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Joe X  

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  • Apple Credit Spreads Say Bank Of America Is Not Too Big To Fail [View article]
    Thanks for the interesting comparison between Apple and BofA. However, I would think the total cost being imposed on the larger banks is much more than their credit spreads, as they pay a disproportionate amount of premiums to the FDIC. They also pay a disproportionate amount of regulatory and compliance costs. Certainly GE's decision to liquidate its finance portfolio is evidence that these costs have now become too burdensome to justify, even for medium-sized players like GE.


    Joe X
    Jun 11, 2015. 12:03 PM | Likes Like |Link to Comment
  • Apollo Commercial - More Of The Same Is OK [View article]
    UStar - ARI raised $193 million of common equity in 1Q, and even though it came closer to the end of the quarter the de-leveraging effect probably cost them something along the way. I would expect leverage to start creeping up again in 2Q/3Q, which should help generate some incremental earnings. It's not unreasonable to assume that by the end of the year ARI has grown into the current $1.76 annual dividend.

    Second, it is management's practice to remove stock compensation expense when reporting ARI's adjusted EPS, which obviously has the effect of boosting earnings. In my view this is an aggressive reporting practice, as it implies that the shares have no cost or value. But if the accountants tell you quite specifically that the GAAP cost of these shares in 1Q'15 was $1.117 million, shouldn't you believe them? When fully deducted as an ongoing expense, real earnings are otherwise lower than reported and the payout ratio higher. That said, it's probably the balance sheet and use of leverage that will ultimately determine dividend coverage for 2015.

    Hope this is helpful.


    Joe X
    Jun 3, 2015. 09:01 AM | Likes Like |Link to Comment
  • Mulling takeout targets in REITs [View news story]
    Preferred stock is very much at risk when a REIT gets bought out. Here's some things to think about...

    1) Preferred stock has no financial covenants, so there is no mechanism to force a par redemption of the preferred if the REIT is taken private. Some public management teams take the high road and offer a par redemption at closing, but it's not a requirement.

    2) Preferred coupons in the 6-7% range are going to look like very attractive mezzanine capital to the new buyer. But these cheap coupons were probably reflective of an investment-grade profile at issuance. In the scenario where a company is taken private and levered up, the new clearing rate is going to be more like 8-9%. So the preferreds are going to drop in price - a lot.

    3) In an even worst case scenario, the new buyer just turns off the pfd. dividends for awhile to save on cash. Preferreds generally let you pass on up to 6 dividends before the preferreds get to elect two directors to the board. But you could pass on 5 dividends without much in the way of consequence, essentially creating an interest-free loan.

    4) Investors need to ask themselves what's the endgame for their REIT preferreds and make sure they're comfortable with the risk. Practically everything has traded back up to par from the 2009 lows, and/or been refinanced at generationally low coupons, so now is the time to think about next steps and swapping into something safer without too much of a yield hit. Is it really worth hanging out in Cedar Realty Trust Series B Pfds. (CDR+B) at a 7.1% current yield when you can swap into Regency Centers at 6.0% (REG+G) with an increased margin of safety? Now is the time to think about it.


    Joe X
    May 15, 2015. 08:37 AM | 6 Likes Like |Link to Comment
  • Mulling takeout targets in REITs [View news story]
    The OP does not seem to be aware that IG-rated corporate bonds issued by REITs incorporate some very restrictive financial covenants. In a buyout situation, these covenants force the issuer to redeem the bonds (at preferential pricing) before all the new secured leverage is piled on.

    So, in fact, REIT buyouts have never been problematic for existing corporate bondholders. What has been problematic is the use of excessive secured leverage to effect the buyout, but that's another matter.


    Joe X
    May 14, 2015. 07:32 PM | 4 Likes Like |Link to Comment
  • ARCP Provides Update on Business Priorities, Lender Consent and Dividend [View article]
    Not surprisingly, ARCP's bank lenders are getting a little restless and seem to have required ARCP to eliminate the common dividend in return for another extension on the financial statements. ARCP also said that when the dividend was reinstated, it would be at a rate consistent with peers.

    ARCP is in the midst of a fairly serious operational, financial and portfolio restructuring. The end result will probably be a stronger company with a stronger balance sheet, but all of these changes are going to be dilutive to FFO. The company also said that it has retained Korn Ferry to search for a new executive team. That's good news, but anyone coming on board is going to want to start with a clean slate. That means less leverage and less goodwill.

    The winner in today's announcement might be the ARCP preferreds. Ultimately there is going to be improved preferred dividend coverage and probably less leverage above you. That said, fallout from the common dividend news could cause some volatility across the board.


    Joe X.
    Dec 24, 2014. 06:29 AM | Likes Like |Link to Comment
  • Heads roll at American Realty Capital; shares -10% [View news story]
    Today's announcement regarding Board and executive changes is good news over the long term, but places increasing doubt on ARCP's maintaining the current common dividend.

    My read is that the independent directors have a very firm grasp on ARCP's need for a complete restructuring of the company's governance and business profile. Morgan Stanley has already been hired to advise on Cole, and the Board has now moved very decisively to make a complete change of the C-suite, Chairman, and ties to Schorsch-related entities. ARCP shareholders, and potential ARCP shareholders, should feel comfortable that these structural issues are now going to get fixed.

    I'm not sure I agree that the removal of David Kay and Lisa Beeson implies that there are additional financial statement problems waiting to be be disclosed. The Board would certainly have used this opportunity to update investors if that was the case. I think the Board understands that ARCP is in need of a very broad makeover (get ready for a name change down the road), and that replacing Kay and Beeson simply had to be part of the process. Given ARCP's profile as one of the largest net-lease REITs, it probably shouldn't be too hard to find experienced managers to fill these roles. Realty Income better be locking in their top managers because you know they'll be getting calls...

    Today's management announcement is just the first step for ARCP. The company must also deal with the complexity of Cole, and that means selling it or spinning it off. Net-lease REITs are first and foremost specialty finance companies, and can only survive they have a lower cost of capital than their tenants. Business complexity and variability work against this, so that implies that Cole needs to exit the picture sooner rather than later. Don't know if Morgan Stanley's mandate stops at Cole, whether there are additional sub-portfolios that are going to get shopped, or whether it's simply prep the company for sale. Since you only want to clean house once, now's the time to put everything on the table.

    The last step is cleaning up the balance sheet. Too much goodwill and more leverage than you'd like to see. This is not rocket science - the goal should be to resemble Realty Income or National Retail Properties in as short a time frame as possible.

    To sum up, the Board took a very decisive first step in ARCP's overall restructuring. There's more to come and ARCP's continuation as an independent public company is perhaps less certain. In my view, all of this increases the probability that the common dividend is going to be lowered.


    Joe X

    Dec 15, 2014. 11:18 AM | 6 Likes Like |Link to Comment
  • American Realty settles lawsuit with RCS over Cole [View news story]
    As noted above, ARCP has effectively cancelled the sale of Cole Capital and will instead receive a breakup payment of $60 million from the former buyer, RCS Capital. This is the strongest indicator yet that the value of Cole Capital has diminished over the last several weeks. In fact, the value has diminished so much that a knowledgeable buyer is willing to pay $60 million just to walk away.

    In my view, today’s announcement reinforces the risk of potential impairment charges to the $2.3 billion of goodwill on ARCP’s balance sheet. Of this amount, $548 million (as of 6/30) is related to Cole Capital’s business value and is specifically attributed to “growth from new income streams and the ability to offer new products.” While Cole at one point may have been a growth story, today’s breakup fee suggests otherwise, and heightens the risk that the auditors will be taking a hard look at these goodwill balances for the next set of financial statements.


    Joe X
    Dec 4, 2014. 08:08 AM | 10 Likes Like |Link to Comment
  • American Realty Capital Properties' Dividend: What We Know, What We Might Know, And What We Can't Know [View article]
    Guys, thanks again for all the comments on ARCP. Here's another risk to the sustainability of the common dividend...

    One of the most negative things about ARCP is the $2.2 billion of goodwill created in the 1Q'14 acquisition of Cole. According to the 6/30 10-Q, approximately $1.7 billion of goodwill is attributed to such items as a lower cost of capital, critical mass, and an enhanced access to capital. Another $548 million of goodwill is attributed to Cole Capital for its "growth from new income streams and the ability to offer new products."

    While it's bad enough to create the goodwill in the first place, it's going to get even more interesting when the auditors need to test these values for impairment. Hard to tell whether the 9/30 balance sheet will take a hit since the accounting issues surfaced after that date. But the 12/31 balance sheet is going to get a real scrubbing, and it's hard to see these values holding up.

    I know some will say writeoffs of non-cash items have no impact. But bond covenants and bank covenants usually work off of book values, and because goodwill represents 25% of shareholders' equity it could be a material item. In particular, goodwill writeoffs will raise leverage ratios at a time when ARCP's credit metrics are under the most scrutiny.

    If book equity gets reduced through writedowns, ARCP may need to sell assets to reduce leverage - and that's where the current $1 dividend could take a hit. Net-lease dividends are a function of asset yield, interest rates on debt, and leverage. The obvious risk here is that if assets have to be sold to reduce bank debt, there's simply that much less cash flow available to drive the dividend. And just because the company punted and paid $0.08333 for December doesn't mean they're committed to paying $1 in 2015.

    It takes a lot of moxie to put $2.2 billion of goodwill on a REIT balance sheet, so take a good look, might not be there much longer.


    Joe X
    Nov 30, 2014. 08:11 PM | 4 Likes Like |Link to Comment
  • American Realty Capital Properties' Dividend: What We Know, What We Might Know, And What We Can't Know [View article]
    Mark - thanks for pointing out the yield on the ARCP preferred stock. Looking at recent prices (WSJ preferred stock table for 11/25), the ARCP 6.7% preferred closed at $21.76 while Realty Income's 6.625% preferred closed at $26.70. That's nearly a $5/share gap on almost identical dividend payments.

    While it's going to be awhile before ARCP has navigated through the mess it's created, there seems to be an opportunity here for the ARCP preferreds to close the gap on benchmark Realty Income. Even if ARCP were to make up $2 of the $5 discount over the next 12 months, that would give you a 16.9% one-year return.

    Key risks are going to be a common dividend cut, which might temporarily unnerve the ARCP preferred too, and the timing of resolving the issues with Cole, the relationship with Nick Schorsch, and cleaning up shareholder lawsuits. But the risk profile could look a lot better by the end of 2015 than it does now. In the meantime, you're getting paid to wait.


    Joe X
    Nov 26, 2014. 06:03 AM | Likes Like |Link to Comment
  • I Found A Nice Margin Of Safety In Omega Healthcare Investors [View article]
    I would be careful about placing too much reliance on the rating agencies for credit predictions, particularly in real estate. All three (Fitch, Moody's, S&P) were spectacularly wrong when it came to analyzing residential real estate in the form of RMBS and CDO's. Their ratings for commercial mortgage-back securities (CMBS) were also faulty during the peak volume years of 2005-2007. About the only place they were actually on the conservative side was the REIT sector, which has seen only one default over the last 25 years (General Growth) and no losses.
    Jun 12, 2014. 07:00 AM | 1 Like Like |Link to Comment
  • A Brand New Mortgage REIT That May Deliver Something Special [View article]
    Brad - thanks for bringing United Development Funding (UDF) to everyone's attention. However, I'm going to agree with more than a few of the guys above that UDF has a ton of intrinsic risk that is not nearly offset by an 8% dividend.

    At the bottom of the housing cycle, there is nothing more worthless than undeveloped or partially developed residential lots. While it's true that there is equity below UDF's loans, that equity will quickly vaporize when the cycle turns, and borrowers will not be able to stand up to their commitments. If you want an example of how this might play out in a public REIT format, look no further than iStar Financial, which is still trading 70% below it 2007 peak and hasn't been able to reinstate a dividend. Going into the downturn, iStar prided itself on itself on its custom-tailored financing solutions to smart borrowers. The company then spent years fighting these same borrowers through foreclosure, and STAR is now the successor owner to a lot of commercial and residential land deals. Sure that's a good thing when the cycle turns up, but STAR's pre-crisis investors were almost completely wiped out.

    If I were looking to take residential development risk, I would look to the established public homebuilder stocks such as Lennar or Pulte, where at least I get the upside of fat development profits on the upside of the cycle to compensate me for the intrinsic land risk. I would also take a hint from these same battle-scarred public homebuilders, who generally try to keep the land risk off their balance sheets.

    The good news I suppose is that we're still in the early innings of the housing cycle, and if you follow basic residential housing stats you find that the uptrends can easily go on for 10-20 years before the inevitable downturn. So it's entirely possible that UDF could have a nice run here. But with such a small balance sheet and concentrated loan portfolio, UDF's price would need to drop a lot more in order to make the value proposition more attractive. I would also keep in mind that an 8.20% dividend yield cannot be UDF's total cost of equity. So if UDF can't lever up (difficult given the collateral) or widen lending spreads (maybe more likely to shrink), then it's hard to see how the dividend is going to grow much. In this scenario, the stock price will then sink to where the dividend yield equals the cost of capital, likely double digits.


    Joe X

    Jun 8, 2014. 08:09 AM | 6 Likes Like |Link to Comment
  • Healthcare REITs May Not Post Healthy Returns In A Rising Rates Environment [View article]
    User 5842391 - congratulations on getting the timing right if you indeed jumped into the net-lease sector toward the end of 2013. However, the gain you are sitting on should make you more cautious, not less. Let's address your points in order...

    1) If rates are at 11-month lows, the risk to companies with long-duration flat cash flows is greatest, not lowest.

    2) The liability side of the balance sheet (leverage) is a secondary issue. It's the asset side that's the problem. Properties under 20-year lease with generally reasonable extension options pose a risk in a rising rate environment. While you may eventually grow your way out of the problem, the typical 1.5% annual lease escalation is not sufficient to offset sudden jumps in market rates.

    3) While it's true that FFO yields might be higher than bonds, this ignores two really key items. First, FFO yields are not the right metric. Many health care REITs, especially the large-cap ones like HCP, HCN and VTR, own properties that require ongoing capital expenditures. Second, "FFO" is often the subject of dubious adjustments to make it look better. Omega Healthcare, in particular, likes to add back tenant credit losses, financing costs, and management stock compensation expense. All of these items combine to lower the yield premium to bonds and should not be ignored.

    Finally, net-lease REITs such as the health care names have much longer duration than the bond market. The weighted average maturity for the entire US bond market (AGG) is 6.9 years. In contrast, the net-lease REITs are usually sitting on something like 10-11 year average remaining primary lease terms, but that doesn't include extension options that can tack on 5-10 years after that.

    Let me also add my thanks to the Chilton REIT Team for providing a timely and thoughtful article on investing in the health care REITs.

    Rgds, Joe X
    May 2, 2014. 07:48 PM | Likes Like |Link to Comment
  • Omega Healthcare Investors: The 'Realty Income' Of The Senior Care Market [View article]
    If you like nursing home risk, OHI is the stock for you. However, there is no free lunch, and in the event of any future cutbacks to Medicare reimbursement - or just nominal increases - that can place pressure on OHI's tenant base. The economics of this business are basically the same for all of OHI's operators, so if one goes under the others are likely to feel the pinch.

    This is a bullish analysis of OHI, but leaves out some important questions. Such as, if demographics are so great, why is industry occupancy flat at best? OHI's own occupancy was last reported at 83.8%, which illustrates that the great demographic wave still hasn't moved the needle. Another health care REIT, HCP, has been seeing cash flow coverage decrease in their SNF portfolio (run by Manor Care), to the point where investors are becoming concerned. Investors should also ask themselves what steps the government will take to control costs if and when demand does increase due to demographics. In summary, that rosy future for nursing home operators might still be a long way off.

    OHI is not just another health care REIT. Diversified companies like HCP, HCN and VTR have a much lower risk profile. I agree that OHI's management is experienced and does a good job running the company within this sector. And there's nothing on the near-term horizon that looks particularly threatening. Just be aware that OHI's higher going-in cap rates and higher dividend yield are there for a reason.


    Joe X
    Dec 2, 2013. 06:31 AM | 8 Likes Like |Link to Comment
  • A Series Of Unfortunate Events For Digital Realty [View article]
    Jerry - from the data you presented I don't know why you see the pricing of DLR's preferreds as irrational. They are each trading with a current yield of 7.7% to 7.8%, which makes sense as they are each pari passu with respect to payment priority.

    I suppose you could say that the varying lengths of call protection (i.e. between 3 and 5 years) should perhaps be reflected in differences in current yield. But the potential for refinancing any of these preferreds is very low - rates have moved higher, seem likely to go higher still - and DLR's preferred issues are here to stay for a long time. It would take a very extraordinary environment again - incredibly low rates, recovery in real estate markets - to produce the kind of market demand where DLR would have the chance to reissue preferreds with lower coupons. This window in time has shut.

    I do agree that if DLR is ever liquidated along the way or purchased by an AAA conglomerate, then the Series G preferreds might be the ones to own. But absent that kind of scenario, all of DLR's preferred stock should (and apparently does) trade within a very tight band. Hope this is helpful.


    Joe X.
    Nov 14, 2013. 09:00 AM | 4 Likes Like |Link to Comment
  • HCP - Cleared For Liftoff? [View article]
    Jon - you're correct that the last sentence was a little on the murky side. What I was trying to express so badly is that net-lease REITs (such as HCP) with their long-duration cash flows are fairly sensitive to changes in the rate environment. When long-term rates started to move in the early summer, the entire REIT sector sold off pretty badly, especially REITs with longer term leases. So rather than spending a lot of time at the moment trying to choose between HCP, HCN, VTR, etc., investors might be better off thinking about whether they want to be in the net-lease sector in the first place, and if so at what level of concentration in their portfolio. Hope that's helpful.


    Joe X.
    Oct 31, 2013. 05:37 PM | Likes Like |Link to Comment