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Ready Capital Corporation (NYSE:RC) Q3 2023 Earnings Call Transcript

Ready Capital Corporation (NYSE:RC) Q3 2023 Earnings Call Transcript November 8, 2023

Operator: Greetings, and welcome to the Ready Capital Third Quarter 2023 Earnings Call [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to the Chief Finance Officer, Andrew Ahlborn. Please go ahead.

Andrew Ahlborn: Thank you, operator, and good morning to those of you on the call. Some of our comments today will be forward-looking statements within the meaning of the federal securities laws. Such statements are subject to numerous risks and uncertainties that could cause actual results to differ materially from what we expect. Therefore, you should exercise caution in interpreting and relying on them. We refer you to our SEC filings for a more detailed discussion of the risks that could impact our future operating results and financial condition. During the call, we will discuss our non-GAAP measures, which we believe can be useful in evaluating the company’s operating performance. These measures should not be considered in isolation or as a substitute for our financial results prepared in accordance with GAAP.

A reconciliation of these measures to the most directly comparable GAAP measure is available in our third quarter 2023 earnings release and our supplemental information, which can be found in the Investors section of the Ready Capital website. In addition to Tom and myself on today’s call, we are also joined by Adam Zausmer, Ready Capital’s Chief Credit Officer. I will now turn it over to Chief Executive Officer, Tom Capasse.

Tom Capasse: Thanks, Andrew, and thank you all for joining the call today. The third quarter results reflect the strength of Ready Capital’s core business and short-term earnings pressure from the ongoing integration of our merger with Broadmark. Our strong relative credit metrics, increased liquidity and lower leverage position the company to grow earnings to target levels against the headwind of the unfolding recession in the CRE sector. The integration of Broadmark is progressing successfully in terms of both financial and product integration. First, portfolio repayments and liquidations. Since the merger closed, 13% of the portfolio totaling $121 million is either paid off or has been sold at or above our basis. As of September 30, the remaining $853 million portfolio of loans in REO with a blended levered yield of 6%, resulting in a portfolio yield drag of approximately 110 basis points.

Currently, we have scheduled liquidations of $100 million through year-end with runoff of the remainder by the fourth quarter of 2024. Second, leverage and liquidity. The transaction reduced Ready Capital leverage from 5.1x to 3.4x versus a target of 4.0x. Although this target is lower than our historical leverage of 5.0x, the ability to raise debt capital for reinvestment will be a large driver of earnings accretion going forward. To date, we have financed 45% of the acquired assets via 2 new facilities yielding proceeds of $360 million, which were primarily used to meet existing debt maturities, including the payout of our $115 million convertible note and of $133 million of securities repo. In addition to de-risking the balance sheet, we expect go-forward incremental dollars to be used for investing purposes at cyclical high 15% to 20% ROEs. Third, cost synergies.

The benefit of scale is the ability to operate the business at a lower operating expense ratio. Through September 30, we have cut 60% of the existing Broadmark fixed expense base, resulting in a 200 basis point reduction to our OpEx ratio with additional expense reduction of $4 million executed since quarter end. Finally, in October, we launched our rebrand of the Broadmark product, a small balance construction and residential finance program featuring loans from $5 million to $20 million, including development and construction financing for multifamily, build-to-rent and lot development for residential developers. These new products complement the existing construction lending program, which provides capital solutions for projects up to $75 million, highlighted primarily by multifamily and industrial.

We expect full accretion of these items by the latter half of next year with a gradual ramp in earnings to or above our historical 10% target. In the quarter, while stress CRE market conditions pressured both transaction volumes and existing portfolios, Ready Capital’s origination business remained active and portfolio credit metrics are healthy. CRE loan originations totaled $463 million in the quarter, comprising Freddie Mac volume, which includes both our tax exempt affordable and small balance multifamily channels of $374 million and bridge volume of 90 million -- 90% multifamily. Profitability reflects cyclical highs with Freddie gain on sale margin averaging 100 basis points and retained yields of 18% on bridge lending. While we expect tight CRE debt market conditions to persist for the balance of ‘23 and into ‘24, we note Ready Capital’s multichannel and multiproduct offering provides a competitive advantage, particularly the acquisition of distressed bank portfolios sourced by our external manager, Waterfall.

The current CRE pipeline across all CRE products totaled $740 million with $690 million committed. With current CREIT trading discount portending book value erosion from higher CECL reserves, particularly in office, Ready Capital’s strong relative credit metrics stand out. In measuring credit risk in our CRE portfolio, it’s important to bifurcate the portfolio into core direct lending and those acquired via mergers or loan pool acquisitions often purchased distressed at significant price discounts. In our originated CRE portfolio, representing 82% and $8.2 billion, our credit metrics continue to outperform the CREIT peer group. First, 60-day plus delinquencies remained low at 2.9%, with most delinquencies concentrated in a modest 5% allocation to office.

Assets with risk scores of 4 or 5 also remain flat at 6%. Second, 80% of the portfolio is concentrated in the middle market multifamily, where record single-family affordability issues skew the buy versus rent metric creating demand and low under 5% vacancy rates. However, with rising multifamily cap rates up 50 basis points year-to-date to 5.8% for Green Street and negative absorption in select markets pressuring rental growth, multifamily prices are down approximately 20% from the peak with another 5% expected, which compares to 40% to 50% for office. Although our portfolio is not immune from these market pressures, we do believe it benefits from our 2021 pivot to more conservative underwriting, including 0% to 5% rent growth, low underwritten stabilized LTVs and an avoidance of negative absorption markets.

For example, using our proprietary GEOtier scoring model, our exposure to the worst multifamily markets that experienced mid- to high single-digit year-to-date rent decline, Austin, Atlanta and San Francisco, is only 6% of our total portfolio. The net result, our current mark-to-market LTV is under 100%. Third, the maturity ladder. Only 2% and 29% of our multifamily bridge assets mature over the next 3 and 12 months, respectively, with the majority of maturities occurring later in ‘24, into 25. Although this provides some protection from immediate takeout risk, the under 100% mark-to-market portfolio loan-to-value and sponsor counterparty liquidity are significant mitigants to negative leverage, affording flexibility in loan extensions and modifications.

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For example, extensions typically feature sponsor equity contributions or repurposing of unneeded CapEx to interest reserves. Further, our solution capital program provides unitranche senior or preferred equity financing for refinancing our best sponsors and projects. Ready Capital’s historic expertise in NPL management and current liquidity from the Broadmark acquisition position us well to avoid foreclosures and losses on REO. In our acquired portfolio, where we frequently purchase impaired loans, 60-day plus delinquencies are unsurprisingly elevated at 17%. The basis for which we purchase these assets accounts for the impairment at the time of purchase and should not be an indication of further principal loss. Now an update on our Small Business Lending segment, a high ROE business unique to the commercial mortgage REIT peer group.

To review, Ready Capital is one of 17 nonbank lenders under the Small Business Administration’s 7(a) program. In the quarter, we originated $129 million 7(a) loans, comprising 63% large and 37% small loans, a 6% quarter-over-quarter increase, with premiums averaging 8.3%. Ready Capital remains the largest nonbank and fourth largest overall 7(a) lender with a 3-year target to double volume to $1 billion, which would bring us to roughly 3% market share. In terms of 7(a) credit, despite the rise in prime to 850 basis points, 60-day plus delinquencies in the 7(a) portfolio remain extremely low at 1%, well below the 6% GFC peaks. The earnings book value impact of defaults in this segment are limited due to both the small equity allocation, less than 5%, and the high ROE of the business, which can sustain higher defaults and losses.

In our residential mortgage business, core returns remain pressured due to lower transaction volume and margin compression. As previously discussed, we have been exploring strategic options for the platform, given the market and our core focus on CRE lending. We expect to move out of this segment over the next few quarters with proceeds reinvested in our core channels. Looking forward, while there will be near-term pressure, the company is well positioned to increase earnings and expand investment activity longer term. First, reversal of portfolio drag and NIM accretion from reinvestment of excess liquidity and balance sheet releveraging post the Broadmark transaction into cyclically high ROEs in both our direct lending and acquisition silos of over 15% versus 12% pre the first quarter of ‘22.

Second, our liquidity remains elevated with $182 million of cash and $1.8 billion of unencumbered assets. Finally, our conservative debt profile with total and recourse leverage of 3.4x and 0.9x, respectively. This collectively provides significant protection from market volatility as well as the ability to raise incremental debt capital to drive investment activity. With that, I’ll turn it over to Andrew.

Andrew Ahlborn: Thanks, Tom. Quarterly GAAP and distributable earnings per common share were $0.25 and $0.28, respectively. Distributable earnings of $52.2 million equate to an 8% return on average stockholders’ equity. Pressure on core earnings related to the Broadmark transaction was approximately 220 basis points and driven by a reduction in portfolio yield due to a higher percentage of nonaccrual assets and the deleveraging of the balance sheet. Interest income increased $17.7 million to $250.6 million due to the inclusion of the Broadmark portfolio for a full quarter and a 25 basis point increase in the weighted average coupon in the portfolio to 9%. Interest expense increased $19.1 million to $191.6 million related to both an increase in debt balances from the financing of Broadmark assets and slightly higher funding costs, which averaged 7.5%.

The levered yield in the portfolio declined to 10.9% as Broadmark’s 7% portfolio yield weighed on the average. We expect levered yields to increase to historical levels as we cycle out of the loans acquired and into new production. The provision for loan losses totaled a recovery of $12.2 million and was entirely attributable to movements in the general loans under performing loan book. We did not see any material movement in expected losses on our impaired or nonaccrual assets. Realized gains decreased $9.5 million quarter-over-quarter, primarily due to lower amounts realized in the settlement of derivatives. Core realized gains from the sale of loans in our SBA and Freddie Mac business were slightly lower due to a decrease in sale activity and lower 7(a) premiums, which averaged 8.3% in the quarter.

Unrealized gains of $80 million were driven by a $2.6 million increase in our residential mortgage servicing rights and the reversal of $13 million of unrealized losses previously recognized on CMBS loans that were transferred from available for sale to held for investment. These reversals were partially offset by the inclusion of new loan loss provisions. The operating expense ratio of the business declined 130 basis points to 5.7%. Included in the OpEx this quarter were several onetime items, including a $2 million noncash impairment related to a Mosaic REO, increased professional fees related to the processing of employee retention credit revenue and $2.6 million of servicing advances payable upon the refinancing of our fourth CRE CLO. On the balance sheet, book value is $14.42 compared to $14.52 on June 30.

The change is due to an adjustment of the bargain purchase gain related to the Broadmark transaction related to the valuation and pending liquidation of 3 assets. Leverage continues to be at historic lows with recourse leverage at 0.9x and total leverage at 3.4x. In the capital markets, we closed our third securitization of SBA 7(a) loans. The $186 million deal had a 71% advance rate with sold bonds having a cost of silver plus 325 basis points. With that, we will open the line for questions.

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