Unlocking The Secrets Behind Ladder Capital

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About: Ladder Capital Corp (LADR)
by: Brad Thomas
Summary

We currently cover a dozen commercial mREITs with a comprised market capitalization of just under $24 billion and an average dividend yield of 8.4%.

In this article today, I plan to reveal several of the catalysts for Ladder and the reason that we continue to own and recommend shares.

The best-kept secret with Ladder is its dividend growth, which serves as the primary catalyst that drives shares higher.

Our commercial mortgage REIT Index, "BLAST", has returned +10.5% year to date, comprised of the following five REITs: Blackstone Mortgage Trust (BXMT), Ladder Capital Corp. (LADR), Apollo Commercial Real Estate Finance (ARI), Starwood Property Trust (STWD), and TPG Real Estate (TRTX).

We created the BLAST in late 2018 as an Index to compare commercial mREITs with our Equity REIT Index, "DAVOS".

Note: DAVOS includes Digital Realty Trust (DLR), American Tower Corp. (AMT), Ventas Inc. (VTR), Realty Income (O), and Simon Property Group (SPG).

One of the reasons that we include commercial mREITs in our research is because it provides us with good intel related to broader economic trends in the marketplace as well as performance within various property sectors and sub-sectors.

We currently cover a dozen commercial mREITs with a comprised market capitalization of just under $24 billion and an average dividend yield of 8.4%. As the U.S. economy moves closer towards the next recession, we believe that our coverage of commercial mREITs will be advantageous because we are likely to see the cracks forming first.

One of our favorites in the mREIT space is Ladder Capital, and over the years, we have benefited from the investment. My very first article on Ladder was written back in May 2015, at which time we initiated a Buy recommendation. Then, in late 2016, we explained that Ladder should return over 20% in 2018:

“We like LADR for all of the obvious reasons - internal management, low dividend payout ratio, diversified sources of income, and experienced management team. Also, we would like to see a more diversified ownership base, reducing concentration with some of the heavy hitters”.

(Source: Yahoo Finance)

As you can see, through December 6, 2018, Ladder shares increased by 31%, and after the REIT selloff in December, the company was still able to deliver on our target by returning +25%. So far in 2018, it has performed well, hitting $18.29 and closing last at $16.71.

(Source: Yahoo Finance)

In this article today, I plan to reveal several of the catalysts for Ladder and the reason that we continue to own and recommend shares. In addition, I will highlight the reasons that Ladder remains an overweight position that promises to generate healthy returns in 2019: we target 15% Total Ann. ROR.

(Photo Source)

Ladder Capital: My Top Commercial mREIT Pick in 2019

It’s no secret that I picked Ladder Capital as my top commercial mREIT in 2019, as I explained:

“we credit the company’s deep experience, as a primary catalyst for growth. Although there are always “gun-slingers” in the lending universe, Ladder has maintained strict discipline and deserves to be the top pick in 2019... we expect 20% annual returns for the new sheriff in town.”

It’s true, credit risk is an important function when it comes to lending, and Ladder has one of the best management teams, as evidenced by the experienced internal team:

(Source: LADR Investor Presentation)

Management and directors own $242 million of LADR stock (11.5% of total equity market cap), and lending is the sole focus of the management team - unique to the sector. CRE Finance Group, led by Ladder’s CEO, Brian Harris, has never experienced a losing quarter through multiple economic cycles and interest rate environments.

The core team members have worked together for over two decades, and the expertise of the fully integrated investment team is one of the most valuable assets (5 members of the management team have 146 years of cumulative experience).

Actions speak louder than words: the company has consistently earned 10-13%+ ROE. And in the past twelve months, Ladder’s after-tax core return was 14.9%, with 2.5x average leverage.

(Source: LADR Investor Presentation)

So clearly, “management” is a competitive advantage for Ladder with a robust origination team with 22 originators in 2 offices, including 6 managing directors. The company has long-standing direct borrower and key broker relationships nationwide.

Another advantage is deal size: Ladder’s average loan size is ~$20 million, with a focus on mid-market lending. Most of the peers focus on much larger deals, so these smaller loans provide the REIT with added diversification. There’s always going to be a problem loan, but Ladder has an extremely loyal customer base - more than 50% of balance sheet loans to repeat borrowers.

Another advantage for the company is “flexibility to originate and manage multiple products”. As you can see below, Ladder has a diversified lending platform, so it can easily deploy capital in the property sectors that offer the best risk-adjusted returns.

(Source: LADR Investor Presentation)

Another advantage for Ladder, arguably the most important, is that it is not just a lender (a mono-line player) but has multiple business lines that allow the company to adapt to changing environments. Now let’s take a look at the various platforms.

The Lending Platform

As viewed below, Ladder 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.

(Source: LADR Investor Presentation)

Ladder’s Senior Secured Balance Sheet business represents a majority of revenue - a business similar to Blackstone Mortgage Trust and Starwood Property Trust. At the end of 2018, Ladder owns $3.3 billion of balance sheet loans, but for the first time in years, the inventory of securities increased by 44% in the quarter, ending the year at $1.41 billion.

This illustrates how flexibly and nimbly the investment platform is able to pivot quickly into different product types as changing market conditions produce different investment opportunities.

(Source: LADR Investor Presentation)

Around 96% of Ladder’s debt investments 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 comprised 76.3% of the total asset base.

(Source: LADR Investor Presentation)

The weighted average loan-to-value (or LTV) ratio of the commercial real estate loans on the balance sheet (as of Q4-18) was approximately 68% (in line with prior quarters). The most meaningful fourth-quarter changes to the asset side of the balance sheet were in the securities and balance sheet loan portfolios.

Also, during Q4-18, Ladder received $730.9 million of balance sheet loan repayments, more than offsetting $237.9 million of balance sheet loan originations during the quarter. The net result was a $3.3 billion December 31, 2018, balance sheet loan portfolio versus a $3.8 billion portfolio at the end of the prior quarter.

The CMBS Segment

While LADR expects its balance sheet lending business to be the primary driver of core earnings in the year, the company also expects securitization activities to supplement quarterly earnings.

As referenced above, Ladder responded to the spread widening and general volatility and the fixed-income markets by purchasing more securities in three months than it had acquired in the preceding year.

The key risk metrics of this portfolio remains in line with historical norms, as 80.9% of the securities portfolio was comprised of securities rated triple A or backed by the US government agency, and the weighted average duration was 29 months, which compares to 30 months at 9/30/18 and 36 months a year prior.

(Source: LADR Investor Presentation)

During Q4-18, Ladder reported income from three securitization transactions to which the company contributed $364.8 million of principal balance of loan held for sale, generating $7 million in securitization gains.

For the 2018 calendar year, it securitized a total of 103 loans with a total principal balance of $1.3 billion in nine securitization transactions, generating a total of $30 million in securitization gains.

(Source: LADR Investor Presentation)

Real Estate Segment

Ladder’s equity platform is often misunderstood, and this is where I believe there is substantial equity to unlock. The company has around 8.3 million square feet, mostly (2/3rd) invested in net lease, and the balance (1/3rd) in binary risky opportunities.

(Source: LADR Investor Presentation)

During Q4-18, it made $7.2 million of net lease and other equity investments, resulting in total net leased and other equity investments of $122.7 million in 2018. Ladder also received $5.5 million of net proceeds from sales of condominium real estate in the fourth quarter, bringing total proceeds from the sales of real estate to $218.7 million for the year.

Ladder’s multi-product model served it well in 2018, as the real estate portfolio accounted for 24% of net investment income, while the balance sheet loan inventory contributed to another 61% of net investment income to core earnings. Here’s a snapshot of the company’s real estate holdings by property type:

(Source: LADR Investor Presentation)

The Balance Sheet

At the end of Q4-18 Ladder had $3.9 billion of adjusted debt outstanding and committed financing availability of $2.6 billion for additional investments. The debt was comprised of $1.17 billion of unsecured bonds that are outstanding maturing in 2021, 2022, and 2025; $743.9 million of long-term non-recourse mortgage debt financing, real estate holdings; and $601.5 million of non-recourse CLO debt.

When combined with $1.64 billion of permanent equity and $176.7 million of other liabilities, $4.3 billion (or 68%) of the company's capital base is comprised of equity, unsecured debt, and non-recourse non-mark-to-market debt.

(Source: LADR Investor Presentation)

At quarter end, Ladder had $1.3 billion of FHLB borrowings with a 2.46-year weighted average maturity and an average cost of 2.55%. In addition, the company further diversified its funding sources, entering into a new financing agreement with another major bank that is new to Ladder to finance both first mortgage and mezzanine loans. This new facility provides $100 million of committed availability, and this agreement expands access to loan repurchase financing.

Also, in November, Ladder successfully accessed the equity market for the first time since the 2014 IPO. The company issued 5.8 million shares of Class A common stock in an underwritten primary public offering, resulting in total gross proceeds of approximately $100 million (shares were issued at a price reflecting a 24% premium over GAAP book value and a 12% premium over underappreciated book value).

(Source: LADR Investor Presentation)

Its year-end undepreciated book value was $15.34 per share, up from $15.25 at 9/30 and up from $14.60 at the end of 2017. As viewed below, Ladder has superior access to capital with liquidity of over $2.5 billion.

(Source: LADR Investor Presentation)

Finally, in the fourth quarter, the company paid a $0.57 per share dividend, including $0.34 in cash and $0.23 in shares of Class A common stock. The $0.34 per share cash dividend reflected a 4% increase in the quarterly cash dividend rate, the sixth increase in four years. Dividends in 2018 totaled $1.535 per share of Class A common stock with a cash dividend payout ratio of 64.3%.

The Latest Earnings Results

Ladder’s equity base grew to $1.64 billion at year end 2018, reflecting an increase of $155.5 million (or 10% in 2018), which resulted from strong 2018 performance in the form of $230.1 million of core earnings, the $100 million primary equity issuance in November, and a base of growing recurring earnings.

(Source: LADR Investor Presentation)

As referenced above, during Q4-18, Ladder received a loan payoff in the bridge loan portfolio of $730.9 million, roughly three times what it would normally expect in a quarter. While the company could have held on to many of these loans by simply matching the terms of the refinancing lender, the terms didn't seem to offer the right risk-reward relationship, so it collected the payoff (with exit fees) and reallocated the capital into what it felt was a better value proposition.

In Q4-18, Ladder produced core earnings, a non-GAAP measure, of $52.5 million, or $0.45 per share, and this resulted in an after-tax core return on average equity of 12.9%. As referenced above, for the full-year 2018, it had core earnings of $230.1 million, or $2.03 per share, and after-tax core return on average equity of 14.9%.

(Source: LADR Investor Presentation)

Increases in recurring sources of income has been an ongoing trend since Ladder’s IPO in 2014, and that has allowed the company to increase its quarterly cash dividend rate six times over the course of four years, most recently in Q4-18.

(Source: LADR Investor Presentation)

The Q4-18 $0.34 per share cash dividend reflected a 4% increase in the quarterly cash dividend rate. Dividends in 2018 totaled $1.535 per share of Class A common stock with a cash dividend payout ratio of 64.3%. Also in Q4-18, LADR paid a special dividend $0.23 in shares of Class A common stock.

(Source: LADR Investor Presentation)

Unlocking The Secrets Behind Ladder Capital

As you can see below, Ladder’s assets have increased by 150% since the IPO to $6.3 billion, with only 11 additional employees:

(Source: LADR Investor Presentation)

Now consider its dividend yield, compared with the peer group below:

(Source: Rhino Real Estate Advisors)

As you can see, Ladder has an attractive dividend yield, and shares are trading slightly below historical levels (based on P/E):

(Source: Rhino Real Estate Advisors)

Here’s how the company and its peers have performed year-to-date (note: 2 of our recommend picks - HASI and ABR - have performed extremely well YTD).

(Source: Rhino Real Estate Advisors)

How To Play It

In conclusion, Ladder is hitting on all cylinders, and it has plenty of liquidity to continue to grow its portfolio. The company has a tremendous advantage over its peers because it can choose when to place bets on the best relative value. It also maintains a very healthy payout ratio (64%) and earns best-in-class returns (14% ROE in 2018). Also, the company focuses on smaller ($20 million) deals that provide enhanced diversification.

Yet, the best-kept secret with Ladder is its dividend growth that serves as the primary catalyst that drives shares higher. Management appears committed to the multi-faceted business model, and we maintain a Buy recommendation with the expectation that shares will return 13-15% over the next 12 months.

(Source: F.A.S.T. Graphs)

Author's note: Brad Thomas is a Wall Street writer, and that means he's 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.

Disclosure: I am/we are long LADR. 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.