If you’ve ended up looking at Sachem Capital Corp. (NYSEMKT: SACH), then it must be the double digit dividend yield that brought you here. Sachem’s high dividend yield is an open secret – its four year average dividend yield is 9.8% most likely reflecting investors demanding a premium return from this micro-cap company.
Source: Seeking Alpha
Entrepreneurial micro-cap company focusing on a niche market
Founded in December 2010 and publicly-listed in February 2017, Sachem is an entrepreneurial company which provides short-term (12-36 months) secured, bridge loans (referred to as ‘hard money’ loans) to fix-and-flip real estate investors to fund their acquisition, renovation, rehabilitation, development or improvement of residential or commercial properties.
It has a simple spread-based business involving mortgage loans issued for an initial term of one to three years, bearing interest at a fixed rate of 5.0%to 13.0% per year, funded with a mix of equity capital and unsecured, un-subordinated five‑year notes issued at 6.88% to 7.75% coupon rates. It also charges its borrowers an origination fees ranging from 2% to 5% of the original principal amount of the loan as well as other fees relating to underwriting, funding and managing the loan, such as inspection fees.
It offers mortgages with a maximum loan-to-value ratio of 70% which was temporarily reduced to 50% loan-to-value during 2Q-2020 at the height of COVID-19 but reinstated to 70% as of July 2020. Moreover, it has set a maximum loan amount limit for a single borrower or a group of affiliated borrowers to 10% of the aggregate amount of its loan portfolio.
Below is some information regarding the size and type of mortgages:
Source: Investor Presentation, December 2020
Until recently, Sachem was active around its home base in Connecticut and the surrounding areas in Massachusetts, Rhode Island and New York. In 3Q-2020 it initiated lending activities in Florida and originated approx. $10 million worth of mortgages during the quarter.
So far, Sachem has posted decent profitability with return on equity ranging from 9 to 10% during the last two years as it has grown its mortgage book by 16% in 2019 and 37% y-o-y in 3Q-2020. It has also established a track-record of issuing unsecured five year notes as it primary source of funding.
Sachem has identified a market niche which a few years back was shunned by banks. In its recently filed unsecured notes prospectus, the management observes that it is facing competition from yield-chasing specialty finance entities funded by investment banks, asset managers, private equity funds and hedge funds.
Like any financial institution, the key to shareholder value creation at Sachem is efficient utilization of its shareholders’ equity. Sachem is moving in that direction by gradually increasing its leverage ratio which results in expansion of return on equity (see ROE analysis section at the bottom of table below).
Based on my back-of-the-envelope projections, Sachem could expand its Total Assets-to-Equity multiplier (or leverage ratio) to 3x over the next three years if it continues with its present pace of mortgage originations. This can allow it to increase its ROE to 16% by 2023 and grow earnings by 60% from 2020 levels.
I believe 3x leverage is the upper bound of its leverage capacity given that the unsecured notes require an Asset Coverage Ratio of 150% i.e. for every $100 of debt, Sachem should have assets or $150 and by implication, it should have equity capital of $50. I get the maximum leverage of 3x by dividend assets of $150 with equity capital of $50.
Sachem has got a decent amount of dry powder to fund its mortgage growth for 2021 after tapping the market three times in the past five months for unsecured 5-year notes at a yield of 7.75% raising approx. $50 million in total. It can issue more notes in 2022 and 2023 until it reaches the maximum leverage of 3x, and then it will need to raise more equity capital in 2023 to keep growing its mortgage book.
Given that Sachem is organized as a REIT, it will be targeting to payout most of its income as dividends. By 2023, Sachem could be valued at $6.0/share assuming a 2023 annual dividend per share of $0.60 and target dividend yield of 10%. For investors with a three year investment horizon, this means a total return of 116% over a three year period.
What’s the catch?
Sachem is a small company with total assets of $169 million as of September 2020 and stock market capitalization of approx. $89 million. In the past ten years, Sachem has successfully transitioned from a privately owned enterprise to a small public company with diversified sources of funding.
It is led by Mr. John L. Villano CPA who wears the hats of Chairman, CEO, CFO and Treasurer i.e. pretty much running the whole show. This is perfectly understandable for a start-up where all the strategy, operations and sales decisions are made by the founder.
For investor taking a longer term view on Sachem, reduction of key person risk, increase in management depth and ease of evolution from entrepreneurial stage to a more formalized organizational structure are important considerations.
Also, Sachem is in the lending business where maintaining underwriting standards while expanding the business volumes is a tough balancing act. Couple of years down the road, the number of mortgage applications being underwritten by Sachem could grow manifold from the present level of approx. 400-500 mortgages which are probably all vetted by Mr. Villano.
How to play Sachem?
For investors interested in taking exposure to Sachem, there are multiple ways to play as explained quite nicely by SA Contributor Rida Morwa here. Options range from the relatively lower risk path of generating a decent income yield but no capital appreciation by investing in the unsecured notes yielding around 7% or to the more higher risk proposition of buying the shares to get the juicier dividend yield and potential capital appreciation.
On a related note, for investors who are willing to invest in non-US companies, there is the option of Canadian mortgage investment corporations who have a more seasoned and well diversified business model of investing in residential mortgages under a pass-though structure. Atrium Mortgage Investment Corporation (OTC:AMIVF) and Timbercreek Financial Corp. (OTCPK:TBCRF) offer dividend yields in the range of 7-8% with capital appreciation potential, although US-based investors may not like the currency risk and paper work hassles.
I will conclude by saying that Sachem offers a decent dividend yield and capital prospects to investors with the risk appetite for taking exposure to micro-caps. However, the opportunity is quite small to attract any interest from portfolio managers/institutional investors and is likely to find buyers among retail investors looking to make some side bets.
If you have read this far and would like to get a notification when I publish a new article, please “Follow” me.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This report is a personal opinion only and should not be considered as an “investment advice” or as a “recommendation” regarding a course of action. Only registered investment advisers can provide personalized investment advice. Investors should get personal advice from their investment adviser and should make independent investigations before acting on any information published here.
Editor’s Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.