Wednesday, September 28, 2011

On ACAS' Debt

At the end of June of 2010, ACAS announced that its long-running effort to arm-twist its many creditors into exchanging one family of debt instruments (under which ACAS was required to maintain asset levels that, under the combined effects of FAS 157 and the post-2008 liquidity crisis, were impossible for ACAS to meet, and led to default-rate interest, despite that ACAS had never missed a payment) for a different set of debt instruments (which granted creditors what they had long demanded: security) had finally succeeded. In the transaction, ACAS paid $1.03B of its loans back 100% in cash, and exchanged the remaining $1.31B for the new secured notes. The overview is here. At the close of the deal, ACAS owed $11m in unsecured old debt that didn't participate in the swap, and $1.31B of newly-issued secured debt.

I've recently been asked about ACAS' risk for being forced to liquidate its holdings in some kind of fire sale. According to the amortization schedule announced with the press release on the restructuring, ACAS didn't have any principal repayment obligation until December 31, 2011. At that time, if it didn't cough up about $70.4M, ACAS would suffer a higher interest rate. ACAS has further principal amortization requirements at the end of June 2012, December 2012, and June 2013 ($100m, $300m, and $350m respectively). Scary, eh? Shall we have a look at ACAS' outlook for meeting the schedule?

The next quarterly report following the debt restructuring was 2Q2010, which included the announcement that ACAS' total debt stood at $2.924B, placing the company at a debt:equity ratio of 0.9:1. Its interest expense in 2Q2010 was $56m, but that included time under the old debt regime. The total debt included the $1.31B in secured debt, and some securitized debt. The following quarter, 3Q2010, ACAS repaid $407m in debt, including $200m of the secured debt due in 2013. In 3Q2010, ACAS' interest expense had declined to $36m, and it foresaw a 4th-quarter secured debt repayment intended to lower its interest rate to the lowest available under its new debt facility. In 4Q2010, ACAS repaid $258m in debt. In that quarter, its interest receivable was $37m and its interest expense was $28m. (For those who cautiously ask about ACAS' actual income rather than its receivable number, its interest and dividend income in 4Q2010 was $133m.) In 1Q2011, ACAS repaid $517m in debt, including $300m of the secured debt due in 2013. (Interest expense was $29m, while interest and dividend income was $146m; fee income grew over the quarter from $10m to $13m.) The 1Q2011 repayment left ACAS with no principal repayment due under the amortization schedule until it owed $250m at the end of June 2013. ACAS' next quarter, 2Q2011, it repaid $100m of its securitization debt. This left ACAS (whose NAV had increased to $13.16 per share) with a debt:equity ratio of 0.4:1. In 2Q2011, ACAS' interest expense had decreased to $20m while its interest and dividend income stood at $131m.

Since ACAS plainly has the wherewithal to keep current on its interest payments, there is no basis for secured creditors (who aren't due any principal until mid-2013) to execute on the security. They're being paid in full. The whole point of the security was to free ACAS from maintaining specified asset levels; the value of ACAS is no longer the security, because the security is the security. Losing your job doesn't cause home foreclosure so long as you make your payments. ACAS' secured refinancing was designed to give it the flexibility to do what made sense without worrying about the market cap, net assets, etc. This is why ACAS was free to shrink the company by spending cold hard cash simply to retire shares. This raises per share value but it shrinks the company. Without a net asset covenant, it's no longer suicide. A few years ago, share buyback was impossible due to ACAS' ongoing concern about maintaining net asset levels to satisfy covenants under its old debt regime. If someone has a term sheet for the new secured debt, I'd love to see it to be sure I understand what else may be required, but as I understood the refinancing I think ACAS is in a great position based on its current earnings.

So, what happens if Paulson is forced to sell? Well, ACAS' capital is permanent capital: no-one can recall it. If Paulson has to dump shares, we may get a fire sale (if the sale isn't private and if there are no buyers lined up to absorb Paulson's block). Heck, with the share buyback plan in position – a share buyback plan which allows privately-negotiated purchases – ACAS itself might enjoy Paulson's fire sale, if there is one. I for one have no idea what Paulson's finances look like, and don't honestly care except that it may present a short-term buying opportunity.

So, why is ACAS' price in the toilet? We've re-entered a period of heightened uncertainty, ACAS' portfolio of small illiquid firms is viewed as vulnerable to turmoil, ACAS' management has couched positive guidance in terms of a continued favorable macro-economic environment, we don't know from day to day what effect market conditions of ACAS' portfolio's comparables has on ACAS' NAV, etc. With uncertainty comes perceived risk, and lower bids. And lower bids follow misinformation: I read a teaser for a new research report that referred to ACAS as having no dividend in the foreseeable future because of expected capital losses. Um, the dividend is expected to be zero for a while because ACAS' loss carryforwards will absorb taxable earnings (whetehr operating income or capital gains), and ACAS' dividend has historically been calculated on the basis of taxable income because it was regulated as a BDC. Claims of expected losses, even bogus ones, can't be good for share prices. Bogus analysis abounds. Anyone got a hard source for an actual forecast of losses? Didn't think so.

I have never claimed to be able to time anything, and I won't try here. One of the more painful investing errors I made was to decide that the market wasn't going anywhere and lose a ton of AAPL to covered call exercises years ago when the stock hadn't moved in ages, and I don't think the shares ever saw that price again. I'm not keen to replicate the experience by trying to time purchase and sale near $7 of a company whose last-announced NAV was north of $13.

My last move in ACAS was to buy 200sh for a niece, which I put into an asset protection trust. Kid's going to need money when she grows up, I figure. And me too!

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