|Shares Out. (in M):||26||P/E||0.0x||0.0x|
|Market Cap (in $M):||33||P/FCF||0.0x||0.0x|
|Net Debt (in $M):||0||EBIT||0||0|
Origen Financial Inc. (“Origen”) is a complex asset play with considerable hidden value and potential catalysts for a significant value event within the next 2-3 years that could offer ~30% annual returns.
The company was written up by rosie918 on October 11, 2010. Numerous events, along with a considerable move in the stock and major distributions, have occurred since then to justify a fresh analysis. The stock also is significantly more attractive than it was back in late 2010 because many of the question marks that the old thesis identified (payoff of rescue loan, repurchase of warrants, resumption of distributions, each of which were discussed in detail in the prior writeup) have now been resolved. This writeup also discusses in detail several key factors that make a near-term catalyst far more likely and incentivize management to act in a value-maximizing fashion.
As background (as per the company website), Origen is an internally-managed and internally advised company specializing in the manufactured housing finance business that has elected to be taxed as a real estate investment trust (a "REIT") for tax purposes. This means that, provided it meets various corporate status, income, asset, and distribution tests under Sections 856 through 860 of the Internal Revenue Code, it is effectively not subject to corporate-level income tax in respect of most income.
Origen no longer originates or services loans, and its remaining activities are simply managing its remaining assets. Its entire business is run out of a 5,192 square foot office suite at 27777 Franklin Road in Southfield, MI (an office tower – I’ve driven by). Its stock was delisted from NASDAQ in late 2008 at the depths of its distress and currently trades on the Pink Sheets, which is cause for added caution and vigilance in analysis, but it continues to trade relatively actively, make audited financial statements available and hold annual meetings and quarterly conference calls, the latter of which are well attended. Since 2008, it has aggressively paid down debt – it currently has no debt other than the nonrecourse debt of its trusts – and has disposed of its major operating assets (its origination and servicing platforms).
Its remaining investments include seven residual interests in mortgage trusts and other miscellaneous investments. The misvaluation of Origen arises from the mortgage trusts. While Origen has audited financials, they should be largely ignored as they are required under SFAS 140 to fully consolidate Origen’s financials with the mortgage trusts, each of which is separate from each other and liabilities of each are nonrecourse to the parent or to the other trusts except in extreme scenarios (such as fraud, mismanagement, etc). Therefore, to the extent one trust is significantly underwater (and several are) but is not recourse to the others, the combined financials are meaningless. I have compiled the information below based on a review of their ABS reports (which are prepared monthly by BNY Mellon and are publicly available), financials, press releases, filings and the quarterly conference calls.
From listening to the last four conference calls and reading every filing and publicly released statement since the disposition of Origen’s servicing business to Green Tree on July 1, 2008, along with every offering document in respect of their mortgage trusts and compiling a spreadsheet of every monthly trustee filing on each trust, I have identified the following material assets and liabilities:
Seven residual interests in securitized mortgage trusts:
Each of these represents 100% of the equity in a trust that holds between about 1,500 and 2,500 loans (“contracts”) in respect of manufactured homes. Each trust is obligor on multiple series of notes (“notes”) that are senior to the equity and are held by outside investors (with one exception, see below). Noteholders receive first priority to payments in respect of the underlying contracts, with the trust required to maintain a target excess of contract balances over note principal amount (“overcollateralization”) in order to safeguard the noteholders’ investment. Provided the target overcollateralization is reached (by directing sufficient payments on the contracts to principal of the notes), the equityholder may, each month, receive any amounts in excess of required interest payments on the notes. Each trust is a separate entity and noteholders may generally only look to the individual trust for repayment (this is a basic ABS structure). I have summarized each trust below in three groups.
2004-A, 2004-B, 2005-A (the good ones)
Each of these trusts is healthy and is overcollateralized by the target amount. As a result, Origen receives payments in respect of their equity each month. In January 2012, for example, Origen received a total of $1.3m in respect of these three trusts. These three trusts are overcollateralized by a total of $64.05m as of January 31, 2012, or $2.47 per share. Origen received a total of $11.3m in distributions in respect of their equity in these trusts in 2011.
This trust is overcollateralized (as of January 31, 2012) by $15.6m, or $0.60 per share, though because the target O/C of $17.6m has not been met, current distributions cannot be made on the equity at this point.
2006-A, 2007-A, 2007-B (little hope)
These trusts are not meaningfully overcollateralized and have sustained substantial losses. In addition to the relevant contracts being of more distressed vintage, the trusts swapped out of the floating rate payments on the relevant notes in each trust in exchange for fixed payments. With interest rates having collapsed in the interim, these swaps are now enormously underwater and there is little reasonable prospect for any recovery in these trusts. They should be treated as fully worthless for purposes of conservative valuation, although of the three, the 2006-A has some overcollateralization and perhaps has some possibility of eventually producing value.
Debt of the trusts:
2005-B Class B-2 Notes
On the Q2 2011 earnings call the CEO stated that Origen still holds notes with a principal amount of $3.5 million. Based on checking that against each of the trust statements (which are publicly available at www.origenfinancial.com) I am reasonably certain that these are the 7.2% Class B-2 notes on the 2005-B trust. Given the level of overcollateralization on 2005-B, these notes should be worth at least their principal amount (and likely more given that market interest rates have declined considerably since issuance in 2005). Origen sold the 2004-B Class B-2 notes on May 24, 2011 for approximately $3 million (when such notes had a remaining principal balance of slightly less than $3 million), and the 2005-B Class B-2’s are extremely similar notes (interest rate within 30 basis points of each other, also protected by significant overcollateralization). I have no reason to believe that the value of these should be materially different.
In assembling a rough value of these remaining assets I have valued the remaining equity interests based on current overcollateralization, for a total value of $3.07 per share (I acknowledge that interest spreads and potential directional movements in the housing market can affect this number, but this is the best rough measure we have – given that these trusts have survived the ’08-’09 downturn while maintaining significant overcollateralization, and have virtually every month during and since produced current income well in excess of any decline in overcollateralization, I view this as a lower bound rather than a higher bound). I value the remaining $3.5 million of notes at par, or approximately $0.12 per share, for a total asset value of $3.19 per share.
I believe it is likely that Origen has other miscellaneous assets too small to be discussed in filings or otherwise show up in financials, but to be conservative I will value them at zero.
Asset Value - $3.19 per share
Origen has no known material fixed liabilities other than the nonrecourse liabilities of their trusts (which are already taken into account in calculating asset value). Origen’s remaining periodic liabilities are compensation, professional fees, and minor lease obligations on their remaining small corporate office. They have 7 remaining employees, including the CEO and CFO. It is nearly impossible to strip out trust-related expenses from the financials, but the cost-cutting plan in their May 2008 proxy estimated future expenses to be approximately $2m per year going forward. I have used a rough estimate of $3m a year to be conservative.
Trailing 12-month dividends:
$0.42 per share, for a yield of 33%, which should of course must be discounted (and is not particularly illuminating) because it is partly a return of capital rather than periodic income. But it does show that distributions are occurring at a rapid rate.
Of course, asset value of $3.19 on a $1.29 stock is worthless unless there are catalysts to unlock this value in due time. There are three reasons, none of which were taken into account in the prior writeup, that Origen should recognize substantial value in the near future. #2 and #3 are the big ones.
1) Section 857 of the Code generally requires that Origen distribute 90% of its “REIT taxable income” (taxable income with modifications that should not be relevant here) each year. To the extent Origen has taxable income, it will be required to distribute most of it to shareholders. Consistent with this, management has resumed distributions as of November 26, 2010 and has thus far distributed a large portion of cashflow, well in excess of taxable income.
2) In April 2009, Origen executed a “Success Fee Letter Agreement” with CEO Ronald A. Klein. Under this agreement, Klein receives up to 1% of the face amount of certain liquidity events, including mergers, significant asset sales, and optional redemptions (as discussed in #3). This provides a significant incentive to Klein to work toward liquidity events, given that his base salary has been reduced to $300,000 per year. An optional redemption by each trust (discussed next) is a specific event referred to in the Letter, and could easily result in a $1.5 million payment to Klein. The officers and directors are also significant holders of Origen (29.5% of the company as of the August 3, 2011 proxy), further aligning their interests with shareholders.
3) Most importantly, the four viable trusts are reaching a key optional redemption date that is not readily apparent from simply reading the financials. Under the indentures for the trusts, the servicer may, once only 20% of the principal amount of the contracts remain outstanding, purchase all contracts from the trust at the greater of (i) par plus the FMV of any foreclosed properties or (ii) the FMV of the contracts as determined by the servicer, and then repay all notes at par. See Prospectus Supplements for Origen Series 2004-A, 2004-B, 2005-A, and 2005-B Notes. Based on prepayment projections and the existing rate of repayments, it appears this threshold should be reached for 2004-A in late 2014 with 2004-B, 2005-A, and 2005-B to follow soon after.
a) Given the healthy interest spread between the contracts and the remaining notes and the strong performance of the contracts in those four trusts (especially the three best performers), I think it is very likely that Green Tree will exercise its redemption options once they become exercisable. If it does this, Origen should then immediately be able to cash out of those trusts for an amount roughly equal to the then-current overcollateralization amount.
b) Origen also inserted a provision in the sale agreement of its servicing platform to Green Tree allowing it to require Green Tree to exercise the option on Origen’s behalf and allow Origen to purchase the contracts and redeem the notes if Green Tree fails to do so. See Section 6.15 of Asset Purchase Agreement of April 30, 2008 (Exhibit 10.1 to Form 8-K). This is less likely since it would require Origen to raise financing to purchase the contracts, but it certainly doesn't hurt to have this option.
Based on these catalysts. I expect a liquidity event to occur within 3 years and result in Origen recognizing at least $3.07 per share in value on the low end (the remaining overcollateralization on the four trusts plus par on the notes, ignoring any trust distributions received in excess of the overcollateralization, any cash currently on hand, and any other assets), which I believe will be largely distributed to shareholders as part of a liquidation or special distribution. Subtracting out expected liabilities to that point of $9 million ($0.35/share) results in an expected return of $2.72 in 3 years, reflecting an annualized IRR of 28.2% based on the most recent close of $1.29. Of course, Origen continues to make periodic distributions and thus much of one’s investment will be returned throughout this holding period prior to this point, increasing the IRR calculation. Note that I have also assumed that all of Origen’s other assets have no value.
Alternatively, if Origen merely continues to receive distributions of a proportional amount of the remaining overcollateralization until maturity (which understates income as remaining distributions will likely exceed overcollateralization and will be proportionately weighted toward earlier periods), backing out the value of the notes and assuming expenses remain constant at $3m per year produces an IRR of approximately 5% annually over 12 years. I come to this figure by dividing the remaining overcollateralization by the remaining average contract term in each trust, and then assuming that such amount (approximately $6.2m per year minus $3 million of annual expenses, or approximately $0.125 per share annually), is distributed for the next twelve years, after which there is no residual value.
These are almost unrealistically pessimistic assumptions, given that distributions would likely be weighted toward earlier periods because of prepayments on the underlying trust contracts, and expenses will likely decline further as less manpower is necessary to manage remaining investments. Investors should also keep in mind that much of this will likely be a tax-free return of capital (as the last five distributions have been) until basis is fully offset. Origen made $0.42/share in distributions last year, or about $0.30/share disregarding the proceeds from the sale of the 2004-B Class B-2 notes, and I expect them to declare their next distribution in late March with their next earnings announcement and release of annual financials.
All in all, Origen looks like an intriguing and fascinating situation, enough that I spent months of free time reading through every available document on EDGAR and the company website and learning about the ABS market (I highly recommend Allman’s Modeling Structured Finance Cash Flows in Microsoft Excel, by the way, for absolute beginners to this space). Would greatly appreciate your comments and constructive criticism – this is my first submission.
Disclosure: I am currently long Origen and may buy or sell it in the future. This posting is solely for the evaluation of fellow VIC members, is not intended as investment, legal, or tax advice and is not a recommendation to buy or sell this stock.
1) REIT distribution requirements
2) Management incentives to work toward liquidity events
3) Key optional redemption dates approaching in late 2014/early 2015