Mark Skousen: “This Stock is PROFITING From the Subprime Mess”

By Travis Johnson, Stock Gumshoe, February 5, 2008

Ah, it’s so nice to have a lovely little sleuthing job to distract me … this is much more enjoyable than watching my own portfolio tick lower, or watching the market indexes crawl frantically into into the basement like scared children in a horror movie. Enough distractions like this, and I can actually follow through on my personal goal of ignoring market gyrations and patiently sticking with good companies.

But that’s beside the point, of course — no reason for you to care about my portfolio. Now Mark Skousen’s, that might be of interest to you. I find him to be a bit off-putting in person, since he gives off an aura of “more brilliant than thou”, which clearly would irritate those of us who are indeed unusually brilliant 🙂 . And to be fair, he does have book jacket blurbs from Milton Friedman, and he’s been publishing a successful newsletter for eons, so I suppose he gets some street cred that way.

But what’s important is that he’s teasing us with a new stock today — if you subscribe to his Forecasts and Strategies newsletter, which is one of several that he edits, he’ll tell you about this company that is “profiting from the subprime mess.”

Good teaser, eh? Now that the investing punditocracy has us all hot and bothered about subprime CDOs threatening to turn western civilization into a big, smoking crater, how can we avoid shelling out a few bucks to find out who’s on the other side of this catastrophe?

What’s that? You in the back, yes? Correct, the answer is, “We can listen to the Stock Gumshoe.” Very good, extra credit for you!

Skousen might be a smart economist, and you might want to subscribe to his newsletter, but if you just want to find the name of this company … read on!

What does he tell us about this one? Other than the fact that we can “Double [our] Money in the Next 12 Months with This Rising Financial Company.”

We do get a few clues:

It’s a Business Development Company (BDC) based in Vancouver that “went public in 2003 and recently listed on the American Stock Exchange.”

The company was specifically worried about US-lending and the subprime collapse before it happened, saying that it was “fearful of lending in the U.S. ‘because of its lending practices and its lending laws.'”

“In third-quarter 2007, the company’s loan portfolio increased 14% over the previous quarter to $273 million.”

There are a few other clues in the ad if you’re interested, but that’s enough to feed into the mighty Thinkolator for a few minutes.

Still spinning.

Ah, there! This is …

Quest Capital (QCC)

Quest is indeed a Business Development Company based in Vancouver, and the clues match exactly. They did make some snarky comments about US residential lending, you can see their press release from August here if you’re interested (it’s a pdf file).

For folks who don’t know, BDCs are somewhat akin to partnerships or REITs, in that they get to work tax-free and push all their taxable income through to shareholders in the form of dividends. I’ve written about a few of the big ones before, like American Capital Strategies and Allied Capital, but Quest is definitely the small fish in this fry. I don’t even know if they were technically called a BDC under Canadian regulations, but after a reorganization last month they’re now essentially a mortgage REIT.

QCC has a market cap of $300 million or so (the big guys in this business are in the $3-10 billion range), and currently pays a quarterly dividend of 2.5 cents/share. The total dividend is 10 cents a share per year at the current rate, which sounds pretty measly until you note that the share price is down near $2, so it’s a yield of about 4%. Low for a BDC or similar REIT, but not bad.

They do believe that they’re in a good spot, as do most mezzanine lenders these days — you’ll probably find that most lenders who specialize in work like this, mezzanine loans or loans to smaller and midsize businesses, are drooling at their prospects. They think that the big guys are scared to lend in this environment, so they have the opportunity to pick up market share and make very profitable loans.

Of course, saying that this firm or any of its compatriots is debt free is a bit misleading — they all use other peoples’ money for some of their lending, though Quest and their compatriots are certainly being more conservative on the leverage front lately. Quest is currently looking to increase their line of credit to help fund more loans, so they do have some risk on that front.

If they’re like most lenders in this business (and I don’t know, I haven’t really dug into their books), then they probably profit primarily from their underwriting acumen (not making bad loans) and from the spread they can achieve on their borrowed money (ie, they have a line of credit at 9% and lend at 13%, getting 4% for their trouble). In these cases, most companies have similar rate adjustments on their lending as on their borrowing, so if the prime rate goes up then both their line of credit and their existing loans also adjust up and it generally should have little direct impact.

So that’s something to look into for Quest, how they handle interest rate risk. Otherwise, I’d think about their lending portfolio, which they disclose in part on their website — mostly in Canada, which might be good if you like the Loonie going forward, and mostly in hard-asset areas.

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The latest news from Quest is that they reorganized into a Mortgage Investment Corporation, which is essentially the same sort of structure as a Mortgage REIT in the US, though not necessarily with the same rules. The announcement of this, and of the closing of their latest line of credit, is here. The big limi