AltFi's David Stevenson reveals where the embattled closed-ended fund may be heading.
AltFi's David Stevenson reveals where the embattled closed-ended fund may be heading.
Another day, another decline in the share price of London listed fund Ranger. The share price is down 2.3% on my screen at the moment, at 719p. 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 on AltFi 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 practises, 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 sidepocket 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 over react to the threat of potential losses on loans – and under estimate the possibility for recovery. If ranger worked with a good asset manager who knew how to work out troubled loans, some of the Princeton position 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.
On a much broader note there are some crucial lessons to learn here. The plight of Ranger tells us that the direct lending model (and balance sheet lending) is not necessarily any less risky than the p2p model. Arguably P2PGI has suffered much smaller aggregate losses from its very diverse loan book compared to Ranger. No one model is superior – everything depends on the lending policy and credit analysis.
Vintage and seasoning of loans also seems to matter. Ranger and the intermediate platforms it worked with seem to have run into trouble roughly two to three years after cash was first deployed – a useful warning signal for other newish funds currently enjoying premium ratings. Survive the 3rd year and logic suggests that your lending model should be robust.
The use of those intermediate platforms should also raise a big red flag. P2P lender Ratesetter had its own particular problems with operating through ‘arm’s length’ originators of loans and has now sensibly changed course. One senses that nothing quite beats proper, own label origination and risk grading – where the fund/platform is the lender and credit analyst. Working with third parties seems to introduce huge behavioural risks.