RCC - Ready Capital: Two Dividend Cuts Later And The Broadmark Acquisition Stings

2023-12-23 00:42:52 ET

Summary

• Ready Capital has cut its dividend for the second consecutive time to $0.30 per share.
• The mREIT currently offers a fat 11% dividend yield and is now trading at a 24% discount to its third-quarter book value of $14.42 per share.
• Distributable EPS of $0.28 means that the rightsized dividend is still not covered.

Ready Capital ( RC ) pushing through two back-to-back dividend cuts has been a sobering experience for its shareholders. The mortgagee REIT's all-stock merger with the residential and commercial real estate lender Broadmark Realty earlier this year has yet to achieve its stated aims with heightened earnings volatility, a disrupted dividend, and a still ominous payout ratio now forming the legacy of the merger. The mREIT last declared a quarterly cash dividend of $0.30 per share , a 16.7% sequential decline for an 11% annualized forward dividend yield. RC described the dividend cut as a "temporary" reflection of the merger while expressing confidence that the integration with Broadmark will deliver long-term earnings accretion. An odd justification as two consecutive dividend cuts on the back of the merger were not flagged by management earlier this year when the combination was announced.

However, the mREIT currently represents a quite steep value proposition with a GAAP net book value of $14.42 per share at the end of its fiscal 2023 third quarter. RC's current market cap of $1.88 billion means it's currently trading hands for a 24% discount to book value. The portfolio is being disrupted with Broadmark having a remarkable 27% of its loans in default at the time of the merger, a metric that shaped my initial description of the RC merger as saving Broadmark from the brink.

RC has four other outstanding securities that offer a safer play on the ongoing integration with Broadmark. There are two preferreds and two baby bonds; Series C ( RC.PR.C ), Series E ( RC.PR.E ), 6.20% Senior Notes due 2026 ( RCB ), and 5.75% Senior Notes due 2026 ( RCC ). The Series E currently offers an 8.5% yield on cost and at $19.13 per share is trading at a roughly 24% discount on its $25 per share redemption value. For common shareholders, the question is whether the twice-rightsized distribution is sustainable against broader macroeconomic risks with the double-digit 11% dividend yield for 76 cents on the dollar forming inherently compelling reasons to buy.

Underwriting Quality And Dividend Coverage

RC's NAV has broadly been on the up over the last five years on the back of acquisitions from Mosaic in 2022 and Red Stone in 2021. The current discount opened up once the Fed started raising rates and could get tighter once rates start being cut back down.

RC realized a third-quarter interest income of $250.6 million , up from $186 million in the year-ago comp and by $17.7 million sequentially due to the inclusion of Broadmark's portfolio and what was a 25 basis points increase in the weighted average coupon in the SBC loan portfolio to 9% . RC's levered yield did decline to 10.8% on the back of the inclusion of Broadmark’s lower 7% portfolio yield which weighed down on the average. Levered yields should increase to historical levels as the mREIT cycles out of the Broadmark loans and into new production. RC realized net interest income after loan losses of $71.13 million during the third quarter, up 6% versus its year-ago comp with a $12.15 million provision for loan losses recovery driving growth during the quarter. This recovery was fully attributable to movements in the general loans under RC's performing loan book. Realized gains dipped by $6.7 million year-over-year due to lower funds realized from the settlement of derivatives.

GAAP diluted EPS during the third quarter was $0.25, down 50% versus the year-ago period with RC generating $0.28 of distributable EPS. This means the current dividend is just 93% covered by distributable EPS, a roughly 107% payout ratio. This lack of coverage forced the recent dividend cut and infers more possible near-term pressure. The optics of a third consecutive dividend cut would not be great and I think another cut on the back of RC flagging the December cut as temporary would materially impair the mREIT's investability and the entire strategic rationale provided when the merger with Broadmark was proposed.

Risk Ratings And 2024 Outlook

The bulk of RC's loans are still with a 1 and 2 risk rating with the mREIT also benefiting from Broadmark's largely unencumbered portfolio and liquid balance sheet for a reduction in net leverage. However, the average risk rating of the portfolio has been rising with SBC loans seeing quite a substantial sequential rise in risk to 2.3 from 2.07, an 11% increase. Further, a huge 30% of SBC loans acquired are also in default. The outlook for 2024 will continue to be clouded by rising non-performing loans until a step change in performance. RC flagged during their third-quarter earnings call that there will be more near-term pressure. The commons are a hold for current shareholders but I don't plan to purchase the commons even at their current discount to book.

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