Resource Capital Corporation (NYSE:RSO) shareholders were disappointed by the December 2015 dividend reduction. This was hardly the first disappointment. Shareholders were blindsided with an unexpected loan write-off last year. Dividends have been reduced 6 times over the last decade. At a recent price of $11.68, RSO is trading at just 66% of the $17.63 book value. The dividend reduction enables RSO to strengthen its balance sheet, repurchase deeply discounted shares and maintain a more sustainable dividend level.
RSO-PC is a par $25 cumulative preferred issue with an 8.625% coupon. Dividends are paid quarterly and RSO-PC now yields 12.4% at a recent price of $17.77. RSO-PC may not be called at par prior to 7/30/2024. It is a perpetual issue, which means that the company has no obligation to call it. The RSO-PA, RSO-PB and RSO-PC cumulative preferred issues are equal in seniority. See prospectus for additional details. Here are the top 10 reasons to consider RSO-PC.
1. Safe preferred stock dividend with 3.8X coverage
How safe is the preferred stock dividend? AFFO (Adjusted Funds From Operation) was $67.3 million ($2.08 per share) for 2015. AFFO is a metric that REITs commonly use to determine how much cash flow is available to pay their common stock dividend. AFFO is calculated after deducting the preferred stock dividends, which now total $24.4 million annually. The RSO preferred issues are senior to RSO. In the worst case scenario, preferred stock dividends could be paid even if the common stock dividend was completely eliminated. Based on the 2015 numbers, the preferred dividend coverage is therefore: (67.3 + 24.4) / 24.4 = 3.8X. Note that management has guided for substantially higher AFFO in 2016 (see item #9). Based on management's guidance, the preferred dividend coverage should be well over 4X in 2016. This is very comfortable coverage level given the lofty 12.4% yield offered by RSO-PC.
2. Credit quality remains excellent.
RSO is in the business of making loans. Nothing is more important than the credit quality of their customers. President & CEO Jonathan started off the Q4 earnings conference call by commenting:
"Our core real estate lending business is doing quite well. Our real estate team has done a tremendous job both in growing commercial real estate loan originations and accessing term financing in various forms. We have accomplished this impressive growth without sacrificing credit quality, which remains excellent in this portfolio."
3. The RSO dividend reduction is good for preferred holders.
Prior to the dividend cut, RSO was straining just to barely cover the hefty common dividend. The lower payout leaves RSO with much more financial flexibility. Lower dividends are painful for RSO holders, but actually help to make the RSO-PC dividend safer.
4. Active securities repurchase program.
By reducing the common stock dividend, more cash is now available to repurchase securities. As discussed on the Q4 earnings call, 6% of all RSO shares were repurchased just between August 2015 and December 2015. A new $50 million securities repurchase program was announced on 3/15/2016. The deeply discounted preferred stock may be repurchased under this authorization as well as common stock. Potential preferred buybacks were addressed in response to a conference call question by Analyst Jennifer Wong at LDR Capital Management:
"In corporate securities, they may or may not include preferred stock. We obviously feel like that is an area that is super cheap as well as our common stock."
5. Excellent liquidity.
Liquidity is always an important consideration for high yield investors. As of 12/31/2015, RSO had $77 million in cash and $425 million in availability under their $650 million of real estate term facilities. See the "Liquidity" section of the Q4 earnings report for details.
6. RSO-PC offers protection against interest rate risk.
Many perpetual preferred stock investors are concerned about interest rate risk. Even the 8.625% RSO-PC coupon could eventually become unattractive if interest rates rise substantially. RSO-PA, RSO-PB and RSO-PC trade at comparable yields, but RSO-PC is a better choice for long term holders. RSO-PC includes a "fixed to floating" rate feature. If RSO-PC is not called by 7/30/2024, it becomes a floating rate issue with a coupon of LIBOR plus 5.927%. There is an 8.625% interest rate floor. The RSO-PC coupon can never drop, but it can increase if LIBOR eventually exceeds 2.698%.
7. The RSO bonds are trading higher.
Bond prices are a great indicator of credit risk. The RSO 8% notes (CUSIP 76120WAB0) maturing on 1/15/2020 are now trading at $94 after bottoming near $90 in January. This is consistent with the CEO's statements (see item #2) regarding strong credit quality.
8. RSO is trading higher.
RSO has rallied 25% over the last 3 months as recession fears have faded and the commercial real estate sector continues to perform well. This is bullish for RSO-PC.
9. Strong AFFO guidance.
Q4 2015 AFFO (Adjusted funds from operation) was 49 cents per share. Improving results are expected going forward based on management's 2016 AFFO guidance of at least $2.65 per share.
10. Insider ownership.
Insider ownership of the RSO common and preferred stock issues is detailed on pages 210 - 211 of the 2015 10-K report. Executive officers and Directors own 1,258,950 shares (4%) of RSO as well as 21,274 shares of RSO-PA.
My Panick Value Research Report is focused on high-yield preferred stocks and exchange-traded debt issues. Sometimes the interests of preferred and common stockholders diverge. The depressed price of RSO-PC may be due to lingering disappointment from the recent common stock dividend cut. Ironically, retaining more capital is actually a good thing for RSO-PC holders.
Disclosure: I am/we are long RSO, RSO-PB,RSO-PC.
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.