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The economic environment is destroying real value in MAR’s timeshare business that is not being captured in adjusted earnings

Before 2008, there was no need for MAR to over-collateralize their timeshare note sales.  MAR was forced to over-collateralize its last two deals (one in 2008 and in March of this year) by 18% and 28%, respectively.  So what exactly did they write off this quarter since they retained no interests in the older deal?

When MAR books a gain on a note sale, the gain is equal to the NPV of the interest the company collects (~13%) and the interest on the notes (~7.5%).  If there is a “trigger event” caused by elevated defaults, MAR doesn’t get that “excess” cash flow and has to write down the value of the residual on their balance sheet as a result of having to use a higher discount rate.  Once a trigger event occurs, this accelerates payment to the senior pieces of the debt structure and MAR no longer gets paid any interest on its “residual”.

In Q1 the company didn’t actually hit the triggers, but were very close so they increased the discount rate used in the NPV to value the excess stream up to 25%.  In Q2 they hit the triggers, wrote down the residual and took the cash flow hit.  Once the hit was taken, MAR was able to decrease the discount rate to 18% because the risk was already reflected across the portfolio. MAR also made the assumption that the triggers cure in 6 months, since the few months during which they experienced heighted delinquencies will roll out (test is on a 3 month rolling basis) if delinquencies stay at currently observed rates of around 10%.

Of course, now that MAR retains the actual over-collateralized pieces, they just take a direct hit when defaults occur, but also reap the benefit of defaults that are lower than projected.  Risk levels are enhanced.  Year to date, MAR has taken $25 million in residual write-offs and $43 million in charges related to loan loss reserves.  This is real value being lost here that cannot simply be discarded as irrelevant, one-time charges.