Sachem Capital Stock: I Prefer The Preferred Stock (NYSE:SACH)
I present to you another compelling opportunity for “hard money” lenders. You may recall that a few weeks ago I was talking about a somewhat similar mREIT, namely Broadmark ReaNess capital inc. (BRMK). This opportunity is with sachem corporation (NYSE: Sach). “Hard money” loans are essentially private equity versus cash flow loans because they focus on collateral (what you can realize in the event of a default) versus business cash flows that you would typically see at a chartered bank .
SACH is much more focused on residential real estate than its counterpart BRMK, which has 54% of its portfolio in this space, as its loans are more focused on “fix and flip”, construction, or bad foreclosure loans. However, they have diversified into commercial lending as a hedge in the housing market due to the reliability of borrowers’ and investors’ cash flow and CAP interest calculations. SACH loans are typically used to renovate/convert a property, such as a warehouse into an apartment building.
55% of SACH’s loans are in Connecticut but have expanded into Florida, NY and other states. Although BRMK loan sizes are typically small and have very short maturities, SACH loan sizes tend to be even smaller at no more than $1 million and their average maturity is only 8 months. SACH can also complete a loan in as little as 5 days. SACH’s portfolio return is about the same as BRMK’s because they charge similar interest rates and have an entry fee of 1-3%. Although BRMK is quite strict in its underwriting process, SACH is even more so as their loans all require personal guarantees and as they run multiple projects for the same developer it is not uncommon for them to cross-collateralize collateral. This means that if the developer defaults on a loan, all of the collateral held by the borrower can be confiscated, not just the collateral backing the defaulted loan. As a result, SACH will allow a slightly higher LTV of 70% for their projects versus 60% for BRMK. Both companies are 100% senior secured.
SACH is slightly more leveraged than BRMK, but it has taken a tremendous amount of work over the past year to issue new unsecured fixed rate notes at interest rates of 6-7.2%, which is lower than today. Nothing is due before at least 2024. Rising interest rates should therefore be a tailwind rather than a headwind, as they can continue to underwrite new loans at higher rates if they come off the books within a year of underwriting, while their ongoing interest expense will remain broadly flat for the next four to five years .
Similar to BRMK, joint dividend coverage has been a concern for some time. Even adding in the $2.5 billion YTD unrealized losses on investments and the $595 million impairment loss, the dividend coverage is ~93% of the recently announced $0.14 quarterly dividend -dollars per share. That’s still a lot better than BRMK’s 130% payout ratio, but not low for a REIT.
Management said last year that it expects net income to cover the combined dividend through 2022 YE. They made the prudent decision to issue shares in 2021 and early 2022 when the share price was trading at a premium to book value as they now have $29 million in cash.
In June 2021, SACH sold a total of 1.70 million common shares of preferred stock at a dividend of 7.75%, representing 7.75% cumulative Series A Redeemable Preferred Stock (NYSE:SACH.PA). SACH raised $45.5 million in new capital, net of fees. SACH also sold a total of 6.10 million shares of its common stock for proceeds of $30.88 million in 2021. SACH also sold two new sheet music offerings. In early December 2021, Sachem raised $43.3 million in net proceeds from the sale of 6.0% Notes due 2026 and then in March 2022 an additional $48.2 million net from those sales, and the Notes will not mature until 2027 The result of issuance of new capital at bargain prices has kept the TBV intact, unlike BRMK, whose TBV has fallen in recent months due to the aggressive dividend.
US housing starts have fallen to their lowest level since 2020 as interest rates have started to hurt the market. However, unlike BRMK, we have yet to see a drop in lending and its revenues, and its default rate has remained at ~3% since Q2 2022, which is in line with its default rate in 2021 and the value of the properties owned by HER.
The 7.75% Series A cumulative redeemable preferred stock has covered ~7 times net income when non-cash expenses are factored in, the loan book could fall more than 50% and the preferred dividend could still be covered. Shares are also cumulative, so payments cannot be suspended unless the common dividend is reduced. The share is non-redeemable until June 2026 and is redeemable with a liquidation preference of $25/share. At the current price of $21.30/share, the yield on the call is ~12.4% compared to the ~14% yield on the common. Sacrificing even 200 basis points seems a fair price for increased protection from a dividend cut and capital loss. Although the shares are convertible, I have chosen not to discuss exchange rates as they do not play a major role in SACH’s current share price.
While SACH has done everything right and is well capitalized as the overall housing market has started to show some weakness, we cannot ignore the fact that this is a tough business and management takes a much more conservative approach when valuing property values almost certainly must be slow growth in the loan book. This will result in some more writedowns that we are already seeing and weaker coverage of the already precarious ordinary dividend. The company is run internally with long term thinking and exactly who we want to borrow for us. The company has a board of directors that reviews $5 million in loans, uses national third-party appraisals, and has an internal second-level review committee to review pre-funding. As a result, the preferred stocks should deliver stable double-digit returns for at least the next four years.