More 9% Dividend Yields Again? I'm Also Buying This One

Summary

• We're starting with our latest purchase, then moving onto some charts.
• Our charts help readers track the sector for both common shares and preferred shares.
• Mortgage REITs and BDCs are included in the charts for comparison based on various metrics such as price-to-book value, dividend yields, and earnings yield.

We recently wrote about our purchase of a 9% yield from MFAN (MFAN). Another one of those opportunities popped up recently, so we went for it again.

Today’s 9% yield (about 8.95% at our purchase prices) comes from RCB (RCB). This is one of the baby bonds from Ready Capital (RC). We purchased shares twice this week. I see this as an attractive choice for risk/reward. We’re feeling a bit cautious about the overall economy. I wanted to take a defensive position, but still have a significant yield.

This is another baby bond, which works well for our risk profile. We have a defined maturity date (limiting interest rate risk) and the requirement to pay interest each quarter plus principal at maturity reduces our credit risk compared to other high-yielding investments.

I sent the following alert:

Trades:

• Purchased 1,133 RCB (RCB) at $23.90 per share.

This is the baby bond from Ready Capital (RC).

Beware liquidity! Volume on these shares tend to be pretty low. Entering a market order for shares would be a terrible idea. It’s a quick way to overpay. The way to enter a position is to monitor the shares and look for that opportunity, then toss in a limit-buy order at a price where you would feel good about the purchase.

RCB dipped recently after trading in the $24.00 to $24.20 range:

That dip has them underperforming most of the other baby bonds we cover. I find the gap between RCB and RCC (RCC) quite interesting.

There are a few differences.

Maturities:

• RCB matures later (7/30/2026)

• RCC matures earlier (2/15/2026)

• Edge to RCC.

Coupon rates:

• RCB has a 6.20% coupon rate.

• RCC has a 5.75% coupon rate.

• Edge to RCB.

Discounts to Face Value:

• RCB at $23.90 has a $1.10 discount.

• RCC at $24.23 has a $.77 discount.

• Edge to RCB.

Yield to Maturity:

• The reason we really needed the maturities, discounts, and coupon rates was for calculating yield to maturity.

• RCC is around 8.1% to 8.2%.

• RCB is around 8.9%.

• Edge to RCB.

I think RCB is the better deal in this case.

What about yield to call?

Either of the baby bonds could be called promptly. It would be a really bad choice for RC to call the bonds because they wouldn’t be able to lock in financing at rates comparable to the coupon rate on the bonds.

If RCB was called promptly (very unlikely), that would be hilarious. We would just record the gain and move on. That would be an outstanding outcome.

We’re not focusing on that scenario though. We’re looking at the attractive yield to maturity. I could sit in these shares for the next two years and a few months. Nothing wrong with that. But if we see prices jump, I’d rather have more flexibility.

The price fell by about $.35 to $.27 recently. How much is $.27 worth?

OK, that’s a really dumb question. I meant to ask how big the impact would be on the yield to maturity.

It impacts the yield to call by about 0.5%. That’s a nice bump for a bond that matures in summer 2026.

If these bonds were trading right about $25.00, would I still want to own them? Not a chance!

If the bonds were trading about $25.00, the yield to maturity would be pretty close to the coupon rate of 6.2%. It would be a bit better because of dividend accrual, but not much.

Spreads to Treasury Rates

The two-year Treasury is paying out 4.734% as of 03/18/2024.

Getting 6.2% would only be about 1.5% over the Treasury rate. That isn’t enough bonus yield.

Getting nearly 9% over that period is much more attractive. We’re looking at a spread of more than 4% over the two-year Treasury rate. That’s a much better deal.

For a reminder that baby bonds can get materially overvalued, investors only need to look at GAINL (GAINL) GAINL 0.08%↑.

Those shares are still at $26.02 today. That’s down quite a bit from the $26.39 when we published a trade alert. Despite the decline, the yield to maturity is still only about 7.37%. If GAINL gets called before maturity (which is a more significant risk given the 8.0% coupon rate), then we would use the yield to call which is under 6%.

Note: I added another 2,450 shares of RCB the next day. That gives us a total of 3,583 shares of RCB.

Another Note: Payments are technically interest, but they're still referred to as dividends.

Fluctuations in the share price will cause the yield to maturity to change. Investors should only use limit orders for trading positions in baby bonds and preferred shares.

How Stable Are Those Shares?

I wanted to go into a bit more depth here.

The following chart shows the absolute share prices for RCB and RCC.

This ignores dividend accrual, but the shares should have the same ex-dividend date. Consequently, it doesn’t make a big difference for comparing them. The dividend payments are different, but not so different that you would notice it in the chart.

You can see from the chart that sometimes RCB has the higher share price and sometimes RCC has the higher share price.

It looks like the gap swings pretty wildly, but that can be caused by poor liquidity some days. Even though the share prices have been quite stable overall, the “closing” share price can still bounce up and down within a fairly tight range.

The price has been trending up relative to 2023, but that makes sense given the maturity. Since RC is required to repay the bond holders on 7/30/2026 (if they haven’t called the shares already), the discount to $25.00 should shrink as we get closer to that date.

When rates are higher or there is more fear in the economy, we may see prices dip. However, they held up quite well with the fear in late 2022. They dipped down to about $22.50. I know many of my investments dipped quite a bit harder than that.

Thesis

These baby bonds make sense for someone who is:

1. Looking for a higher yield.

2. Willing to take on more risk than cash.

3. Comfortable with the weak liquidity that can make opening and closing positions a bit slower.

4. Capable of always using limit orders, because market orders on any illiquid investment would be a bad choice.

5. Comfortable with the idea of holding a baby bond until 7/30/2026.

I haven’t decided if we will hold the bonds for that long. If we get the right price relative to other investments, I would swap out of them and go back to trading in the preferred shares. I think that will probably happen. We may see a higher price on the shares and simply exchange them for another investment. We trade this sector actively to take advantage of swings in the supply and demand driving modest price movements.

If we don’t see a high enough price for swapping to other investments, then I can just sit in the shares and await maturity.

I want to remind investors that the yield to maturity can swing materially with changes in the share price. The coupon rate on these bonds is 6.2%. The rest of the yield comes from the discount face value. I would be far less interested in these shares if they were trading around $25.00. The prospect of buying the baby bonds for $23.90 while they are required to pay $25.00 at maturity makes the shares much more appealing. The yield to maturity factors in the benefit from the purchase price being less than the value at maturity.

Updated Charts

The charts we have below are updated to use the values for the end of Q4 2023. We wait to do the update until we have data on all or almost all of the stocks in the sector. We don’t want to be using Q4 2023 for one stock and Q3 2023 for another stock. That would lead to a stupid comparison if the quarter was particularly strong or weak.

Stock Table

We will close out the rest of the article with the tables and charts we provide for readers to help them track the sector for both common shares and preferred shares.

We’re including a quick table for the common shares that will be shown in our tables:

If you’re looking for a stock that I haven’t mentioned yet, you’ll still find it in the charts below. The charts contain comparisons based on price-to-book value, dividend yields, and earnings yield. You won’t find these tables anywhere else.

For mortgage REITs, please look at the charts for AGNC, NLY, DX, ORC, ARR, CHMI, TWO, IVR, EARN, CIM, EFC, NYMT, MFA, MITT, AAIC, PMT, RITM, BXMT, GPMT, WMC, and RC.

For BDCs, please look at the charts for MAIN, CSWC, ARCC, TSLX, TPVG, OCSL, GAIN, GBDC, SLRC, OBDC, PFLT, TCPC, FSK, PSEC, and MFIC.

This series is the easiest place to find charts providing up-to-date comparisons across the sector.

Notes on Chart Sorting

Within each type of security, the sorting is usually based on risk ratings. However, it's quite common to have a few shares that are tied. When the shares are tied for risk rating, the sorting becomes arbitrary. There may occasionally be errors where a share’s position is not updated quickly following a change in the risk rating. That can happen because the charts come from a separate system. When I update the system we use for members, it doesn’t change the order in the charts.

When I say “within each type of security,” I’m referencing categories such as “agency mortgage REITs.” The “hybrid mortgage REITs” are all listed after the “agency mortgage REITs." However, that does not mean RC (lowest hybrid) has a higher risk rating than the highest agency mortgage REIT. Each batch is presented by themselves.

PMT and RITM are tied for risk rating.

Finally, there’s an outlier. We don’t cover EARN. However, it was frequently requested for this series. Consequently, I added it to the charts. The important part here is that EARN was never assigned a risk rating. Since it has no assigned risk rating, it got lumped in at the top. However, I do not believe EARN would actually get a higher risk rating than IVR. I believe EARN would actually be less risky than IVR.

This could probably be written better. If someone feels inclined to take it upon themselves to write a section that's objectively better at communicating these points, I would be interested in using it. I’m grateful to have the best readers on SA. I attribute this to self-selection bias. I include enough things to offend the dumb people that I’m left with the best readers.

Note: The chart for our public articles uses the book value per share from the quarter indicated in the chart. We use the current estimated (proprietary estimates) book value per share to determine our targets and trading decisions. Those estimates are not included in the charts below. PMT and NYMT are not showing an earnings yield metric as neither REIT provides a quarterly “Core EPS” metric. Presently, a few other REITs also have no consensus estimate.

Second Note: Due to the way historical amortized cost and hedging is factored into the earnings metrics, it's possible for two mortgage REITs with similar portfolios to post materially different metrics for earnings. I would be very cautious about putting much emphasis on the consensus analyst estimate (which is used to determine the earnings yield). In particular, throughout late 2022 the earnings metric became less comparable for many REITs.

Residential Mortgage REIT Charts

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Commercial Mortgage REIT Charts

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BDC Charts

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Preferred Share and Baby Bond Charts

I changed the coloring a bit. We needed to adjust to include that the first fixed-to-floating shares have transitioned over to floating rates. When a share already is floating, the stripped yield may be different from the “Floating Yield on Price” due to changes in interest rates. For instance, NLY-F already has a floating rate. However, the rate is only reset once per three months. The stripped yield is calculated using the upcoming projected dividend payment and the “Floating Yield on Price” is based on where the dividend would be if the rate reset today. In my opinion, for these shares the “Floating Yield on Price” is clearly the more important metric.

Click to enlarge

Note: Shares that are classified as “Other” are not necessarily the same. Within The REIT Forum, we provide further distinction. For the purpose of these charts, I lumped all of them together as “Other.” Now there are only two left, PMT-A and PMT-B. Those both have the same issue. Management claims the shares will be fixed-rate, even though the prospectus says they should be fixed-to-floating.

Preferred Share Data

Beyond the charts, we’re also providing our readers with access to several other metrics for the preferred shares.

After testing out a series on preferred shares, we decided to try merging it into the series on common shares. After all, we're still talking about positions in mortgage REITs. We don’t have any desire to cover preferred shares without cumulative dividends, so any preferred shares you see in our column will have cumulative dividends. You can verify that by using Quantum Online. We’ve included the links in the table below.

To better organize the table, we needed to abbreviate column names as follows:

• Price = Recent Share Price - Shown in Charts

• S-Yield = Stripped Yield - Shown in Charts

• Coupon = Initial Fixed-Rate Coupon

• FYoP = Floating Yield on Price - Shown in Charts

• NCD = Next Call Date (the soonest shares could be called)

• Note: For all FTF issues, the floating rate would start on NCD.

• WCC = Worst Cash to Call (lowest net cash return possible from a call)

• QO Link = Link to Quantum Online Page

Second batch:

Third batch:

Strategy

Our goal is to maximize total returns. We achieve those most effectively by including “trading” strategies. We regularly trade positions in the mortgage REIT common shares and BDCs because:

1. Prices are inefficient.

2. Long term, share prices generally revolve around book value.

3. Short term, price-to-book ratios can deviate materially.

4. Book value isn’t the only step in analysis, but it's the cornerstone.

We also allocate to preferred shares and equity REITs. We encourage buy-and-hold investors to consider using more preferred shares and equity REITs.