Description

MuniMae is a little nugget of value still hidden in the smoldering wreckage of the post-crisis financial sector.  To see the value, one needs to make a lot of adjustments to a complex balance sheet to make up for the shortcomings of GAAP accounting and also for subsequent events.  While the range of potential fair values is wide, I think the shares are worth at least $2 and probably much more.  Significant recent buying by the CEO seems to back up my thesis.  So does the repurchase program, which has recently reduced the share count by almost 8% - much of that in the last couple months.

While this company’s history is long, you really only need a brief summary:

Traditionally, MuniMae originated and managed debt and equity investments backed by affordable housing that offered tax incentives.  But the market for tax-exempt debt securities declined sharply in 2007, forcing the company sell assets at distressed prices to meet all sorts of collateral calls.  At one point their auditor flagged them as a going-concern risk.  Adding insult to injury, the company was also forced to spend over $51 million on an accounting restatement.

But they kept the ship from sinking, and a recent sale of a large bond portfolio has significantly de-risked the balance sheet.  That portfolio - the "MuniMae TE Bond Subsidiary LLC" (TEB) – was sold to an affiliate of Bank of America Merrill Lynch, allowing MuniMae to shed much of their short-term floating rate debt.   The remaining bond portfolio is now only 55% leveraged and much of it is non-performing, so they’ve basically swapped interest rate risk for underlying asset performance risk.  That’s a good thing, as MuniMae has its own team devoted to workouts in distressed real estate.   The sale also allowed them to convert from a partnership to a corporation.  As a partnership, the company was forced to pay a lot of phantom gains out to shareholders due to the company repurchasing their own debt at a discount.  Going forward, they'll be able to utilize their $405.9 million of NOLs and - for all intents and purposes - never pay income tax again.  Further, the switch to C-corp status helps to clear the way for MuniMae to get off the pink sheets and relist on a major exchange, something management is “looking hard at” doing.

Unfortunately, the TEB also dramatically reduced their net interest income spread, which necessitated some layoffs.  But their staffing needs are now lower as well, so it all works out.  The company is operating close to breakeven now and should close that gap as the year goes on.

Getting to fair value:

MuniMae historically sponsored Low Income Housing Tax Credit Funds ("LIHTC Funds") where they sourced capital for the development of tax advantaged affordable housing.  The developer of the affordable housing project would start out as the General Partner, however during the credit crisis many of these projects and developers ran into financial trouble, causing MuniMae to step in become the GP in order to protect their investors’ interests in the project (and also because MuniMae guaranteed certain investor's investments).  So even though MuniMae has a limited (0.01-0.03%) equity investment in these LIHTC Funds, as the GP, they're deemed for GAAP accounting reasons to be in control and must consolidate these funds on their balance sheet.  Similarly, GAAP accounting consolidates a affordable housing fund in South Africa that they manage (more on this below), and as a result the financials are a tangled mess. 

Thankfully, MuniMae recently began issuing 8Ks with an adjusted balance sheet to make it easier to see just what exactly they own.   The latest one (March 24^th) shows a book value per share of $1.61 as of year-end (Dec 31^st). 

From there we make some relatively straightforward adjustments for: 

• Real estate sold in 1q14 ($24.09 million adjusted real estate held-for-sale goes away, the proceeds add $35.80 million to cash)
• Share buybacks after 12/31/13 (0.68 million shares purchased in 1Q14 at an average cost of $1.28, plus 0.75 million shares purchased in a block trade on 4/2/14 at $1.53 – see April 3^rd 8K)
• $2.5 million for unrealized appreciation on real estate related to available-for-sale bonds (due to the quirks of variable-interest accounting, MuniMae is forced to apply real estate accounting rules to these bonds).
• $6.0 million for tax credits which don’t begin to expire until 2027 (unlike NOLs, these offset taxes dollar-for-dollar)

…which gets us to $2.13 per share - a comfy ~35% above the current share price.

But wait, there’s more!  We then need to adjust for a bunch of stuff that’s tougher to value, but likely has significant val$405.9 million of NOLs which don’t begin to expire until 2027

• $405.9 million of NOLs that don't begin to expire until 2027
• Unrealized appreciation of real estate owned (REO):  MuniMae now owns a few parcels of undeveloped land and a multi-family property that used to collateralize certain bonds which have since defaulted.  On a 7/8/13 call, management said these properties were originally valued at 5-10x their current $30.8 million book value at the time the original bonds were issued.  This REO was marked down during the financial crisis, and while real estate has generally bounced back since, GAAP doesn’t allow them to mark it back up.  To be clear, management has not provided any guidance as to fair value.  I’m just saying that raw land, etc. in places like Phoenix is probably worth more now than it was back in the dark days of the financial crisis.  These properties include:

1.    The Belmont – multifamily housing in the Greater New Orleans area.  Currently undergoing renovation. 
2.    Red River – entitled land with road and sewer in Phoenix, AZ.  Could build residential, office, retail or all 3.
3.    Russell 150 – raw land zoned for residential in Winchester, VA (about an hour outside Washington D.C.)
4.    Lancaster, CA – raw land on the outskirts of Los Angeles, CA.  Highest and best use may not be for housing, but rather for solar energy.  (Note: 1-4 are collectively booked within “adjusted real estate held for use”.)
5.    Savannah, GA – non-controlling 1/3 stake in a JV that originally intended to build housing, but as with Lancaster, CA, they’re now looking at alternative uses.  Booked at $6.3 million in “adjusted other assets.”

• Potential general partner incentive income:  MuniMae has an 83% stake in International Housing Solutions (IHS), a South African asset manager that runs private equity funds that invest in affordable housing.  South Africa happens to be a great market for affordable housing.  It has a 2.2 million unit shortfall of supply, while new construction is only 200,000 to 400,000 units per year.  Recently introduced housing subsidies have unleashed pent-up demand, but due to long project lead times and legacy issues, supply is extremely constrained.

          IHS launched a multi-investor fund around 2010 that began with $150 million in equity capital.  It just closed on a new fund with a single investor (a large North American pension fund) with $30 million in equity           capital, and currently has $50 million in firm commitments for a third fund which hopefully will be as large as the first.  The funds target IRRs in the mid-teens, have a 2% management fees while funds are being           invested, and incentive fees of 20% of profits above some (undisclosed) hurdle rate.  The first fund should be wound up in about 4-5 years.

          Likewise, MuniMae could potentially earn GP incentive income on the LIHTC funds, but not until roughly 2018/2019.  While management does not provide guidance on these performance-based fees, they have           noted that it might be possible to put some sort of estimate on the books in a couple years’ time.

• Potential for $16.7 million of deferred revenue liabilities to go away without any associated costs:  MuniMae has booked $16.7 million relating to performance guarantees on the LIHTC funds.  Given adequate performance, this entry will gradually drop to zero over time as the funds are wound up.

So what’s it all worth? 

The $16.7 million of deferred revenue equates to $0.43 per share.  I could see the NOLs being worth close to $1 per share, assuming they could invest the cash at something like a 15 P/E, and that their tax rate is ~40%.  At 5-10X their current book value, the REO would be worth an incremental $3-7 per share (!!!)  Even 2X would add about $0.80.  I‘ve encouraged management to disclose more about these properties because this could be one of the largest chunks of hidden value.  Similarly, the incentive fees could also be quite important … but I’ll leave the estimates to you.   All in all, MuniMae is likely to be somewhere between a base-hit and a home-run.  Like I said, it’s a wide range.

Risks:

They could do something stupid with all that cash.  Management is looking at a number of options, including acquisitions.

Potential $3.3 million increase in interest expense.  The company has about $112 million of Subordinate Debentures with pay-rate concessions that expire in March/April 2015.  Last year, MuniMae repurchased $45.5 million par value of these bonds at 38 cents-on-the-dollar.  Additional repurchases could be more expensive now that their balance sheet is in better shape.  Management says that dealing with these bonds is a “high-priority” for 2014.

Links:

www.munimae.com

http://www.ihsinvestments.co.za/

Some info on Russell 150:  https://www.dropbox.com/s/a4tt4qypnprz2y9/Russell%20150%20CDA%20FY2008%20Annual%20Continuing%20Disclosure%20Report.pdf

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