The share price of Stanley Gibbons continues to fall. Earlier this week we learned that SG’s Guernsey business has gone into administration. This is the unit that was used to house the various guaranteed investment schemes, which have subsequently been revealed to be anything but guaranteed 9or an investment). Looking at the numbers released ruing the announcement it seems obvious to this observer that all those investor’s with guaranteed plans are now being thrown to the wolves. In effect, they’ll be forced sellers, all at the same time – with an obvious impact on the value of their stamps….unless of course, am missing some valuable piece of information that could give some reassurance. In retrospect, these investment schemes look a lot like misspelling by any definition and one wonders where the FCA are when you need them! As for the remaining business, this seems ring fenced at the moment and under the protection of the long suffering bankers. But the continually drooping share price tells you everything you need to know. Stanley Gibbons is now flirting with bankruptcy.
Another share that seems to be enjoying a steady drip of bad news and wilting share prices is Ranger Direct Lending. With this listed fund, I think there is a much better chance of a very positive outcome. The shares are down 3.9% on my screen at the moment, at 707p, implying a discount of well over 32% against ‘net asset value’. Curiously the Ranger ZDPs have barely moved. More on that in a moment.
By my reckoning any closed end fund with a discount of more than 30% and a steadily declining share price, tells you something. The market is in open panic and is going to demand something really quite drastic. In this case we already have a hint from the board about what might happen next – its declared that it is in discussions with two to three potential co managers who “could assist in and strengthen some or all aspects of the Manager’s current role and responsibilities, including identifying new lending categories, sourcing platform partnerships, conducting platform due diligence, structuring investments, portfolio management and back-office support”.
My guess is that now might be a good time for investors to perhaps re-engage with the shares. I suspect we could end up with a situation where a new manager is brought in and the fund in effect broken up. What’s much more interesting though is the story behind the Ranger fund. In many respects this London listed fund was the poster child for a different type of lending income fund – arguably a superior model, well constructed and with engaging ideas about how to lend money.
I’ve mentioned before in this blog that the US has a vibrant business development company fund culture – these BDCs, as they are called, are popular with investors largely because the yields are so generous (usually around 9%pa). The vast majority of these BDCs are in effect direct lending platforms who lend out money to SME businesses at chunky rates.
Simply having a BDC quoted on the London market would be a major advance and Ranger probably comes closest to that closed-end fund direct lending model. In addition, Ranger represented what many would maintain is a superior lending model. Although its manager had invested in p2p loans in the past (via a system called TruSight) the core business model was based on lending from its own balance sheet to other direct lenders who also took on principal risk. This balance sheet approach is, many argue, a less risky way of lending.
Crucially Ranger was also very diversified in its lending practices, which meant it wasn’t just focused on one particular part of the SME lending space. According to one broker note from last year (Cantor), Ranger invested in loans originated on 11 to 12 direct lending platforms across various categories including secured SME lending, real estate loans, invoice financing, equipment finance and platform collateralised debt. Again, this should tick lots of boxes as regards proper diversification, not least that over 80% of its loans were secured – unlike many P2P lenders who have loan books full of unsecured borrowers.
Investors also lapped up a number of related, unique features. The targeted dividend yield of 10% pa was one of the highest amongst its peers, and to its credit, the fund has until recently largely delivered on that promise. Crucially the fund also had low gearing (typically 20-40% of NAV, max 50%) and managed to get cheap funding via a zero dividend share. Ranger issued £30m of ZDP shares with an initial life of five years, with a final capital entitlement of 127.63p. The redemption yield equated to about 5% per annum based on the placing price.
But these weren’t the only selling points. Ranger was also fairly forward thinking in that it actively built a loss reserve – a soon to be mandatory requirement for direct lending funds because of IFRS 9. This helped give some investors some comfort that losses could be sustained and the dividend still paid out. Also, the fund’s managers were fairly transparent about average expected loss rates – at 2.3% comprised of 0.7% for SME, 0.6% Real Estate, and 7.4% for Consumer. As an aside, the average loan terms in months according to a note from Cantor was 20 for SME clients, 13 for Real Estate, and 40 for Consumer. Last but by no means least Ranger also had an excellent track record in building its own proprietary credit risk analysis -TruSight – which has been running for many years underwriting loans via the big US P2P platforms. According to the Cantor note, loans selected by this TruSight outperformed all Lending Club and Prosper loans that have matured since 2010 by 5-9%.
No wonder the share price of the fund took off in the last few years, helped along by sterling’s devaluation – the fund had always, rightly, stayed unhedged. Ranger was alongside Honeycomb, one of the stars of the direct lending sector. And then disaster struck. The fund admitted that one of the platforms it had worked through, Princeton, was in trouble after lending to Argon Credit (which in turn had gone bankrupt).
Over the past few months, we’ve had a steady drip feed of ever-worsening bad news about this loan. Only recently we learnt from the fund the managers that they’d had to make yet another impairment of c.4% of NAV in relation to the fund, Princeton Alternative Income. But the board also cautioned that “it is unable to confirm the precise impact of the reserve on NAV at the current time”. According to a note from Numis this “follows a notification from Princeton that intends to take a gross reserve of c.$10.4m against the Argon portfolio due to a decline in recent cash flows from the portfolio. The uncertainty arises because the notification does not contain detailed financial records or portfolio information which would allow Ranger to fully assess the basis on which the reserve has been taken…. The company has written to Princeton “urgently seeking” additional information. Arbitration proceedings are due to commence on 20 November 2017. “ That last sentence really doesn’t sound very promising at all!
Ranger has already made a 3.1% of NAV impairment in relation to Princeton (this was originally estimated at c.4%) – according to Numis as at 30 June, the Princeton side pocket was $21.7m, representing c.9% of net assets. Numis suggests that after the latest write-down the residual exposure to Princeton assets will be c.5% of net assets.
Not unsurprisingly the funds share price has continued to decline and is now sitting on a 30% plus discount. But I have a sense that this might all be an overreaction. In income terms, the fund is still making generous payouts. Ranger notes that the reserve against Princeton does not impact the third quarter dividend which was 21.7p (28.45 US$ cents). Again, according to Numis, that Q3 dividend represents an annualised yield of 11.1%.
The share price also seems to be factoring in certain Armageddon on the Princeton loans – and more. And it is true that Ranger has been hit by loan losses in southern states battered by natural disasters. But experience teaches us that most equity investors overreact to the threat of potential losses on loans – and underestimate the possibility for recovery. If ranger worked with a good asset manager who knew how to work out troubled loans, some of the Princeton positions might be salvageable. More importantly, there doesn’t – yet – seem to be any structural problems with the other lending platforms. So, arguably the potential for losses is already in the price.
I’m not a shareholder – nor have I ever been – but personally I think there is a fair chance that the managers might be forced to run down the existing book of troubled assets, and return cash. As for the more “steady” assets, these could be hived off into a separate share class and slowly amortised down – or even handed over to another manager. Much depends of course on what the main shareholder – Invesco – decides but the presence of activist investor LIM suggests that a deal may be in the offing. Crucially I’d also keep a close eye on the ZDP shares. These have barely budged over the last few weeks, which to me seems anomalous. I realise there’s still lots of value in the fund, which means the zeroes are fully covered. But I’m surprised we’ve not seen any forced sellers, pushing the zero price down sharply given poor liquidity. In these kinds of unfortunate situations, it’s not unusual to see an income instrument move from a small premium to a chunky discount of as much as 15 to 20%. My guess is that the zeroes might be next in the firing line. If that does happen, I’d definitely be a buyer as it seems to me that by early next year we’ll be in the end game for Ranger – with the board forced into some drastic action. That, in turn, might push the discount on the ordinary shares down to a more reasonable level of around 20%. One to watch.