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Two Great Income Options, Yields Up To 10.2%, From Sachem Capital
Jul. 15, 2019 8:35 AM ETSachem Capital Corp. (SACH), SCCBLOAN78 Comments20 Likes
Summary
Sachem Capital (SACH) is a hard money lender.
Their location is prime for their type of lending.
Our primary concern for SACH has been solved.
This 10.2% yield bargain will not last for long.
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Co-produced with Treading Softly and Trapping Value for High Dividend Opportunities
Previously, we covered Sachem Capital (SACH) and highlighted the opportunity to invest in this niche lender. At that time we stated:
Based on our analysis, this stock offers 40% upside potential in addition to the 10.6% yield.
Since then, SACH has risen 19% and paid a dividend to its shareholders.
ChartData by YCharts
Major Concern Solved - Liquidity
We had one major concern regarding SACH, it was running out of easy money to grow. Their credit lines were used up and they were low on options. As previously mentioned, management filed a universal S-3 registration at the end of the third quarter of 2018 to help fund growth outside of their credit line. In this registration, SACH can issue up to $100 million in various types of securities (preferred, common stock, other debt instruments like bonds) and use these funds to further their growth. Basically, management is providing themselves all avenues to best reward shareholders while not slowing their growth.
To date SACH has issued $16 million worth of shares at the market through this registration. SACH has been doing so carefully. SACH's portfolio yields 12.74%while its shares currently yield 9.8%. This means ATM, at the market, share issuance has become more accretive since our last report.
Growth Is Supported by Company Size
Another concern brought up concerning SACH is continued growth. SACH is a small company with a small number of employees. As they continue to grow, they will need to hire more people, train them and pay those expenses prior to seeing the payoff in growing their portfolio. Thankfully, this is already in play. Last quarter, SACH's operating costs rose faster than their income which put pressure on their net income. What caused this? Preparing for the growth we are looking for from SACH. This exchange was a great foretelling for SACH investors:
Paul Drees
But you're suggesting or saying you think you've got the structure in the back office to support another $20 million of equity?
John Villano
“Yes. I think the personnel cost is now where it should be, and I don't see any further increases in that area. We will see increases in interest income.”
SACH's management consistently mentioned an additional $20 million in portfolio size and growth without at that time highlighting how it would be possible to produce it. SACH has wisely built up its back office support and systems to support their growth prior to taking any major actions. Normally for larger companies these increased costs would be minimal compared to their own going expenses, for SACH it was more noticeable. Its dividend remained strongly covered during this process - supporting strong FFO per share growth moving forward. We know now that their plan was to raise capital not through common share issuance, but through a baby bond.
SACH has a Baby Bond - SCCB
SACH issued out its $23 million in its inaugural baby bond last month. It trades under the name of Sachem Capital Corp., 7.125% Notes due 6/30/2024(SCCB) and yields 7.125% matures 6/30/2024 and is callable 6/30/2021. This baby bond net SACH $21.7 million in capital for use.
SCCB issues its first dividend on 9/30/19 and makes payments on the 30th of March, June, September and December. It also offers common sense provisions for protection - restricting additional debt and raises in common stock dividends unless 150% coverage is maintained on SCCB.
SCCB's proceeds will be used by SACH to pay off its revolver. This will allow SACH to reuse its revolver as needed to fund new loans. Given that SACH's portfolio yields 12.74% - SCCB provides room for SACH's new loans to be accretive to the tune of 5.612%. This is obviously a vast improvement from issuing boat loans of common equity to achieve the same goal.
SCCB currently yields 7% and is a strong buy for conservative income investors. Note that SCCB has lower volume than most investors are acquainted with, so limit orders are a must.
This Removes Our Largest Near-Term Concern
When it came to SACH our largest near-term concern was their ability to find funding to grow. Their S-3 filing provided a multitude of options for them to grow but at that point SACH has only used its common equity. Now SACH has used $39 million of this $100 million filing. I would expect it SACH finds the ability to continue to conservatively originate loans that additional bonds or preferred shares are not out of the question. The Co-CEOs are also SACH's largest shareholders and have been extremely shareholder friendly to date. They don't want to hurt their equity and thus won't hurt yours.
How Is The Housing Market?
SACH is extremely exposed to Connecticut housing market. This affects them in two ways. First, it helps them in their lending process evaluate if a property will appreciate or depreciate. Secondly, it helps them evaluate overall loan activity.
https://static.seekingalpha.com/uploads/2019/7/2/saupload_GBVVQRURLNDZNEXT5MCC55AGBY_thumb1.jpg
Source
As a hard money lender, all their loans are backed by real assets - property. Lending activity in CT remains strong but home sales and values are seeing a trend of weakness. January through March, home sale prices dropped 2% in CT. This however hasn't weakened SACH's ability to originate loans. Why? That is because demand remains robust and above their ability to fill it. They stated it this way:
To wrap up, we are encouraged by the outlook for the business and remain fully committed to our goal of providing investors attractive risk-adjusted returns. Our lending platform is solid and sustainable, given our strict underwriting criteria and extensive due diligence. The demand for our loan products and services remain strong as traditional lenders are unable to satisfy demand. We are encouraged by our ability to compete effectively with larger market participants and will continue to build a larger more efficient platform to conduct our business operations. We remain fully committed to conservative lending.”
SACH's non-traditional, less than 3 year, loans, are unable to qualify as mortgagesin the mind of banks and traditional lenders. These short-term loans also provide protection from changing rates and real estate value fluctuations. CT is not a hot market to build new homes, and often current homes are older in age. This provides a prime market for house flippers to come in and revamp old homes to resell - these are the exact clients that SACH's lending appeals to.
Key risks
SACH is facing increasing competition for banks and the CEO alluded to this in the latest conference call.
Notwithstanding, the Fed's rate increases in 2018, we decided not to raise our rates in order to remain competitive and capture market share. In retrospect, given that the demand for our products continues to be strong, it seems that our strategy was correct.
Based on our analysis to this point, we do think that it still has room to grow but future margins could be a bit lower than in the past.
SACH also has higher default risks from being concentrated in a single market. The company does neutralize this to some extent by conservative lending practices. Below is an excerpt from its 10-Q.
As a matter of policy, we do not make any loans if the loan-to value ratio exceeds 70%. In the case of construction loans, the loan-to-value ratio is based on the post-construction value of the property. Under the terms of the Webster Facility (described below), mortgage loans exceeding $250,000 require a third-party to complete an appraisal of the collateral. Failure to obtain such an appraisal would render the loan ineligible for inclusion in the borrowing base. In the case of smaller loans, we rely on readily available market data, including tax assessment rolls, recent sales transactions and brokers to evaluate the strength of the collateral. Finally, we have adopted a policy that limits the maximum amount of any loan we fund to a single borrower or a group of affiliated borrowers to 10% of the aggregate amount of our loan portfolio after taking into account the loan under consideration.
To put 70% in the right context, the average LTV in US was 86% in 2018.
https://static.seekingalpha.com/uploads/2019/7/5/47392447-15623634037547104.png
We believe this does create the right additional buffer for the shares.
Finally, while we believe the underlying real estate collateral for SACH is sound, SACH can take time to liquidate real estate in case of defaults and in a crunch it might get into an "asset-rich-cash light" situation as it maximizes values of its properties on liquidation.
Key Takeaways
SACH remains a strong niche lender with a history of sound growth. There immediate issue of liquidity has been soundly solved in a highly accretive manner. Investors considering buying SACH should look to get in under $5.50 and enjoy SACH as it rises to best its only peers pricing - Manhattan Bridge Capital, Inc (LOAN). Last article we encouraged LOAN investors to consider switching from LOAN to SACH for a better investment choice.
ChartData by YCharts
During this time SACH has continued to pull away from LOAN and remains the stronger choice.
SACH’s current yield of 10.2% will not last long. As the market sees the improved results due to the added liquidity at cheap prices compared to their portfolio yield. Their share price will rise and provide additional dry powder for SACH to grow. SACH historically issues out set dividends and a larger “catch up” style dividend at the end of the year. Investors buying at these prices should expect to actually see a higher yield due to this “catch up” dividend. The march to $6’s continues for SACH.
For fixed income investors, the baby bond SCCB with a yield of 7% provides conservative choice to collect solidly covered dividends and have exposure to this niche lending sector. SCCB is suitable for conservative investors and is a strong buy too.
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Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.
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Disclosure: I am/we are long SACH, SCCB. 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 stock is mentioned in this article.
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Comments (78)
Newest
Comment author depsee
depsee
Comments (372)
Jul. 16, 2019
Seams to be a lot of negative comments about this company. I looked into it and decided to buy after reading Rida's last article about it. Up 22% as of this moment. Thank you very much.
1 Like
Comment author Treading Softly
Treading Softly
Comments (2.16K)
Jul. 16, 2019
@depsee I feel you there. I bought when I wrote my original article many months ago and am up significantly
1 Like
Comment author depsee
depsee
Comments (372)
Jul. 17, 2019
it wasn't very long ago I read Rida's last article.Sounded interesting and done some studying and decided to buy. I was looking for a excuse to dump m-reit TWO which has been a dog for me. With dividends re-invested I had been down around 25% give or take a while now. I dumped TWO and bought SACH and within a short time Im up over 20%. A good trade off I would think.
2 Likes
Comment author Maggot44
Maggot44
Comments (77)
Jul. 16, 2019
way overpriced, 4 buck stock
Comment author Trapping Value
Trapping Value
Comments (15.47K)
Jul. 16, 2019
Is that "4 buck stock" calculated the same way you got the length of the company's public history? Because I would get a $9-$10 in the same cas
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