Sachem: I’m out of this world and in the bond of the baby (NYSE: SCCE)
I am no longer with Sachem (NYSE: SACH) common stocks due to deteriorating credit market conditions, the looming prospect of a recession and the recent dividend cut. The strange 7% dividend cut raised the question of whether management is overwhelmed and not inspiring confidence in the face of what is shaping up to be one of the toughest macroeconomic conditions for real estate since the 2008 global financial crisis.
First, although management said the cut would happen on its previous earnings call, it basically didn’t make sense that the quarterly cash payout would be increased and then immediately reduced afterwards. The company’s ordinary shareholders are primarily income investors seeking stability. Unnecessary downward moves in terms of payout would rightly shake confidence in management. An additional dividend payment should have been used if management wanted to return excess cash to shareholders. When combined with the lack of fixed reporting dates and their small cap status, the bulls wonder if the company will be able to fully weather the current economic malaise.
Don’t throw the baby out with the bathwater
The 6.00% Notes due 03/30/2027 (NYSE: SCCE) offer more stability with fixed coupon payments. The baby bond was issued earlier this year as part of a $50 million debt offering and comes with an annual coupon of $1.50 paid quarterly and currently trades at $20 per share . This is a 20% discount on their cash value of $25 and for a current yield of 7.5%. The bonds are part of the company’s financing structure which includes seven other baby bonds and preferred shares.
Although they carry no voting rights, bonds rank higher in the capital structure than stocks. Bond interest payments are a legal obligation and are payable before tax. Non-payment of the coupon would mean a default in dividend payments which can be waived whenever the company faces financial difficulties.
Sachem recently announced its results for its third quarter of fiscal 2022, which saw revenue of $13.5 million, a 58.8% increase over the prior year quarter and in accordance with consensus expectations. This was due to an increase in originations, which increased loan interest income to $11.5 million from $6.1 million in the prior year quarter.
The company recorded $4.1 million in net income attributable to common shareholders, which translates to EPS of $0.11. Additionally, non-GAAP adjusted EPS of $0.13 exceeded consensus estimates by $0.01. This was driven by adjusted earnings of $5.2 million and helped support a $7.5 million share buyback program as the company takes defensive measures to protect its finances in the face of deterioration. macroeconomic outlook. This will see a reduction in its typical loan terms. The acquisition of New Haven is also meant to be a defensive measure to be expertise in all phases of construction in-house. Management believes this will reduce the risk associated with distressed properties and allow Sachem to take on larger, more profitable construction loans.
The macro environment has heightened risks
Real estate continues to be rocked by back-to-back interest rate hikes as high inflation forced the Fed to take aggressive action. The Fed funds rate is now between 3.75% and 4%. It is expected to be increased by at least another 50 basis points when the Federal Open Market Committee meets in December.
What is the impact ? A further increase in financing costs for developers and speculators alike. Sachem offers fixed and flip loans, bridging loans, new construction and refinancing. As a result, federal funds rates reaching new highs will put further pressure on an already shrinking real estate market.
Sachem’s loans remain short-term as they are usually granted for a period of 12 to 36 months. Short-term loans mitigate the company’s exposure to interest rate fluctuations and allow for a more agile approach to lending in their core markets as the environment changes over the coming year.
Freddie Mac’s main mortgage market survey put the 30-year fixed mortgage rate at 7.08%, a significant increase from a year ago when rates hovered just above 3%. That’s against Fannie Mae’s home buying sentiment index which fell to its lowest level since 2011, when it hit 56.7 in October, its eighth consecutive one-month decline on the other. As mortgages become increasingly unaffordable for millions of people, real estate transactions will slow dramatically and send the market into a state of shock.
The median sale price for existing homes is down, down 7% from the recent high of $413,800 to $384,800. The short-term outlook for the US economy is also poor, with a recession expected in 2023. However, interest rates are expected to peak in early 2023 and inflation to approach the Fed’s target in the second half of the year. .
This rare combination of negative economic growth, high inflation and rising interest rates will further accelerate the downward trend in housing confidence and provide further impetus to the decline in house prices. As a result, Sachem could face a high rate of loan defaults, which could affect its ability to pay a covered dividend on its commons. This led to the baby-bond move, with the commons likely to continue to face near-term headwinds from a capital gains perspective.