2023-04-03 05:34:04 ET
Summary
- Ladder Capital was wounded in COVID-19, but managed to get back on its feet.
- The current setup is one of a high yield stock, arguably, well under liquidation value.
- We tell you why you are not getting paid for the risk.
Investors who have followed our work have seen that we have generally avoided mortgage REITs of all stripes. To us, they fit in the bucket that produces poor to extremely poor total returns over the long run. That said, you can have opportunities when things are radically mispriced. Most of the time though, these "opportunities" require nimble trading and near perfection in timing to make money. We look at Ladder Capital Corporation ( LADR ) and go over why despite the well covered yield, we think you are not getting paid for the risk.
The Company
Ladder has engaged in 3 main types of loans. Over the course of its public entity career, it has varied the proportions of these 3, but currently it is only focusing on first mortgage loans. The other two are pretty much a rounding error.
LADR Q4-2022 Presentation
Even pre-COVID-19 (Q4-2019 numbers shown below), the focus was always on this part of the lending portfolio.
LADR Q4-2019 Presentation
The individual loans are modest in size and focus on the middle market segment. Of course, if you have been reading the headlines, the most important point of your focus will be "what percentage of that is office?" That answer can be seen below as well.
LADR Q4-2022 Presentation
Direct office exposure is 25%, although some mixed use property loans will also get impacted by the office segment fallout.
Recent Results
The lead slide of the Q4-2022 was about as perfect as it could get. The distribution coverage ratio of 1.35X was further bolstered by the near $1.0 billion in liquidity.
Insider ownership is also comforting, and we think should be at a minimum of 10% for mortgage REITs which historically have not even come close to beating Treasury bonds . Ladder also complemented the giant distribution by repurchasing small amounts of stock ($7.9 million) throughout 2022. The final icing on the cake is that most of its loans have been floating with the higher rates, but its own debt is less subject to higher rates.
Valuation
Like other mortgage REITs, we prefer looking at LADR in relation to its tangible book value. You can see below that the company traded at a lofty valuation prior to COVID-19.
Post the 2020 crash, the 1.0X multiple has acted as a ceiling rather than a floor. At 0.84X, you have some margin of safety based on this alone. The 0.84X multiple is based on the GAAP value, undepreciated book value is a bit higher at $13.66.
LADR Q4-2022 Presentation
If we couple this with the information that the office segment is just 25% of the total, we have a good margin of safety. Even that 25% has to fall below the loan to value percentage to take a hit.
If we assume that all office loans are impaired by 50%, then Ladder takes about a 26% loss (18%/68%) on those loans. So the loan to value ratios protect and dampen the downside. On the other hand, there is an amplification effect because of the leverage in the corporate structure. Applying this loss to the office segment would create about a $350 million ($5.4 billion X 25% X 26%) equity loss. Arguably this is the worst case scenario for the office segment as not all office will be impaired by this amount. Even the actual losses that will flow through to Ladder are likely to be lower as there is some secured debt against this portion of the portfolio. But modeling the worst case gives us about a $3.00 per share loss. Ladder is already trading about $2.70 cents a share below tangible book value. In other words if the risks with the office segment play out in the worst manner, Ladder shares should have already discounted it.
Why We Are Not Buying
While there are many positives here in the valuation, there are also risks with the ownership of Ladder. The first being that in a recession, the drops in values are likely to spread beyond the office segment. In our view, the massive move out of bank checking accounts into money markets will freeze up lending. This will add to the stress from the maturing debts. Commercial Real Estate debt matures at the rate of $500 billion a year over the next 5 years.
Morgan Stanley
A freeze is likely to be extremely deflationary across this asset class. Further, in some office markets, the losses will easily exceed 50%.
CBRE
But our key reason for staying away from the common shares has nothing to do with anything above. It has to do with the company's debt. Ladder has a "well-laddered" debt structure.
That structure finances the loans that it issues. We don't believe any of its upcoming maturities can be refinanced at anywhere close to the old rates.
If you plug in market debt rates into the equation, Ladder's earnings would collapse. Those market rates also provide an additional reason to stay away from the equity. You can get excited about the 9.74% yield on the stock.
Seeking Alpha
Or you can get excited about the 11% yield on the debt.
Obviously a higher point in the capital structure, for a higher yield, makes more sense. Also as a side exercise, try plugging in those yields as a cost into the Ladder distributable earnings slide (spoiler alert, there are no distributable earnings left). Of course, Ladder has years to deal with rollover and likely whatever recession we have will be over long before that. Nonetheless, investors should be diligent in doing their research and checking their assumptions. The 9.7% yield comes with risks and when you can get an extra 1.5% with less risk, we would never touch the equity. At present there are some extremely high quality securities yielding close to 8% and that has been the focus of our fixed income picks. Ladder and other mortgage REIT bonds are on our watch list and we might make a move if the yields get high enough to compensate for their risks.
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.
For further details see:
Ladder Capital: 9.7% Yield, But There Are Better Choices