A Little Risk for a 10% Reward

Never stopping in the search for a little extra yield without extraordinary high risk I stumbled across an old friend ( a security I held previously for some amount of time) that may well be worth a minor position in a portfolio generally characterized by conservative holdings.

I have been looking at the 6.50% $25 Senior Notes of REIT Ready Capital (RC) which trades under ticker RCP. This issue was originally issued by Sutherland Asset Management which was the company’s previous name.

These senior notes have been callable since 4/29/2019 and offered a early call bonus of 1% (callable at 101% of $25) until 4/30/2020–after which it is callable under more normal terms – $25 plus accrued interest.

The baby bonds closed at $24.13 today (Wednesday) and have been trading perfectly flat at this level for over 1 month.

Now the interesting part of this baby bond is that it will reach maturity on 4/30/21–about 10 1/2 months from now. The bond goes ex-dividend (interest) next Monday 7/12 (for a 7/31 payment) which means that an investor could garner 4 interest payments prior to maturity and additionally if bought at $24.13 there will be a capital gain of 87 cents. This means a gain of 10.3% is possible if held to maturity in 10.5 months.

Now as you might expect with the potential 10.3% return you will be taking more risk than a security with potential for a 5% return–that is what this game is all about–risk/reward.

Ready Capital is a mREIT and the lions share of the loans they make are in the small and medium sized commercial marketplace–honestly in the current environment this is a ‘dicey’ part of the market. RC is a company of $5.3 billion in assets with shareholder equity of $775 million. The company announced a loss of $50.4 million on the most recent quarterly earnings compared to profit of $29.4 million a year ago. It would not surprise me a bit if the company reported substantial losses for the next 2-3 (or more) quarters as the commercial end of the mortgage will be very messy as this recession unfolds.

The company recently cut their common dividend from 40 cents/share to 25 cents/share and may well cut again–or even suspend it.

We can’t recommend this security since every single reader has different needs–different risk tolerances–but I personally will get at least a starter position with consideration to adding in the future as economic conditions unfold.

For those wanting a position in these shares make sure to go through the SEC 10-Q below which provides data not only on the companies financials, but gives explanations about which segments of the marketplace the company operates in.

The latest 10-Q for the quarter ending 3/31/2020 can be read here.

48 thoughts on “A Little Risk for a 10% Reward”

    1. Aview, I make no judgement of this issue, but this guy is a train wreck, so seek supporting facts before following his lead. His picks leave a monetary trail of tears longer than the Cherokees endured. Hell he thought Amtrust debt was A rated, but didnt realize that was subsidiary companies claims paying ability, not the holding company debt he was touting which was closer to CCC rating than investment grade.
      I think his service “Panic Investor” is most appropriate as I would be in full panic mode watching my portfolio shrink with his ideas. He is in my opinion one of those half ass balance sheet “experts”, knows just enough to get himself in trouble.

  1. recent RC securitizations seem positive for this RCP strategy. traded flat today at around $24.10 [ex-D 7/14].

    Ready Capital Corporation Announces Completion Of Two Securitizations
    07/10/2020
    NEW YORK, July 10, 2020 /PRNewswire/ — Ready Capital Corporation (NYSE: RC), a multi-strategy real estate finance company that originates, acquires, finances and services small- to medium-sized balance commercial loans, announced today the completion of two securitizations, totaling $609 million, in the second quarter of 2020. First, a $405 million commercial real estate collateralized loan obligation secured by 56 originated floating-rate transitional loans. The Company sold 80% of the capital structure to investors with a weighted average blended interest rate of LIBOR plus 236 basis points and the most senior bond priced at LIBOR plus 215 basis points. Second, a $204 million fixed-rate securitization of 228 acquired small balance commercial real estate loans. The Company sold 85% of the capital structure to investors with a weighted average blended interest rate of 4.0% and the most senior bond priced at 3.43%. The proceeds from the securitizations were used to reduce the Company’s secured borrowings by approximately $430 million and generated approximately $60 million in cash.

    At June 30, 2020, the Company had unencumbered cash of approximately $225 million, an increase from the Company’s March 31, 2020 unencumbered cash balance of $122 million, and secured borrowings of approximately $1.2 billion, a 25% decrease compared to the Company’s March 31, 2020 secured borrowings balance.

    “We are very pleased with the successful completion of two securitizations in this challenging market and believe the attractive pricing reflects the markets positive view of our small-to-medium business lending model,” said Thomas Capasse, Chairman and Chief Executive Officer. “In the face of increased volatility and market instability, the closing of these securitizations is a testament to our focus on increasing liquidity and reducing mark-to-market liabilities. These transactions enhance our liquidity to further support our opportunistic growth initiatives in the current market environment.”

    http://ir.readycapital.com/investor-relations/News/news-details/2020/Ready-Capital-Corporation-Announces-Completion-Of-Two-Securitizations/default.aspx

    1. That is interesting news on Ready Capital, aview…not sure what it means for the company’s long term prospects, but they seem to have stabilized their portfolio and their liquidity in the near term. Another cut to the common dividend may be on the horizon for RC, but the note holders should be OK.

    1. Bill W, I agree with you on WCC-A. The parent is making money in what is considered an essential business. You’re not having to deal with REIT losses and instability. The 10%+ return is set for 5 years before reset. It feels significantly less risky than this REIT.

  2. Sure feels like the tech bubble will eventually pop like it did 20 years ago, FANG & associated tech stocks rallying while value stocks get decimated. It’ll be an interesting shorting opportunity once QQQ rolls over

  3. I think RCA the 2023 bond is the better buy. If they can get through the next 10 months which will be very rocky, then it should be reasonably smooth sailing to 2023. Most of the risk for RC is in the next 2-3 quarters.

    1. A word of caution on the RCA notes, they are convertible to common shares or some combination of cash and common shares starting in August 2021.

      1. Citadel – RCA is like a busted convertible, isn’t it? The ability of the company to call is limited – “On or after August 15, 2021, we may redeem for cash all or any portion of the notes, at our option, if the last reported sale price of our common stock has been at least 120% of the conversion price then in effect for at least 20 trading days (whether or not consecutive), including the trading day immediately preceding the date on which we provide notice of redemption, during any 30 consecutive trading day period ending on, and including, the trading day immediately preceding the date on which we provide notice of redemption.” The initial conversion price at the option of the holders was at 1.4997 shares of common stock per $25 principal amount of Notes, which is equivalent to an initial conversion price of approximately $16.67 per share of common stock. I don’t know if that initial price has changed but with RC @ 7.80, I don’t think callability for cash or shares is much of a factor right now. U agree?

        1. Offhand 2wr…no, I don’t think RCA is ‘busted’. Ready Capital experienced a sudden drop in common share price related to uncertainty caused by the economic shut down, not some fundamental problem with the company. Other similarly effected mREITs have bounced hard on positive news, so I think it’s too early to draw any hard conclusions about an early redemption.

          1. My point is that my only concern about any call would be the company’s ability to pay for a conversion with shares instead of cash… Given the limitations on the conditions necessary for them to evoke a call, a holder of RCA will have plenty of opportunity to cash by selling RCA well in advance of any potential elected call by the company so as to not end up with common shares if that’d be a concern to others as it would be to me… There’ll be no surprises. And yes, I agree that the target price might not be all that far off if things ever normalize, but still, right now RC would have to rise 260% before RCA would be callable at the company’s option.

            1. Just to play devil’s advocate…what would prevent Ready Capital from doing a reverse 1:3 stock split to bring the common share price up to meet the conversion provisions? They have 55M common shares out standing and converting RCA to common @ $16.67 would add back roughly 6M shares. This would bring the new total of shares outstanding down to about 24M while reducing debt by $100M.

              1. Citadel, if they do a reverse split on the common, you have to then adjust the conversion shares appropriately for RCA. The shares represent a value of the market cap, hence you cant change the # of shares and increase the value 3 times of the market cap. If allowed, this is giving a fraction of the increased shares and hence RCA drops 66% in value overnight. You would have chaos for conversion investments if this would be allowed as splits could either create or destroy wealth. Companies would do this all the time, and it would be like printing money for free.

                1. My idea was sound, but I think my math was off :-). Since this was a reverse split (share price goes up, and shares of stock goes away), the # of conversion shares for RCA would have to go down because there are less shares of common stock because of the reverse split. So actually if this was allowed, RCA investors would make out like bandits.

                  Regardless… if the # of common shares are split up/down (ex. 3:1 or 1:3, …), any conversion investments based on the # of common shares has to adjusted as well. You can’t create/destroy wealth by not adjusting the conversion shares. This is because # of shares and the value at creation time was based on a market cap. Increasing/decreasing # of shares cant change your market cap.

                  1. Yes, Mr. Lucky I agree. I have observed a few of these splits with “convertibles” and they were always adjusted afterwards to match it.

                2. > You would have chaos for conversion investments if this would be allowed as splits could either create or destroy wealth. Companies would do this all the time, and it would be like printing money for free.

                  oooh, it happens 🙂 I’ve seen securities where they don’t get adjusted for splits. nice insider enrichment scheme

                3. Good morning Lucky…I’ll disagree with your premise that a 3:1 reverse stock split would cause the shares to tank. Reducing the number of common shares outstanding makes the remaining shares more valuable, which is why many companies engage in share buyback programs. Some upward adjustment would have to be made for dividends, but that would also be price supportive going forwards.

                  Ready Capital was paying $.40 per share and trading around $16.00 before the pandemic, and recently reduced that to $.25 per share. To be equitable, they could raise the dividend after the reverse split back to $.40 or even $.50 per share…a reasonable amount to compensate existing shareholders and an attractive yield for new ones should the existing shareholders decide to sell.

                  None of these changes would be feasible until there were signs the pandemic was over, but for a small cap mREIT like Ready Capital where bankruptcy is a real possibility, it might make sense… and RCA investors would be fully compensated under such a reverse split conversion program, whereas under Chapter 7 they’re left holding a bag.

                  1. The part I cant get over though on reverse splits is they seem to cure the symptom but never the problem. I seen issues like Chesapeake and Frontier do massive reverse splits only to continue cratering even more. I dont understand whats under the hoods of these cars, so I dont typically kick the tires here. Maybe my investing “T” level has gotten so low, I need to go to the Doc for a “T” shot, ha.

                  2. Hi Citadel. I think technically 3:1 means a 3 for 1 stock split. You get 3 more shares where before you had just 1. This happened a lot with tech companies in the 2000’s. A 1:3 would be reducing your shares. Splits are also used to manipulate liquidity. The outcome is not 1 size fits all. Too many factors at play with investor confidence, # of years the company has been around, ratings, CEO, and dozens of others.

                    Can you explain what you mean by “Reducing the number of common shares outstanding makes the remaining shares more valuable?”

                    In my opinion, companies buy back stock for several reasons and making them valuable is probably not the top reason.
                    – Corporate taxes are really cheap, and it is an easy way to dump money into after capital investments, payback on loans, etc.
                    – A big reason why they buy back stock is that companies earnings and evaluations of return on investment and other metrics are “masked.” Why? You can make your earnings look really good when you have fewer shares. The sad thing is that companies are doing this when they should be paying down debt. But… their earning look better and better when they are really not improving or increasing.
                    – A big reason why companies buy back stock is because over time this will increase the price of your stock, and hence the continual rise and march upward in the stock market, and hence inflated prices. Increase in share prices make board members, CEO’s, etc happy because some times the share price affects millions in bonuses.

                    Your thought on them removing shares and then boosting the dividend back is an interesting play. Can they do it? yes. Many investors want investment confidence. Having CFO ‘s that play financial games is not going to garner investment confidence in my opinion. Playing games like this can also warrant SEC investigations, and let alone the thousands of vulture law firms that will have them in court for the next decade. I cant imagine what the stock price would be decimated to as who would want to put their hard earned money into a company that does this? You could never trust anything from them.

                    1. Hey Lucky…Normally a company will simply issue additional common shares to raise capital, a practice which dilutes shareholder value. Very hard to grow equity when more shares keep getting added. For example, Medical Properties Trust (MPW) did this for years as a way to raise capital, to the chagrin of long term investors like myself. MPW acted more like a bond than a stock until they finally started issuing some debt to fund their expansion. In the simplest terms…reducing the number of shares makes each remaining share more valuable and vice versa.

                      In the case of Ready Capital, a reverse split/RCA conversion preserves shareholder value and strengthens the balance sheet. I haven’t looked closely, but offhand Ready Capital will need an extra $50M cash when RCP matures in 2021 and another $100M cash in 2023 if RCA is allowed to mature. A private equity lender might look favorably on a deal which rolls the $50M due in 2021 into another unsecured debt vehicle with a 4-5 year term on similar terms, with the proviso that the $100M due in 2023 is converted to equity via a reverse stock split. Maybe the PE lender also takes an equity stake in the deal, although there are plenty of other ways they could get paid. All this would be contingent on Ready Capital not having suffered a permanent portfolio impairment as a result of the pandemic, and the pandemic ending before the $50M debt matures. I have to imagine Ready’s cash reserves are going to be constrained going forward and that this reverse split + debt to equity conversion would have some appeal.

                  3. Citadel – Could you explain what you mean by “with the proviso that the $100M due in 2023 is converted to equity via a reverse stock split?” How do you figure a reverse split will allow RCA to be converted to equity? The terms of the conversion in the original prospectus on RCA would be adjusted to take into account the reverse split, right? So a reverse split wouldn’t bring RCA any closer to exposure of a company mandated conversion to stock, would it? What am I missing?

                    1. GM 2wr….Absent a ‘fundamental change’ which would give note holders the opportunity to demand cash, I’ve found nothing preventing Ready Capital from converting RCA to equity once the terms of early redemption have been met. I could also find no verbiage in the prospectus defining an adjustment to the share price redemption trigger requirements should there be a split or combination of shares. What constitutes a fundamental change is defined in the prospectus and stock splits and combinations are excluded.

                      I’m not a lawyer, but so far I’ve seen nothing indenturing Ready Capital from combining common shares in a reverse split to meet the share price requirement and converting RCA notes to equity shares after Aug 15 2021. There may be some adjustment needed to the number of common shares a RCA note holder would get if such an event took place, but nothing I’ve found would obstruct or prevent it.

                    2. CW, to stay within your market cap for the value you have for your outstanding shares, a 1:2 split will cause outstanding shares to go to 27.4 m and a 1:3 split will cause your outstanding common shares to go to 18.2 m. The price of the shares then either go to 8.3 ish or 16.7 ish depending on the split. With me so far?

                      If you do not change the conversion # of shares, essentially you are giving the bond holders twice the # of shares for a 1:2 split, and you are giving them 3X the # of shares for a 1:3 split. If initial formula of 1.4997 shares times a fair value estimate at the time in the fall of 2017 yielded $25… then you are in a sense either now turning their $25 bond into a $50 bond, or even a $75 bond. If you dont change the conversion # of shares to either .74985 shares or .4999 shares the bond doubles or triples in value. With me so far?

                      This is why you do the conversion because you are instantly giving the bond holders 2 or 3 times the value when the common stock holders have the EXACT same value they had before. Their shares got cut in 1/2 or by 1/3, but their share price doubled or tripled, but in the end it is the EXACT same value they had before. But their friendly bond holding neighbors just now doubled or tripled their money. With me so far?

                      So now the company tries to implement this scheme and they have to come up with twice the amount or triple the amount of money to pay off the bond holders in cash or in stock (in prospectus). This is because 1.4997 shares was based on a market cap of a fair value estimate of the common shares being $16.67. Those shares are now worth double or triple the value because you did a split. 1.4997 shares are worth a whole LOT MORE after the split. … let alone the company NOW has to come up with twice or triple the amount of shares for the bond holders for the conversion. They will have purchase a lot of shares just for the bondholders.

                    3. forgot to post the current price of $8.02. 1:2 split will cause it to go to $16.04, and 1:3 split will cause common share price to go to $24.06. I had the double and triple #’s for share price incorrect.

                    4. Hey Lucky…Yes, RCA note holders would gain a little extra depending on where the share price is at conversion and when it occurs, but a reverse split would not double or triple the value of the RCA notes on conversion. The conversion adjustment table shown on p. S-44 of the prospectus has the adjustment values and limitations.

                      I’d also disagree that the company would have to purchase the common shares used to redeem the RCA notes, as opposed to simply issuing new shares to satisfy the terms of equity conversion.

                    5. CW – My eyes quickly glass over when trying to understand the actual formulas but did you consider the language on p 35 of 424B5 prospectus dated 8/7/17 under “Conversion Rate Adjustments? https://www.sec.gov/Archives/edgar/data/1527590/000104746917005057/a2232938z424b5.htm I’m not about to dust off my algebra skills to try to interpret what it actually says, but I bet the math formulas protect against what you’re suggesting… I can’t cut and paste because of the math formulas involved otherwise I’d paste it in here…. I’d be surprised if this is not the protective language needed.
                      .

                    6. Very cool, sounds like you have this all figured out. This is why I enjoy investing. We each have our own interpretation of accounting, investing, laws, etc,. This is what makes a market. I work for one of the big banks, and I have spent the last year working very closely with our law department, building NLP models, identifying Libor related contracts, identifying fall back language, etc. There is one thing I have learned from our law department. They spend thousands of hours writing these contracts, so that they dont have to spend thousands of hours in litigation. They are pretty strict on the language. This is why these contracts are 100-500 pages in length.

                      I did take the time, and did find it in the prospectus that they will adjust the conversation rate if the common stock splits up or down. I would have expected this from any standard law department. I unfortunately have had the experience of reading hundreds of these over the past year to identify buyer, lender, agents, margins, fall back language, principal, and about 30 other fields, and hence this was pretty easy to find. If you dont find it.. well, lawyer speak is a little different from the average joe.

                    7. Doh. nice work 2whiteroses. You get the brownie points. Yes that is the standard formula for calculating conversion rate after a split. My back-of -the-napkin math was correct after using the formula. Post conversion rate = Pre conversion rate multiplied by Post common shares / Pre common shares.

                      The formula also proves that if you dont do the conversion, the bonds will double in value for a 1:2 stock split. This is why lawyers write these things. Imagine… boom your $10,000 investment is now worth $20,000 on stock split day. Congrats!

                    8. Mr. Lucky – Back in my working days, pre-computer databases, I was fortunate the firm I worked for had an actual library of old prospectuses for munis… That gave us a huge competitive advantage We used to peruse the prospectuses when situations came up and look for forgotten language not being properly applied… Most of the time it worked advantageously but one time we actually had a trustee conclude that though it was obvious what the lawyers intended the language to convey, that’s not what was written… So even though everyone agreed what should be done, it wasn’t going to happen.. Nice…… So I get what you say about lawyers spending hours writing to avoid spending hours in lit…………….

                    9. Mr. Lucky…All right come clean time…Best guess since you are working with Libor contracts. What do you think will happen to the old Libor adjusted preferreds? They usually have the standard 3 bank overnight whatever if Libor isnt available. You think they will stick to that or go to that SOFIl (whatever it is I aint looking now). Or be nice and add a bit since it is a lot lower…Or just revert to last libor and stick to it? Or be nice and just redeem and reissue something from scratch?

                    10. Grid, we probably have another 6 months to go on the project. One of the machine learning models we built were for classification of fallback language in the contract. This is where we are teaching the model what weak, medium, and strong language looks like in a contract.

                      The ones with weak fallback language are basically ones that dont have paragraphs discussing what happens when libor goes away. I believe they talked about going through a process to cancel and re-issue the contract which will be a painful process. These should be replaced with SOFR, and they will also have strong language when/if SOFR goes away to prevent this madness from happening in the future.

                      The ones that have strong language clearly define what happens when libor goes away. These are all unique to language in that specific contract. For example it could have language that if the libor metric goes away, the last known libor rate will be used going forward. If strong language already exists for what happens, the contract will stand as it is, and use whatever is stated there. It does not automatically go to SOFR.

                      I believe the ones with medium language will have to be gone through one by one by lawyers. That is because they have some specifics, but might need an amendment to the contract to clarify what happens. This will probably take the most time.

                      Lots of contracts need to be processed that are of the floating type. Mortgages, Corp loans, etc.

                    11. GM 2wr…I took a look at the equation you’re referring to on page s-35. The equation and the governing clause around it are intended to protect note holders from a large dilution of common shares caused by a merger or acquisition by inflating the adjustment factor accordingly. In a reverse split the equation you referred to has the opposite effect, reducing the adjustment factor to reflect the reduced share count. If a 1:3 reverse split were determined to be a ‘fundamental change’ that allowed note holders to convert their shares as per the s-35 equation, I doubt there would be many takers.

          2. cw
            I agree with you but there is another issue with rc which is that they bought out another firm about 6 or 8 months ago and the combination does not seem to have gone as smoothly as it might. I’m not that close to rc so I do not know the story but my feeling is that the issues here are greater than the economy as such. Liked their story but was concerned even pre covid. best SC

  4. Off topic, but saw yesterday that NGHC was being acquired by Allstate for $4B. This caused a big bump in the common as might be expected. For me, I have owned a large chunk of NGHCN for more than a year at average about $21 per on average. It had been trading recently around $24 but bumped up to $25.60s on the acquisition news. Looking for ideas here – is it a sell at $25.50+? What happens with it as a result of the acquisition? Thoughts welcome.

    1. expect them to be called sometime in 2021

      hold for now collect income and your capital gains are locked if you have average cost of $21

      im holding the nghcz issue

    2. There is a lengthy discussion of NGHC on the “Reader Initiated Alert” page. Rather than start another discussion of it here (which is off topic of this thread), you may want to join that discussion.

  5. Thanks Tim. I added a full position in this one a couple weeks ago. Also bought a few shares of RCB last week which is their 2026 baby bond.

    1. Gary–I would have done the same sooner–just no time to hut for stuff–too much ‘real work’.

      1. For little risk what about NLY-d. It is a 7.5 fixed, can be called anytime but is selling less than $25 and with libor almost 0 it looks to me to be better than their fixed to floatings. Am I missing something?

        1. If NLY then why not NLF-f, NLY-g earch trading in $20-$21s and thus yielding over 8%? These do not switch to floating tille 2022/2023

          1. My thought was to be safer and get fixed at a speck lower yield but with more safety. I assume that no matter what the economy does the fixed with a chance of being called at 25 would always be paying 7.5 and be eligible to be called probably before the lower floatings. Whereas the floating with a libor for who knows how long will be extremely low could go up….but could also go down. A year ago i felt differently on floatings. I figured libor would at the least be at two and probably be a lot higher so floating was not an issue…maybe even a plus. I’m in my mid seventies so want to be as risk free as possible. a bird in the hand

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