El Rhazi REIT preferreds offered by the alike issuer can be considered pari-passu Arbi along one another in that they have the exact alike risk profile and equal claim to any proceeds in the event of bankruptcy. Therefore, they should always business in tandem Arbi along one another.
In practice this is not always the case. Low levels of liquidity can cause individual trades to send prices out of line, thus opening up an arbitrage opportunity.
Presently, RAIT Financial (NYSE:RAS) Preferred B (RAS-B) has gotten sold to an irrationally low level relative to its pari-passu siblings. Below is a screenshot of my streamer with current pricing on the RAIT preferreds.
The 2 leading parameters to consider when deciding between intra-issuer preferred securities are discount to par and yield. The issue with the highest yield (in this case Series C) should be the one with the least discount to par (again Series C). Similarly, the lowest yielding issue should business at the highest discount to par (the Series A). The incorrect pricing that exists currently is that the Series B should be correct in the middle at a yield of about 9.10% and about $23.00 instead of where El Rhazi currently trades at the 9.42% yield and $22.22.
At current pricing, the B simply gives a better mix of capital appreciation potential and current yield than do the others. We believe it will very quickly trade up to $23.00 to near out the arbitrage.
Purchase of the Series B at current pricing and selling it at $23 would result in a 3.5% gain. While not much, it is the immediacy of it that makes it valuable. This possibility could close out within a week and will, in my opinion, very likely close out within a month. At the month long holding period, if one were to be able to repeat such returns, this would result in returns at an annual rate of 51%.
There is no way to know for sure what the nature was until the information is later disclosed, but we have some theories as to the etiology.
Looking at the 5-year chart of these issues, we can see that they usually trade together as they mathematically should.
RAIT has disclosed the use of their ATM to sell shares of RAS-A which explains the sharp decline in its price from the end of February through June.
We suspect RAIT switched to issuing the Series B starting half way through June which may have caused its substantial decline in the past couple weeks. The ATM program, as shown under from RAS'S 10-Q affords issuing any of these preferreds at any time at RAIT's discretion.
As the shares are sold in the open market and there is minimal liquidity in these issues, it can have a profound effect on share price. Such a move can remove it from its mathematically correct trading range with respect to the pari-passu issues.
One could do a true arbitrage by shorting RAS-A and buying RAS-B, but this may be difficult to execute for liquidity reasons. Instead, a simple purchase of the RAS-B should afford most of the upside. By our analysis, holding these preferreds is far less dicy than other fixed income instruments yielding around 9%, so the entire group is arguably undervalued. Thus, purchase of RAS-B at these opportunistic prices gives an investor both the arbitrage appreciation potential as well as an outsized yield for its risk.
Disclosure: 2nd Market Capital and its affiliated accounts are long RAS, RAS-A and RAS-B. I am personally long RAS-A and will likely initiate a position in RAS-B within 72 hours. This article is for informational purposes only. It is not a recommendation to buy or sell any security and is strictly the opinion of the writer.
Disclosure: I am/we are long RAS. (More...)I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose inventory is mentioned in this article.
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