ALTISOURCE RESIDENTIAL CORP – 10-K – Management’s Discussion and Analysis of Financial Condition and Results of Operations.
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We were incorporated in
Marylandon July 19, 2012. Our primary business is to acquire, own and manage single-family rental properties throughout the United Statesthat meet our investment criteria. We currently intend to acquire single-family rental assets primarily through the acquisition of sub-performing and non-performing loan portfolios. Our objective is to provide attractive risk-adjusted returns to our investors over the long-term, primarily through dividends and secondarily through capital appreciation. We believe that the events affecting the housing and mortgage market in recent years create an opportunity to acquire single-family properties for rental purposes at valuations that meet our investment objectives. We believe that our ability to effectively acquire properties through the non-performing loan channel and to efficiently manage a widely dispersed portfolio of single-family properties will provide us with a competitive advantage in pursuing our strategy. We conduct substantially all of our activities through our operating partnership. The operating partnership was organized on June 7, 2012. We own 100% of the operating partnership's general partner, and as of December 31, 2012, we owned 100% of the outstanding partnership interest in our operating partnership. We are managed by AAMC. We rely on AAMC for administering our business and performing certain of our corporate governance functions. AAMC also provides portfolio management services in connection with our acquisition of non-performing loans, single-family properties and other assets. AAMC was formed on March 15, 2012and was spun-off from Altisource concurrently with our separation from Altisource.
Our business objective is to provide attractive returns to our shareholders primarily through dividends. We believe we can accomplish this with the following strategy:
• We expect to acquire single-family rental assets primarily through our
acquisition of non-performing loan portfolios. We believe that the
non-performing loan acquisition channel will give us a cost advantage over
other acquisition channels such as foreclosure auctions and other real-estate owned, or "REO," acquisitions because: ? we believe we will be able to purchase our single-family
assets at a
lower price because there are fewer participants in the non-performing loan marketplace leading to a higher discount rate and ? we believe we will be able to purchase non-performing loans at a lower price because the seller does not have to pay the broker commissions and closing costs of up to 10% of gross proceeds that typically are incurred when selling REO after foreclosure. • We expect to generate near-term cash-flow through the modification of our
non-performing loans and subsequently refinance them at or near the value
of the underlying property without waiting for entire loan portfolios to
reach stabilized rental state. • We expect to operate and manage single-family rental properties at a
predictable and attractive cost structure after converting non-performing
loans to rental properties due to the competitive property management fees
offered to us under our services agreement with Altisource: ? our management of single-family rental properties using
nationwide vendor network is not dependent upon scale. Unlike many of our competitors, we do not require a critical size of single-family rental assets in a geographic area to attain operating efficiencies and 18
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? non-performing loan pools typically contain properties that are geographically dispersed requiring a cost-effective nationwide property management system. Because of our arrangement with Altisource, we are positioned to acquire properties throughout
the United Statesallowing us to bid on large distributed
that geographically constrained competitors cannot.
• We expect to generate a stable cash flow stream through our preferred
investment in a title insurance and reinsurance business that is positioned to perform the title search and insurance services for our network of single-family assets. As further described in "Item 1. Business." we believe that Ocwen's mortgage servicing experience will enable us to shorten non-performing loan resolution timelines by (1) converting a portion of the non-performing loan portfolio to performing status and (2) managing the foreclosure process and timelines with respect to the remainder of the portfolio. We also expect that our 15-year master services agreement with Altisource for construction management, leasing and property management services will allow us to operate single-family rental assets at a lower cost than our competitors due to Altisource's established real property management experience and centralized vendor management model. Further, because of Altisource's widely-distributed established vendor model, we can acquire assets nationwide. We believe this will enable us to competitively bid on large sub-performing or non-performing mortgage portfolios with assets dispersed throughout
the United States. We expect our results of operations to be affected by various factors, many of which are beyond our control. Generally, we expect that our mortgage loan portfolio may grow at an uneven pace, as opportunities to acquire distressed mortgage loans may be irregularly timed and may involve large portfolios of loans, and the timing and extent of our success in acquiring such loans cannot be predicted. Our operating results will depend heavily on sourcing sub-performing and non-performing loans. As a result of the economic crisis in 2008 that continues through today, we believe that there is currently a large supply of sub-performing and non-performing loans available to us for acquisition. A recent study estimates that the average pre-REO delinquency levels that are in excess of levels typically experienced in a balanced market, known as shadow inventory, were approximately 5.1 million units over the past four years. The available amount of shadow inventory provides for a steady acquisition pipeline of assets since we plan on targeting just a small percentage of the population. Our ability to grow our business by acquiring sub-performing and non-performing loans is dependent on the availability of adequate financing including additional equity financing, debt financing or both in order to meet our objectives. As a REIT, we generally will need to distribute at least 90% of our taxable income each year (subject to certain adjustments) to our shareholders to qualify as a REIT under the Code. This distribution requirement limits our ability to retain earnings and thereby replenish or increase capital to support our activities. Because our decision to issue equity through accessing the capital markets or debt through entering into credit agreements will depend on market conditions and other factors beyond our control, we cannot predict or estimate our future capital structure. Because we believe that the majority of acquired loans will be converted into rental property, the key components that will affect our rental and other revenues over the long-term will be average occupancy and rental rates. We believe that demand for single-family rental assets will either increase or at least remain relatively constant in the future. In response to the economic crisis, the origination of subprime mortgage loans has dramatically declined. In addition, lenders have increased their credit standards for originating new loans. Furthermore, a significant number of families cannot obtain a new mortgage due to impairment of credit history caused by foreclosure on past loans or the lack of savings to make a down payment. All of the above factors and the shift in demographics point towards a robust demand for single family rentals in the future. Our expenses primarily will consist of loan servicing fees, rental property operating expenses, depreciation and amortization, general and administrative expenses, expense reimbursement and incentive management fees and interest expense. From time to time, expenses also may include impairments of assets. Loan servicing fees are expenses paid to Ocwen to service our acquired loans. Rental property operating expenses are expenses associated with our ownership and operation of rental properties and include expenses that are either impacted by to occupancy levels, such as utilities and turnover costs, and expenses that do not vary based on occupancy, such as property taxes, insurance and HOA dues. Depreciation and amortization is a non-cash expense associated with the ownership of real estate and generally remains relatively consistent each year at an asset level since we depreciate our properties on a straight-line basis over a fixed life. The general and administrative expenses consist of those costs related to the general operation and overall administration of the business. The expense reimbursement consists primarily of management and employee salaries and other personnel costs and corporate overhead. The incentive management fee consists of additional compensation due to AAMC should we achieve certain levels cash available for distribution. The interest expense consists of the costs to borrow money. 19 -------------------------------------------------------------------------------- (table of
Other Factors Influencing Our Results
The way a non-performing loan is resolved will impact the amount and timing of revenue we will receive. The exact nature of resolution will be dependent on a number of factors that are beyond our control including borrower willingness, property value, availability of refinancing, interest rates, conditions in the financial markets, regulatory environment and other factors. In addition, we expect that our real estate assets would decline in value in a rising interest rate environment and that our net income could decline in a rising interest rate environment to the extent such real estate assets are financed with floating rate debt and there is no accompanying increase in rental yield. The state of the real estate market and home prices will determine proceeds from sale of real estate acquired in settlement of loans. While we make extensive efforts at anticipating real estate price trends and estimate effect of those trends on the valuations of our portfolios of mortgage loans, future real estate values are subject to influences beyond our control. Generally, rising home prices are expected to positively affect our results of real estate acquired in settlement of loans. Conversely, declining real estate prices are expected to negatively affect our results of real estate acquired in settlement of loans. The size of our investment portfolio will also be a key revenue driver. Generally, as the size of our investment portfolio grows, the amount of revenue we expect to generate will increase. The larger investment portfolio, however, will drive increased expenses including servicing fees to Ocwen, property management fees to Altisource and related fees payable to AAMC. We may also incur additional interest expense to finance the purchase of our assets.
Completion of Spin-Off
As of the close of business on
December 21, 2012, we completed our spin-off from Altisource. Our shares began "regular way" trading on the New York Stock Exchangeunder the ticker symbol "RESI" on December 24, 2012. The spin-off was treated as a taxable pro rata distribution by Altisource of all of our outstanding shares of Class B Common Stock to the shareholders of record of Altisource as of the record date, December 17, 2012. The shareholders of Altisource received one share of our Class B common stock for every three shares of Altisource common stock held and cash in lieu of fractional shares.
Results of Operations
The following sets forth discussion of our results of operations from inception on
We have generated no rental revenues for the period from inception to
Gains on Acquisition of Property
We have generated no gains on acquisition of property for the period from inception to
Gains on Repayment of Non-Performing Loans
We have generated no gains on repayment of non-performing loans for the period from inception to
December 31, 2012. We expect to generate gains on repayment of non-performing loans in 2013 through short sales or through modification and refinancing of non-performing loans.
Gains on Disposition of Property
We generated no gains on disposition of property for the period from inception to
December 31, 2012. We expect to generate gains on disposition of property in 2013 through liquidation of the underlying collateral of non-performing loans after completion of foreclosure. 20 --------------------------------------------------------------------------------
(table of contents) Loan Servicing Fees
We have incurred no loan servicing fees for the period from inception to
Rental Property Operating Expenses
We have incurred no rental property operating expenses for the period from inception to
Real Estate Depreciation and Amortization
We have incurred no real estate depreciation and amortization for the period from inception to
December 31, 2012. We expect to incur real estate depreciation and amortization 2013 upon acquisition of non-performing loans and conversion to single-family rental properties.
General and Administrative Expenses
Our general and administrative expenses consist of those costs related to the general operation and overall administration of our business from inception to
December 31, 2012. We expect our general and administrative expenses to increase in 2013 as we increase operations.
Our expense reimbursement consists of direct and indirect costs incurred by AAMC on our behalf since inception and primarily includes compensation costs. We expect our expense reimbursement to increase in 2013 as we increase operations.
Incentive Management Fee
We have incurred no incentive management fee from inception to
Segment Results of Operations
We currently operate under one reportable segment.
Liquidity and Capital Resources
In conjunction with our separation, we received a capital contribution from Altisource of
$100 millionwhich is unrestricted for our use. We intend to use the proceeds from this capital contribution to invest in sub-performing and non-performing loans, renovate acquired real estate, fund our operating costs and fund our preferred investment in NewSource. As a REIT, we generally will need to distribute at least 90% of our taxable income each year (subject to certain adjustments) to our shareholders to qualify as a REIT under the Code. This distribution requirement limits our ability to retain earnings and thereby replenish or increase capital to support our activities. As a result, in the event we decide to grow our business, we will evaluate a number of potential capital raising alternatives including the issuance and sale of shares of Class A common stock, the issuance and sale of debt securities and entering into credit facilities with banks or other lending institutions. Because our decision to issue equity through accessing the capital markets or debt through entering into credit agreements will depend on market conditions and other factors beyond our control, we cannot predict or estimate our future capital structure.
Our primary cash flows to date have been the capital contribution we received from Altisource in conjunction with the separation.
(table of contents) Capitalization
The following table sets forth our capitalization (in thousands, except per share amounts):
December 31, 2012 Class B Common Stock Outstanding 7,810,708 Per Share Stock Price $ 15.84 Total Capitalization $ 123,722 Recent Financing Activity On
December 21, 2012we issued 7.8 million shares of Class B common stock in connection with our separation from Altisource. Altisource contributed to us total cash of $100 million. The proceeds from the capital contribution were contributed by us to the operating partnership for 100% of the then outstanding preferred interest in the operating partnership. We plan to use the contributed cash for working capital purposes and for the funding of our acquisition and renovation activity.
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements as of
The following table sets forth a summary regarding our known contractual obligations including required interest payments, if any, as of
Amounts Due During Years
Total 2013 2014 2015 2016 2017 Thereafter NewSource Subscription $ 18,000 $ 18,000 $ - $ -
$ - $ - $ -
Recent Accounting Pronouncements
Critical Accounting Judgments
Accounting standards require information in financial statements about the risks and uncertainties inherent in significant estimates, and the application of generally accepted accounting principles involves the exercise of varying degrees of judgment. Certain amounts included in or affecting our financial statements and related disclosures must be estimated requiring us to make certain assumptions with respect to values or conditions that cannot be known with certainty at the time our Consolidated Financial Statements are prepared. These estimates and assumptions affect the amounts we report for our assets and liabilities and our revenues and expenses during the reporting period and our disclosure of contingent assets and liabilities at the date of our Consolidated Financial Statements. We routinely evaluate these estimates utilizing historical experience, consultation with experts and other methods we consider reasonable in the particular circumstances. Nevertheless, actual results may differ significantly from our estimates and any effects on our business, financial position or results of operations resulting from revisions to these estimates are recorded in the period in which the facts that give rise to the revision become known.
We consider our critical accounting judgments to be those used in the determination of the reported amount and disclosure related to the following:
(table of contents) Income Taxes We believe that we will comply with the provisions of the Code applicable to REITs beginning for the year ended
December 31, 2013. Accordingly, we believe that we will not be subject to federal income beginning the year ended December 31, 2013on that portion of our REIT taxable income that is distributed to our shareholders as long as certain asset, income and share ownership tests are met. As a REIT, we generally will not be subject to federal income tax to the extent we distribute our REIT taxable income to our shareholders. If we fail to qualify as a REIT in any taxable year, we will be subject to federal income tax on our REIT taxable income at regular corporate income tax rates and generally will not be permitted to qualify for treatment as a REIT for federal income tax purposes for the four taxable years following the year during which qualification is lost unless the IRSgrants us relief under certain statutory provisions. Such an event could materially adversely affect our net income and net cash available for distribution to shareholders. Our taxable REIT subsidiaries, if any, will be subject to federal and state income taxes. Income taxes are provided for using the asset and liability method. Deferred tax assets and liabilities will be recognized for the future tax consequences attributable to differences between the Consolidated Financial Statements carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities will be measured using enacted rates expected to apply to taxable income in the years in which management expects those temporary differences to be recovered or settled. The effect on deferred taxes of a change in tax rates will be recognized in income in the period in which the change occurs. Subject to our judgment, a valuation allowance will be established if realization of deferred tax assets is not more likely than not. We will recognize tax benefits only if it is more likely than not that the tax position will be sustained upon examination by the appropriate taxing authority. A tax position that meets this standard will be recognized as the largest amount that exceeds 50 percent likelihood of being realized upon settlement.
Non-GAAP Measures - FFO and NOI
We believe that funds from operations, which we refer to as "FFO," and FFO per share are important indicators of the performance of any equity REIT. Because FFO and FFO per share calculations exclude such factors as depreciation, amortization and impairment of real estate assets and gains or losses from sales of operating real estate assets which can vary among owners of identical assets in similar conditions based on historical cost accounting and useful life estimates, they facilitate comparisons of operating performance between periods and between other REITs. We believe that historical cost accounting for real estate assets in accordance with GAAP implicitly assumes that the value of real estate assets diminishes predictably over time. Since real estate values have historically risen or fallen with market conditions, many industry investors and analysts have considered the presentation of operating results for real estate companies that use historical cost accounting to be insufficient on a standalone basis. As a result, we believe that the use of FFO and FFO per share, together with the required GAAP presentations, provide a more complete understanding of our performance relative to our competitors and a more informed and appropriate basis on which to make decisions involving operating, financing and investing activities. FFO and FFO per share are non-GAAP financial measures and, therefore, do not represent net income or net income per share as defined by GAAP. Net income and net income per share as defined by GAAP are the most relevant measures in determining our operating performance because FFO and FFO per share include adjustments that investors may deem subjective, such as adding back expenses such as depreciation, amortization and impairment. Furthermore, FFO per share does not depict the amount that accrues directly to the stockholders' benefit. Accordingly, FFO and FFO per share should never be considered as alternatives to net income or net income per share as indicators of our operating performance.
Our presentation of FFO is consistent with FFO as defined by the
• net income/(loss) computed in accordance with GAAP;
• less dividends to holders of Preferred Stock and less excess of Preferred
Stock redemption cost over carrying value;
• less net income attributable to noncontrolling interests in consolidated
• plus depreciation and amortization of depreciable operating properties;
• less gains or plus losses from sales of depreciable operating properties,
plus impairments on depreciable operating properties and excluding items that are classified as extraordinary items under GAAP; • plus or minus adjustments for unconsolidated partnerships and joint ventures (to reflect FFO on the same basis) and • plus or minus adjustments for depreciation and amortization and gains/(losses) on sales of depreciable operating properties, plus impairments on depreciable operating properties and noncontrolling
interests in consolidated affiliates related to discontinued operations.
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In calculating FFO, we add back net income attributable to noncontrolling interests in the operating partnership, if any which we believe is consistent with standard industry practice for REITs that operate through an UPREIT structure.
For the period from inception to
In addition, we believe that net operating income from continuing operations, which we refer to as "NOI," and same property NOI are useful supplemental measures of our property operating performance because such metrics provide a performance measure of the revenues and expenses directly involved in owning real estate assets and provides a perspective not immediately apparent from net income or FFO. We define NOI as rental revenues from continuing operations less rental property expenses from continuing operations. We define cash NOI as NOI less straight line rent and lease termination fees. We define our same property population as those properties owned for the entirety of the comparative reporting periods. Other REITs may use different methodologies to calculate NOI and same property NOI than we do.
For the period from inception to
To the extent we provide, FFO, FFO per share and NOI in any future reports, we will provide a reconciliation of these non-GAAP financial measures to GAAP net income.