

We can also look at ORGN's valuation from a BV perspective.  Consolidated TBV per FD share was $2.73 at the end of Q2.  So ORGN is trading at 66% of TBV.  However, this is after TBV has been penalized by $43.2mm ($1.50 per FD share) of "unrealized derivative liabilities".  Basically, the last 3 securitizations that ORGN did (2006-A; 2007-A; 2007-B) issued floating rate bonds to investors in the securitizations.  But these were hedged them from floating to fixed rate via interest rate swaps.  The interest rate swaps that qualify as cash flow hedges for GAAP accounting purposes have their values marked to market each quarter through OCI instead of the income statement.  Short term interest rates have plunged in recent years, driving these swaps into a liability position.

Penalizing TBV by the full $43.2mm of unrealized derivative liabilities seems overly punitive.  First, the company says these derivative liabilities are inside the 3 securitizations and completely non-recourse to the parent or the other securitizations.  Conveniently, it just so happens that these 3 securitizations are the ones that have never cash flowed anyway (and are the most likely to be written off in the future).  But again, ORGN's residual interests in these securitizations should not be worth less than $0.  Moreover, as time passes, the notional amounts of the swaps roll off and the liability would also fall, holding everything else constant.  In fact, the Q2 report suggests that $17.9mm of the liability would roll off over the next 12 months, holding everything else constant.

For all these reasons, the $43.2mm should be added back to TBV.  But then to be fair, we can assume that the residual interests in the 3 securitizations housing the derivative liabilities are all worthless.  I don't know exactly how much of the consolidated TBV is coming from those 3 securitizations, but we can estimate it and then subtract it off.  Making these adjustments gets us to $3.44 of adjusted BV per FD share, and implies ORGN is trading at 53% of that figure (see below).

            Per FD Share P/BV
GAAP BV at 6/30/10     75,926 $2.62  
Plus: Warrant Strike Price Proceeds     3,172 $0.11  
  FD BV       79,098 $2.73 66%
Plus: Derivative Liabilities     43,246 $1.50  
  Adj BV       122,344 $4.23 43%
Less: OC from last 3 securitizations at 6/30/10   (35,148) ($1.22)  
Plus: Estimated Reserve Balance $ buried in last 3 securitizations 12,440 $0.43  
  Further Adj BV     99,635 $3.44 53%

Another seemingly conservative way to triangulate to an "economic" BV estimate is by adding up the OC in each of the 3 cash-flowing deals and assuming the other 4 deals are worthless.  There was a lot of equity in the 3 cash-flowing deals at the end of Q2 - OC as a % of assets stood at 32%, 25%, and 24% for the 3 deals.  The OC in these 3 deals alone gets us to $2.72 per FD share and implies ORGN is trading at 67% of this BV measure.  Adding in the OC of 2005-B (the deal that previously cash flowed and may well do so again in the future) would increase this metric to $3.35 per FD share. Again,  2005-B's OC at the end of Q2 was 18% of assets, up from 11% at origination; if OC were at 19% of assets today, it would be cash flowing; so it is not inconceivable that it will cash flow once again in the future.

Cash-flowing Deals Summary     ($000s) $ / FD Share Implied "P/BV"
OC at 6/30/10 of 3 Cash Flowing Deals   $78,727 $2.72 67%
OC at 6/30/10 of 2005-B     $18,223 $0.63  
  Subtotal       $96,950 $3.35 54%

In summary, I think that at a minimum there is real value in the 3 cash flowing securitizations.  Perhaps at some point down the road there will even turn out to be some value in the 2005-B securitization or even the 2006-A (in an upside scenario).  Having suffered for so long and to such an extent, ORGN stock trades at a big discount to TBV and at a huge implied "dividend yield" based on where distributions could come out. 

I believe that the restarting of distributions to shareholders should serve as a catalyst to revalue the shares higher.  ORGN is effectively liquidation, but a very slow motion one at that.  Once the dividend checks start flowing again, I would expect people to pay less attention to the consolidated GAAP income statement and focus more on the cash flows.  In today's yield-starved world, valuing ORGN on a dividend yield basis could drive the shares up.  Likewise, as the dividend checks start coming in again with some regularity, I would expect confidence in BV to increase and the large discount to BV to diminish. 



The main risk is credit.  Unemployment in particular drives defaults.  Higher frequency of default and higher severity given default drives less cash flow available for the residual interests that ORGN holds.  It would also make it take longer to receive the cash flows and even raise the likelihood that residual interests stop receiving cash flows altogether.



ORGN starts paying distributions to common shareholders again.


ORGN starts paying distributions to common shareholders again.
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