RoyalDutch wrote up UDFI on VIC March 20, 2019 at $4.05. Currently it is trading in the $2 range.
RoyalDutch laid out the case till last year well and I would recommend one goes and reads that write up first. No reason for me to repeat what he already laid out. The same issues as 2019 are still in mostly in play now, foremostly the financial statements. The main difference now are
- - Despite the stock already being cheap at $4 in March 2019, it is now trading below $2.
- - Covid has created more uncertainty around the economic prospects for Texas.
- - Nextpoint has just flipped its 13G to a 13D and wrote a letter to management.
UDFI is a mortgage REIT that funds real estate projects in Texas, with significant presence in Dallas and Houston. Urban Texas overall is an attractive market for development because of large scale migration to those areas. Just to put it in perspective, from 2010 till 2019 Texas added 3.85 million additional people. Let’s assume there are 2 people to an average family (I know the number is lower.) then that meant a need for 1.925 million new housing units for those nine years or an average of 213.8K new units needed a year.
UDFI ended up getting tangled up with Hayman Capital and the SEC as is laid out in the RoyalDutch write up. The Hayman Capital lawsuit is ongoing. It has been going UDFI’s way, but honestly, I would be worried about putting odds on it that are much in excess of 50%. Still given that the UDFI stock trades below $2 and has only 30.672 million shares outstanding, even a payout of $31 million after costs would add a value per share of $1. My guess is that in case Hayman loses the trial the payout might end up being higher than my number of $31 million. Still I am assuming there is zero value added by the lawsuit, actually I deduct the cost of the lawsuit, but do not assign any value to its outcome. My guess is that the parties at some point will settle as I do not think Hayman wants a risk losing a trial against UDFI for reputational reasons.
One of the reasons why UDFI stock price is struggling is that since 2016 it hasn’t filed financials and UDFI told investors the filings would be made up to date 16 months ago and still nothing. The expectation was then extended to the first half of 2020 and then Covid happened which probably is delaying it even more. It looks like there is a good chance UDFI will get its registration pulled because of it.
Except if we have a Wirecard scenario, which I think is unlikely, it is hard to see based on my SOTPs how we lose money. But first allow me to address Covid and the economic outlook for Texas. In March I was also on board with a severe economic recession argument, but the FED has proven me wrong and now even my cleaning lady thinks she is a stock market genius. Someone asked me how far the FED could take this QE thing and I had to tell that person “I have no idea”. But as long as core inflation does not become an issue I wonder if there is even a limit. Also I used to own rentals and people do need a place to live and will fork over a large percentage of their budget to have a place to live. Anyway, back to the real world, Texas is getting hit by the oil bust, but its economy is more diversified than it used to be and I am taking a huge loss reserve in my SOTP by taking a 50% loss to underlying collateral just to be safe.
Lastly Nextpoint changed its 13G filing to a 13D filing. It sent a letter to the board asking for a constructive conversation stating that because of the operational issues of the last few years, they want to take over running the portfolio and I guess they are also interested in cashing in on the fees related to the UDFI portfolio. They also threatened the UDFI board that in case they were not seeing progress they would file a lawsuit in Maryland to force UDFI to have an annual meeting. UDFI’s board wrote back a letter where they are asking Nextpoint to address concerns they have about their relationship with Hayman. Also, the board for UDFI moved to stagger the board. I am not sure how this will all work out, but see it as a reasonably positive sign as it put the board on notice.
Now to my SOTP.
Expenses since 2016
Management fee - $45.41 million ($9.56 million a year times 4.75 years)
G&A - $35.34 million ($7.44 million a year times 4.75 years)
Interest expense - $20.96 million ($10.48 million times 2 years. Loans were paid back by end of 2017. This number is likely lower.)
Additional legal and regulatory expenses - $23.75 million ($5 million a year times 4.75 years)
SEC settlement - $8.2 million
Class action settlement - $10 million
Total = $143.66 million
Loan balances outstanding in order to calculate interest income
I assume a 13% interest rate from filings by UDFI.
2016 beginning loan balance of $625 million (85% LTV. UDFI states that the highest LTV they accept is 85% so I assume all outstanding loans were at 85% LTV. Also do not forget the “value” part of LTV is 2016 Texas real estate values, not 2020 Texas real estate values.)
Provision for loan losses of $257.5 million. (As mentioned above, I take quite a large provision for loan losses in order to compensate for increased uncertainty because of Covid. I take the full value of the 2016 loan collateral being $625 divided by 0.85 which gets me $735.3 million in 2016 loan collateral. I assume that 2016 real estate collateral value still fell by 50% to $367.64 million. $625 million minus $367.64 million gets me to a loan loss provision of $257.5 million)
Ending loan balance then becomes $349.5 million.
Debt balance paid off through 2017 $170 million
Ending net loan balance now becomes $179.5 million.
I now get to an interest income since 2016 of $110.8 million. (13% times the Ending net loan balance of $179.5 million. $23.335 million times 4.75 which gets me $110.8 million. I think I am being pretty conservative in my assumptions here as the outstanding loan balance for these years has been higher since 2016.)
2016 Beginning loan balance of $625 million.
Add Interest income of $110.8 million.
Deduct the loan loss provision of $257.5 million
Deduct expenses since 2016 of 143.66 million.
Deduct the loan paydown of $170 million.
Deduct dividends paid of $10.6 million
Total $154.04 million
Shares outstanding 30.672 million.
SOTP per share - $5.022
This number is lower than RoyalDutch’s NAV number. I think the reality is closer to RoyalDutch’s number, but given the additional uncertainty caused by Covid I wanted to be more conservative now, granted I did exaggerate markedly in my assumptions. The total interest expense is probably closer to $10/$15 million than the $20.96 million I took. I also took a massive loan loss provision of $257.5 million of 2016 collateral values. Even in the 2009 crisis in Vegas it was hard to have such deep discounts in value of collateral. So, it is fine with me to add a few dollars per share to the SOTPs if you ask me, but for now better to be conservative.
- This is a Wirecard like situation where management is stealing money. I think that is a low probability given the past investigation. I do believe they are trying to get their financials out.
- The company gets deregistered. Seems like an outcome we have to take into account.
- The Texas economy takes a huge hit. Despite my massive haircutting, I would assume the stock trades down anyway for some time.
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.
UDFI is able to publish its financials. It seems reasonable to expect that over the next 12 months.