SACH - Sachem: How To Run From The Specter Of A Dividend Cut

Summary

• Sachem is trading at a large discount to its tangible book value as investors price in the prospect of a dividend cut.
• The worsening macro backdrop could see financials deteriorate just as the combined common and preferred share dividends are not covered by adjusted earnings.
• I'm attracted to the underlying business model and the preferred shares offer another mode of exposure.

Sachem Capital ( SACH ) is a profitable hard money lender whose common shares like many of its peers have pulled back markedly. The 43% retracement of the commons over the last 12 months has meant the company's cash dividend yield has swelled to a near-term high. The last declared quarterly per share cash dividend payout of $0.13 , in line with the prior payout, meant its yield now stands at an incredible 15.8%. This has only ever been eclipsed by the yield available at the immediate onset of the 2020 pandemic.

The question running through the mind of bulls is how sustainable the current payout is. No one wants to be sucked into a yield trap, a risk heightened by the 50% dividend cut by the company's close comparable peer Broadmark Realty Capital ( BRMK ). Highlighting just how destructive a dividend cut will be, Broadmark's dividend yield would remain above 10% in the weeks following the cut because its common shares fell markedly as income-based shareholders closed their position.

Sachem is operating under the same economic pressures that have sunk its competitor and now raises the specter of the company following through with a cut of its own. This would be one of the worst-case scenarios for its income investors.

The Safety Of The Dividends In The Age Of Volatility

A dividend cut would likely see the commons sink below $3 and would come against net income attributable to common shareholders for its last reported fiscal 2022 third quarter of $4.1 million . Adjusted earnings attributable to common shareholders was higher at $5.2 million due to adding back unrealized losses on investment securities of $1.08 million.

The business model is straightforward. The non-bank lender provides short-term secured loans to both residential and commercial real estate developers. It mainly focuses on originating loans to investors in Connecticut, New York and Massachusetts and funds its loans through notes payable. Sachem's notes payable net of deferred financing cost stood at $279.6 million as of the end of its third quarter, up from $160.5 million in the year-ago comp to form the fuel for the 58.8% year-over-year revenue growth the company realized. These notes form the long-term liabilities Sachem owes its financiers and came against mortgages receivable that grew to $448.5 million from $292.3 million in the year-ago comp.

Bulls would be right to flag that the lender is currently trading at a 39% discount to its tangible book value per share of $5.47. However, bears could state that mortgage receivables face material headwinds from the rising rate environment which would force writedowns just as the collateral experiences a pullback. The Fed fund rates are expected to increase to between 5% and 5.25% this year, a 17-year high. This comes as house prices are widely expected to experience their worst year since 2008 with prices forecasted to fall by up to 20% in 2023 . This is the worst environment for a lender that only went public in 2017 and was founded in 2010. The company has not been tested in such a landscape with much of its operating history characterized by low-interest rates, rising property values on the back of buoyant housing demand, and strong economic growth.

Single-family landlords and iBuyers are already pulling away from the housing market with Redfin recently shutting down its iBuying operations. Blackstone-backed Home Partners of America has stopped home purchases in 38 US cities. Overall, nationwide investor home purchases fell by 30% year-over-year in the third quarter of 2022, the largest decline since the 2008 financial crisis. This comes as the 30-year fixed-rate mortgage rate hovers at its more than decade-long highs. However, at 6.42% it has recently pulled back from just over 7%.

Running From A Cut With The Preferreds

The company paid $5.3 million in dividends to its common shareholders for its last reported quarter and around $900,000 in total dividends to its preferred shareholders. The combined payout of $6.2 million is in excess of the company's adjusted earnings. Whilst the dividend on the commons could be maintained due to a cash and equivalents balance that stood at $35.5 million as of the end of the third quarter, this is not a sustainable long-term strategy and would contribute to a decline in tangible book value.

The Sachem Capital Corp. 7.75% Series A Cumulative Preferred Stock ( SACH.PA ) would offer some respite for bulls from the specter of a dividend cut. They currently pay out a $1.9375 coupon for a 10.3% yield. Whilst lower than the commons, they are safer and come with a call date that's three and a half years into the future. I'm especially a fan of the $25 redemption value and its cumulative clause. This essentially means Sachem is obliged to buy these for $25 per share at the call date and pay back any unpaid coupon. Hence, there is a low risk the coupon is suspended. The preferreds owners would also stand to benefit from a 33% capital uplift on their position in the event the shares move back to their redemption price. I still own the baby bond ( SCCE ) but these offer great value.

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