RCC - Ready Capital: 3 Reasons To Not Get Bearish Down Here

2023-10-25 09:00:00 ET

Summary

• Ready Capital Corporation has cut its distribution, but the reduction was less than what we expected.
• We go over three reasons why bears should exercise caution at these levels.
• We also tell you which security likely beats the common by a mile.

Our recent coverage of Ready Capital ( RC ) stock focused on the distribution. In May 2023, we targeted a distribution reduction from 40 cents to 25 cents.

Realistically, 25 cents a quarter is what is sustainable after the two companies merge. That does not mean that they need to cut right away. Overpayment can sometimes continue for a long time in the case of REITs before the reality is acknowledged.

Source: Quite The Deterioration In Q1-2023

We doubled down on distribution unsustainability in August.

But it will decimate the distribution coverage. RC was struggling in Q1-2023 to produce 40 cents of distributable earnings with a 5.1X leverage. There is no way in Hades they are going to cover it with a 3.5X leverage.

Source: Leverage Vs. Distributions

The company did cut its distribution to 36 cents a share . The stock has fallen about 13% since the May article but total returns have been buffered by large distributions.

We go over where we stand with it today and give you three reasons why investors should not push bearish bets here.

1) A Cut In Time, Saves Nine

The distribution cut was rather minor relative to our expectations. At the same time, we expected the RC to likely delay the decision a bit and pay the 40 cents amount for perhaps 2-3 quarters. By cutting it early, RC protects book value and also signals that it is "ready" to make adjustments as required. It also has likely chased away those who want a steady income source. There is less selling pressure ahead when the next distribution cut comes.

2) Valuation Is Not Too Bad

The key for mortgage REITs is always tangible book value and leverage. It definitely is not the distribution yield. Income chasers should note that RC's large distribution has partially been funded with an eroding book value. That is why if you consumed the distributions, you are sitting 3.36% annualized returns.

Of course, some may ignore the unrealized capital losses, but those unrealized capital losses are the exact reason your distribution was cut once again. That all said, RC's price to tangible book value ratio is in an attractive zone. Ignore that big drop lower and bounce back in 2016. That is a chart error. Overall, the 10 year median was such that RC traded at a modest premium to tangible book value (1.087X).

Of course most of it was during ZIRP (Zero Interest Rate Policy), so one has to be cognizant of that. But even adjusted for that and the plethora of issues that the company likely has ahead in its asset books, we think 0.75X is close to the worst levels we should see. That does not mean it cannot go lower. We could be wrong and/or tangible book value could erode as losses pile up. But there is a time to be negative and this really is not it.

3) Leverage Improves Odds Of Positive Returns

Here, by leverage we mean the low leverage that RC sports. RC's acquisition of Broadmark completely changed its leverage profile. Broadmark had virtually no leverage to speak of and the equity issuance left RC light as a feather. At 3.5X to 1, RC is about as low as it has ever been on the leverage front. This improves confidence in point number two, that the current tangible book value multiple represents some sort of a floor.

Outlook & Verdict

Q3-2023 will likely show more stresses creeping into RC's asset books. We have already see a bit of this but it should accelerate into the recession. At a 3.5X leveraged ratio though, RC will likely weather this relatively well. A key question will be as to when they dial the leverage back up. If they start doing it now, we would expect poor returns over the next 15 months. If they wait, things should be ok. From a tactical stand point, we would consider a trading buy under $9.00 and a sell rating over $11.50 for this stock.

Ready Capital Corporation 6.50% CUM PFD E ( RC.PR.E )

This remains our "preferred" investment choice for investing in RC. While the current yield of 9.4% may be less enticing than what we are getting in some other investments, the lower leverage alongside a far higher total equity cushion (from the Broadmark merger), add appeal to this security. One has to also consider here that RC's 10 year total returns for those that consumed the distributions, was just 3.34% annually. In that context, going higher up the capital structure for a 9.4% yield, which is 600 basis points over RC's performance primarily through ZIRP, seems like a no-brainer to us. We are long this one.

Ready Capital Corporation 6.25% CNV PFD C ( RC.PR.C )

This yields only 8.3% and is an expensive relative to RC.PR.E. The likely factor here is the potential convertibility.

It still strikes as odd that there is such a premium here considering the conversion price and RC's extremely poor history of NAV preservation. We would avoid this one or consider switching to RC.PR.E.

Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.

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