A 9% Dividend Yield For Enterprising Investors

Jan. 2.14 | About: Resource Capital (RSO)

Resource Capital (NYSE:RSO) is a real estate investment company that is based in New York. The common stock pays an 80 cent annualized dividend on a sub-$6 stock, good for a current yield of 13.5%, however, given RSO's earnings, I'd say that likely isn't the safest dividend around. And besides, as income investors we all know that something is amiss when a stock is yielding 13.5%. Regardless, there is a better option for income seekers when it comes to RSO and that is the Series A Cumulative Redeemable Preferred Stock (RSO-A, may differ depending on your broker). In this article, we'll take a look at RSO-A to see if it is a good fit for your high-yield portfolio.

To begin, we'll define exactly what RSO-A actually is. RSO-A is a traditional preferred stock, meaning it has no stated maturity date and also has no debt issue backing it. In other words, barring bankruptcy, a sale of the company or early redemption, this issue will persist in perpetuity. And speaking of ways this issue could be redeemed, beginning in June of 2017 RSO can call this issue at the full issue price of $25 at its option. In addition, upon a change in control of the issuing company, RSO-A may either be exchanged for common stock or called outright for $25 per share.

RSO-A was issued at $25, as I said, and the $2.125 annualized dividend, paid in quarterly installments, works out to a coupon yield of a whopping 8.5%. However, as RSO-A is currently trading at a modest discount to its issue price at $23.53, the current yield is actually decently higher at 9%. In addition to the ridiculous current yield, RSO-A's discount also offers some buffer against capital losses. Should the issue be called, holders at this price would be entitled to a decently sized capital gain of nearly $1.50 per share. Thus, holders of RSO-A needn't fear early redemption and in fact, may welcome it as a way to be made whole and then some.

RSO-A, very importantly, is cumulative as well. This means that even if RSO misses dividend payments it is obligated to make them up. Essentially, barring bankruptcy, your dividends are guaranteed with RSO-A, unlike many preferreds. This is a tremendous positive on a higher risk issue like RSO-A. And make no mistake; RSO-A is a higher risk issue than many preferreds but given the cumulative nature of the dividends and the extraordinary current yield, I believe you're being compensated for those risks. You must do your own due diligence before taking any position but especially with a small, specialty finance issuer like RSO.

RSO-A is subject to the same interest rate risk as any other preferred issue and that is something you must be comfortable with before investing in any preferred security. However, RSO-A is riskier than other issues and I want to make it clear this is not the safest preferred on the market. The current yield suggests RSO-A is riskier than other issues and it's true; RSO is in a risky business and it is a very small and relatively new company. The discussion of RSO's business model is outside the scope of what I want to cover in this article but you must ensure you feel comfortable with RSO's finances before initiating a position in RSO-A.

Finally, even though RSO-A is a preferred stock issue, since it was issued by a REIT it is ineligible for the favorable dividend tax treatment. This is a large negative for holders in a taxable account as the after-tax yield will be significantly lower than a traditional preferred that is eligible for the preferential tax treatment. If you are holding RSO-A in a retirement account it won't matter but if you are thinking of holding RSO-A in a taxable account, it is something you need to keep in mind in the context of your personal tax situation.

RSO-A is a riskier security than most preferreds. While I don't believe RSO is in any imminent danger of failing or anything of the sort, it is a small company in a risky line of business and as such, any securities it issues are going to be stepping out on the risk curve for investors. If you decide to get into RSO-A please make the position a smaller part of your income portfolio and make sure you understand the risks of owning it. If you can do that, RSO-A can provide a huge current yield that sports cumulative payments and a nice discount to the issue price.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.