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Ranger prepares to gear up for 10% yield
How much borrowing should high-yielding loan and peer-to-peer funds use to leverage their portfolios? Ranger Direct Lending is about to find out.
How much borrowing should direct lending and peer-to-peer funds use to gear up their portfolios? That’s the question fund managers and shareholders are grappling with as the £1.8 billion fledgling sector battles against a sudden cooling in investment sentiment.
Ranger Direct Lending (RDL ), a loan fund that raised £135 million at its flotation last May, has revealed it is considering how much leverage it needs to maintain the 10% yield target it set itself.
Having seen its shares drop below their £10 launch price in the New Year market mayhem the investment trust already yields 10% with an unlevered portfolio, the highest among the seven direct loan and peer-to-peer funds in the Association of Investment Companies' Debt sector.
But to ensure it can keep paying quarterly dividends at that level and afford costs like currency hedging the US-focused fund feels it needs to boost its total return to around 13% with some judicious borrowing.
Bill Kassul of Ranger Alternative Management, the Texas-based debt specialist that manages the investment trust, said the company was in discussions with lenders which could see it either open up credit facilities or issue bonds.
Gearing is, of course, used by many investment trusts but the timing of the debt funds’ deliberations on the matter is sensitive. The bout of risk aversion that has gripped stock markets in recent months has seen shares in Ranger and rival P2P Global Investment (P2P ) lose the high ratings they enjoyed last summer to trade at discounts of around 7% below net asset value.
The derating can also be blamed on the sector expanding just as investor demand was waning. The launches of Funding Circle SME Income (FCIF ) and Honeycomb (HONY) raised nearly £250 million at the end of last year while Ranger Direct squeezed out a £13 million ‘tap’ share issue in December, just before the January sell-off, having invested all the money raised at its listing.
The emergence of discounts on the shares has left investors nursing capital losses of 5-11% over six months even though the underlying portfolios have made gains, in Ranger’s case of 12%.
The question is do these funds really need borrowing to make their shares more volatile?
Kassul (pictured) sought to reassure investors by saying the trust would borrow no more than it needed to back the yield target. ‘We might only need 20% gearing just enough to hit that 10% yield,’ he told Citywire.
Kassul pointed out that along with Funding Circle, Ranger had the lowest cap on gearing in the sector. It is permitted to borrow a maximum of 50% of net asset value compared to 150% maximum at P2P and VPC Specialty Lending (VSL ) and 100% at Honeycomb.
In practice, the other trusts don’t intend to get anywhere near those levels of borrowing with target gearing of between 25% and 80%, according to research by Cantor Fitzgerald analysts.
Nevertheless, Ranger can claim to be steering towards the low end of the gearing scale, while maintaining the highest yield among its peers, who offer 6% on average.
Aware that the high yield makes it look high risk, Ranger is keen to distance itself further from the other peer-to-peer funds.
Kassul pointed out that at the end of December only 18% of its portfolio was in the sort of unsecured, consumer loans that most of the peer-to-peer funds focus on. The rest is made up of secured, short-term loans to smaller businesses and property developers abandoned by traditional banks since the credit crunch.
The presence of collateral behind its loans protected the fund, said Kassul. ‘If you get a $1 million building and lend $600,000 on a 12-month term, a lot has to go wrong for you to lose money on that.’
The company has set aside 2.36% of assets as a loss reserve to deal with anticipated bad debts and loan defaults.
Prospects for alternative lenders were good, said Kassul, with the market set to grow as banks would not return to these niche areas even when they repaired their balance sheets. A constant refrain he heard from former banking colleagues was: ‘It costs me the same amount to underwrite a $50 million loan as a $5 million one but I get paid a lot more with a $50 million loan.’
With lower costs and more sophisticated credit scoring systems, the eleven lending platforms that Ranger worked with could afford to operate in these areas, he said.
Alternative did not mean new either, Kassul added. Although peer-to-peer platforms were young, some of the platforms they sourced loans from were up to 40 years old. 'They have very experienced managements,' he said.
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by Gavin Lumsden on Sep 26, 2016 at 07:00