Arthur Koestler's great book, Darkness at Noon, inspired me, as a snide undergraduate, to give the same name to an impenetrable course on Pre-Socratic philosophy that met three days a week at 12 p.m.
RAIT Financial Trust (NYSE:RAS) released its fourth quarter financials this morning; the conference call featured analysts congratulating the company with kudos like "nice job in the 4th quarter" and "congrats on a great quarter" -- but the market saw it differently and the stock tanked by 53 cents (or 8.67%) all the way down to $5.58. This leads to investor confusion and, thus, my title.
What are we to make of this? Are the analysts right in viewing RAS as having had a "great quarter" or is the market right in trashing the stock? Under the Efficient Market Theory, the answer to the question is clear: RAS is worth much less now that the fourth quarter financials are out. But the Efficient Market Theory has led many lambs to the slaughter over the past several years, and so I am not sure if that is the end of the debate.
I have written in the past that commercial mortgage REITs tend to have enormously complex and confusing balance sheets. RAS reported solid AFFO numbers, well up from a year ago. But GAAP earnings were a disappointing $15.6 million loss. Sorting through all of this is a tedious task of peeling various artichokes and onions and tracing the seemingly untraceable.
Like many commercial mortgage REITs, RAS has a variety of assets and a lot of debt. Most of the debt is non-recourse (which generally means that the lender is not entitled to any claim in excess of the value of the assets securing the loan). Thus, in effect, the company is organized into a series of silos - some of which are special purpose entities consisting of debt instruments as assets and various claims on the assets with various levels of seniority. While I categorize RAS as a mortgage REIT, it also owns buildings encumbered by mortgages. To the extent that a mortgage is non-recourse, the building and mortgage are a little silo.
I use the term "silo" because each cluster of assets and debt is insulated from the others. If one silo develops negative value because the debt exceeds the value of the assets, it still cannot be worth less than zero to the company because the debt is non-recourse. Unfortunately, GAAP rules require that, under certain circumstances, all of the silos be consolidated into one hopelessly confusing set of financial numbers.
Some companies have attempted to dispel the fog by reporting results for each of the major silos separately and explaining which debt is recourse and which debt is non-recourse. This would be a big step forward. Another important step would be to report asset value on a consistent basis - if debt instruments are marked to market then consideration should be given to reporting the value of buildings the same way. Finally reports of borrowings should always include the actual face amount owed for each borrowing regardless of its fair market value.
You are probably getting impatient and think that I am dodging the issue on RAS, so here goes. The charges that led to the loss involved unrealized losses in certain silos that have minimal effect on the overall value of the company. RAS is doing much better in terms of operating results from its real estate holdings and there are encouraging developments in it loan portfolios.
RAS has a book value of nearly 4 times its market cap and, while the unrealized losses result in a lower book value, the company is still very, very cheap on a price to book basis. I think operations are improving and the company has a bright future as confirmed by the last quarter's results. In other words, once again, the Efficient Market Theory bites the dust.
I bought some RAS this afternoon after it got clobbered and I think it will turn out to be a good investment -- especially at this price. But I also think that more transparent reporting of financials could obviate the confusing reaction the market had to RAS's essentially good numbers.
Disclosure: I am long RAS.