I’ve been buying the Ladder Capital 5.25% bonds due 1st October 2025 @ 80 cents on the dollar. This gives me a 6.6% running yield and 10.8% yield to maturity. This represents great value as you can lock in double digit IRRs for over 5 years in a zero rate environment with minimal risk of capital loss.
I am going to give a brief overview of why I think the risk is minimal and won’t get into much of the technical details. Happy to expand in the comments if necessary.
Let’s stress test the asset side of Ladder’s balance sheet which looks as follows:
46% balance sheet loans (first mortgage loans, 70% LTV)
25% securities (AAA rated CMBS)
15% net real estate
12% unrestricted cash
I recommend reading the Q1’20 results call transcript to understand why the CMBS are money good even with massive defaults. Since Ladder only has exposure to the AAA tranche, there is 50% subordination in the debt structure alone with the equity on the mortgage loans usually accounting for another 30%. Therefore before the AAA is even touched, we’d need collateral values to fall 60-70%. And even before that happens, the over-collateralisation provisions means cash flow would accrue to AAA and they’d part amortise thus building an even greater buffer. It is hard to envisage a scenario where these are not money good and Ladder’s liability management means they can hold them until maturity if needs be.
The net real estate is relatively safe too. Weighted average lease terms of 12 years with necessity based tenants (groceries, pharmacies, dollar stores, wholesale clubs). They are also financed on a non-recourse basis therefore downside is capped.
So really we need to think mostly about the balance sheet loans. These aren’t junior tranches. They are first mortgage loans and half of them are unencumbered meaning Ladder is not restricted in working through any issues that may arise in their borrower base. As we discussed, LTV is 70% which gives a decent equity cushion. 99% of the book remained current in April. They’ve received preliminary requests for potential interest deferrals from 20% of the book and these will be assessed on a case by case basis. We can discuss the details of these loans (transitional properties, low duration, etc) but I want to keep the post high level for now and am happy to discuss details in the comments.
What would need to happen for the unsecured debt to be compromised?
- Net real estate: let’s wipe out all equity in the net real estate portfolio (any greater loss is non-recourse so this is worst case scenario)
- Hotels and retail balance sheet loans: $400m of exposure at 70% LTV. If collateral values fall -65% then that is a 50% haircut on their exposure which equals 3% of assets.
- Remaining balance sheet loans: write off 100% of mezzanine exposure (small). Then let’s get draconian and assume 20% haircuts on the first mortgage loans (ex hotel and retail i.e. multi family, industrial, offices, mixed use). Given LTVs of 70%, that means collateral values would have to fall almost 50%, far exceeding GFC falls closer to 30%.
In this draconian scenario, book value would fall from $1.5bn to $0.3bn but crucially remain positive thus protecting the bonds. In fact, since we’re buying the $1.9bn of unsecured bonds at 80c of face value, we have the $300m of remaining equity cushion as well as the $380m bond discount before we start losing any principal. We are underwriting the first mortgage balance sheet loans at 35-40% LTVs on a geographically and use case diverse asset pool. And getting paid double digit IRRs.