Sachem Capital Corp. annual report, FY2018

Sachem Capital Corp. — 2018 Form 10-K

Business context and reporting period. The filing covers the fiscal year ended December 31, 2018, with 2017 comparisons. Sachem is a Connecticut-based mortgage lender and REIT that originates short-term, generally interest-only loans secured by first mortgages on investment real estate. Its portfolio had 403 loans totaling $78.9 million at year-end; about 89.5% of principal was secured by Connecticut properties. The 2017 comparison includes predecessor operations before the February 2017 IPO.

Financial and operating performance

Metric	2018	2017
Total revenue	$11.71 million	$7.00 million
Interest income from loans	$8.96 million	$5.43 million
Net income	$7.77 million	$4.86 million
Basic and diluted EPS	$0.50	$0.38
Cash provided by operating activities	$6.22 million	$4.84 million
Cash used in investing activities	$16.84 million	$28.93 million
Cash provided by financing activities	$9.82 million	$23.48 million

• Revenue increased 67.4% and net income increased about 59.9%. Operating costs and expenses rose 84.5%, to $3.94 million, including $1.67 million of interest and deferred financing cost expense, up from $664,000.
• Loans originated fell to $42.1 million from $53.5 million, while outstanding portfolio principal grew to $78.9 million from $63.3 million. Weighted-average contractual loan yield was 12.85%, versus 12.08% in 2017; the Webster Facility rate was 6.50% at year-end.
• Year-end assets were $86.0 million, including $78.9 million of mortgage loans and $2.9 million of real estate owned. Liabilities were $33.2 million and shareholders’ equity was $52.8 million, down from $54.6 million.
• Total debt was $27.5 million: $27.2 million drawn on the $35 million revolving facility and $291,000 of mortgage debt. Cash and restricted cash totaled about $159,000. At March 28, 2019, the revolver balance was about $30.4 million, with approximately $4.6 million available.
• Year-end unfunded construction-loan obligations were $5.96 million. The company reported 13 non-performing loans, with principal and accrued unpaid interest of approximately $5.1 million (about 6.5% of portfolio principal), compared with 12 loans and $2.2 million in 2017. Management said collateral value exceeded balances on these loans; all had been referred to counsel for foreclosure or settlement.

Material changes and notable items

• The company replaced its former Bankwell credit line with a $35 million Webster revolving facility in May 2018. It is secured by substantially all company assets, bears interest at 30-day LIBOR plus 4%, and matures May 11, 2022. Borrowing availability is subject to eligible-collateral and borrowing-base terms.
• At December 31, 2018, tangible net worth was below the facility’s $52 million minimum covenant. Lenders waived the breach; the filing says first-quarter 2019 ATM share sales subsequently raised tangible net worth above the threshold.
• Management said lending was curtailed in the fourth quarter because of working-capital constraints, adversely affecting fourth-quarter revenue and net income. In the first quarter of 2019, the company sold 511,635 shares through its at-the-market program for approximately $2.2 million net.
• Loans matured in 2018 but not repaid or extended included 36 loans, which the company said were being modified and could be extended subject to underwriting conditions.
• Real estate owned increased to $2.94 million from $1.22 million. The company recorded a $67,000 impairment charge in 2018 and a $75,000 net gain on real estate sales.

Outlook, management commentary, and risks

• Management believed cash, revolver availability, and anticipated operating cash flow would fund operations for the next 12 months. It was also exploring alternative financing, but had no definitive agreement beyond the ATM offering.
• Management expected borrowing costs to rise in 2019. It had not raised loan rates to match recent funding-cost increases, preferring to build market share; it acknowledged this could squeeze spreads and hurt near-term profit and cash flow. It sought to limit new loans to one-year terms where possible.
• Management observed stagnant or declining Connecticut property values and longer sale periods beginning in the second half of 2018, alongside tighter bank credit and continued demand for Sachem’s loans. It said it was unclear whether these market changes were temporary or longer-term.
• Key risks include fixed-rate loan assets funded partly by floating-rate LIBOR debt, Connecticut concentration, borrower defaults and lengthy foreclosures, collateral-value declines, limited liquidity, reliance on external capital, and facility covenant/default risk. The filing also flags the planned phaseout of LIBOR and uncertainty over replacement benchmarks.
• The company intends to maintain REIT status and generally distribute at least 90% of REIT taxable income. Dividends remain at the board’s discretion. 2018 dividends paid totaled $6.79 million; a further $2.62 million dividend, or $0.17 per share, was paid January 10, 2019.
• The auditor gave an unqualified opinion on the financial statements. Management concluded disclosure controls and internal control over financial reporting were effective; auditor attestation on internal control was not required.

Important facts for investors to verify

• Current borrowing-base availability, covenant compliance, lender waivers, and the effect of subsequent ATM proceeds on tangible net worth.
• Trends in non-performing loans, foreclosure outcomes, recoveries, and real estate owned, including whether collateral values support management’s loss assessments.
• Whether loan yields can keep pace with floating-rate funding costs and whether the company can maintain origination volumes without weakening underwriting.
• Liquidity after accounting for the $5.96 million of unfunded loan commitments, dividends, and available revolver capacity.
• Exposure to Connecticut real estate conditions, LIBOR transition terms, and continued qualification as a REIT and exemption from Investment Company Act registration.