Value Investor Blog

Asta Funding

Posted in Application, Uncategorized by aaronstackhouse on December 7, 2009

This will be the first of several posts on Asta Funding, Inc.

Asta Funding, Inc is in the business of acquiring, managing, servicing, and recovering portfolios of consumer receivables, including credit card, auto deficiency, and telecom receivables. The company purchases receivables at steep discounts from the face values of the underlying claims (3.4-4.0% of face value over 2004-2008). Typically the receivables have been previously written off by the originator and collections have previously been attempted by one or more parties.

I first found this company from a yahoo finance screen designed to find companies trading below net net working capital.

The industry has been strongly affected by the economic downturn. Many of the recoveries come from court settlements including wage garnishing or property sales. With employment and property trends of late, these recoveries have suffered significantly.

One view of ASTA Funding is a simply a pool of assets. From this perspective, I believe a good estimate to the value of ASTA Funding could be determined as:

Fair value of stockholders’ equity + Hidden Value (discussed below)

Fair Value of Stockholders’ Equity

ASTA Funding is current trading in the market at a P/B of 0.49. Understandably, the market has taken a skeptical look at a company with such exposure to the recessionary environment. However, after digging into the company’s balance sheet and under conservative assumptions that I will outline below, I believe the common stock of ASTA Funding is significantly undervalued.

As the figure below shows, the stock has historically traded most of the last six years at P/B ratios between 1.8 – 3.0.

Of course one of the key questions is how the carrying value of the company’s assets compare to the fair value. The value of consumer receivable pools has taken a dramatic hit over the past couple of years, so let’s take a closer look.

The company’s assets

Substantially all of the company’s assets are its portfolios of consumer receivables. When these portfolios are acquired, they are pooled into “static” loan portfolios for reporting purposes. The company then accounts for its receivable portfolios under one of two different accounting regimes.

a) The interest method

Under the interest method, projections are made at the acquisition as to the timing and size of future cash flows. These projections are discounted back to the purchase price to determine a benchmark IRR for the pool.

As cash is received, it is recognized as income and principal as it would be for an ordinary, fully-amortizing loan. Cash flow estimates are reassessed quarterly. These projections are then discounted at the previously established IRR and impairments are recognized to the extent that the present value of the expected cash flows fail to meet the carrying value of the assets. Conversely, the cash flow estimates cannot increase the carrying value – instead, the benchmark IRR is revised up and used to value the portfolio going forward. This has the effect of recognizing more income going forward, but the carrying value is not revised upwards. So long as the cash flow projections are reasonable, this interest method results in economically meaningful reporting, with the carrying value always equal to the present value of the expected future cash flows. For a more detailed description, google AICPA Statement of Position 03-3.

The downside of the interest method is that is relies heavily on assumptions that are made by the company. Economic uncertainty or poor assumptions can distort carrying values. Worse, it allows plenty of room for executives who are incentivized by compensation tied to income, or bank covenants requiring certain interest coverage, to manipulate the assumptions leading to inflated asset values.

b) The cost recovery method

Under the cost recovery method, all cash flow from the consumer receivables is first applied to principal. Only after the principal carrying value is reduced to zero are cash flows recognized as income.

Generally speaking, the cost method is an overly conservative accounting treatment. Because all proceeds are applied first to principal, the carrying value of the asset will become understated and the income will be inappropriately deferred. (An exception of this is that it could be used to hide further impairments).

The company currently uses both method of accounting. As of 6/30/09, 38.3% of the company’s assets were accounted for using the interest method and the other 61.7% were accounted for under the cost recovery method.

Impairments

Like all credit instruments, the value of consumer receivable portfolios has decreased significantly during the credit crunch.

Each quarter, the company separates its portfolio into interest method and cost recovery method, and reports certain statistics including: beginning balance, new acquisitions, sales, cash collections, finance income recognized, impairments, and amount transferred from interest method to cost recovery method.

Although there is not enough detail for a precise calculation, by tracking the cumulative impairments starting with the quarter ending 12/31/07, and adjusting for $30.3 million of impairments that were taken on the Palisades Portfolio (see below) before it was transferred to the cost recovery method, I have estimated that the carrying value of the current interest method portfolio would be $205,508,000 had no impairments been taken. By comparing this to the actual carrying value ($136,440,000), I estimate that assets in the interest method pool have been impaired 33.6% between 12/31/07 and 6/30/09.

“The Palisades Portfolio”

In March 2007, the company acquired its largest ever portfolio of receivables for a purchase price of $300MM. For the purposes of this report, I will refer to this portfolio as the Palisades Portfolio. To finance the purchase, the company used $75MM from its line of credit and obtained a $227MM loan from the Bank of Montreal. The company formed a wholly-owned subsidiary, “Palisades XVI” to own and manage the collections of this portfolio. The Bank of Montreal loan was initially only full recourse to the Palisades XVI subsidiary; however, the loan has been amended several times and now includes a limited recourse guarantee of up to $8MM from Asta Funding, Inc.

Initially, the Palisades Portfolio was accounted for using the interest method. The portfolio has not performed well. An impairment charge of $30.3 million was taken against it in FY 2008. Further, the company moved the portfolio from the interest method to the cost recovery method in the quarter ended June 30, 2008, citing an inability to develop “a reasonable expectation as to both the timing and amount of cash flows.

As of the most recent reporting date, 6/30/09, the company reported the following balance sheet items:

ASSETS

Cash and equivalents                             3,223
Restricted cash                                         2,256
Receivables portfolios
– Interest method                               136,440
– “The Palisades Portfolio”               181,400
– Other cost recovery method         38,424
Other assets                                             30,423

Total Assets                                           392,166

LIABILITIES

Debt
– Line of credit                                        35,488
– Bank of Montreal                             109,400
– Subordinated debt                               8,246
Other liabilities                                        2,622
Total liabilities                                    155,756

STOCKHOLDERS’ EQUITY              236,410

Shares outstanding, 6/30/09        14,272
Book Value per Share                        $16.56
P/B                                                                  0.49

Because it represents almost half of the company’s total assets, the valuation of the Palisades Portfolio is of obvious importance. On the company’s May 11, 2009 conference call, CEO Gary Stern described the exposure of the Palisades Portfolio. According to Stern at the time of the call, the “doomsday” scenario is that the Bank of Montreal takes back the portfolio, in which case the company would recognize a loss on the portfolio that would allow it to receive $30 million back from the federal government for taxes paid on income recognized on this portfolio while it was still being accounted for under the interest method.

Hidden Value

Under the interest method of accounting, a portfolio can become fully amortized and still be generating cash flow. While the collections are recognized fully as income, there is no corresponding asset on the balance sheet.

Asta Funding has collected between $10.2 million and $12.2 million in EACH of the last seven quarters from fully amortized loan portfolios. In addition, the company collected $23.9 million from completely amortized loan pools for the preceding fiscal year. This is VERY material for a company with a total market capitalization of only $96.5 million (as of 11/30/09).

To the extent future collections are likely, there is tangible hidden value to these loan portfolios. Unfortunately, it is difficult to have visibility on this. To be conservative I have limited the valuation of this hidden asset to 1x trailing earnings ($42.9 million).

Adjusted Balance Sheet

The following is a conservative version of the balance sheet. I have made the following adjustments to the actual reported balance sheet:

1)      On my balance sheet, the Bank of Montreal forecloses on the Palisades Portfolio. Asta Funding has an $8MM exposure to a limited guarantee to Bank of Montreal that I have included in “other liabilities.” “Restricted cash” is cash that Palisades XVI is currently holding for payment to the Bank of Montreal loan the following month, so in a foreclosure that would be applied to the Bank of Montreal loan.

2)      As noted above, I estimate the company has already impaired the assets in the interest method pools by 33.6%. To add an additional margin of safety, I have reduced the carrying value of these assets by an additional 25%. This implies that the value of these assets has fallen in half since 12/31/07.

3)      I have reduced the carrying value of the Cost Recovery Method assets (excluding the Palisades Portfolio) by 50%.

4)      I have added a “Hidden value asset,” valued at 42.9 million, which is equal to 1x earnings over the previous 4 quarters from fully-amortized loan portfolios.

ASSETS

Cash and equivalents                              3,223
Receivables portfolios
– Interest method                               102,330
– Cost recovery method                      19,212
– Hidden value asset                            42,900
Income tax rebate receivable        30,000
Other assets                                             30,423

Total Assets                                          228,088

LIABILITIES

Debt
– Line of credit                                        35,488
– Subordinated debt                               8,246
Other liabilities                                      10,622
Total liabilities                                       54,356

STOCKHOLDERS’ EQUITY              173,732

Shares outstanding, 6/30/09         14,272

Book Value per Share                         $12.17

P/B                                                                  0.67

So the Price/Book value under this scenario would still be 0.67.

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6 Responses

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  1. Value Investor said, on December 7, 2009 at 7:07 pm

    Very good analysis. Well done.

  2. PlanMaestro said, on January 5, 2010 at 4:41 pm

    Very good analysis, I like your point on the cash flow being generated by already amortized receivables. I like the margin of safety of the situation and the industry should continue to grow.

    But I have concerns on the UPSIDE given that if that portfolio defaults not only could impact equity but also compromise the access to credit lines basically leaving the company in run-off. Given the terrible performance that looks like a high probability scenario.

    What do you think of the probability of Great Seneca defaulting? There are several distressed financials with good margin of safety and big upside so I think that question is critical.

  3. aaronstackhouse said, on January 5, 2010 at 11:59 pm

    Thank you PM!

    I think you make a great point about the upside. The company’s acquisitions have dramatically tapered off and a run off situation would eat away at that margin of safety pretty quickly.

    Despite this, on the most recent conference call the CEO indicated that the company expects $80-85 million to be available for acquisitions of new portfolios in 2010 just out of cash flow. At first glance, and with at least SOME possibility of receiving a new credit line, this should be enough to avoid a run down situation. But you make a great point and I plan to dig a little deeper in the next couple weeks to look at this from a cash flow perspective instead of just focusing on the balance sheet.

    A bit puzzling that they weren’t able (or chose not to?) secure a new credit line going into 2010. They also extended a subordinated loan to a related entity (related to management) and increased the interest rate significantly from 6.5 to 10%, which doesn’t make much sense especially since they have paid down almost all of the debt senior to it in 2009.

    The Bank of Montreal loan matures in April 2011 – and at this rate they will need to refinance or extend to avoid further defaults. A lot will come down to working it out with B of M. The good news there is that the parent only has limited exposure (8 mil) that can’t be collected on until 2014 under likely conditions. In my analysis I really had just assumed that whole subsidiary was worth a net liability of $8 million so any news on that would be good news.

    By the way, I saw your blog – you’ve got some awesome stuff on there!

    A

  4. Value Investor said, on January 6, 2010 at 12:17 am

    I believe the $80 – $85 Million is a high estimate. One reasons being is that the company states that $47 Million of that comes by way of a tax refund. When the company released its 10-K, they also stated that they couldn’t be certain of when they would receive the tax refund because IRS regulations allow for the individual corporate tax case to be under review for up to 3 years. Secondly, there was no guarantee that the IRS wouldn’t dispute the refund amount. So, the tax refund, although hopeful is still at the speculative stage. What the company does have a high degree of certainty is that they’ll be able to generate approximately $35 Million in annual Revenue. That, by its own merits, is a good margin of safety.

  5. PlanMaestro said, on January 6, 2010 at 2:48 pm

    Thanks for the compliments and hope to read more of you in the future. Asfi’s posts are great.

    Tax Refund: VI’s point (Jim I suppose) on the tax refund seems like a very valid one.

    Ridiculous provisions: ASFI’s situation is not unique. CCRT has been basically in run-off buying up their CDO notes and convertibles, even though they have been generating substantial cash flow. Now they are spinning off some of their businesses I imagine to solve this.

    Credit Lines: some creditors in particular banks do not want to be near close subprime credit cards and “predatory” lending for the potential PR issues. Not something that they want given the need for TARP and regulations coming their way. CCRT has been suffering from this issue as they stated in a recent release.

  6. [...] Part 1 [...]


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