Business Context and Reporting Period
Company: Alesco Financial Inc. (a specialty finance company and REIT)
Filing Type: Form 10-Q (Unaudited)
Period Ended: September 30, 2009
Overview: The Company invests in trust preferred securities (TruPS), mortgage-backed securities (MBS), residential mortgages, and leveraged loans. Operations are significantly impacted by the ongoing credit crisis, resulting in widespread asset defaults, over-collateralization test failures in CDO/CLO structures, and a shift in investment strategy toward more liquid assets. The Company is in the process of a proposed merger with its manager, Cohen & Company, expected to close in Q4 2009.
Key Financial Metrics
| Metric | Three Months Ended Sep 30, 2009 | Nine Months Ended Sep 30, 2009 | As of Sep 30, 2009 |
|---|---|---|---|
| Net Investment Income (Loss) | $3.6 million | ($18.6) million | N/A |
| Net Income (Loss) Attributable to Common Stockholders | ($197.1) million | $140.7 million | N/A |
| EPS (Basic & Diluted) | ($3.31) | $2.34 | N/A |
| Total Assets | N/A | N/A | $3.89 billion |
| Total Indebtedness | N/A | N/A | $3.31 billion |
| Cash and Cash Equivalents | N/A | N/A | $90.1 million |
| Loan Loss Reserve | N/A | N/A | $179.2 million |
| Parent Stockholders' Equity | N/A | N/A | $208.4 million |
Material Changes vs. Prior Period
- Net Income Volatility: The Company reported a net loss of $197.1 million for the three months ended September 30, 2009, compared to net income of $62.4 million in the same period in 2008. Conversely, for the nine-month period, net income attributable to common stockholders increased to $140.7 million from $66.1 million in 2008.
- Fair Value Fluctuations: The Q3 loss was driven by a $190.5 million net loss in the fair value of investments and non-recourse indebtedness, primarily due to a $241.0 million loss on liabilities offset by $50.5 million in asset gains. The nine-month period saw a $357.3 million gain in fair value, driven by a decoupling of asset and liability pricing in TruPS CDOs.
- Loan Loss Provisions: Provision for loan losses increased significantly to $34.7 million in Q3 2009 (from $14.8 million in Q3 2008) and $134.9 million for the nine months (from $32.7 million in 2008), reflecting deteriorating credit quality in residential mortgages and leveraged loans.
- Asset Quality:
- TruPS: 23.6% of the portfolio ($1.2 billion) is in default or deferring interest. $567.3 million has been written off.
- Residential Mortgages: 60+ day delinquencies rose to 28.4% (from 9.6% in 2008). $179.8 million of loans are on non-accrual status.
- Leveraged Loans: Seven defaults totaling $16.5 million occurred. The warehouse facility was liquidated in Q3, resulting in a $38.3 million realized loss of first-loss cash deposits.
Guidance, Outlook, Risks, and Unusual Items
- Merger with Cohen & Company: A definitive merger agreement is in place. Upon completion, the Company expects to cease qualifying as a REIT. The transaction involves a 1-for-10 reverse stock split and is subject to shareholder approval.
- Over-Collateralization Failures: All eight TruPS CDOs and three Kleros Real Estate MBS CDOs have failed over-collateralization tests. Consequently, the Company is not receiving cash distributions from these entities. The Kleros CDOs have also experienced events of default, giving debtholders the option to liquidate assets.
- Liquidity and Financing: The Company entered a new $500 million repurchase agreement in October 2009 to finance agency RMBS. However, access to new CDO/CLO financing remains severely restricted due to market conditions.
- NYSE Listing Status: The Company is not in compliance with the NYSE minimum share price standard ($1.00). The cure period has been extended until the 2009 annual meeting of stockholders. Failure to comply could result in delisting, which may trigger repurchase obligations on $28.7 million of contingent convertible debt.
- Internal Control Remediation: The Company identified and remediated a material weakness regarding valuation models discovered in July 2009. No prior financial statements were restated as a result.
Investor Verification Checklist
- Merger Completion: Verify the status of the Cohen & Company merger and the impact on REIT status and capital structure.
- Delisting Risk: Monitor the Company's ability to cure the NYSE listing deficiency and the potential cash impact of the $28.7 million convertible debt repurchase trigger.
- CDO Liquidation Risk: Assess the likelihood of controlling debtholders in Kleros Real Estate CDOs exercising their right to liquidate assets, which could impact REIT qualifying assets.
- Asset Valuation Sensitivity: Review the sensitivity analysis for Level 3 assets (TruPS and MBS), noting that fair value estimates rely heavily on unobservable inputs and internal models.
- Cash Flow Sustainability: Evaluate the Company's ability to meet operating expenses and debt service without distributions from the failed CDO/CLO structures.