Asta Funding, Inc. (NASDAQ:ASFI) reported its fiscal 3rd quarter 2017 results on August 9, 2017. Quarterly earnings were $4.2 million before tax, net income was $1.8 million and diluted earnings per share were $.27. What was interesting about Asta’s quarterly earnings was that it earned $4.2 million pretax even after including the loss of $5.3 million from the sale of the life contingent annuities. (Asta Fiscal 3rd Quarter 2017 Earnings Release) If the $5.3 million loss from the sale of annuities were backed out of the quarterly results, pretax earnings would have more than doubled to $9.5 million! That’s a lot of earnings in one quarter for a company with a $50 million market capitalization.
Management had previously disclosed, on May 4, 2017, through an 8-K filing (Asta 8K Filing May 4, 2017) that it would be taking a loss of $5-6 million on the sale of the annuities. On the fiscal 2nd quarter conference call on May 26, 2017, when asked if the transaction was included in the current financial results, Gary Stern, CEO, responded “Well the asset itself has been written down so the loss is realized in this particular quarter.” This was a confusing answer. I interpreted his answer to mean the asset was written down and the loss was realized in Asta’s fiscal 2nd quarter with the actual sale taking place in the 3rd quarter. Regardless of the timing of the write down, this event is behind them.
Earnings Ramping Up
As described in detail in my previous article on Seeking Alpha dated August 2, 2017 (Asta Funding: An Overlooked Deep Value Stock), Asta’s conservative cost recovery method of accounting for its Consumer Receivables portfolio has obscured the true earnings power of this division. The Consumer Receivable’s book value and earnings have been understated in prior accounting periods. Asta does not count any cash flows from a consumer receivables pool as interest income until the cost is completely recouped and the book value of the receivable pool is $0 on the books. Each quarter more and more receivable pools are hitting $0 basis and all future cash flows from those pools will be counted as 100% interest income. This means the earnings will keep rolling in even after the book value is down to $0. The total book value of Asta’s Consumer Receivables portfolio, as of June 30, 2017, is down to only $9.1 million. Meanwhile the company shows the fair value to be $41.4 million, as shown on page 27 of the fiscal 3rd quarter 10Q (see table below). This means the book value for these assets understates the fair value by $32.3 million, or $4.87 per share.
Management finally seems to have reigned in the spending at GAR Disability Advocates. This division has shown losses since its inception several years ago. It had previously bled cash as it ramped up revenues. This quarter the division actually broke even. Per the company’s fiscal 3rd quarter conference call on August 9, 2017, CEO, Gary Stern stated that “…management has worked diligently to reduce the costs associated with this segment and decreased its operating expenses by approximately $1 million in the third quarter compared to the prior period.” This came from reduced headcount as well as reduced internet marketing. I’m glad to see management embrace profitable growth for this division rather than the previous approach of unprofitable fast revenue growth. The model for the Disability Advocates division is to act essentially as consultants. Hardly any capital investment is required with this model. If management can continue to right the ship here, this division’s return on invested capital could be very high.
Management continues to deploy capital into the Litigation Funding and the Structured Settlements divisions. Litigation Funding earned $3.6 million in pretax profits this quarter. Asta is in the process of extricating itself from the previous Litigation Funding outsourced management that ran Pegasus Funding, which is now being liquidated. $24.7 million of cash on Asta’s balance sheet is classified as restricted from this venture until the legal wrangling between the old Pegasus management and Asta is resolved. (This is probably a partial explanation of why Asta felt compelled to sell a portion of their structured settlement portfolio at a loss this quarter to raise cash.) All new investments in the Litigation Funding division is being run through Simia Capital. Although the timing of cash flows from this division is difficult to predict, recent results are encouraging. Even with the management changes and turmoil in this division, returns on capital remain high.
Earnings from the Litigation Funding division were partially subdued in previous quarters by allowances taken against investments made in this segment. The Litigation Funding division has fairly substantial reserves against the personal injury cases funded by Pegasus, according to management in the 2017 fiscal 2nd quarter earnings conference call.
The Structured Settlements division is now the largest division based on total assets. It ended the quarter with $89 million in assets. Even with the $5.3 million loss from the sale of the life contingent annuities, the division earned $4.1 million pretax this quarter. This division uses fair market value accounting. This is why unrealized gains and losses are reported each quarter on the fair market value of the Structured Settlement portfolio as interest rates move around. Management has offset much of Asta’s interest rate risk by raising funds via notes securitized by pools of these structured settlements. As these structured settlement payments are received by Asta, a portion of the cash flow is used to pay down the notes. The difference is kept by Asta.
As of June 30, 2017, Asta owned structured settlements with a fair value of $89 million and $72 million in associated non-recourse notes. So Asta’s net exposure was only $17 million. Asta also had $4.3 million drawn against its revolving line of credit to fund the structured settlement purchases before they become securitized.
The structured settlement market is a regulated market. Each transaction must be reviewed and approved by court order before a sale/purchase is made. The majority of these structured settlement annuities are due Asta from insurance companies. This division offers a nice complement to the inconsistent cash collections of the Litigation Funding and Consumer Receivables divisions. The continued growth of the structured settlement portfolio should provide Asta with more consistent earnings going forward.
Asta’s current fiscal 3rd quarter earnings were obscured by the $5.3 million loss taken on the sale of the life contingent annuities. Earnings were strong otherwise. Asta’s earnings should remain positive and with better consistency going forward. The growth in Structured Settlements should help profits increase in a more consistent fashion. Losses from the Disability Advocates division stopped this quarter and hopefully will turn to profits in the future. Previous cash flows from the Consumer Receivables division weren’t being reflected as income because of Asta’s use of the cost recovery method of accounting. Going forward, a greater percentage of this cash flow will be booked as income as more and more of their receivable pools hit $0 basis.
The source of much of Asta’s earnings disappointments in previous years came from write downs in the Consumer Receivables and Litigation Funding businesses. These write downs should not repeat themselves. The Consumer Receivables portfolio keeps cash flowing even as the book value is down to almost nothing at $9.1 million. Additionally, the Litigation Funding division has substantial reserves against its portfolio. Removing these write downs and allowances should allow the true earnings power of Asta to shine.
Asta currently trades at a market capitalization of about $50 million. Its shareholders’ equity was $121.9 million as of, June 30, 2017, which dramatically understates the true fair value of the assets. As stated previously, pretax earnings would have been $9.5 million this quarter if the $5.3 million loss from the asset sale were added back.
Soon investors will recognize that Asta trades at less than half of understated book value and at a single digit P/E ratio.
Disclosure: I am/we are long ASFI.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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