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Resource Capital Corp. Message Board

  • patrick1980sc patrick1980sc Nov 4, 2009 12:52 PM Flag

    Seeking Alpha Article - Author's Notes

    Hi all - I am the author of the SA post about Resource Capital that sparked such, shall we say spirited, commentary on this board. I appreciate the valid points that were made and ignored most of the snide comments made (except the CYS screw-up that I made - that was a mistake but CYS was basically the last amREIT standing to declare a dividend, so you had a biennial event).

    However, I thought there was some pretty good wisdom on the board and I had a few questions for some of you:

    1) Is it economically sound for a REIT to distribute more than 100% of its taxable income in a given year? What are the benefits of such a practice? Does the dividend appear to be keeping a floor on the stock price?

    2) What are the advantages of returning capital to shareholders versus retaining the capital to pursue high ROE opportunities such as debt repurchase (which incidentally, creates deferred taxable income) or common share repurchase? RSO's common share price still trails, GAAP book value, so a share repurchase continues to make economic sense as a means of growing book value.

    3) Why are so few of RSO's competitors following a similar strategy? RSO's dividend yield is quite high compared to competitors like NRF,PCC, and RWT, yet the market is not rewarding it with a premium valuation. Why might that be?

    As a side note, I do not have nor have ever had a short position in RSO. I simply wanted to raise the question of why a REIT would choose to pay a return of capital (i.e. liquidating) dividend instead of conserving cash for higher ROE activities. I have raised the same question for Realty Income (O) in other SA threads.

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    • If they were to hold back the dividend temporarily to buy more of those 12 cent/dollar bonds, I'm certainly ok with that. I suspect that those deals are not very common though.

    • add to that the expenses they are adding to RSo, take a look at the numbers for Q3, after deferring them for a couple qtrs they have resumed. Interesting that no one asked about the new costs for staff- not good news in my view, and will erode the net interest income- think dividends. be nice to get some more color on this at some point... I think that anyone not valuing this as a wasting asset is in the wrong investment vehicle.

    • All good questions

    • Patrick makes the point that RSO is in slow liquidation mode at this junture.

    • Patrick,

      Good job tuning into your critics.

      I'm not going to answer your questions as stated, 'cause they've got a little of the "When did you stop beating your wife" flavor. I'll just give you some personal impressions of RSO, and hopefully some insight into why I've got about a good portion of my equity assets in the company.

      First, some ancient history. Reggie Jones, the CEO of GE "BW" - before Jack Welch, used to designate GE companies as red, yellow and green. Green companies were growing and demanding of resources - not providing much return, but with promise for big returns in the future. Yellow companies were more mature - sometimes needing investment beyond internally generated cash flows - but providing good returns on their own. Red companies were those in decline - but that generated cash that could be used to fund the green and yellows. (Jones picked different kinds of leaders for the three different types of companies - Welch BTW was CEO of the plastics division of GE - at the time a "green division".)

      RSO, is in my view, a "red" company. It is in the "harvesting" portion of a company's life cycle. Their assets are in 5 CLOs and CDOs that don't require much in the way of new investment.

      Not much growth to look forward to in a "red" company. That's OK by me. The bulk of my RSO assets are in Roth accounts. I pay no taxes on the generous dividends. I really don't care if the share price ever sees $6 again.

      The Cohens also profit nicely from the cash generated from RSO - both personally and through their primary vehicle of investment, REXI. Ed and Jonathan own about 3% of the shares, and REXI about 9%, as I recall. Additionally, if I'm right, REXI will get somewhere in the neighborhood of $16 to $20 M annually in incentive payments from RSO.

      Still OK with me. I'm kind of resigned to accepting 80 cents a year, after taxes, for each $4 share I bought. More than that is cream cheese icing on the carrot cake.

      With regard to how the market views RSO's share price - I think Tom Carey had it right - paying out more than you are obligated to is something akin to the "kindness of strangers". Tough to count on in the long run.

      I don't imagine I've answered all of your questions - but I think I've given you enough to understand why I believe RSO is a suitable investment for me, and for some of my friends and family that are in similar circumstances.

      Now how about giving me insights into two areas I puzzled over in my original post...

      First, your timing for publishing the piece was terrible. Any explanation?

      Second, pls explain your comment on taking tax losses earlier than necessary.

      • 1 Reply to andydee
      • 1) I submitted the article for publication shortly after reviewing RSO's earnings release because I wanted it to be as timely as possible. I had the information I needed to discuss the nature of the dividend (i.e. it's not being covered by taxable income).

        2) As for the acceleration of tax losses, I was attempting to describe the Catch-22 nature of selling/transferring loans out of the securitizations. If the CLO had been able to pass the covenant tests (IC, O/C, etc.) without removing the loans, any tax losses wouldn't be realized until the end of the securitization's life at the clean-up call. Because the CLOs were about to fail the covenant tests and thus trigger the cash flow diversion, RSO had to rehabiliate them by swapping bad loans for good loans. The sale of the bad loans of course caused a realizable loss then and there. It's certainly a more economic decision to keep the cash flow structure intact - especially if RSO chose to use the taxable losses to shield itself from distribution requirements.

        Ultimately I know RSO has the cash flow to support the current dividend, and maybe the strategy is to simply liquidate RSO as a vehicle given the closure of the securitization market. I suppose the character of the dividend is really meaningless if the long-term growth of book value and EPS is not a concern.

    • Ah, thanks, I wanted to reply but my AVG firewall is blocking the SA login popup.

      1. Taxable income is a paper number that does not necessarily reflect cash flow or economic income in any given period. RSO sold out of some positions at a loss, which creates a tax deduction given the completion of the transaction. But they did so in a fashion that created an economic benefit, using the proceeds in a more profitable manner.

      Taxable income, GAAP income, cash flow, they all end up in the same place start to finish, but can be wildly different in any given year. Loan reserves are not deductions, and gains on debt repurchases are deferred taxable income, it takes years for those timing differences to unwind.

      What creates the ability to pay cash dividends is cash flow from operations, and that is running 20 cents over distributions YTD. It was flat this quarter as REXI caught up on some inventive fees, but it fully supported what was paid out.

      As to the relationship between the dividend and the stock price, I don't understand why it would create a floor. The market is skeptical over the sustainability of the dividends given the assets in the securitizations. With some reason of course, though so far (knock on wood), RSO's underwriting has been peerless.

      2. Keep in mind this entity is designed to distribute income. Define "income" as cash flow, and management has been true to the purpose of the entity, and has respected the right of the stockholders to our income, because that's what it is.

      Could they grow the entity by retaining capital? Sure, but that's not a REIT, it's not an MLP. That's a regular corporation.

      3. As to the market price, see above. Why is RSO distributing cash when NRF is not (much)? Because it's flowing the cash from net interest income, and for the last several quarters NRF has not. RSO is different from other mREIT's in that it's so simple. All it is now is the residual interest in five securitizations, that's all, there's little to buffer cash flow from the stockholders, and practically no other assets or debt. If cash flowed, it was income, and it's been distributed.

      Remember that RSO is not a company, it's a filing cabinet and a hard disk in REXI's office. It's almost like a royalty trust now, there's little hope of creating more CDO's in the forseeable future, and so far the securitizations are all in the black. So long as the loan portfolio holds up, it will remain a cash flow machine for many years to come.

    • IMO it comes down to how certain are the REITS that their loans are going to get paid.

      RSO must be almost 100% certain that substantialy all of its loans are going to be paid and therefore does not need to set aside its cash flow as loan loss provisions.

      The other REITS don't have any idea how many of their loans are going to default, so they are hoarding cash to make up the shortfall.

      Note that RSO has bought back over 700,000 of its shares and it does continue to extinguish its debt at 12 cents on the dollar.

      As to why they continue to a dividend, it may be a calcuation that a continuity of payment, besides maximizing the value of the investment here and now, WILL enhance the value of the stock when they do need to do a secondary offer later on to raise capital to make new loans.

      In other words it may be that RSO is actually operating the business to the benefit of its shareholders. I know that is hard to believe, but it does happen on rare occassions.

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