A dividend cut is truly one of the worst possible outcomes for a REIT investor, as it almost always comes with the dual impact of weakening the commons and reducing a crucial source of income. for the respective shareholders. Thus, when Ready Capital (New York stock market :CR) recently declared its quarterly cash dividend of $0.40 per share, down 4.8% from the previous payment, shareholders reacted by selling their positions. While the cut was less than some investors had hoped for and is now where it was in the years immediately before the pandemic, the new payout of around 12.4% has raised the specter of a further cut. .
The reduced payment which does not remain stable in the face of the economic disturbances expected this year now forms a new fear. Ready Capital is a commercial mortgage REIT that acquires, originates, manages and finances real estate loans and real estate related securities. The mREIT held a portfolio worth $10.2 billion at the end of its last reported third quarter of fiscal 2022. These were more than 5,500 loans in 50 US states and Europe, of which approximately 99% were first liens.
How safe is the reduced payment?
Ready Capital made a net profit of $66.3 million for its third quarter of fiscal 2022, it was about $0.53 per share and up 12% from net income of $59 million in the prior second quarter. It generated distributable earnings of $58.2 million which, at $0.46 per share, just covered the previous quarterly dividend payment of $0.42 per share. The mREIT’s net book value per share at $15.40 per share was an increase of about $0.12 from $15.28 per share in the second quarter. This puts the current price of the commons at a 16.6% discount to book value.
Around 66% of the portfolio was made up of bridge financing, with commercial mortgage-backed securities making up the second largest position at 11% of the portfolio. The mREIT made investments totaling $1.5 billion during the quarter, including $831.1 million focused on SBC creations and acquisitions, $534.3 million in residential mortgages and $133.6 million in dollars on loans from the US Small Business Administration.
Originations and acquisitions in SBC, the largest segment, consist of loans across nine products, including mid-market construction, and target a yield of 4% to 10%. The fundamental basis of an mREIT is to use leverage to invest in income-producing assets with the idea that the cost of funding will be lower than the income earned from the assets. As a result, higher federal funds rates have the effect of increasing interest on loans made by Ready Capital. However, this also increases the cost of financing.
This is mainly reflected in the gross leveraged yield which decreased by 80 basis points compared to the previous second quarter. Managing this combination of higher funding costs and higher loan origination rates provides the basis for dividend stability in the quarters to come. The company held cash of $200 million at the end of the quarter, so the reduction was largely in response to some pressure on its leveraged gross yield. I think it’s unlikely there will be any further reductions this year.
Purchase stability with Series E Preferreds
Ready Capital Corp. 6.50% Series E Cumulative Preferred Shares (New York stock market :RC.PE) pays an annual coupon of $1.625 for an 8.16% return on cost. Although it is more than 400 basis points lower than the yield available on the commons, the two yields are not at the same level. Preferred shares are a form of fixed income exposure and have several characteristics that incorporate stability while maintaining healthy returns.
First, they come with a cash value of $25. This means that Ready Capital will have to buy them back at some point in the future at $25 per share, about 20% more than their current price. This redemption event is scheduled for June 10, 2026. However, there is no obligation for the company to redeem on this date, it just has the option to do so. Thus, potential preferred stock investors can buy an asset at a 20% discount to face value, or about 80 cents on the dollar. This creates a very healthy return profile over the next three years until the redemption date.
Assuming Ready Capital redeems the Series E Preferred Shares on its stated redemption date in the summer of 2026, its holders should expect total coupons of $5,281 from today until then. This would be aggregated with a capital payment of approximately $5 per share on redemption for a total nominal return of approximately $10.281 per share, a 50% yield to redeem over the current preferred stock price. If you think the commons can deliver an even return over the next three years and four months, you can ignore the privileged. The mREIT could very well redeem itself at par years after that date to disrupt that projected return.
Crucially, with their cumulative clause that means any unpaid coupon accumulates for eventual redemption and their relative stability, preferred stocks might be worth further consideration by risk-averse income investors. I’m neutral on the commons but the still double-digit return after a cut seems safer.