Ready Capital Corp (RC) 2016 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Sutherland Asset Management Corporation's third-quarter financial results and general business update conference call.

(Operator Instructions)

It is now my pleasure to turn the floor over to your host, Rick Herbst. Sir, the floor is yours.

Thank you, Samantha, and good morning, everybody. Thanks for joining the call today. Before we begin, I'd like to remind everyone that during the course of this conference call (technical difficulty) remarks and our answers to your questions we may make certain statements and assumptions that contain or are based upon forward-looking statements in such terms as described in Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and such statements are intended to be covered by the Safe Harbor provided by the same.

Such forward-looking statements are subject to numerous assumptions, uncertainties, and known or unknown risks which could cause actual results to differ materially from those anticipated. Forward-looking statements included in this conference call are only made as of the date of this call and we are not obligated to publicly update or revise them. The purpose of this call is to review the results of the third quarter of 2016 and provide additional color to investors about our Company.

Attached to the earnings release distributed last night and available on our website today was a deck containing supplemental financial information as of and for the third quarter ended September 30, 2016. Before we discuss that, I thought it might helpful to summarize how the financial reporting will work going forward. As you all know, our merger with ZAIS Financial Corporation closed on October 31 and we began trading on the New York Stock Exchange on November 1 under the ticker symbol SLD.

Legally, though, ZFC was actually the acquire of Sutherland and Sutherland is, I'm sorry -- ZFC is actually the surviving Company, which was then renamed Sutherland Asset Management Corporation. For accounting purposes, though, Sutherland was deemed to have been the acquirer. Therefore, the statements presented as of and for the period ended September 30, 2016 reflect just the results of Sutherland as a standalone Company.

Sutherland will then -- we will pick up the financial results of the former ZFC entity effective November 1. So our fourth quarter results will include the results of Sutherland only for the month of October, and then the combined Company for November and December and forever thereafter. Hopefully, that did not confuse you too much, and now I will introduce our CEO, Tom Capasse.

Thanks, Rick. We are, obviously, excited to close the merger transaction with ZFC and we welcome the ZAIS investors as investors in our Company. Becoming a public Company has been the number one priority we've been working toward since our formation in 2013. It is a significant milestone for us and will benefit our Company and our shareholders in several ways.

Number one, it lowers our cost of capital by opening access to the public retail and institutional unsecured debt and preferred stock market not available to us as a private Company, and we will talk more about that later in the call. Number two, it provides liquidity to our investors with registration as a public Company. And number three, compared to an IPO, it had a far lower cost in terms of dilution.

In terms of a business update, our core earnings for the quarter were $10.1 million. Core earnings reflect adjustments for the transaction expenses occurred during the quarter, one-time severance costs related to staff reductions in the third quarter, and our continued deemphasis of MBS investments which will reduce [volatility] as MBS are subject to fair value reporting. While core earnings increased 10% from the prior quarter, we recognize the need to increase our return on equity and we remain clearly focused on doing so.

Our goal is to return to a double-digit ROE next year. In a few minutes, we will discuss steps underway to get there. Before we do that, I'd like to give some background on our Company.

Our income was up about $1 million, or GAAP income was up about $1 million, or 12% over the last quarter. This increase is primarily due to increased gains on sales of SBA loans, positive marks on our derivatives, and a reduction in operating expenses, partly offset by a decline in the net interest margin.

We've included some additional slides describing our business, and I won't go into a lot of detail, but I will provide some highlights. For our new investors, slide number 2 provides an overview of our businesses. Our direct lending businesses provide capital deal flow, which as they grow, will provide a steady source of revenue and income for the firm.

Our business is simple. We offer investors in Small Balance Commercial properties, conventional, transitional or Freddie Mac multi-family loans through our ReadyCap commercial entities, and owner/occupants, typically small businesses of Small Balance Commercial properties, loans through the Small Business Administration to our ReadyCap lending subsidiary. In addition, we have the ability and have a history in acquiring distressed loans from banks when we have the capital to do so.

Slide 3 includes information as of September 30 pro forma for the ZFC merger transaction. Our pro forma book value on that date is $17.07 per share and pro forma total equity is over $560 million. We are pleased to report that we closed our third ReadyCap conventional mortgage securitization yesterday.

We are benefiting from a significant improvement in the securitized debt market since the volatility in the first half of this year evident in commercial mortgage-backed security AAA and BBB spreads tightening 25 and 200 basis points to 110 and 525 basis points from the end of the second quarter to present. Correspondingly, the senior AAA tranche of our deal priced at the 2-year Treasury plus 165 basis points, which was 63 basis points tighter than our fourth quarter 2015 transaction.

Investor demand was strong with the AAA 2.4 times over [subscribed] to 20 accounts, many of which were new, reflecting in part our positioning of the ReadyCap shelf as a CMBS product by the inclusion of Moody's. The deal provided a conservative 82% advance rate and an approximate debt cost of 3.2% for a 12% to 15% yield on the retained tranches. In addition, we plan to launch an investor owned or owner occupied securitization next week which we anticipate will close over the next month or so.

As an aside, one observation on Sutherland's reliance on securitization in the context of our overall funding strategy, we treat securitization as an opportunistic low-cost form of non-recourse financing, but it is not our only financing strategy. Only the conventional SBC loan business primarily targets securitization as its funding source. The Small Business Administration and Freddie MAC businesses obtain 75% to 100% of their funding from government programs and the transitional loan program and acquired loan programs can both utilize term bank financing, as well as securitization.

Meanwhile, fundamentals in the SBC market remain strong providing ample lending opportunities. SBC property prices were up 3% through July versus 1.7% for large balance properties, this being the first year since the credit crisis that year-to-date small balance commercial prices have outpaced more volatile large balance property prices. Originations in the second quarter for SBC totaled $46 billion, and that excludes the SBA, but they were up 5% quarter-over-quarter despite a decline in sales volume driven by refinancing.

Finally, demand for small business credit remains robust with year-to-date SBA 7a Authorizations of $20.7 billion through November 4, with our ReadyCap lending subsidiary rising to a number [77] position in the market. Slide 5 reconciles our gross levered yield of 16.9%, similar to last quarter, to our bottom line ROE. We believe additional leverage will increase our gross leverage yield, and reducing our operating expenses will further increase our bottom line.

We will talk more about that in a minute, but first Rick will cover a few more slides.

Thanks, Tom. Slides 6 through 8 provide additional detail on each of the three major business lines. Slide 6 depicts the acquisitions business. There is some decline in the gross margin in this business as loans previously acquired at a discount are now paying down, and due to capital constraints, we have not been as active in this business line and, frankly, that portfolio has declined a little bit over the last few quarters.

Slide 7 summarizes our conventional investor lending business. The leverage yields here are up a bit from the previous quarter, primarily due to portfolio mix and various fee line items. Slide 8 summarizes our SBA business which continues to provide exceptional leverage returns.

Of note here is we recently expanded our staff of new loan originators, and we are starting to see the fruits of this effort. Although relatively small, we did have our highest quarterly new loan origination volume and our pipeline is at a record high. We anticipate a higher level of new loans in the fourth quarter, and we believe we are well-positioned for a great year of originations in 2017.

Slide 9, a new slide to those who are familiar with our presentations, summarizes where our invested funds went in the third quarter. Our intent with this slide is to give investors a sense of the market and some additional data points for our new loans and the return profiles for each of these businesses.

Slide 10 depicts a percentage of net interest margin contributed by each of the business lines. So as shown in this chart, the new loan originations are contributing more and more of our net interest margin. This migration from capital gains on liquidations of distressed loans to stable net interest income from our lending businesses reflects the successful rollout of our origination platforms and maturation of the credit cycle where rebirth in lending follows a recession. However, one strength we saw in SBC strategy is the ability to produce an attractive dividend across this credit cycle by pivoting from lending to acquisition based on economic conditions.

Slides 11 and 12 reflect the diversity of our portfolios, both on the investor-owned businesses, as well as the small business credit sectors. Our portfolios, as you can see, are diverse geographically by collateral type and loan size, primarily first lien positions with limited [skewness], particularly compared to some of the large balance commercial mortgage REITs in the market.

And slide 13 summarizes our current financing facilities and leverage. Our leverage ratios are fairly low, and as Tom will discuss, we believe a bit of additional leverage will provide opportunities to increase our ROE going forward.

Thanks, Rick. Before we open it up to questions, we'd like to provide some additional color on the steps we are taking to return ROE back to double-digits, and I would ask you refer to Slide 14. Number one, leverage. One of the benefits of being a public Company is access to the public debt markets.

We are currently marketing a five-year rated note offering and are actively engaged with numerous potential lenders. If all goes well, we should be able to close this transaction in December. Given our strong investment pipeline, we are confident we will be able to deploy these funds very quickly which would be immediately accretive to earnings.

Now as I mentioned earlier, we closed one securitization yesterday, have another on tap for December, and plan a CRE -- commercial real estate collateralized loan obligation backed by our transitional loans for the first quarter of 2017. We estimate that these transactions collectively can improve our ROE by 60 basis points to 300 basis points depending on the timing and successful execution of each.

The second factor is operating expenses. Last quarter, we undertook a Phase 2 review of the operating expenses in our core businesses following, if you may recall, the -- exiting non-core businesses in the fourth quarter of last year. In September, we reduced our headcount by 16 employees, reducing our ongoing compensation expenses by $1.9 million annually.

There were related one-time severance expenses of $360,000 in the third quarter, but the annual savings will increase ROE by 40 basis points annually. Thirdly, in terms of taxes, we are currently working with our financial and tax advisors to implement a strategy to reduce the level of taxes due at our taxable REIT subsidiaries. Such reductions will have a dollar for dollar benefit to the Company, and we estimate that when implemented this can improve ROE by 50 basis points to 75 basis points.

Finally, in terms of the level of non-earning assets, which continue to be a drag on earnings, we are going through every single line item to optimize the earnings capacity for each item. This includes bidding up cash cycles, obtaining additional leverage and converting non-earning assets to earning assets wherever possible. As we make progress with those items, we believe we can realize an incremental ROE benefit of 20 basis points to 40 basis points next year.

In conclusion, the Appendix contains some additional information about the Company, which we thought might be helpful to new investors, and Rick and I would be happy to cover those at investors' option. At this point, this concludes our prepared remarks and we will open it up for questions.

Once again, we are very excited to have completed the merger with ZFC and become a public Company. We believe this will be a great benefit to Sutherland and its shareholders, and we look forward to the many opportunities being public presents. Thank you for your confidence in us and we'll now open it up to questions.

Thank you.

(Operator Instructions)

Jessica Levi-Ribner.

Hi. It is Jessica Levi-Ribner from FBR, how are you?

Hey, Jessica, how is it going?

A question on your target leverage. You mentioned a couple times that you believe that you can increase your ROE by increasing your leverage, but what is kind of the leverage ceiling that you feel comfortable at?

We try to run the business -- the recourse leverage, kind of the cap is around 1.5 times, but then as we do more securitizations that leverage will creep up over time. We are running now about 2-to-1. It will probably get to 3-to-1, and maybe a year or two down the road above that. But that's kind of the range we are looking at. But, again, we view the recourse versus the securitized leverage very differently in terms of capacity.

Yes, fair enough. Recourse leverage, I just want to clarify, could go to 3-to-1 or even higher down the road?

I'm sorry, recourse, we try to cap around 1.5 -to-1.

Oh, I see, the securitized leverage, you are saying, could go to 3-to-1.

Yes, the total leverage with securities can go to 3-to-1 and potentially over time a bit higher than that.

Okay. And then in terms of allocating your capital, I know you provide the table that shows where the capital went this quarter, what is your priority in terms of capital allocation, like where does it go first? How do you think about that?

We tend to -- we definitely optimize scarce capital by allocating to the various businesses based on the highest ROE on a prospective six-month or forward basis. And a lot of that is, for example, driven by rates. So for example, in a -- when the 10-year is very low, the conventional program is not as competitive with banks. And our floating-rate programs tend to be very -- as well as the Freddie Mac program -- tend to be very competitive in that environment. So there we would allocate capital to those businesses, and now that rates are rising, we may take a different tact in terms of that business, the conventional business, becoming more competitive.

And then, apart from all of that, the ROE on the SBA business is significantly higher than the other lending businesses. A lot of that having to do with the fact that it is a niche business with various [dentry] due to the licensing -- limited amount of licenses that are available. So we would tend to probably in short, based on allocated capital, first to the SBA business, to grow that, and then depending upon where interest rates move and the ROE change on the non-SBA businesses allocate capital to the lending business.

And finally, if there are there are opportunities on the acquired loan side and we have incremental liquidity, which we plan on generating from these four debt offerings over the next couple of quarters, we would then look to potentially capitalize -- opportunistically invest in some acquired portfolios.

Okay, fair enough. And then, one last one for you guys, the gross levered yields on the SBA portfolio ticked down just a little bit, but it looks like it has been ticking down over the last three quarters. Can you give me an idea of how that -- what the dynamic is there?

Sure. It is still great returns, as you can see there. A lot of the returns come from the acquired loan business that we purchased from CIT back in the summer of 2014. And some of that revenue is from servicing that portfolio.

That portfolio is running down, obviously, as loans pay off, so it is just the absolute servicing fee income and the portfolio earnings out of that has declined as those loans pay off. Now that our originations are ramping up, we expect in 2015 that our originations -- I'm sorry, 2017 -- that our originations will catch up with the run-off in the portfolio, so that, hopefully, by the end of the year we will have reached the inflection point where that will turn around on the upside again. In the meantime, though, new originations generate pretty good returns just from gains on sale from the -- selling the guaranteed portion to investors.

Okay. Great. Thanks so much for taking all my questions.

Sure.

Jim Young.

Yes, hi, with West Family Investments. You mentioned about the capital allocation, but I was wondering how do you factor in share -- potential share buyback? When I look at the stock, it is $13 relative to your pro forma book it is $17.07. It is, obviously, trading at a huge discount, so I'm just wondering how you think about a share buyback in that context?

It is something we've talked about internally and at the Board. Currently -- we've just been capital constrained. I think if we had excess capital, it is something we would absolutely do given where we think -- [lower] trading versus some of the other commercial mortgage REITs. Obviously, our goal is to get us back in line with the rest of the commercial mortgage REITs given our returns.

But up until this point, just with the lack of capital, it has been difficult to sustain the loan origination business at the same time as buying back shares. But, again, it is something we've talked about from time to time. The ZFC merger didn't create a lot of cash, it created a fair amount of excess capital, but it didn't generate a significant amount of cash.

A lot of that capital was tied up -- not tied up, it was dedicated to the GMFS business, which is the residential mortgage company. But over time, as we build cash reserves and if we, particularly if we are successful on all these debt facilities that we've mentioned it is something that, particularly if we continue to trade where we are, it is something that would probably gain a higher likelihood.

Jim, just to follow on to Rick's comments. The key thing -- aspect here -- is to improve valuation by building our franchise. And we build our franchise by investing in the businesses, so that's definitely number one. Because if we are able to generate a 10% return on book, that is a significant premium to the large balance REITs, which, hopefully, would drive valuation.

That being said, we have undertaken reviews with a couple of investment banks in terms of going through the aspects of actually setting up a share buyback program, and we will probably move forward with that next year.

Okay. So what I'm hearing is that a share buyback will likely be announced sometime in early 2017, because, again, if you are talking about a 10% ROE you are looking at a 24% discount to book at current market prices. Can you talk about the performance of the GMFS mortgage business and what are your thoughts on that entity going into 2017?

Just in terms of the operating side of the business, and I'll let Rick touch on the incremental ROE, which we believe to be accretive. But generally speaking, that company is a very -- compared to other mortgage originators -- it is a very balanced business because of its dominant position in the Southeast -- Louisiana, Alabama, Mississippi, et cetera.

And they have what is key in terms of a mortgage company, is they have a balanced mix of purchase and refinancing, as well as more of an emphasis on retail, and they have a significant MSR, mortgage servicing rights, portfolio which offsets the inevitable volatility in originations tied to the movement in the 10-year Treasury. So I think we view it as an accretive addition, granted it is less than 10% of our NAV, and we are also -- have begun a program to educate the GMFS salesforce to cross-sell both the SBA small balance program, as well as the Freddie Mac multi-family, both of which are sourced through residential channels.

So what kind of an ROE is the GMFS business producing currently and what is the prospect for 2017?

They've been generating about 15% or so ROE, and just to be clear, though, some of that is based on the creation of mortgage servicing rights which are capitalized and they are historical accounting practices [lead to] fair-value of those servicing rights which we will continue. So it will be accretive, we believe it will be accretive to our ROE. Given where interest rates are going, the values of those servicing rights will probably increase over time.

Okay, thank you.

Thanks, Jim.

Jessica Levi-Ribner.

Hey, sorry, just one last one. The note that you mentioned, the note offering that you mentioned, can you give us a little bit more color on that? In terms of just -- yes.

We are in the market now. We've been talking over the last three weeks or so with numerous potential lenders, so we don't have final terms yet. We've been exchanging term sheets and going back and forth. And having said that, I can't give you 100% assurance it is going to close, but we are cautiously optimistic.

It is $75 million to $100 million offering of five-year notes secured by second liens and that type of thing, not first lien lending. Depending on -- I can't talk too much about the coupon at this point because we're really talking with two different lender bases, insurance companies, which we do -- it is a rated instrument, which insurance companies care more about. And we're also talking with more, so-called, high-yield lenders. So depending on where we come out and where the demand is that will dictate probably where the pricing is.

Okay. Thanks so much.

[Barry Prevor].

Hi, guys. I'm just a private investor. I have a question for you. I just want to clarify, the release of the numbers that you gave here is really based on the old shares of Sutherland, and these shares were exchanged for 0.8356 shares of ZFC which became SLD now. So really, when we look at a number like $0.30 in earnings, that's really 20% more, 19.7% more on the current shares. So when you say $0.30 earnings, if you are really looking at that from -- on the current shares that's really $0.36 per share on current shares, is that correct?

I'm not sure that's how I would characterize those. I think I know what you are getting at. Sutherland shareholders got 0.83 shares per each share, so I think what you are saying is going forward prospectively, if we were to do $0.30 in the fourth quarter, let's say, just hypothetically, the Sutherland shareholders would only get 83% of that because they've been diluted a little bit to ZAIS investors.

Well, the opposite really, it's that one of the old shares is now only 0.8356 shares, so really it is 1.197 of the old shares are now one share. So $0.30 earnings on the old Company, it is kind of irrelevant, it is really $0.36 for a current holder. If you continue to earn that same amount, you would be reporting $0.36 in the next quarter.

That's true.

Okay, that's just what I wanted to clarify. Now when you speak in slide 14 about your thoughts on potential core ROE of 10% to 12.8%, do you -- would you look at that -- are you looking at that only on the old business or do you believe that's a good thought on the current shares?

In other words, if we look and say, okay, the current book, pro forma book value is $17.07 a share, if your core ROE thoughts are 10% to 12.8% then looking forward you are thinking that the Company could make core return on equity of $1.70 to $2.18 a share?

That is our goal if we are successful in all of these items that we've talked about implementing. And everything else being equal, the top line would have to be the same, 8.3, but our goal is, yes, to get into double-digit ROE with the new share count and with the new book value per share.

Great. Fantastic. It is a great business, great quarter. Thank you very much.

Thanks.

Jim Young.

Yes, hi. Regarding your dividend, in the September quarter you declared and paid a $0.30 cash dividend. Can you talk about how the Board is thinking about the dividend policy going forward into the -- not only the fourth quarter but also into 2017? And when are you expecting to declare your next quarterly dividend? Thank you.

Sure, thanks, Jim. The fourth quarter we will declare before the end of the year. We need to do that for tax purposes as a REIT. We are still going through, frankly, the ZAIS taxable income calculations, which are little bit, I guess, more complicated than normal given we paid -- before the merger they shed about [$300 million] of loans and there was a difference between the tax basis and the GAAP basis.

Since the acquisition, we have disposed of their mortgage-backed security portfolio, which is $100 million or so. So we are still going through those. So the fourth quarter might be a little squirrelly, although our intent is to keep the dividend kind of on a par with where it has been in terms of return. But if something comes out of that tax analysis that could change, up or down, frankly. So the fourth quarter is a little unusual.

Going forward, though, our intent would be -- we'll talk about it at the Board level -- is to exchange the dividend policy at the beginning of year with what we believe is a sustainable dividend for the year based our projections in how the business is going and then maintain that over the course of year. But that would probably not be announced until the first quarter dividend.

I would also add we will likely -- historically Sutherland, we've waited until the end of the quarter to declare. As we did in September, the dividend wasn't declared until October 14. Our goal would be to declare the dividend within the quarter, get a little bit more timely, and, hopefully, more predictable in terms of the timing of those dividends. Does that answer your question, Jim?

Actually, let me follow up, maybe just one other thing. Again, our goal is to get the ROEs up. Our strategy has always been to distribute as close to 100% in taxable income as we can estimate. Sometimes it is a little difficult to estimate until you do the final tax return, but assuming that the taxable income is on par with the GAAP income -- you guys can do the math depending on how quickly we can get to those returns if we do, based on a $17 or so book value, let you do your own calculations.

Okay, then, lastly, can you just remind us how much stock does Tom own, how much stock, Rick, do you own, and how much stock do other insiders in the Company own at this time? Are there any plans to increase insiders equity ownership?

The specific ownership levels are included in the proxy, if you look at the management shareholdings and we just filed Form 4s. So those are publicly available. Collectively, the management team and affiliates own a little over 3% -- between 3% and 4% of the stock of the Company.

We are actually just debating internally if we can open up our trading window, as public companies have their trading windows. Typically that trading window doesn't open up until a few days after the earnings release, which is today, and then generally close the first day -- at least our policy is to close it the first day of, in this case, December 1, the first day of the last month of the quarter. We're still going back and forth if we can open up the trading window for a couple of days and then individuals can make their own decisions.

Okay, and I'm not showing any more questions in queue.

Again, we thank everybody for their time and, again, we are excited to be a public Company and look forward to future correspondence earnings calls.

Thank you, ladies and gentlemen. This does conclude today's conference call. You may disconnect your phone lines at this time, and have a wonderful day. Thank you for your participation.