Description

Investment Thesis

HCFT is a microcap REIT ($77 mm) primarily focused on investing in, financing and managing transitional multi-family and other commercial real estate loans.  The Company has increased its quarterly dividend 25% over the past 2 quarters from $0.06 per share to $.075 per share and 2Q19 core earnings of $.09 cents per share were well in excess of the second-quarter dividend of $0.075 per share.  I expect earnings and the dividend to continue to inflect higher.  At second-quarter end, HCFT had $43 million of undeployed cash within its 2 CLOs, which it anticipates deploying over the remainder of the year.  $43 mm of cash invested at 5.0% (I conservatively model investment spreads of LIBOR+300 -- a 50 bps contraction from 2Q originations at a spread of L+350) equals incremental earnings of $2.15 mm and potential earnings accretion of $0.09 based on ~23.7 mm shares outstanding.  2Q19 core earnings of $0.09 per share translates into $0.36 per share annualized and once the undeployed cash is reinvested the Company could earn as much as $.45 per share in 2020.  I project a payout ratio of 90 to 100% of core earnings.  I believe that residential and mortgage REITs generally trade on a dividend yield basis and that the market is NOT forward-looking when it comes to projecting dividends.  At an annualized dividend rate of $0.30 per share the stock at $3.26 trades at a dividend yield of ~9.2% which feels about right.  However, if you believe as I do that the Company is likely to raise the dividend in step with core earnings increases to a run rate dividend level of $0.40 to $0.45 cents a share in 2020 assuming that the required dividend yield stays constant at 9.0% to 9.5% the stock price should increase commensurately to $4.20 to $5.00 a share.  Incidentally, I consider Arbor and Exantas the closest mortgage REIT comps (although their business models have significant differences with HCFT’s and ABR and XAN are trading at annualized dividend yields of 9.0% to 9.5%.  My 1-year price target is $4.20 a share which represents price upside of ~28% which when coupled with the dividend yield of ~9% represents a total return opportunity of 35%.

Company Description and Background

As noted earlier, HCFT is a real estate investment trust primarily focused on investing in, financing and managing transitional multi-family and other commercial real estate loans. As of January 18, 2018, the Company is externally managed by Hunt Investment Management, LLC.  Management by HIM has provided the Company with a new strategic direction through the reallocation of capital into new investment opportunities focused in the commercial real estate mortgage space and direct access to Hunt's pipeline of transitional floating-rate multi-family and commercial real estate loans. Hunt and its affiliates have extensive experience in the origination, servicing, risk management and financing of this asset class.

Investment Strategy

HCFT’s investment strategy is to invest in debt and related instruments supported by institutional-quality commercial real estate in attractive locations.

The investment strategy targets the following assets: 

·        Transitional multi-family and other commercial real estate loans, which are floating-rate loans secured by multi-family and other commercial real estate properties that are not guaranteed by a U.S. Government-sponsored entity, or securitizations backed by such loans;

·        Securitizations backed by multi-family mortgage loans, or Multi-Family MBS; and

·        Other mortgage-related investments, including mortgage servicing rights ("MSRs"), CMBS, other loans or securities backed by real estate, or ownership interests in real estate.

Hunt Background

Hunt Companies, Inc. is a diversified global real estate organization dedicated to creating value through the development, construction, investment, management, and financing of real estate assets.

Privately owned and founded in 1947

·        Over 1,700 direct employees among 46 offices nationwide. Including affiliates, the companies employ over 6,000 additional employees across 80 offices

·        Broad platform with expertise across the real estate industry

·        3rd largest U.S. apartment property management portfolio

·        7th largest U.S. multifamily owner

·        Top 15 non-bank originator of agency multifamily loans

·        Since its inception, Hunt and its predecessor companies have originated over $30.6 billion of commercial mortgage loans

·        Strength in Servicing. Hunt currently manages a $16.5 billion servicing portfolio. In-house active asset management and servicing ensures the implementation and execution of sponsor business plans and budget

Hunt Progress in its strategic transition of HCFT since becoming the Manager in Q1 2018

·        Hunt acquired 9.5% of outstanding common shares at book value  

·        Capped expense reimbursements to the Manager            

·        Disposed of all of the Company’s legacy RMBS, multifamily MBS, and derivative positions and redeployed capital into the new floating rate commercial mortgage loan strategy. As of 3/31, 99% of the investment portfolio consisted of floating rate commercial mortgage loans

·        Acquired Hunt CMT Equity, LLC, which included a commercial mortgage loan portfolio financed through Hunt CRE 2017-FL1, loan participations, and lending licenses

·        Closed Hunt CRE 2018-FL2, a $285 million commercial real estate CLO transaction       

·        Improved capital structure via successful refinance of 8.75% Preferred Stock

Targeted Investments

Targeted investments are $5 mm to $50 mm loans (primarily first lien) on stabilized or transitional assets at a 80% loan to cost and up to 75% of stabilized value.  The property type focus is multifamily (88% of the current portfolio).  HCFT continues to anticipate that the substantial majority of its loan activity will be related to multifamily assets.  Term is typically 3 to 5 years. The weighted average interest rate of the portfolio is L+388 although 2Q19 originations were L+350 a result of contracting credit spreads and the Company anticipates some additional limited spread compression on a going-forward basis.  

The total portfolio of floating-rate loans at quarter-end, had an outstanding principal balance of $600 million. The portfolio consists of 47 loans with an average loan size of $13 million and provides for a significant asset and geographic diversity. There are no defaults or delinquencies in the portfolio, and HCFT has not seen any material change in the portfolio performance over the quarter.

2Q Earnings and Other Key Highlights

·        Q2 2019 Core Earnings of $2.23 million, or $0.09 per share, which was up $0.02 per share quarter-over-quarter.

·        Q2 2019 Book value per share of $4.60 compared to a book value per share of $4.61 as of Q1 -- the end of Q1. This decline was due to distributions being in excess of GAAP net income for the quarter, which was primarily due to a decline in MSR value.  (MSRs balance sheet value is $3 mm vs. total asset value of $657 mm).

·        On June 10, 2019, the Company announced the declaration of a cash dividend of $0.075 per share of common stock with respect to Q2 2019, which represents a 7% increase over the Q1 2019 dividend of $0.07 per share and a 25% increase over the Q4 dividend of $0.06 per share.

·        This is the Company’s second consecutive quarterly dividend increase

·        In Q2 2019, HCFT acquired $52.9mm of new loans and participations at a weighted average spread of LIBOR + 3.55%

·        95% of the new acquisitions were multifamily assets

·        The Company experienced $38.9mm of loan payoffs during the quarter

·        As of Q2 2019, 99% of HCFT’s investment portfolio consisted of floating-rate CRE loans

·        The $599.8 million CRE loan portfolio had a weighted average remaining term of 21 months (1) and a weighted average coupon of L + 3.90%

·        88% of the portfolio was multifamily

·        The Company’s only remaining legacy investment consists of $3.2 million of mortgage servicing rights

·        The floating-rate CRE loan portfolio is financed with $510 million of investment-grade notes issued through two CRE CLOs

·        As of 6/30/2019, the Company had $7 million of unrestricted cash and the CLOs had $43 million of reinvestment capacity

·        The $43 mm of undeployed cash within its 2 CLOs HCFT anticipates deploying over the remainder of the year which they, in turn, expect to further improve core earnings.

·        HCFT is focused on reducing their G&A expenses by leveraging Hunt's broader relationships and has already achieved meaningful reductions in its recurring professional fees, which they expect to begin to benefit from at the end of this year.

Catalyst

Dividend increases