Ready Capital Stock: The 12.4% Yield Is Still Exciting (NYSE:RC)

A dividend cut really is one of the worst possible outcomes for a REIT investor as it almost always comes with a dual impact of weakening the commons and reducing a crucial source of income for respective shareholders. Hence, when Ready Capital (NYSE:RC) recently declared its quarterly cash dividend of $0.40 per share, down 4.8% from the prior payout, shareholders responded by selling their positions. Whilst the cut was lower than some investors expected and is now at the level 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 payout not remaining stable against the economic disruption expected this year now forms a new fear. Ready Capital is a commercial mortgage REIT that acquires, originates, manages and finances commercial real estate loans and real estate-related securities. The mREIT held a portfolio worth $10.2 billion as of the end of its last reported fiscal 2022 third quarter. This was constituted by over 5,500 loans across 50 US states and Europe with around 99% being senior lien.

How Safe Is The Reduced Payout?

Ready Capital earned a net income of $66.3 million for its fiscal 2022 third quarter, this was around $0.53 per share and a growth of 12% from a net income of $59 million in the prior second quarter. It drove distributable earnings of $58.2 million which at $0.46 per share just covered the previous quarterly dividend payout of $0.42 per share. The mREIT’s net book value per share at $15.40 per share was an increase of around $0.12 cents versus $15.28 per share in the second quarter. This places 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 forming the second largest position at 11% of the portfolio. The mREIT made investments totalling $1.5 billion during the quarter with $831.1 million of this concentrated on SBC originations and acquisitions, $534.3 million in residential mortgage loans, and $133.6 million on US Small Business Administration loans.

SBC originations and acquisitions, the largest segment, is made up of lending across nine products including middle-market construction and targets a return of 4% to 10%. The fundamental basis of an mREIT is to use leverage to invest in income-bearing assets with the idea that the cost of financing will be lower than the income derived from assets. Hence, rising Fed fund rates have the impact of boosting the interest on loans originated by Ready Capital. However, it also increases the cost of financing.

This is most reflected in gross levered yield which was down by 80 basis points from the prior second quarter. Managing this blend of higher financing costs and higher loan origination rates forms the basis of the stability of the dividend in future quarters. The company held cash of $200 million at the end of the quarter, hence, the cut was very much in response to certain pressures on its gross levered yield. I think it’s unlikely that there will be any further cuts this year.

Buying Stability With The Series E Preferreds

Ready Capital Corp 6.50% Series E Cumulative Preferred Stock (NYSE:RC.PE) pays a $1.625 annual coupon for an 8.16% yield on cost. Whilst this is more than 400 basis points lower than the yield available from the commons, both yields are not on the same level. The preferreds are a form of fixed-income exposure and come with several features that embed stability whilst maintaining healthy returns.

Firstly, they come with a $25 redemption value. This means that Ready Capital will at some point in the future have to buy them back at $25 per share, around 20% higher than their current price. This redemption event is slotted in for June 10, 2026. However, there is no obligation for the company to redeem at this date, it just has the option to do so. Hence, prospective investors in the preferreds can pick up an asset at a 20% discount to their par value, around 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 preferreds at 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 payout of around $5 per share at redemption for a total nominal return of around $10.281 per share, an 50% yield to call from the current price of the preferreds. If you think the commons can deliver an equal return over the next three years and four months, then you can ignore the preferreds. The mREIT could very well redeem at par years after this date to disrupt this projected return.

Fundamentally, with their cumulative clause which means any unpaid coupon accrues for eventual repayment and their relative stability, the preferreds might be worth further consideration by risk-averse income investors. I’m neutral on the commons but the still double-digit yield after a cut does seem safer.