Management calculates a value per share of $34 in the Q2 call. The assets are predominantly first position loans that the company can manage in the event of a refinance failure by the borrower. The company does have some credit line debt, but the lines aren't due in the near term, and debt maturities are also modest through 2009. The company is well capitalized, the preferred issuances are minor.
Problems? Aside from the general horrific climate, 10% of their loans are in trouble, but they are almost all senior debt, and the company can manage the debts, if necessary by taking the collateral of course. Unfortunately a material amount of the non performing loans are in Florida, which is probably a black hole of death for awhile.
Although market write downs exhausted reported income, taxable income (and distributions) is forecast at 30 to 40 cents for Q3. Fourth quarter will catch up to YTD taxable income, but it could be zero, management did not have a forecast. 2009 is obviously iffy.
So, while not everything is rosy, they have a comfort level for getting through the end of 2009 even in a worst case scenario, 50% non performance on repayments.
In contrast to other loan REIT's I've looked at, particularly RSO and NRF, this is much larger, but their loan portfolio is not performing as well. Problems at RSO and NRF were few. Future cash flow does not seem as reliable, particularly from RSO, which forecasts .36-.39 per quarter based on no new business, just portfolio income. The debt here is larger, a material amount of it is in revolving facilities, and they are dancing on the margins of covenants, though default restrictions are not fatal on any of them.
So, the attraction here is not the return, certainly it will not be the ridiculous 90% on the Yahoo splash. But, probably it will be in the 8-10% range through the end of 2008, which is pretty good, though that might be it for awhile. It's the appreciation potential, that the company can struggle through 2009 and hope that the credit markets have recovered by that time. If so, the company can live on, and hopefully make that $34+ value claim come true some day. S&P has a report on the company, pointing out these problems, but rates it a hold.
I see this as a speculative play, and would weight it about a quarter hold compared to RSO and NRF, the strongest high-yielding REIT's I've analyzed. Comments?
Katy Rice (CFO) held an extended exegesis on this in the last CC, transcript of which is available.
Bottom line is that there are two major types of covenants, one easier to meet than the other, due to qualifying income and loss, etc.
The bank covenants are a little more restrictive and if broken preclude additional borrowings rather than require pay downs.
The covenants that SFI is close to breaking make it so SFI cannot raise additional debt. The covenants do not allow for the bond debt to be called for payment.
From the conference call last quarter:
"The fixed charge coverage ratio in our bond covenant is an incurrence test, which means that if we were to breach the covenant in future quarters, we would not be able to incur additional debt. As we discussed earlier, based on our liquidity profile, we do not expect to raise additional debt or equity in 2008 or 2009."
SFI has a total of $3.9 billion in revolving debt capacity, of which $2.4 billion was outstanding at June 30. Maturities on these facilities are 2011 and 2012. I don't see this circumstance as a problem.
The huge discount to adjusted book value provides a cushion for any future permanent impairments in the loan book.
SFI has a very attractive and stable CTL portfolio.
When writeoffs abate (and they will) and NPLs are recycled into earning assets, SFI's earnings power will be enormous.
I do not believe the "business model" is broken. Lending has been around for a while. The previous funding model may be broken but that can be accommodated over time. At this point SFI does not need to grow to make tons of money.
The company is a premier asset manager that has brought home very attractive returns on equity on a comparatively unlevered basis. These skills are durable.
NRF I own and like. I got rid of RSO because of the Cohen connection and its size.
Any equity is a speculative play, but in SFI you're getting cover by acquiring the underlying assets at cents on the buck.
i would submit that sfi looks worse right now, but if the liquidity issue gets fixed, it will suddenly look like a much better play than rso. The reason is leverage levels. SFI has built expertise over the last 10 years in earning 15-22% return on equity using almost all first mortgages and a leverage level of around 3 to 1. Very hard to do and appears to be a business model not in the least effected by all that has happened (assuming capital markets return to somewhere near normalcy by 2010) RSO on the other hand, I believe is leveraged at about 8 to 1? It is possible that business model is now dead, and thus the dividend, while looking good now, will gradually die out unless they can figure out how to earn it on less leverage.
I wouldn't say the business model is dead, but definitely on hold for awhile. I kinda ballparked RSO's dividend as decreasing a couple cents per quarter (still an absurd return) to take into account repayments used to reduce debt, eliminating that profit spread. RSO seems to be another hold until things get more rational play, but with significant cash flow in the near term.