Legacy Nonperforming Loans And REO Pressures Will Challenge Real Estate Lending Recovery Potential

Catalysts

About Sachem Capital

Sachem Capital provides short term, collateralized real estate lending solutions and related real estate investments focused primarily on residential and small balance commercial assets.

What are the underlying business or industry changes driving this perspective?

• Although lower benchmark rates and tighter bank credit create a larger opportunity set for private lenders, Sachem may struggle to convert its strong pipeline into high quality originations quickly enough to offset a smaller performing portfolio and drag from nonaccruals, which could limit near term revenue growth.
• While the ongoing housing affordability gap and persistent preference for renting support demand for bridge and multifamily finance, elevated NPLs and a concentrated Naples exposure could continue to pressure credit costs and constrain improvements in net margins even as new deals are added.
• Although Urbane and Shem Creek provide embedded access to development and multifamily finance that can scale with recovering transaction volumes, protracted foreclosure timelines and REO carrying costs may consume liquidity and mute the impact of these higher yielding platforms on earnings.
• While management has extended debt duration and increased secured capacity to support future loan growth, higher funding costs and the need to maintain covenant cushions could force more conservative leverage, which may cap the pace at which interest income and fee revenue can rebound.
• Although post COVID originations are performing well and are structured at attractive double digit yields, the time needed to fully resolve legacy NPLs and recycle capital back into newer vintages may delay a sustained recovery in book value per share and common equity earnings power.

Assumptions

This narrative explores a more pessimistic perspective on Sachem Capital compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts. How have these above catalysts been quantified?

• The bearish analysts are assuming Sachem Capital's revenue will grow by 165.5% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from -942.5% today to 29.0% in 3 years time.
• The bearish analysts expect earnings to reach $21.2 million (and earnings per share of $0.34) by about December 2028, up from $-36.8 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 3.6x on those 2028 earnings, up from -1.4x today. This future PE is lower than the current PE for the US Mortgage REITs industry at 13.1x.
• The bearish analysts expect the number of shares outstanding to grow by 0.81% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 9.04%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• The large legacy nonperforming loan portfolio of $104.1 million, including the highly concentrated $50.4 million Naples exposure that remains on nonaccrual, could take longer and prove more costly to resolve than expected, restraining revenue and keeping earnings under pressure.
• Persistent elevated levels of REO at $18.9 million and the strategy of intentionally converting more distressed loans into owned real estate may increase property tax, maintenance and preservation costs over time, compressing net margins even if top line revenue grows.
• Funding growth with high cost debt, such as the 9.875% senior secured notes and other facilities tied to relatively elevated benchmark rates, while maintaining firm loan pricing, may not fully offset interest expense if competition forces yield compression, limiting future earnings growth.
• Secular headwinds in real estate, including stretched housing affordability, weak existing home sales and ongoing permitting and construction hurdles, could continue to weigh on origination volumes and keep a higher mix of loans in nonaccrual, dampening revenue and delaying improvement in credit related earnings.
• Maintaining dividend payments that currently exceed GAAP net income, as evidenced by aggregate preferred and common dividends of about $3.5 million against breakeven quarterly profit, risks further erosion of book value per share and may undermine long-term earnings power if not aligned with sustainable cash generation.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bearish price target for Sachem Capital is $1.2, which represents up to two standard deviations below the consensus price target of $1.48. This valuation is based on what can be assumed as the expectations of Sachem Capital's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $2.0, and the most bearish reporting a price target of just $1.2.
  
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2028, revenues will be $73.1 million, earnings will come to $21.2 million, and it would be trading on a PE ratio of 3.6x, assuming you use a discount rate of 9.0%.
  
• Given the current share price of $1.09, the analyst price target of $1.2 is 9.2% higher.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.