Business Context and Reporting Period
Company: Alesco Financial Inc. (Note: Metadata listed "Cohen & Co Inc." but the filing is for Alesco Financial Inc., managed by Cohen & Company).
Filing Type: Form 10-Q (Quarterly Report).
Period Ended: June 30, 2008.
Business Overview: A specialty finance company and Real Estate Investment Trust (REIT) investing in Trust Preferred Securities (TruPS), mortgage-backed securities (MBS), leveraged loans, and residential mortgages. The company utilizes significant leverage through Collateralized Debt Obligations (CDOs) and warehouse facilities.
Key Financial Metrics
| Metric | Three Months Ended June 30, 2008 | Six Months Ended June 30, 2008 |
|---|---|---|
| Net Investment Income | $28.0 million | $54.6 million |
| Net Income (Loss) | ($81.2) million | $3.7 million |
| Earnings Per Share (Basic) | ($1.36) | $0.06 |
| Total Assets | $6.27 billion | (Balance Sheet Item) |
| Total Indebtedness | $5.82 billion | (Balance Sheet Item) |
| Stockholders' Equity | $203.4 million | (Balance Sheet Item) |
| Cash and Cash Equivalents | $136.0 million | (Balance Sheet Item) |
Loan Loss Provision: $7.9 million (Q3) and $15.5 million (YTD).
Impairments: $4.3 million (Q3) and $12.8 million (YTD), primarily related to residential mortgage charge-offs.
Material Changes vs. Prior Period
- Net Loss Increase (Q3): Net loss widened to $81.2 million from $47.2 million in the prior year quarter. This was driven by a $132.7 million net loss on the fair value of debt securities and non-recourse indebtedness, partially offset by gains on derivative contracts.
- Net Income Improvement (YTD): Net income improved to $3.7 million from a $35.4 million loss in the prior year period. This improvement is largely attributable to the adoption of SFAS No. 159 (Fair Value Option), which resulted in significant fair value gains on liabilities offsetting asset losses.
- Investment Portfolio Decline: Investments in debt securities and security-related receivables dropped from $6.63 billion (Dec 31, 2007) to $4.17 billion (June 30, 2008) due to fair value adjustments and asset sales.
- Debt Reduction: Total indebtedness decreased from $11.1 billion to $5.8 billion, reflecting the deconsolidation of entities and fair value adjustments on CDO notes payable.
Guidance, Outlook, Risks, and Unusual Items
Accounting Changes (SFAS No. 159)
Effective January 1, 2008, the company adopted the fair value option for TruPS, MBS, and related CDO liabilities. This resulted in a one-time $2.6 billion gain to stockholders' equity and a $1.1 billion increase to accumulated deficit at adoption. Subsequent changes in fair value are recorded in earnings, creating significant volatility in reported net income.
CDO Over-Collateralization Failures
- TruPS CDOs: Six of eight TruPS CDOs failed over-collateralization tests due to defaults/deferrals (including IndyMac Bancorp). Equity distributions are suspended until cured. Management projects cures within 3-6 quarters for three deals and 20-35 quarters for the others.
- MBS CDOs (Kleros): All three Kleros Real Estate CDOs failed over-collateralization tests and experienced events of default. Kleros III was liquidated in June 2008 and deconsolidated. Kleros I and II remain at risk of liquidation.
Liquidity and Market Risks
The credit crisis has severely restricted the ability to complete new CDOs and CLOs. The company holds $40.1 million in cash collateral for warehouse facilities; if securitization markets remain closed, this capital is at risk. The company maintains $136 million in cash and cash equivalents.
Legal Proceedings
The company is pursuing collection on a $13 million judgment against guarantors of the "Penland Loan," though some guarantors have filed for bankruptcy. A receiver has been appointed for the collateral property by the North Carolina Attorney General.
Investor Verification Checklist
- REIT Qualification: Verify if the liquidation of Kleros CDOs impacts the company's ability to meet REIT asset and income tests, potentially triggering corporate taxation.
- CDO Cure Status: Monitor the timeline for curing over-collateralization failures in the six affected TruPS CDOs to assess the resumption of equity distributions.
- Warehouse Collateral Risk: Assess the risk to the $40.1 million cash deposit held by warehouse lenders if securitization markets do not reopen.
- IndyMac Exposure: Confirm the final write-off status of the $145 million in defaulted securities, including IndyMac, and any potential recoveries.
- Dividend Sustainability: Evaluate the ability to maintain the $0.25 quarterly dividend given the suspension of cash flows from failed CDOs and the volatility of fair value earnings.