Contrarian investors are always on the lookout for unloved securities where the bad news is already baked in and there is a catalyst on the horizon to turn things around. A prime example is Ranger Direct Lending (LON:RDL), whichwas set up in 2015 to provide alternative secured funding to US small and medium-sized companies and consumers. The fund has suffered from a poor investment and is now yielding 12.5% and trading on a 20% discount to NAV with a change of manager on the horizon.
RDL has put together a $217 million portfolio of debt obligations of which 86% are backed by assets or personal guarantee. Most of these loans originate in the US and they include business loans, consumer loans, commercial real-estate debt and platform debt. These are highly lucrative areas that enable the fund to target unlevered returns of 12% to 13% per annum after bad debts with the aim of being able to distribute a target dividend of 7% to 10% on the issue price.
Unfortunately, things have not gone to plan and the fund has suffered a series of write-downs, most notably in regard to its exposure to Argon Credit, a lending platform that went into bankruptcy in late 2016. RDL had an indirect interest in Argon via an investment in the Princeton Alternative Income Fund. This arrangement has rather muddied the waters and made it difficult for the fund to estimate the impact on its NAV and how much it needs to write-off.
The residual exposure to Princeton/Argon Credit is around $29 million, which represents about 13% of net assets. It is unclear how much of this money will be recovered, but the fund is pursuing a strong legal challenge and there are indications that it would be very unlikely for the whole amount to be lost. Despite this, the uncertainty and lacklustre performance have pushed the shares to a 20% discount to NAV that more than covers the potential write-down.
When the fund was set up in May 2015 a three-year management contract was awarded to Ranger Alternative Management II, but the disappointing performance has raised concerns about their due diligence process. The contract expires in a few weeks’ time and the Board has been actively considering different options. It has also appointed an independent firm to value the portfolio.
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The high target returns are indicative of the high level of risk inherent in these types of loans and a number of bad debts are to be expected. At the end of December, 472 out of the 7,297 loans were late and a further 374 were in default, although many of these were backed by assets or personal guarantee. In theory these are covered by the provision for bad debts that at the end of February amounted to 6.3% of the NAV.
RDL is a classic contrarian opportunity that has been recognised by the value manager Oaktree Capital, which has recently increased its stake to more than 18%. A change of investment manager and the eventual resolution of the Princeton/Argon Credit situation would restore confidence in the fund and lead to a narrowing of the discount. Investors who want to take advantage and who are willing to accept the risks can lock in a 12.5% dividend yield that according to the available data is fully covered by earnings.