The fallout in sub-prime residential lending and the accompanying housing crunch has given rise to a concern that commercial lending may face a similar fate. We have seen tightening credit standards throughout the lending industry. Investor appetite for Commercial mortgage back securities [CMBS] and collatoralized debt obligations [CDO] has subsided recently due to fear of a spreading real estate meltdown and widening credit spreads. This has created some volatility in the market for these securities and the stocks of companies originating, managing, and trading them. Take JER Investors Trust (JRT) for example, which rose nearly 50% in the second half of 2006, but has struggled throughout 2007. Their most recently quarterly report sent the shares tumbling 5%. The company cited widening credit spreads and competition as the reasons they did not meet analysts' high expectations.
Another company in the commercial lending business organized as a REIT is Northstar Realty Finance (NRF), and they just reported Adjusted Funds From Operations [AFFO] of $.39 per share for the first quarter 2007. This beats analysts estimates of $.34 per share. They previously reported another increase in their dividend to $.36 per share from $.35. This company has achieved tremendous growth since its IPO two and a half years ago. This report gave the stock a much needed 2.5% boost. The stock has struggled since the February correction, but the revenue continues to grow by triple digits.
Why the difference from JRT? Northstar's management believes their business model allows them to take advantage of widening credit spreads and market volatility. They actively manage their diverse portfolios including their nine CDOs, which allows them to make adjustments as the market changes and manage risk better. Their flexibility and responsiveness, not only to the market but also to customers, gives them an edge over the competition. They are the first among their peers to adjust the prices of their debt obligations in response to interest rate increases.
The strength of Northstar's reputation and the certainty they provide their customers has allowed them to raise prices without losing business. This strength is evidenced by the credit rating increases they have achieved as well as an impressive zero losses due to bad debt. Let me repeat that: zero losses due to bad debt.
It seems to me that NRF's competitive advantage comes from their management team. Every member of their executive board has twenty years or more of experience in the market and many of them have individually managed balance sheets significantly larger than Northstar's. It is difficult to quantify great management, but I believe this company deserves a premium to its peers on account of the leadership.
The stock has lagged recently along with the rest of its industry; however, with a 165% increase in revenue year over year and a 9.5% dividend yield, I don't expect it will hang around its 200 dma much longer.
Disclosure: Author has a long position in NRF
NRF 1-yr chart