Five Oaks Investment's Preferred Offering Viewed Through The Eyes Of A Preferred Investor

| About: Five Oaks (OAKS)


Accept reality even if it hurts, then adapt, change, and hopefully prosper.

Preferred shares cannot be viewed through the same prism as their common brothers.

I utilize a combination of web sites to help me make my investment decisions.

I like to compare the performance of the stock I want to invest in with the S&P and others in its sector.

In conclusion, an investment in OAKS-A at this time is problematic.

I became a preferred investor when I discovered I was not as smart as I thought I was. I had a rude awakening at the beginning of 2009 when I still believed I was smart enough to dig down into the numbers and really understand a company's financial statement, at least well enough to figure out how well they were actually doing. Sadly, I couldn't. Around that time, after spending hours listening to a number of conference calls, it dawned on me that they were often spun to make bad seem good and down, up. Around that time, I discovered SA and began reading its articles to help me make sense of everything. However, no matter how intelligently each article was written and constructed, I found, more often than not, the comments of other SA participants often contradicted and vehemently argued against the contributor's point of view. Which side to believe? I didn't have a clue; I knew I simply didn't have enough information to decide. And that's when I realized that I would either exit the market or discover a way that an investor with limited knowledge could succeed. I became a preferred investor when I realized that all I had to do was determine whether or not a company, I would invest in, was relatively safe from an imminent existential threat. Notice, I qualified it as imminent. I did this because I don't have a crystal ball, nor does anybody else, and nobody can predict the future, spit happens. Any company could suffer an existential threat, especially the ones I intended to invest in, which offered a higher dividend yield and were certainly more risky than most.

Past is prologue. That would be the basis of my research. Maybe not perfect, but what I believe, is this was data I could rely on. I can't tell the future, or even rely on financial reports, but I can, with a great deal of reliability, monitor how well a company performed over the past few, or as many, years I am prepared to research. Company officers lie, or spin, during conference calls. Financial reports, likewise, can be spun utilizing legal accounting tricks. But investors wage their hard earned capital on what they truly believe is in their perceived economic interest, which might be correct or not. Regardless, the record of price movement of a company's stock cannot be spun or tweaked, it's a matter of record. This, I have come to rely on.

Additionally, I like to do a brief review of each company's balance sheet as displayed on Yahoo Finance; where I can get a snapshot of their assets, liabilities, and debt structure. Finviz's financial highlights also helps me fill out the picture of the company sufficient for me to decide to invest or not.

Considering an investment in a company's preferred shares should not necessarily be considered exactly as one would while considering an investment in that company's common shares. There are a number of reasons for this disparity of thought:

  • Preferred shareholders are primarily interested in a stable source of income rather than price appreciation, which is most often the primary goal of the common shareholder.
  • Consequently, the common shareholder is, and must be, more attuned to near-term corporate events. Although similarly relevant to the preferred shareholder, unless they are harbingers of potential existential threats, they should be of no major concern. Likewise, the knowledgeable preferred shareholder, should view periodic price fluctuation with little concern or interest beyond the possibility of making opportunistic acquisitions of additional shares.
  • Most importantly, the only way a cumulative preferred shareholder can ultimately lose on his investment is if the issuing company goes bankrupt or if the holder is forced, or decides, to sell his shares at a loss. Although it might take years, should the company survive, all missed payments will have to be repaid at some future date, and the price will most assuredly, not only return to its call value, but will surpass it by approximately the total amounts of missed dividend payments due.

Therefore, when considering the acquisition of Five Oaks Investments' (NYSE:OAKS) preferred OAKS-A shares, it's necessary that we view that company through a different set of eyes than we would were we interested in acquiring its common shares.

Consequently, unlike its common cousins, it's necessary that we first study the offering prospectus of the preferred shares we are interested in acquiring. To accomplish this, let's visit my favorite preferred search site, Quantum Online, which I set to open to Five Oaks. Below is a snapshot of a slice of that page:

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A quick review informs us that Five Oaks Investment is a REIT that invests in, finances and manages a leveraged portfolio of agency and non-agency residential mortgage-backed securities, loans and other mortgage related securities. I'm immediately interested in the amount of leverage they utilize, and I'm not particularly fond of the fact they are externally managed, which, in my opinion, opens a company up to the possibility of financial shenanigans, which, more often than not, works to the detriment of the investors. However, as a preferred investor, I consider this of little concern.

What I don't like is that this is a micro cap stock, having a very small market value of $69.1 million. In my experience, small cap companies are more prone to bankruptcy than are large cap companies in the event company-specific, sector-specific, or general market forces might turn against them.

Let's click on the Find Related Securities to examine any preferreds this company has to offer:

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Here we learn that OAKS offers only one preferred (OAKS-A), which they offered at an interest rate of 8.75%. That's a moderately expensive borrowing rate, which concerns me. My first impulse is that this expensive cost of capital might be directly related to the small size of the company. Now let's click on OAKS-A itself. Because this page contains more information than can be covered in a snapshot view, I suggest you open the page and view it as I discuss the contents that interest me:

  • I like that this preferred is cumulative, meaning that in event that payments are suspended, they accumulate and are owed the shareholder, and will be repaid in full if and when the payments are restored. And they must be completely repaid before the common shareholder will be allowed to receive any further dividend payments. Additionally, there are probably more sanctions and restrictions placed on the company, and will remain so until the missed payments are repaid in full. As a rule, I only invest in cumulative preferreds. Although bank preferred's dividends are usually secure, they are almost always non-cumulative, consequently, I, don't buy them.
  • These shares are callable at the company's option on 12/23/18 at $25.00 plus any accrued interest owed. There is also no maturity date, which means they virtually never have to call it.
  • They pay a fixed/adjustable dividend of $2.1875 per share per year, or 0.1822917 per month, which I like even more than quarterly payments. However, on or after 12/27/18 dividends will be paid at an annual rate equal to the three month LIBOR + 7.151%, which is a good thing because this will only occur if the rate proves to be higher than the existing rate.
  • In the event the preferred dividends are not paid in full during any six dividend payment dates, the interest rate will rise an additional two percentage points, which would be good were the company to survive and not go bankrupt.
  • Change of control of the company by a person or entity, would require the acquirer to redeem the preferreds at the $25.00 call value. Conversion rights are discussed, however, I am unconcerned because I would not ever consider conversion to common shares.
  • Dividends are not eligible for the preferential income tax rate of 15% or 20% depending upon the holder's tax bracket, which I don't like. However, the company might consider such payments as return of capital, ROC, requiring no tax payment each yearthey are collected, with the understanding that it will reduce the cost of acquisition of those shares by the amount of dividends paid and not taxed, which will ultimately affect the capital gain or loss when the stock is sold or called.
  • As usual, preferreds, upon liquidation, rank senior to commons and junior to debt, both secured and unsecured.

However, simply knowing and understanding the preferred issues of a company in no way allows one to gauge a company's long-term health or fully comprehend its business model. To better accomplish this, a knowledgeable investor should be able to dig down into the numbers and, at least marginally, understand a company's financial statements and conference calls. Sounds reasonable, but extremely difficult for most investors, including myself. I often rely on interpretations by SA contributors who have proven more knowledgeable than myself. Unfortunately, the vast majority of their articles are written with the common shareholder's interest in mind rather than those of the preferred shareholder, which, on occasion, might not be in alignment.

Consequently, rather than attempting to digest and understand complicated financial statements, which I realize I won't be able to realistically accomplish with any degree of accuracy, I usually visit two web sights to get an abbreviated, yet broad-based view of the particular company I'm considering investing in. They are Yahoo Finance and Finviz. I have cued each to open to the financials of OAKS.

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Above is a screenshot of OAKS' 5 year chart, which, as far as I'm concerned is not a pretty picture. Although choppy, the price of their shares during this time has trended down to its present price of $6.06. Furthermore, by clicking on its balance sheet (found in the left column of the Yahoo finance report) I discovered a troubling decline of asset value, while its liabilities were increasing, leading to a further decline of its net asset value. Also, during this past year, OAKS reduced its common share dividends from a monthly 0.10 to 0.06.

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Above is a screenshot taken from a Finviz view of OAKS' financial highlights. This company has a market cap of $88.10 million dollars and showed an income of minus $3.10 million, and although it has recently trended higher, along with the basic market, its stock price over the past year has fallen by approximately 34.76%.

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The final nail in the coffin of investing in OAKS, as far as I'm concerned, was made with the help of the Yahoo chart above, which negatively compared OAKS with the S&P and its peer group of residential REIT's: American Capital Agency (NASDAQ:AGNC), Apollo Residential Mortgage (NYSE:AMTG), Armour Residential REIT (NYSE:ARR), Capstead Mortgage (NYSE:CMO), and Apartment Investment and Management Co. (NYSE:AIV).

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The final chart illustrates the 3 year price movement of the preferred issue OAKS-A we are interested in acquiring. Again, because of its moderately high dividend yield, its price hovered around $25.00 until 2015 when it began its precipitous fall, which over the past two months has recovered somewhat along with the general market. I wonder if the attractive yield is worth the risk of investing in this micro cap company, although the recent upward trend is somewhat encouraging, it's most probably a matter of all hips being lifted by the rising tide.

My bottom line decision to invest or not is often determined by my review of the charts of the common and preferred share performance over the past few years. I also want to determine whether or not the company is, over that period of time, prospering or losing market value. Ultimately, I have to decide how safe this company is from an existential standpoint rather than how well its share price will perform over the next quarter or the following year. My bottom line is whether or not I believe in the long-term survivability of OAKS, which might be problematic. The jury is out; this is your decision to make. It's your money. Invest it carefully and wisely. Do as I say, not as I do.

Disclosure: I/we 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.