Tuesday, December 23, 2014

A Rant about (TREE)

I'll keep this short because the story is simple. There is a great write up on Seeking Alpha by New Capital: The Beauty of Shorting I will just highlight a few observations here.

  • This website asks you a bunch of questions then sell your contact information to strangers.
  • The company has been in business for 18 years and still can't make any money.
  • Management makes absurd claims that their brand is more recognizable than Citibank.

I tried for this research and now I'm flooded with calls from strangers. I've given away my phone number, and there's still no rate quotes - just brokers calling me. Who in the world wants this??

And yes they had the galls to ask for your social security number - again before showing any rate quotes. Who in their right mind does this??

TREE trades at 42x PE, 3x sales. Revenue is growing at a modest ~10% pace, but that is fueled by marketing and advertising spends. There are no operating leverage in this business, so no amount of sales will translate to EBITDA or earnings growth. The company has proven this in its history.

I've looked at other "lead-gen" companies. Most of them trade at sky-high prices but few are as bad as TREE. TrueCar is as least innovative and disruptive, if somewhat easy to copy. Zillow/Trulia both have name recognition and together could be considered a monopoly. is easy to use and actually have contents. TREE is none of these.

The only sensible thing to do is short the fuck out of this. Unfortunately it's a bull market out there so you have to pick your spots. Check out the LendingTree website, do your research, and short on signs of weakness.


Here's TREE asking for your social security number:

LendingTree wants your social security number

Here they try to sell me a real estate agent – despite having indicated that I’m not interested in one earlier:

LendingTree wants to sell you real estate agents

And of course, LendingTree is more famous than Citibank:

LendingTree more famous than Citibank

Monday, December 15, 2014

Musing on Ocwen’s Liquidity Situation


Last Friday (12/12/2014) Ocwen (OCN) announced the purchase of $253mm Ginnie Mae early buyout (EBO) loans. On the surface this looks like good news as it appears that OCN is back on their feet doing business again.

Reading between the lines, I see this as a confession that they lack liquidity.

1) The company was obligated to buy those loans. Barclays’ MBS analysts noted that Ginnie Mae requires servicers to maintain delinquency levels below a 5% threshold, and delinquencies on OCN serviced pools have ran above that threshold for months.

2) In November the scuttlebutt was that Ocwen tried to sell those Ginnie Mae loans but were unsuccessful.

3) Last Friday OCN finally bought what they had to buy all along. But they turned around and sold it to an “unaffiliated third party”. Since Ocwen was already the servicer on these loans, this is not adding to their mortgage servicing rights portfolio.

So here’s the more complete narrative. OCN faced obligations to put up cash for loans. They were delinquent in doing so and tried unsuccessfully to offload that obligation. When they finally bought the loans, they had to bring in a 3rd party to finance it.

Is OCN having cash issues?

Latest Liquidity Situation Uncertain From Filings

At 9/30/2014, Ocwen had almost $300mm of cash on balance sheet but planned to use that for upcoming debt obligations and share repurchases.

Ocwen has to “advance” payments on behalf of delinquent borrowers and raise the money for that through securitization of advance receivables. The advance securitization notes each have their own “amortization date”, which is when OCN has to start paying down those notes and new advances are no longer financed. October 2014 was when the majority of these notes were supposed to start amortizing. In the latest 10Q, Ocwen said they subsequently paid off some of these notes, pushed back the amortization dates of some notes, and issued new notes. The disclosures are vague in terms of dollar sources and uses, so I’m unable judge their current liquidity situation regarding the advance receivables notes. Given the show of weakness on these Ginnie Mae EBO loans, I have to wonder.


The conventional view is that Ocwen services such a large portion of the subprime market that they’re “too big to fail”. But “too big to fail” does not mean shareholders won’t be wiped out, so investors can’t ignore the tail risk. Still, Ginnie Mae loans are a small subset of OCN’s overall servicing portfolio, so how might this sink Ocwen?

Liquidity issues, like runs on banks, are a bit of circular logic. Confidence (or lack thereof) feeds on itself. It doesn't help that Ocwen may have a large legal settlement coming anytime and capital requirements for servicers are still being discussed. Should Ocwen somehow lose Ginnie Mae’s business or show further signs of liquidity/capital strains, rating agencies may feel intense pressure to downgrade them further (rating agency analysts are people and they have to protect their career risk!) Further rating downgrades could effectively make banks pull their credit facilities - lower advanced rates, higher interest cost, covenant triggers...etc. At that point the issue is no longer confined to advance receivable facilities, but spills over to MSR financing, warehouse lending, corporate debt issues, capital requirements. In short - everything. In fact banks are probably already worried about OCN. No credit access = even less liquidity -> securities price spiral downward -> less confidence -> even less cash access.

Ocwen can try to ease its cash outflows by stop advancing earlier, and quicken the pace of modifications/principal reductions. Keep in mind though, investors have already threated to sue Ocwen due to opaque servicing practices. Any further changes in operations could lead to revolt in the MBS investor base.

In theory, servicing advances and EBO loans are high quality assets with virtually no credit risk, so there should be plenty of hedge funds, insurers…etc willing to provide funding and take these assets off Ocwen’s hands. On the other hand, the corporate high yield market is currently in shambles and liquidity is also scarce there. If I were a hedge fund and OCN desperately seeks my help, I wouldn’t do so without extracting my pound of flesh (perhaps some sort of convertible preferred?)

What If Liquidity Deteriorates

3 Scenarios: 

· Most likely. OCN gets its liquidity at higher funding cost or equity dilution. Ocwen and PennyMac (PFSI) appears to have some sort of alliance going on.

· Possible. Without funding, OCN couldn’t originate loans or acquire MSR. It goes into runoff mode.

· Low probability. Liquidity and confidence evaporates suddenly. Government or a consortium of investors take over OCN on emergency basis and stock goes to 0.

OCN is near the cusp of a tipping point in confidence. It’s possible that capital market goes into raging bull mode, liquidity splashes everywhere, in which case all these issues go away and stock goes back to the 50’s. For now I’m still on the sidelines, viewing Ocwen with a negative bias. If a trend emerges, I’m ready to act either way.

Friday, December 5, 2014

Risk Control and my Mortgage and Housing Portfolio

I mentioned my mortgage/housing portfolio a few months ago and here’s what it looks like now:
  • Title insurance: FNF/FAF/STC
  • Asset pools: AGNC/MTGE/ HLSS
  • Origination and servicing: PFSI/WAC. A short put position in OCN that is fully hedged 
  • Builders: UCP
  • A tiny position in Freddie Preferred.

Combined, these are more than 20% of my portfolio. My housing exposure is actually more if I count Wells Fargo, Citibank…etc.

Since that last post, I have traded in and out of STC with incredible luck, and it looks like my patience in title insurers are now paying off. I’m not so lucky in OCN however. This one killed my returns this year. Analysts are bound to make wrong fundamental calls at some point, but you have to control your losses with sound portfolio management and this is where I failed. 

Getting Scalped by Gamma

Among the many lessons I learned (and paid for), a more interesting one is the negative convexity of shorting options. I got into OCN with short put positions thinking I can subsequently adjusted my net exposure up and down by going long/short stocks. That turns out to be naïve. A simplified example using fake numbers go like this.

Time 1
Stock trade at $34.
My long position: sold 100 shares of puts strike $35, this is now in the money so I’m net long.
My short position: short 100 shares of stocks.
Net exposure:  zero; I’m hedged right?  right?

Time 2
Stock spikes to $37.
My long position: now 0. That 100 shares of $35 puts is now out-of-the-money
My short position:  still short 100 shares of stocks.
Net exposure:  
all the sudden I’m net short, when stock is making a run upward! I close my short stocks to bring net exposure down to 0.

Time 3 
Stock goes back down to $33.
My long position: Those sold puts struck at $35 went In-The-Money again.
My short exposure:  0. I closed my shorts in time 2
Net exposure: long 100 shares, but stock is plummeting.

So basically, that short put positions goes in and out of the money at the worst times. What I thought was a fully hedged position could turn into a net short exposure when stock is making a run upward; and vice versa, it turns to net long when stock is tanking.

People talk about “gamma scalping” by going long call option and shorting stock. With my set up I was short gamma and got scalped instead. 

Controlling Risk with Technical Analysis

FNF, and to some extent FAF, are core positions I plan to hold through the cycles. The rest however are not what most people would consider “quality” companies and my positions in them fluctuate greatly. When the fundamentals are shaky and information dissemination is sparse, I learned to use technicals to control my risk. That means buying things near some technical support level (ideally around 52 week or all-time lows), and cut my losses when they drop below that support level. Since that doesn’t always work (some of these stocks are known for taking a big gap downward), I further control risk by diversify my sector bets into multiple names, and look for cheap valuation (low P/Es or P/B multiples) 

Blending of Risk across Sub-sectors

Some of these sub-sectors offset each other with respect to specific risk factors. 

For example, my positions in title insurers could be hurt if mortgage transactions get lower. A partial hedge to that is a position in AGNC. This agency mortgage REIT benefits in that scenario because lower MBS issuance would drive its asset valuation higher. On the other hand, the mREITs have duration risks and could be hurt when rates go higher. The mortgage servicers provide some offset here with their MSR holdings. And so on. 

This is not an exact science because it’s hard to quantify the effect of various risk factors. Nevertheless, it’s good to think through what you’re trying to bet on and the risk you’re exposed to. For now, this portfolio is a bet on household formation, higher mortgage volumes, regulatory environment stabilizing, and various company specific factors such as operating efficiency, low valuation…etc.

Finally, I just started positions in PFSI and WAC this week. Those are for a separate post.