Ready Capital Corp (RC) 2017 Q1 法說會逐字稿

Good day, and welcome to the Sutherland Asset Management First Quarter 2017 Earnings Call. Today's conference is being recorded.

At this time, I would like to turn the conference over to Rick Herbst, the Chief Financial Officer. Please go ahead.

Thank you, Cynthia, and good morning, and thanks to those of you who are joining us on the call this morning. Some of our comments today will be forward-looking statements within the meaning of the Federal Securities Law. 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 conditions.

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 first quarter 2017 earnings release and our supplemental information. By now, everyone should have access to our first quarter 2017 earnings release and the supplemental information, both of which can be found in the Investor's Section on the Sutherlands website.

And with that, I'll turn it over to our CEO, Tom Capasse.

Thanks, Rick. We achieved some significant milestones since our last call and remain encouraged as we look forward. We successfully completed the $75 million note offering to fund our growing origination pipeline and anticipate that we will fully deploy the proceeds by the end of the second quarter. Given the timing of the offering in the middle of the quarter, and the resultant amount of cash on balance sheet along with reduced gains from loan dispositions, our core ROE showed a slight decline of 0.05% or $0.02 per share. Had half of funds from the net offerings been fully deployed on the day we closed that transaction, our core ROE would have been at or above last quarter. Core earnings adjust for onetime income and expenses and changes in the fair market values of mortgage servicing rights. Rick will provide additional details in a few minutes. Our initiatives to boost SBC originations volumes, as discussed previously, resulted in originations volumes rising to $177 million, an increase of 13% compared to the last quarter.

In addition, our SBC current pipeline, which is a leading indicator of volume, is over $275 million, its highest level ever. As of today, we have now deployed 2/3 of the notes offering proceeds. We remain committed to achieving double-digit ROE through programs designed to hit target financial and operating leverage ratios. Financial leverage includes additional issuance of nonrecourse debt, which will improve operating leverage by investing in increased originations to optimize our fixed cost base. We anticipate that future financial leverage would be added more gradually, unless we have specific acquisitions in place. Thereby, minimizing the earnings drag of having excess funds. Regarding operating leverage, we have increased our loan originations staff while holding the line on support and servicing staff. And in terms of the market backdrops, strong fundamentals in the SBC investor property and small business markets continue to support superior risk -- risk-adjusted returns in real estate lending, particularly in comparison to the more competitive large balance market.

Recall that we define at a small balance commercial real estate as real estate with an appraised value of less than $5 million and under 50,000 square feet. Now a few market observations. The health of the SBC property market is evident in the SBC quarter end national vacancy rate of only 7%, which is 120 basis points below the precrisis low plan, due in part to new supply in terms of SBC completions, recovering only to 25% of their precrisis peak. Despite these tight market conditions, SBC prices are still 5% below their precrisis peak as compared to large balance prices, which are 11% above the peak. With this backdrop, SBC originations reached a precrisis high of $183 billion in 2016. Now in terms of the small business market, growth in small business loan demand is reflected in 17% average growth in SBA-approved capacity since the 2009 crisis bottomed to $26 billion in 2016, with 13% growth projected for the next 2 years. This market remains highly fragmented with approximately 1,700 active SBA lenders, mostly community banks. Our SBA subsidiary is only 1 of 14 nonbank lenders, of which 4 are active. Despite only restarting originations in the fourth quarter, our ready-cap lending subsidiary is already in the top 3% of SBA loan originators.

With that, I'll hand it off to Rick to discuss our financial results.

Thanks, Tom. I won't go through every slide, but would like to highlight a few of them.

Slide 3 reconciles our gross leverage yields, both on a GAAP and core basis. On a core basis, from 47% to a bottom line with core ROE of 7.9% for the quarter. We've reconfigured the slide a little bit from the previous quarter to more accurately reflect the contribution from our residential mortgage banking unit. As Tom mentioned, our top line leverage returns reflect the fact that we used note offering proceeds to delever of our warehouse lines until those funds could be gradually deployed into new loan originations. We estimate the earnings drag during the quarter was about 50 basis point. Gains on asset dispositions were a bit lower, offset by a reduction in our effective tax rate.

Slide 4 provides some metrics on our acquired loan portfolio. Gains from asset dispositions of this portfolio are lumpy, based on resolution of larger loans. And the gains this quarter were $300,000 lower than the last quarter. We acquired $11 million of new assets during the quarter, but as we've stated in the past, as we look to remain prudent with how we deploy capital, we have stayed extremely disciplined on acquisitions.

Slide 5 summarizes our conventional investor lending business, with the leverage yields here off a bit from last quarter. Lower fees earned on loans when they mature impacted the returns here. And in addition, paying down our warehouse lines with proceeds from the note offering had the effect of delevering this segment, which in turn reduced the levered ROEs here. Furthermore, approximately 60% of the equity invested in the conventional loan business was allocated to warehouse inventory where leverage returns generally lower in the warehouse aggregation period until the loans can be securitized.

In addition to stronger origination volumes this quarter, our pipeline is up 25% or over $40 million since last quarter. Importantly, the credit quality of this portfolio remains extremely strong.

Slide 6 summarizes our SBA business, which continues to provide exceptional levered returns. The returns are a bit lower this quarter due to higher prepayments of loans this quarter, which reduced the value of the related loan servicing rates. I'll also point out that as of March 31, approximately $16 million of our new loan originations were not fully funded, and, therefore, we carry them at cost. Once they are fully funded, they can be sold at premiums that have been running north of 10%. So these loans represent a good source of earnings in future quarters, as those loans are completed and can be sold. We added 5 new loan officers this quarter, and our originations more than doubled from last quarter. In addition, our pipeline is at a record high, increasing over 20% from last quarter.

Slide 7 summarizes our residential mortgage business, which continues to produce strong results. That operation joined us in November as part of the ZAIS merger. GMFS is a market leader in the Southeast, and retains mortgage servicing rights to hedge fluctuations in originations due to changing interest rates. These retain MSRs provide an increased revenue stream, and you can see the increase in those MSRs as depicted on the right side of this page. That said, despite a rally of the 10-year treasury post the Trump sell-off, GMFS' origination volume this quarter was up 6% over the first quarter of last year. And we are aware that many mortgage companies have seen volume declines during the same period. Slide 8 shows the specific investment levels by type for the quarter, which provides perspective on where our funds were placed during the quarter. Compared to last quarter, Freddie Mac disbursements were up about $12 million. And the core business and transitional loans combined were down about the same. Slide 9 depicts the net interest margin contributed by each of the implementation businesses, and the increase in net interest income from our lending businesses reflect the successful rollout of our origination platform and should provide a more stabilized net interest margin going forward. The next few slides reflect the diversity of our loan pools geographically, by collateral type and by loan size. And the slide summarizes our current financing facilities and leverage. Our leverage ratios are fairly low. And we continue to seek opportunities to deploy additional leverage to generate improved risk-adjusted returns. Lastly, as we announced last week in the filing with the SEC, we entered into a settlement agreement with a counterparty who had asserted claims again GMFS regarding loans sold to the counterparty between 1999 and 2006. We were aware of the considerable diligence around this issue in advance of the ZAIS merger transaction. And we are glad to have the settlement behind us. The settlement had no material financial impact as the settlement amount will be offset against contingent consideration payments that were previously accrued for.

Now I'll turn it back to Tom for some final thoughts.

Thanks, Rick. And before we open up the call for questions, I'd like to update you on our progress to improve our ROEs as highlighted on Slide 13. First leverage. As discussed in our fourth quarter call, as a newly public company, our $550 million equity base provides access to accretive issuance of recourse debt, such as notes and preferred stock. Our first debt was the February note offering, which capital should be fully deployed by the end of the quarter. We continually evaluate the lowest marginal cost of capital alternatives in a currently receptive debt market. With recourse debt-to-equity ratio of approximately 1:1, we feel we have additional capacity currently available to us. So in terms of nonrecourse or securitized debt, we are currently working on 3 additional securitizations in the near term: the first is a securitization of a acquired SBC owner-occupied loans; the second is a commercial real estate collateralized loan obligation, or CLO, backed by our transitional loans; and the third is a securitization of newly originated Freddie Mac SBC multifamily loans. ABS demand evident in market spreads near precrisis lows remains strong. We continue to make progress on bringing these deals to market.

Now in terms of originations, as we've discussed in the past, our primary focus this year continues to be at increasing new loan originations across all of our products and platforms. As Rick mentioned, we have hired 5 new loan officers since year-end, bringing the total to 23, and are developing parallel affinity programs to generate repeatable origination volume.

Finally, in terms of taxes. As discussed in the fourth quarter, we are implementing strategies to reduce the level of taxes due at unprofitable taxable REIT subsidiaries, the benefit of which is reflected in the quarter.

In closing, we remain focused on our efforts to increase scale and grow the platform. The first quarter represents our first full quarter as a public company, post the merger last fall. With additional investment in the infrastructure, we are beginning to see growth in the loan pipeline. As we've said before, the goal remains to create a nationwide, nonbank, small balance commercial lending and servicing platform with scale in a highly fragmented SBC market where regulatory constraints on banks has constrained the supply of credit with small investors in and owner-occupants of SBC real estate.

In a short time since the merger, we had made great strides in establishing the framework for our business for years to come. Looking ahead, we remain excited about the prospects of Sutherland and the ability to create value for our shareholders. Thank you for your confidence in us. And we'll now open up the line for questions.

(Operator Instructions) And we'll take our first question from Jim Young with West Family Investments.

Regarding the GMFS, how much equity is in this business? It looked like you get common shareholder equity of $511 million, but how much is attributable to GMFS at this time?

The equity is between $60 million and $70 million. It fluctuates with the mortgage servicing rights valuations, but it is approximately 12% of our total equity allocation.

Yes, you can see that, Jim, on Page 3 of the deck, upper left, where it shows the ROE of the business and the equity allocation in that quarter end. It was 11% and 15% ROE as of the end of the first quarter.

Yes. And will the -- in the current quarter, in the June quarter, will there be any additional benefits from this settlement reflected in the financial statement, be it on the balance sheet or the income statement?

No. We backed up the impacts of it. It wasn't settled till a couple of weeks ago. But the accounting requires that we back it up through March 31. There will be effects of error and it was really just a reclassification of liability from 1 line to another.

Okay. And then, you had mentioned that you're still committed to a double-digit ROE. Over what kind of timeframe do you think it will take to achieve this goal?

It's hard to give specific guidance. Hopefully, towards the end of the year, I think. It's not going to happen in this quarter. But we're looking for a gradual improvement from where we've been the last couple of quarters.

Okay. And has there been -- given the transitional nature of Sutherland in an active stage of its evolution, has there been any consideration in waiving some of the management fees? Other companies during similar periods have either eliminated management fees or have reduced management fees. Is that something under consideration at this time?

Yes, Jim. We actually look at that on a marginal cost basis in terms of the external manager. And at this point, the amount of revenue from the management fee is not -- does not cover the fully allocated expenses. So at this point, that -- it's unlikely that, that would be under consideration. There may be some thought in terms of -- we have been supporting the REIT in terms of cost reimbursement, not fully allocating direct cost of the external manager. So there may be some consideration there. But at this point, it's not in the management fees.

(Operator Instructions) We'll take our next question from Raj Patel with Farallon.

Can you talk a little bit about -- you're halfway through this quarter at this point, if you've had a material pickup in originations that you can actually use the cash on your balance sheet?

The originations continue to be at a rate kind of similar to where they have been in the first quarter. The pipeline is much stronger. It's hard to project with as much certainty how much of that pulls through between now and the end of the quarter. Obviously, if it all did, we would be well above where we are, but that's unlikely, I would say. But our projections, the way the originations have been running and with the pipeline, we will deploy all of the term loan funds, certainly, we believe, by the end of the quarter, absent a big falloff in some of the production.

And is that the cause of most of the drag, just those funds from that $75 million? Or is there other cash that is under deployed?

No. It's really those funds where we use the funds to pay down warehouse lines. So it kind of has a double whammy effect on the lever deal of those businesses. You're reducing the leverage within that business. And then, we're paying down 4% res debt until we can redeploy it into more a profitable loan origination.

But actually, Raj, to that point. If you look at Slide #3 on the far right, the impact that Rick just referenced of the negative carry associated with the note offerings, that was reflected in the top line ROE. However -- but I will also point out that exclusive of that, in terms of improving the capital efficiency of the business, there's always a float on secured -- we own all the MSRs on the loans we originate, which is part of our retail-based strategy within our lending business. So there's float there, there may be liquidity pledges by bank lines of credit. So we've been working on reducing all of that. And you could see at least in this quarter a reduction in cash and nonearning assets from 2.5% to 1.3%.

Oh, I got you. The 2.5% to 1.3%, even though you have more cash drag that's even bigger on the nonearning assets, is that right?

It's cash drag, but it's really we've paid down the warehouse lines. So it kind of affects the denominator in the calculation.

But it's a valid point to bring up generally and we're very -- we have a team that's focused on forecasting liquidity and trying to match any debt issuance with actual acquisitions or originations as well as trying to reduce the amount of nonearning cash for, like, bank lines and other activities.

If you go back a couple quarters to what I thought was the best [buzz] that you guys put up since you've been public that the pro forma ROE charge you started with Q3 '16 core ROE. And I think I go back to the February call, since then, I guess. You must have made the staff reductions by now. And I think you stated that the transferring the taxable income, that's already been done. Is that right?

Yes, the effect of that has been recognized this quarter.

So you started with [8 3] and each of those things combined, plus the first loan securitization and its note offering. That's all been done. So you've done most of those things other than, I guess, invest the money. And yet our ROE is actually gone below where we started. Just trying to reconcile what's been going on there.

Since the gains have been a little lower over the last couple of quarters than they had been prior, the term loan, which is really the biggest driver, again, that didn't happen until middle of February, and it turned out to be a little bit of a drag this quarter, but we think it will be accretive in the second quarter. So the effects of that hadn't kicked in. The securitizations have taken a bit longer than we thought they would have. Back in the fourth quarter I think we would have told you that we felt we would be done with them by now. We're getting much closer but they are not done yet. So we haven't seen the impacts of that, either.

If you had the securitizations done, do they just repay more expensive debt? Or put more cash on your balance sheet that would then take some time to invest anyway?

Well, it's cheaper cost of funds than we generally advantage rate.

Yes, then we move -- the other thing it does is it reduces our recourse, deferred benefit is it reduces our recourse debt ratio.

Got you. So you have more firepower to do the same thing again a quarter later or whenever you need to?

Correct.

Okay. Is there anything -- on the gains part, there's nothing negative to really see there? I mean, that's just lumpy. As long as you're seeing performance in that bucket, that doesn't really -- you just don't know when it's coming, right?

Correct.

All right. Well, I guess one more thing. I think you just stated that note proceed, that line item will actually turn -- be accretive for second quarter. That's the case, even though you haven't, sitting here at May 10, you haven't deployed those funds?

Well, we've deployed about 2/3 of them as of now.

We plan to deploy the rest over the next month or so.

Okay. And with the levered yield, the 2/3, it's already accretive? On average, generally?

Yes.

And it appears there are no further questions at this time. I would like to turn the conference back to the company for any additional or closing remarks.

Thanks. Again, we appreciate everybody's continue support. And we look forward to our earnings call next quarter.

And that concludes today's call. Thank you for your participation. You may now disconnect.