Sachem Capital Stock: 5 reasons why SACH will have strong 2022
I have written about Sachem Capital (SACH) several times in the past, but refrained from establishing a significant position until I saw significant progress in their earnings. I own shares of competitor Broadmark Realty Capital (BRMK) based on an attractive valuation at the time of purchase (~ $ 9.15 end of November 2021), as the stock had sold as a result of the behavior broader market risk surrounding the latest COVID resurgence.
Last year’s performance of BRMK and SACH with a strong divergence in recent months. From portfoliovisualizer.com
However, by 2022, I believe Sachem has a better chance of delivering superior returns through its multidimensional approach to earnings per share growth. Below, I’ll briefly touch on the five most important reasons why Sachem should have a great year.
Before starting, I want to quickly remind readers of Sachem Capital’s business model. The company provides high-cost loans primarily for the construction and renovation (fixed and reverse) of residential and commercial properties. The company is primarily active in the northeast, but has also recently expanded its presence in Florida and Texas. For those wanting a more in-depth look at operations, I encourage you to check out Brad Thomas’ recent article here.
When I first researched Sachem Capital a few years ago, I assumed that the high degree of safety in protecting capital in the event of default is simply because their loans are prioritized ( the first to be paid) and secured (secured by the underlying property). What I haven’t given them credit for is their ability to cross-insure with additional properties and / or rent payments from the debtor’s other cash assets. If I had known this rarely discussed feature, I would have bought shares by hand when they dropped $ 2 per share in the wake of the COVID pandemic in 2020.
In addition to their ability to negotiate possible defaults with increased collateral from their debtors, the amount of money pumped into the economy in 2020 and 2021 has significantly lowered default rates on many loans. According to Fitch Ratings, the default rate on institutional leveraged loans was 0.6% in 2021, the lowest in a decade. Admittedly, the amount of loans granted by Sachem is tiny in comparison and are not granted to large institutions, but I think that this nevertheless represents a good indicator. Many defaults on the industry’s balance sheets are legacy loans from early 2020, not new defaults. Each time these old loans are paid, the fixed capital is returned to the companies for reinvestment.
5 reasons why Sachem will prosper in 2022
1. Churchill buyout contract
Sachem secured a new superior financing method in July 2021 with Churchill Real Estate. Until recently, this had not yet been used in any meaningful way, but it will be a huge boon for the company in the future. In fact, I like the deal as a potential investor for two big reasons.
First of all, the rate is very low. Churchill will charge a cost of capital of 4.25%, but will lower the rate as more capital is drawn on the deal. This could result in effective rates of around 3.5%, as it is used more towards the $ 200 million limit.
Second, I trust management, but I also like the concept that another large institutional credit and lending entity, Churchill Finance, also confirms the credit quality of the loans it reviews as part of its agreements. with Sachem. This is essentially another look at all of Sachem’s loans.
2. New bond issue and debt refinancing
Sachem recently issued $ 45 million in unsecured bonds about two weeks ago, plus an over-allotment of $ 6.75 million for total proceeds of just under $ 50 million. The notes carried a 6.0% coupon and were due in 2026. This is the lowest rate Sachem has ever been able to obtain through bonds or preferred stock, and although Broadmark has been able to obtain 5.0% a month earlier, it still represents an excellent move by management.
Outside of the Wells Fargo margin, this is what the debt situation looks like:
$ 23,663,000 x 7.125% = $ 1.686 million
$ 34,500,000 x 6.875% = $ 2.372 million
$ 56,363,750 x 7.75% = $ 4.368 million
~ $ 8.426 million in interest per year
New notes of approximately $ 50,000,000 at 6.0% represent $ 3 million
This money could theoretically be used to eliminate most of the debt of 2024, resulting in the following (without considering fees or penalties):
$ 7,500,000 x 6.875% = $ 0.516 million
$ 56,363,750 x 7.75% = $ 4.368 million
$ 50,000,000 x 6.0% = $ 3 million
~ $ 7.884 million in interest per year after notional refinancing
Annual savings of $ 542,000 on interest charges on approximately 29 million shares amount to 1.9 cents per share, or 0.5 cents per quarter. This would require no special skills, expand the company’s debt maturity profile, and create additional wiggle room with the dividend payout ratio (last quarter earnings and dividend were both 12 cents per year. action), allaying some fears and potentially causing an increase in public investment.
Smaller and growing companies like SACH rarely go this route, however, I could also see them using the proceeds to invest at around 12% and achieve a spread of around 6%. The towel’s calculation suggests that this could generate around $ 300,000 per quarter in net income, or about $ 0.01 per share.
3. Awaiting training from PSPC
Last July, SACH filed the documents with the IPO of a PSPC they had just formed as a subsidiary. I expect this offer to materialize soon, as it has been a while. Sachem intends to hold shares in the company after the IPO, which could value the company at around $ 57.5 million assuming an over-allotment. Essentially, this is a public fundraiser for an investment vehicle that will turn a modest initial investment from SACH into a decent-sized operating company. This has the ability to make a significant contribution to SACH’s consolidated financial statements for years to come. I am optimistic about this course of action despite Broadmark’s liquidation of their private investment vehicle due to the relative size of each. At the time of liquidation, Broadmark’s private REIT was $ 42 million in size, compared with a market capitalization of about $ 1.35 billion for the parent company. Sachem’s stake in SPAC could be worth more relative to its market capitalization at around $ 172 million. This has the ability to move the needle for the latter business only.
4. Despite competitive pressure, the portfolio’s return remains high
One of the main concerns regarding the secured bridge loan investment space is the increasing competition. Broadmark and Sachem are just two of the companies providing these loans. In the last year or so, other companies that I know of have made forays into the same or similar investments. New Residential (NRZ), one of my most important positions, just completed the acquisition of Genesis Capital, which provides development loans to residential real estate. iStar (STAR) has started its own special version of development finance with Ground Lease Plus, which provides bridge loan financing for a property from groundbreaking to stabilization. This then feeds into their normal ground lease loan portfolio.
While these are not always in direct competition with Sachem per se, there is enough competition for Broadmark to warn investors that the expected return on their portfolio will continue to decline:
As of September 30, the return on our portfolio was 15% down from 16.6% a year ago. And over the next few quarters, we expect the portfolio’s return to stabilize in the 11% to 12% range – Jeff Pyatt, CEO of Broadmark
However, Sachem has been successful in keeping its portfolio performance high and continues to charge origination fees to help cushion any cut in the base rate. They’ve also gone for larger prime loans, which will help offset the lower rates with slightly higher margins on the expense side.
5. The term risk is very low due to short term loans
The same short-term positive effect of abundant and cheap currency on default rates can have long-term negative effects on fixed rate loans if interest rates rise to fight inflation. However, duration risk is only really an issue for longer-term investments (obviously) such as bonds over 10 years. The typical loan term in this industry is around 12 months (Sachem’s average is 11 months), which means that if interest rates rise, the loan proceeds will be quickly reinvested at those higher rates. The vast majority of Sachem’s financing is fixed rate debt, which also shields the company’s balance sheet from increased interest charges.
I am optimistic about this investment space and the very fragmented market associated with it. There is no reason why lenders like SACH, BRMK, NRZ, etc. cannot continue to be very profitable. The main reason why these companies have not been able to exploit their immense potential is related to the challenges of COVID of speeding up foreclosure procedures and being able to redeploy capital in a timely manner. Going forward, this should be less of a problem, and the aforementioned five reasons listed in the article should give Sachem Capital a fantastic future ahead of it.