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Altisource Residential: Irrational Sour Grapes Proxy Fighters Set Up #1 Reit Investment


Altisource Residential (NYSE: RESI) should deliver the best total returns over the next 12 months over any other REIT with the lowest downside.

We forecast that the total return (capital gains plus the 6.5% dividend yield) will deliver 56% in the next 12 months from the current share price of $9.14 on July.

The current investment opportunity has presented itself from: the recent cut of the dividend from $0.55 to $0.15, misunderstood strategy change, and flows from sour grapes large proxy fight sellers.

Altisource Residential (NYSE:RESI): Misunderstood and Deeply Undervalued

Atisource Residential is a mortgage Reit undergoing a strategy change from purchasing and resolving Non Performing Loans ( NPL's) into a Single Family Rental operator. Management has stated they are going to sell all of the NPL's and Real Estate ( REO's) turning about 75% of these balance sheet assets into cash prior to the end of 2016 and the rest by mid-2017. Then, they are taking the cash from the asset sales, and buying high yielding Single Family Rental Homes (SFR's). They have stated that they have already achieved purchases of rentals (some 2,700 units) that have hit a 12% gross yield and a 6.5% net yield. After using leverage on the rentals, this 6.5% yield is turned into an 11-13% return on equity (ROE) given their 3.5% borrowing cost. Management has stated that they expect to own 10,000 rental homes by the end of 2016 and 20,000 rental homes by the end of 2017.

Altisource Residential should deliver the best total returns over the next 12 months over any other REIT driven primarily by the simple sale of assets in the balance sheet at levels close to, or even slightly below, carrying value. Having a conservative nature, I'm assuming asset sales come in under their marks like 1-4% below on all assets sales.

I forecast that the total return (capital gains plus the 6.5% dividend yield) will deliver 56% in the next 12 months from the current share price of $9.14 on July 20, 2016. This puts the share price at $13.71 in 12 months. These favorable expected returns are framed against an argument for limited downside - the assets in the RESI balance sheet that I will discuss below have light leverage and are tied to physical real estate assets trading in liquid markets. The Price/Book ratio of RESI ($9.14 Price/$19.75 Book Value) is 0.46 and essentially you are buying assets at 46 cents on the dollar that management is saying, the bulk of which will be turned into cash in the next the next 5 months.

So why is this price dislocated from the fundamentals?

Having been an owner of RESI shares for quite some time, I would assert that the current investment opportunity has presented itself as a result of: the proxy fight, the recent cut of the dividend from $0.55 to $0.15, misunderstood strategy change, misunderstanding of the balance sheet assets and associated liquidity, and most importantly- the significant selling flows in the past 2 months from redemptions (forced selling) and proxy fight losers (irrational selling - sour grapes).


has low debt

RESI has 1.05bb of debt and 1.08mm equity for 1x debt/equity ( Page 2 of Form 10-q, Q1 2016) This is a very lightly levered Reit.

Agency Mortgage Reits like (NYSE: AGNC) deploy about 6x, and (NYSE: CYS) deploy 7x

Private Label RMBS Reits like (NYSE: NLY) deploy 5x, (NYSE: CIM) deploys 4x, (NYSE: TWO) deploy 3x and (NYSE: NRZ) deploys 4x.

The point here on leverage is important. Deep value plays where there is discount to book are less risky when there is limited debt and more risky when there is more debt. Said another way, if you sell off assets and turn them into cash, if you are highly levered and are a little wrong on asset pricing, this can impact your equity on a levered basis. Here with RESI, they are selling off NPL's and REO's and a small variance in the sale pricing if this did occur of 1-4% wouldn't impact much the book value too much because there is low leverage.

Asset Sales:

RESI has stated that they are selling all of the 924mm fair market value of NPLs ( Page 2 of form 10-q and pages 28-29 of Form 10-q) and will be selling all of the REO's held for sale 297mm (Page 2 of Form 10-q), and will be selling part of the Real Estate Owned ( REO's)not held for sale of 329mm. The REO's are the result of what happens when NPL's that are not modified are foreclosed upon and result in the hard real estate on the balance sheet. The last bucket of REO's of 329mm, not held for sale, is under evaluation to either a.) turn into SFR's if appropriate or b.) sell. I would estimate that likely 75% of this last bucket will be sold and 25% will be turned into cash flowing SFR units.

This means that 924mm + 297mm + 246mm of loans and real estate will be sold in the near future. I believe management has stated they expect to sell 75% of all NLP and REO assets before the end of 2016. For investors worried that these sales might not achieve the carrying value that appears in the balance sheet for these items I might direct investors to the 2016 Q1 company presentation slide 5. This slide states that 384mm of Unpaid Principal Balance (UPB) of NPL's were sold in Q1, 2016 within 1% of the carrying value. Investors should also reference Slide 5 in the 2015 Q4 Company Presentation that stated that in Q4, 296mm of Unpaid Principal Balance (UPB) of NPL's were also sold within 1% of the carrying value.

These two sales of 384mm + 296mm or 680mm of NPLs sold within the last two quarters represent about 1/3 of the total that management set out to sell. Pages 29-30 of Q1 Form 10-q state that there are 1.27bb of UPB of NPL's left to sell. If these assets are sold within 1% of the carrying value of 924mm or 72% then the $19.75 book value will stay mostly intact.

I might direct next investors to Page 3 of the Q1 Earnings Call transcript that quoted RESI CFO Robin Lowe as saying that the market value of all real estate assets (rentals and Reo's) exceed the carrying value by 68mm. If there are 54mm shares, this would imply that there could be another $1.25 of unrealized gains that exist in the book value over carrying value. This is a little complicated discussion of why this occurs, but the reason is that GAAP accounting requires that the REO assets mark downs carrying value when fair value is below market value but does not permit mark ups to fair value when fair value exceeds carrying value. Some of these added gains can be realized upon the ultimate sales of REO assets. It's possible, that this gain of 68mm that is not reflected now in book value can partially offset NPL sales that might come in 1-3% lower than the marks. Robin Lowe clarifies this again on page 7 of the Q1 Earnings Call Transcript saying that when I convert my NPL's into REO's, I do so at the latest market value available, in other words, the latest BPO (Broker Price Opinion). He says he has to mark down REO's taking impairment on the BPO's that are lower than the carrying value but he can't mark up the ones that are higher than carrying value. These extra gains he is saying will all come out upon the ultimate sale of the real estate.

Mark to Market at RESI: How do they price the NPL's and REO's ?

The NPL's are priced...