On December 21st, 2015, Seeking Alpha published my article, "My Best Long Idea of 2016: RAIT Financial Trust Retail Note 7.125% Due August 2019" in which I recommended the purchase of these retail notes ("RAIT 2019 Notes") as my best investing idea of 2016 (found here). This is a debt instrument issued by RAIT Financial Trust (NYSE:RAS) which is typically referred to as a "baby bond" due to the $25/share face value (in lieu of a typical $1,000 face value) and is an Exchange-Traded Debt Instrument, traded on the Nasdaq Global Select market, with a stock ticker of RAS.
In that article, I argued that this security could provide significant gains relative to its relatively low risk. In brief, I argued that the investment was safe (with assets backing the full face value of the security), that cash flow was such that the issuer (RAIT Investment Trust) would continue to pay interest on these notes and that the return on this investment would be large relative to the low risk that purchasers were taking when buying this security in late December 2015. I indicated that it appeared to me the purchaser could secure a reliable 15% return on Retail Notes, typically a very low risk security, through redemption in August 2019.
Obviously, this type of investing is for a certain type of investor; that is, this investment would be of interest to those investors seeking higher income, while absorbing disproportionately lower risk, as well as those patient value investors who are comfortable buying securities for which their value has become depressed due to negative headlines. In the case of RAIT, the company had cut the dividend on the common, creating concern for investors in RAIT securities of all types that there were deeper problems. The common shares, the preferred shares, and the Retail Notes had their values reduced significantly after this announcement.
I used the balance sheet, current at that time, to argue the relative safety of the Retail Notes, included here:
Please find the comparable sheet reconstructed with the financial data as of March 31st, 2016 here:
Assets net of liabilities has decreased a bit over the past two quarters, by a bit less than 4%, but most of the decline is in intangible assets, so net tangible assets net of liabilities has remained nearly the same (down only 1.4%). However, there remain sufficient assets to backstop each $1 of RFTA face value (and RFT, which I own) with a substantial margin of safety.
Cash flow continues to ensure that interest payments can be made in a timely way. Interest paid for the RFTA and RFT Retail Notes are provided here:
About $9,562K of a total interest expense of $113,588K incurred in 2015, representing less than 10% of the interest expense for an income statement with positive Net Income. Operating cash flow is a positive $87,871K after having paid all of the net interest expense (included in the net income line), so the ability to pay net interest expense does not seem to be an issue at RAS.
In addition, there are significant cash flows employed to pay the preferred and common dividends of $106,817K (taken from cash flow statement for year-end 2015). If cash flow became constrained, an additional source of funds would be the cessation of dividend payments, first to the common and then to the preferreds. Indeed, dividends were reduced to the common which triggered the reduction in prices for all of the securities. At the time of the first article, in spite the reaction of the market, I commented that the reduction in dividend was a credit-positive event, not a credit-negative one, especially as the preferred share dividends had remained current. In fact, stopping payment of all dividends would provide enough cash to pay nearly all of the interest. I am NOT suggesting that this is needed or that it will happen, only that there are sources of cash to pay the interest if current revenues would be constrained. This provides a higher degree of safety for ongoing payment of interest, in which owners of RFTA are interested; obviously, preferred and common shareholders would be less enthusiastic about this development.
Since the publication of the reference article, RFTA has increased in market value, which is now approaching the face value. As such, those investors who had originally purchased it with a potential gain in mind are now approaching a maximum value (i.e., the face value) that can be expected from a security like this. However, it appears that this security will continue to pay interest going forward to redemption. Given the change in valuation, investors in this security should review why they bought it, which impacts whether they should continue to own it, to wit:
Conclusion For Total Return Investors: If you took my recommendation to purchase RFTA, you secured a gain of 21% in less than six months plus an additional return of 4.4% through interest payments. As the market value of RFTA has approached its face value, little upside remains. If your primary incentive was to secure a relatively safe investment offering a 25% upside, you should be selling this security now, given the limited, additional upside.
Conclusion for Cash Return Investors: A good 7.125% cash return on face value is an attractive income investment in a ZIRP or NIRP world. One can continue to receive 8.95% on the capital invested at the time the recommendation was made ($19.90/share on Dec. 21st, 2015) through to redemption in 2019. If you are more focused on cash returns and income, continue to hold through redemption to collect a relatively high cash return on a relatively lower risk investment. Even if it does backtrack in value, the market value of this security will converge on face value as we approach the redemption date of 08/30/2019. You should be holding this security as it will provide above average, below risk income to redemption.
I did not purchase RFTA, but I had purchased RFT at an average discounted price of $18.89/share (yielding 10% on invested capital), a longer term note due 2024 paying 7.625% on face value. I plan to hold RFT to redemption to secure the higher yield and small remaining gain, having increased in market value to $21.99/share (06/10/2016). RFT continues to represent a good investment, if not great, providing an 8.7% yield at current market prices.
Disclosure: The author does not own RFTA, but owns a sister security, RFT, and this position represents a significant percentage of the author's assets.
Disclaimer: No guarantees or representations are made. The Owl is not a registered investment advisor and does not provide specific investment advice. The information is for informational purposes only. You should always consult an investment advisor.
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.