RCC - Ready Capital: A Fat 14.5% CRE Yield After The Merger With Broadmark

2023-09-03 07:16:42 ET

Summary

• Ready Capital is paying out a 14.5% dividend yield.
• The mREIT is also currently trading for 76 cents on the dollar following its merger with Broadmark Realty.
• There is some dividend uncertainty as its payout ratio sits at 111%.

Ready Capital ( RC ) last declared an aggregate quarterly cash dividend of $0.40 per share , in line with its prior payment and for a 14.5% annualized forward yield. The income is the prize, and Ready is paying out a fat double-digit yield that would be the highest in over a decade if the pandemic was adjusted out. This comes off the heels of the closure of the mortgage REIT's acquisition of Broadmark Realty, a move that I initially stated presented a type of salvo for Broadmark's long-suffering shareholders, who had seen their equity position and dividend cut in half. To highlight the prior criticality of the situation, Broadmark's total principal outstanding for loans in default was $250.4 million on 40 loans and against a total loan portfolio of $1.42 billion as of the end of its fiscal 2022 fourth quarter.

Is the ticker a buy? It depends. The mREIT's yield has moved to new highs because market confidence in its coverage has waned with a miss on earnings also recorded for its recent fiscal 2023 second-quarter earnings. However, the Fed funds rate has likely reached its peak at 5.25% to 5.50% with the market currently pricing in a 94% chance that the Fed keeps rates unchanged at the next FOMC meeting on the 20th of September. This is up from an 80% probability a week ago on the back of US jobs data that saw unemployment rise to 3.8%. This has raised hopes of a Goldilocks economic scenario where the US economy stages a soft landing with inflation coming back to the Fed's 2% target.

The Discount To Net Book Value

Ready reported revenue of $364.53 million for its second quarter, a growth of 195% over its year-ago quarter as it included Broadmark's financials. The mREIT's portfolio had a $10.4 billion average carrying value and a 14.2% levered yield as of the end of its second quarter, rendering it the fourth-largest commercial mortgage REIT. Ready also made $1.1 billion in total investments, comprised of $512 million of SBC originations and $424 million of residential mortgage loans. There were also $121 million of US SBA loans made during the quarter.

Critically, Ready's capital net book value of $14.52 per share means the commons are currently swapping hands at a roughly 24% discount to net book value. To be clear, Ready is currently offering a historic 14.5% yield for 76 cents on the dollar. Management is cognizant of the discount and initiated a $100 million stock buyback program at the start of June. This saw roughly 1.7 million shares of the Company’s common stock bought back at an average price of $10.82 and for a total consideration of $18.39 million during the second quarter

This discount is not as pronounced across the universe of the mREIT's publically traded securities. For example, its 5.75% Senior Notes due 2/15/2026 notes ( RCC ) are currently swapping hands for a 2.32% discount to their $25 par value, just under 98 cents on the dollar, whilst offering a 6.14% yield on cost. The price follows NAV, and the direction of Ready's net book value on a nominal basis over the last 5 years has been upwards. Hence, the current discount seems awkward when set against this and likely opened up due to uncertainty around the consolidation of Broadmark and the current macroeconomic backdrop.

Dividend Coverage

Ready reported GAAP earnings of $1.87 per share with distributable earnings at $0.36 per share, around $46.88 million, and a $0.01 miss on consensus estimates. For some context, Ready alone reported distributable earnings of $0.31 per share in the prior first quarter and $0.48 in its year-ago period. Hence, Broadmark's contribution to distributable earnings has been marginal at best, with the consolidated entities around 12 cents below Ready's year-ago figure. This was expected, with Broadmark's end of 2022 fourth quarter seeing a GAAP net loss of $153 million and distributable earnings prior to realized loss on investments of $12.3 million.

Hence, the REIT is paying out around 111% of its distributable earnings as a quarterly dividend. Not only does this eliminate the possibility of a dividend raise of the type you'd expect of the consolidation of the two entities, but it also raises the specter of a dividend cut. However, the REIT wouldn't have embarked on a $100 million stock buyback program if the near-term viability of its dividend was threatened. Ready had cash and equivalents of $227.8 million as of the end of the second quarter, and was clear during its second-quarter earnings call that it intends to pay out a dividend that is equal to a 10% ROE. Hence, with net book value at $14.52, this would imply a dividend of $1.45 per share, around $.363 per quarter. Management stressed they want to establish a distribution that is consistently covered by distributable earnings to imply some leeway around coverage for some quarters until better dividend coverage. However, they were also clear that the board would be open to a cut if this metric does not improve. Hence, I'm neutral on a position in the ticker, even though shareholders are still likely to enjoy a double-digit yield in the event the dividend was rightsized to reflect distributable earnings.

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