Description

Hi, guys --

Here’s the table of contents:

1: Super-Quick Summary

2: At Some Price

3: The Macro Call/Preferreds In General

4: Corporate Background

5: The Issue At Hand

6: Putting It All Together

1: Super Quick Summary

CLNS-B is is an 8.25% REIT preferred. The combination of a generous yield and some risk mitigants make it attractive despite the zero upside. It’s trading below par and I think it will be called soon, so the rest of this write-up is pretty much a waste of time and brain cells.

1: At Some Price

I’m on record as not liking preferreds. In the past, I’ve said:

“Preferred stocks are the scratch-off lottery tickets of the investment world, for suckers and degenerates only, in God's name who buys this stuff? Would you marry someone if you only got it when she was in the mood, and after five years she could back out at any time, but otherwise you were stuck for life?”

https://www.valueinvestorsclub.com/idea/NUVEEN_PFD_AND_INC_TERM_FD/111229

Now I’m suggesting the purchase of a preferred stock. What’s up with that? It’s partly a macro call -- preferreds are starting to like a decent enough house in a bad enough neighborhood -- and this issue/complex has some features that mitigate the general suckiness of preferreds as an asset class.

2: The Macro CallI

I’m going to steal some charts from philosphicaleconomics.com. (If you’re not familiar with Jesse_Livermore’s work, read the whole thing, tons of thought provoking stuff):

20 Year YTW For A Bunch Of Different Fixed Income Asset Classes

Here’s a table Jesse_Livermore’s put together to summarize the above:

Relative Spreads Summary

My takeaway from this is that the “search for yield” has impacted preferreds less than other asset classes. Livermore concludes that:

“[...] US preferred stocks are priced attractively relative to the rest of the fixed income space.  They aren’t screaming bargains by any means, but they look better than the other options.  They also look better than US equities, which are trading at nosebleed levels, already well above the peak valuations of the prior cycle.”

He’s focused on C-Corp preferreds, especially those of financials, but we’re looking at a REIT preferred. I’m not going to through the trouble of dredging through the past, but can point to similar conclusions. Per BofA/ML, REIT/Treasury spreads and REIT/BBB spreads are right about their historical averages. I don’t know of the top of my head how to source historical REIT/REIT preferred spreads. At the moment, I’ve got my REIT proxy, VNQ, the Vanguard REIT ETF, at a 4.75% yield, vs. equity REIT preferreds at 6.66%. No idea what the common/preferred spreads has historically been, but I’d eyeball that as being wide, or at least not out of line.

4: Corporate Background

CLNS Northstar is a result of a 3-party merger between between CLNS, NRF and NSAM. CLNS was originally two companies but internalized the asset management, while NRF and NSAM were originally one company that spun out the asset manager. There’s an awful lot of history here, some already covered on VIC. The main things to keep in mind are the distinction between asset management and direct investment, and between core and opportunistic real estate. “Core” means you own some buildings with a fixed-incomey intent, you’re in the game for reasonably steady (although not guaranteed) cashflow. “Opportunistic” means you’re actually trying to make money from real estate. If you can make money buying fixer-uppers, you’ll do that, if you can make money issuing CMBS, you’ll do that, if you can make money originating construction loans, you’ll do that. I think we all know what asset management is about, and that it’s easier to justify fees with an opportunistic than a core approach.

The Colony and Northstar complexes were historically opportunistic. NRF ran into a buzzsaw because, right around the time they spun off the asset management part, externally managed REITs fell into disfavor due to, among other things, the blowups of a couple of high profile externally managed companies (Prospect Capital and … VEREIT? I can’t keep the names or tickers straight at this point), and perceptions of excessive management greed. NRF became damaged goods and sold off to an insane valuation. The merger with Colony was designed to collapse the external management structure and remove the taint.

The current strategy is to transition to a “Core/Plus” entity -- to let the pretty short-term legacy assets run off, invest the proceeds into core real estate, and do the non core stuff mostly on an “other peoples money” basis, with asset management fees as kicker. If this works -- and I don’t see why not -- returns could be could be great, like, I don’t know, 100% over 3 years if nothing changes and they wind up trading at a premium as opposed to the current discount. The strategy is driven by public/private arbitrage. At least for now, the public markets want core and only core, while institutional investors are very interested in opportunistic approaches.

CLNS is an interesting investment in its own right, but the strategy is relevant to this write-up because it’s credit-positive. They want to de-risk, de-leverage and simplify to drive up valuation for the publicly traded REIT. While not an explicit goal, the company is open to having an investment grade rating.

5: The Issue At Hand

CLNS-B was issued by NRF in 2007. It trades around par for an 8.25% yield. It’s cumulative. There’s a step up in yield if it’s not exchange traded. It’s subject to call on 30 days notice and has been callable since 2012. I think it’s trading around par because it’s callable. I think it weren’t for the callability, it would be trading higher. Because it’s callable, there is no upside above coupon. Because it’s cheap, I think there is a (limited) margin of safety in the face of adverse developments.

6: Putting It All Together

This is the same thesis as my SAQ write-up: There’s more uncertainty here than risk. I think this should be trading at more like 7% than 8%, and if the strategy works, would say 6% is not out of reach. It’s not actually going to sell at 7% or 6% because of the call anti-feature. There’s no upside here. But there is some downside protection. Moderately adverse rate or credit developments shouldn’t move the price. This is not a screaming buy. This is, to use the terminology introduced above,  a “Core/Plus” investment. It’s not a home-run. You will suffer ruinous losses insolvency seems possible, like, there tends to be a bid around $4-$5,

But CLNS blows up, it’ll have to do it fast, because I think the preferreds get taken out over the next year. Here’s some commentary from the latest CC:

“[T]he preferreds currently are about $1.6 billion in total balance, all of which are priced above market relative to what we could do on a new issue basis. Now, not all $1.6 billion are callable today. I think by the time we get to the end of 2017, approximately half of that $1.6 billion, so $800 million of the $1.6 billion, will be callable. And so, certainly that’s one area where we can look to go in and do some accretive refinancings.”

And later:

Mitch Germain

Good morning. Just on that question about debt refis, what about some of the corporate level debt? I know you’ve got some notes and converts.

Darren Tangen

Yes, we do. We do have some convertible debt. That’s probably the most noteworthy of the other corporate level debt that we have. I am not sure that refinancing that right now, Mitch, is going to reap a lot of reward from a bottom-line perspective. So, that’s probably not where we’re going to be initially focused. I think the preferreds are definitely a bigger opportunity for us at the corporate level.

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Certainly rates and the economy could evolve to the point that CLNS would no longer choose to redeem this. If that happens, as long as there’s nothing company-specific going on, I’d rather own this and clip coupons going into whatever-it-is than most other stuff.

Yours,

Bowd

Catalyst

Coupon, call.