The Best Vote Of Confidence Is Having 'Skin In The Game'

Summary

• I am pleased to see this puppy bounce as I knew a long time ago that this company had all of the ingredients of something special.
• It took a while for the big money players to get serious with Ladder, but it appears that the pre-IPO shareholders have moved on, and trading volume has picked up.
• We believe that based on the latest earnings results and strong “skin in the game,” there’s more room to run.
• Members of my private investing community, Intelligent REIT Investor, receive access to my breaking news coverage of this idea. Get started today >>

My first research article on Ladder Capital (NYSE:LADR) was over three years ago, and since that time I have maintained optimism regarding this uniquely-positioned commercial mortgage REIT. In November 2016 I explained,

We like LADR for all of the obvious reasons - internal management, low dividend payout ratio, diversified sources of income, and experienced management team. We would like to see LADR take a few steps to get more visibility in the marketplace - like issuing preferred shares. Also, we would like to see a more diversified ownership base, reducing concentration with some of the heavy hitters.”

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Boo-yah back at ya’. Yup, I am pleased to see this puppy bounce as I knew a long time ago that this company had all of the ingredients of something special. It took a while for the big money players to get serious with Ladder, but it appears that the pre-IPO shareholders have moved on, and the average daily trading volume has picked up quite a bit.

In addition to being internally-managed, Ladder has a few more distinct differentiators, including:

• A robust origination team with 20 originators in 2 offices, including 7 Managing Directors
• Long-standing direct borrower and key broker relationships nationwide
• Loyal client base - more than 50% of balance sheet loans to repeat borrowers
• Certainty of execution and ability to act quickly with key decision makers in the same building
• Flexibility to originate and manage multiple CRE products
• Leveraging deep CRE credit expertise through the capital stack

Additionally, one of the best things I like about Ladder is the fact that management and directors own over $185 million of stock (that represents over 12% of total equity market cap). That goes without saying, senior executives can talk all they want, but the best vote of confidence is putting one's own money on the line just like outside investors. It makes a big difference when there’s plenty of “skin in the game.”

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Inside Ladder

Ladder Capital is a diversified commercial real estate company that was formed in 2008 and went public in 2014 (as a C-Corp). The company's primary business strategy is to originate and securitize first mortgage loans on stabilized, income-producing, commercial real estate properties. LADR is one of the largest non-bank contributors of loans to CMBS securitizations in the U.S.

However, LADR has a unique model in which the company does not rely exclusively on securitization for its revenue and has other diversified sources of revenue, including earning a significant portion of its revenue from first mortgage balance sheet loans and property rentals as well as expanding its market share in the commercial mortgage loan origination market.

In 2014, LADR commenced the necessary steps to convert from a C-Corp into a REIT structure, and during the first quarter of 2015, the company received shareholder approval to convert to a REIT (On March 2, 2015, LADR said that shareholders had approved the plan to restructure as a REIT).

LADR has maintained a disciplined credit culture throughout the organization with zero credit losses since inception. The company operates as an internally-managed REIT (the other peers referenced are externally managed) that originated first mortgages secured by commercial real estate and invests in commercial properties and highly-rated CMBS (commercial mortgage-backed securities).

LADR has stable and diverse income streams from Commercial Real Estate. The company's tactical approach to the mREIT sector is rooted in the flexible manner in which it can interact in periods of change.

The company has three main business lines - lending, investment‐grade rated securities, and real estate equity (mostly net lease) - adding up to over $6 billion of assets. This multi‐cylinder approach is inherently safer than a mono‐line approach and better able to produce profits through cycles and a wide range of market conditions.

As you can see, the "blue" shaded slices represent the lending segment, the "green" shaded slices represent owned real estate, and the "orange" shaded slices represent CRE securities.

The Lending Portfolio

LADR's Senior Secured Balance Sheet business represents a majority of revenue and this business is similar to Blackstone Mortgage Trust (BXMT) and Starwood Property Trust (STWD). Generally, LADR's loans are for 2- to 5-year terms.

Approximately 96% of balance sheet loans are first mortgages and this inventory has grown 46% over the last 12 months. During Q2-18, Ladder funded $479.8 million of balance sheet loans. The average spread for LIBOR on new floating rate loans was 584 basis points.

The third quarter is also off to a good start: Ladder originated a total of $179.6 million in balance sheet loans at an average interest rate of 8.149%, resulting from a spread to LIBOR of 602.4 basis points. Of the total commitment, Ladder has funded $140.93 million to date.

During this past quarter, Ladder originated a total of $711.9 million of loans. Ladder's portfolio of balance sheet loans increased over $3.76 billion, up from $3.53 billion at March 31.

There are three components of this portfolio. The quarterly growth was in the floating rate first mortgage component of the portfolio, which stood at $2.98 billion at June 30 and represented 79.2% of the total balance sheet loan portfolio with an average mortgage loan interest rate of LIBOR plus 5.59%.

The fixed rate first mortgage component of the balance sheet loan portfolio decreased by $22.8 million to $623.3 million at June 30 and is earning a weighted average coupon of 5.21% with a weighted average remaining term to maturity of 1.92 years.

The final major component of the balance sheet loan portfolio is $157.9 million of mezzanine loans, which was almost unchanged during Q2 and had a weighted average coupon of 10.82% at quarter-end. This portfolio is financed by a combination of CLO debt, FHLB advances, and committed loan repurchase facilities.

Securities Segment

While Ladder expects its balance sheet lending business to be the primary driver of core earnings in the year, the company also expects securitization activities, along with rents from and sales of select real estate assets, to supplement quarterly earnings.

Ladder’s gain on the sale securitization business was also a contributor to core earnings in Q2-18. Ladder contributed a total of $400.8 million of loans into three securitizations, earning an average net profit margin of 2.1% from the sale of these loans.

During the month of July, Ladder has originated $65.75 million of loans intended for securitization with a weighted average fixed interest rate of 5.24%.

Ladder's conduit loan balance was $107.7 million at the end of the quarter during which Ladder originated $232.1 million of new conduit loans, while contributing $400.8 million principal balance of loans to three securitization transactions. Those securitizations generate $8.5 million of core gains.

As a result of a steady and methodical reallocation of capital for investments in CMBS and into balance sheet loans and real estate investments in recent quarters, approximately 76% of net revenues over the past four quarters have been derived from recurring sources of earnings. This increasing trend in recurring net revenues has been ongoing since Ladder's IPO in 2014.

Real Estate Segment

The final leg to the stool is Ladder's equity platform - representing around 12% of capital. As I explained in a recent article, this part of Ladder’s business is the most misunderstood, “LADR has over $378 million of equity invested in this segment, and the company continues to believe this is an underappreciated component of holdings with embedded value in excess of book.”

Ladder expects to sell the remaining seven condominium units at Veer Towers by year-end. The company has sold 420 units at Veer Towers through June 30. Ladder also expects the sellout of the Terrazas condominiums within the next 18 months or so as there are 36 units remaining from an original inventory of 324 units. During Q2, core gains from the sales of condominium units totaled $1.4 million.

In Q2-18, Ladder acquired five net least assets, with remaining lease terms averaging 14.5 years for a total of $6 million, in addition to a 75% equity interest in a 40-property, 641-bed portfolio student housing units in Southern California.

Balance Sheet

As of June 30, 2018, around 96.8% of Ladder’s debt and investment assets were senior secured including first mortgage loans and commercial mortgage-backed securities secured by first mortgage loans, which is consistent with the senior secured focus of the company.

Senior secured assets plus cash comprise 76.9% of the total asset base. Total assets stood at $6.39 billion, 2.5% higher than at the end of Q1-18. Quarter-end total equity was $1.5 billion, resulting in an adjusted debt-to-equity ratio of 2.66 to 1.

Total unencumbered investments including cash were $1.7 billion at quarter-end and unsecured debt outstanding stood at $1.2 billion, reflecting an unencumbered assets to unsecured debt ratio of 1.46x.

The weighted average loan-to-value ratio of the commercial real estate loans on the balance sheet at June 30, 2018, is approximately 67%, in line with prior quarters. On the financing side, Ladder had $4 billion of core debt outstanding and committed financing availability of $2.3 billion for additional investments.

Over the past four quarters, Ladder has further enhanced the diversity of its funding base through the issuances of unsecured corporate bonds, non-recourse CLO debt, and the addition of long-term non-recourse mortgage debt to finance real estate. When combined with the $1.5 billion of permanent equity and $174.5 million of other liabilities, $4.3 billion (or 67%) of Ladder's capital base is comprised of equity unsecured debt and non-recourse non-mark-to-market debt.

Ladder had the full $241.43 million capacity of its syndicated unsecured revolving credit facility available to be drawn upon as needed.

Ladder has also extended the maturities of two of its existing bank financing facilities. The final maturity of those facilities is in 2022 and 2023, respectively. As was the case in Q1, Ladder continues to benefit from notable spread reductions in its cost of balance sheet loan funding and that favorable trend seems to be continuing.

At quarter-end, Ladder had $1.3 billion of FHLB borrowings with 2.43 year weighted average maturity and an average cost of 2.07%.

Finally, Ladder paid a $0.325 per share cash dividend in Q2-18, reflecting a $0.01 per share increase in the quarterly dividend rate and marking the fourth dividend increase during the 14 quarters since the company initiated dividend payments.

Ladder's annual cash dividend rate is now 30% higher than it was at the start of 2015. On a rolling-four-quarter basis, Ladder paid $1.255 per share of dividends, while earning core EPS of a $1.82 per share, resulting in a solid 69% dividend payout ratio.

In summary, in Q2-18 Ladder generated $50.4 million of core earnings, $0.45 a share of core EPS, resulting in a core after-tax return on average equity 13.3%, originated total of $711.9 million and securitized $400.8 million of loans, resulting in $8.5 million of net securitization gains.

The company paid a $0.325 per share cash dividend in a quarter on which core EPS was $0.45 per share and the company continues to apply a disciplined approach to use of leverage and the selection of longer term investments in loans and real estate.

The Latest Earnings Results

It was another strong quarter at Ladder, in Q2-18 the company’s core earnings, a non-GAAP measure of $50.4 million, was $0.45 per share. For the first half of 2018, Ladder generated $114.2 million in core earnings and in the trailing 12 months the company reported core earnings of $210.2 million.

The company’s annualized after-tax core return on average equity in Q2-18 was 13.3% and the underappreciated book value per share ended the quarter at $14.97 per share.

The asset base has been carefully positioned to benefit from rising short-term interest rates, with LIBOR now almost five times higher than it was just two and a half years ago. If short-term interest rates continue to rise, Ladder expects earnings to rise right along with them.

At the beginning of Q2-18, Ladder owned an inventory of $3.764 billion at an average end of quarter interest rate of 7.42%. Around 79% of this loan inventory is comprised of LIBOR-based mortgage loans.

Because roughly 55% of funding costs are tied to fixed interest rates as LIBOR increases, the cash flow and earnings from the bridge loan portfolio increase substantially.

Evidence of this favorable dynamic can be seen in Q2-18 revenues as the bridge loan portfolio contributed $54.5 million in revenues in the quarter, up from $46.2 million in Q1-18.

Show Me The Money

There is no argument that Ladder had a “fist pump” kind of quarter…

The solid quarterly results are supported by a growing stream of recurring earnings and Ladder is realizing the benefits of rising short-term interest rates. As Ladder’s CEO Brain Harris pointed out on the earnings call,

In short, earnings are up, the dividend has gone up with earnings, profit margins are strong and stable, and given a robust U.S. economy with Federal Reserve seemingly determined to continue hiking short-term rates, there is plenty of room for optimism and thinking that earnings can continue to grow for the foreseeable future.”

And who doesn’t like dividend growth, as Harris added,

The growth and sustainability of this earnings screen provided much of the impetus behind decisions to increase the quarterly dividend rate four times in the past three and a half years and twice in the past three quarters.”

Now consider Ladder’s dividend yield, compared with the peers:

Keep in mind, Ladder has grown its dividend more than any other commercial mREIT and the payout ratio is lower than the others:

Ladder has been a top-performer and the results below validate the call:

Finally, in my most recent article (in February) I explained that I considered “the true value of LADR, based on my analysis, to $19.91 per share.” Since that time, shares have surged from $14.41 to $16.64, and we believe that based on the latest earnings results and strong “skin in the game,” there’s more room to run.

Note: Brad Thomas is a Wall Street writer, and that means he is not always right with his predictions or recommendations. That also applies to his grammar. Please excuse any typos, and be assured that he will do his best to correct any errors, if they are overlooked.

Finally, this article is free, and the sole purpose for writing it is to assist with research, while also providing a forum for second-level thinking. If you have not followed him, please take five seconds and click his name above (top of the page).

Source: F.A.S.T. Graphs and LADR Investor Presentation/Supplemental.

Other REITs: HASI, CLNC, JCAP, KREF, GPMT, BXMT, ARI, STWD, TRTX, ACRE, and ABR.

Analyst’s Disclosure: I am/we are long ACC, AVB, BHR, BPY, BRX, BXMT, CCI, CHCT, CIO, CLDT, CONE, CORR, CTRE, CXP, CUBE, DEA, DLR, DOC, EPR, EQIX, ESS, EXR, FRT, GEO, GMRE, GPT, HASI, HT, HTA, INN, IRET, IRM, JCAP, KIM, KREF, KRG, LADR, LAND, LMRK, LTC, MNR, NNN, NXRT, O, OFC, OHI, OUT, PEB, PEI, PK, PSB, PTTTS, QTS, REG, RHP, ROIC, SBRA, SKT, SPG, SRC, STAG, STOR, TCO, TRTX, UBA, UMH, UNIT, VER, VICI, VNO, VNQ, VTR, WPC. 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.