Ready Capital Corp (RC) 2022 Q1 法說會逐字稿

Good morning, and welcome to Ready Capital Corporation First Quarter 2022 Earnings Conference Call. (Operator Instructions) Please note that this event is being recorded. I'd like to turn the conference over to Mr. Andrew Ahlborn, Chief Financial Officer. Please go ahead.

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 first quarter 2022 earnings release and our supplemental information, which can be found in the investor relations section of the Ready Capital website. I will now turn it over to Chief Executive Officer Tom Capasse.

Thanks, Andrew. Good morning everyone, and thank you for joining the call today. In a volatile quarter featuring rising long rates and widening credit spreads, our performance in terms of both stable earnings and book value underscores the benefits of our diversified business model in times of market uncertainty. To begin, lending activity in our small balance commercial, or SBC, segment remained at record levels with over $2.2 billion originated. Our bridge lending business led the way with $1.9 billion originated, 95% of which was multifamily. In response to wider credit spreads in the CRE CLO market, pricing on the asset side has increased proportionally, driving higher leveraged yields versus the fourth quarter of 2021. Additionally, our focus on strong sponsors and high quality properties in our lower-middle market niche continues to provide significant equity cushion.

High bridge volumes were supported by $61 million of fixed and CMBS production as well as $135 million in Freddie Mac small balance loans. The market for fixed and CMBS product remained highly competitive and quarterly volume declines were due to us staying disciplined on yields, markets and collateral type. We do expect to ramp up activity in this channel over the upcoming quarters. In our Freddie SBL program, quarterly volume declines were due to rate increases. Current Freddie SBL pricing in top tier markets is 4.5%, up 150 basis points since year-end. We expect slight volume declines in the program headed into the third quarter as the product becomes less competitive with fixed and CMBS products. Red Stone, our affordable tax-exempt lender, originated $62 million, representing a large quarterly decline, which was anticipated due to seasonality. Affordable housing typically experiences lower first quarter loan volume due to developers pulling deals forward in the fourth quarter to realize current year tax benefits. In our small business lending segment SBA 7(a) production totaled $101 million.

This quarter marks the first time we have exceeded $100 million in the absence of government stimulus programs and is a significant step in achieving our goal of a $600 million annual run rate. We expect growth in this segment from the continued development of our small loan lending segment, now the 11th largest in the country, and the realization of front end investments made in 2021. On the residential side, as expected, volumes decreased 12% to $769 million in the quarter as higher rates lowered refi activity. GMFS is better positioned than the peer group to weather the rate cycle with higher-than-average purchase and retail channels and its historic strategy of retaining mortgage servicing rights. This is reflected in relative outperformance in the quarter, with gain on sale premiums 50 basis points to 100 basis points higher and volume declines 35% less than the peer group. We believe the diversity of our business model, which provides full life cycle financing to FPC properties, will allow us to deploy capital in response to the current changing market dynamics.

Current pipelines remain strong at over $1.3 billion, which includes $875 million and $200 million money up in our SBC and SBA channels, respectively, and $350 million in April originations. Record originations have resulted in portfolio growth of 99% year over year to $9.4 billion. Today, 2/3 of the portfolio is in high conviction defensive sectors, comprising multifamily and industrial. Additionally, 81% of the portfolio is floating rate, with average LIBOR floors at 50 basis points. With short term rates at or above 80 basis points, we have reached a point where upward movements positively impact earnings.

The remaining portfolio is either hedged or match funded through securitization. Credit metrics have returned to healthy pre-pandemic levels, with 60-day-plus delinquencies under 2%. Our continued post-COVID credit outperformance versus our large balance commercial REIT peer group (inaudible) number of factors: portfolio granularity, the top 10 loans equal only 8% of total loans; less competition in the SBC property market resulting in strong credit parameters; cap rates and debt yield 100 basis points to 200 basis points higher than large balance;

finally, an underwriting discipline targeting lower risk CRE sectors in the top MSAs using our proprietary GEOtier scoring model. A unique risk overlay is our proactive asset management, which applies our non-performing loan servicing capabilities to avoiding defaults on our performing portfolio. In our bridge portfolio, which is predominantly multifamily, NOI growth from unit stabilizing of market rents is outpacing rising rates. Today, with the post-pandemic return to normalcy, our teams are prudently moving back into other property types and asset classes, but with a cautionary eye on potential economic weakness in 2023 at this stage in the credit cycle. In the quarter, we continued our strategy of funding growth through accretive M&A, eschewing a singular reliance on secondary offerings, adding $670 million of equity through the closing of the merger with Mosaic and a secondary offering in January. Since the beginning of 2021 equity increased 135% to $1.9 billion, ranking us as the 6 largest commercial mortgage REIT.

Since 2016 we have completed 6 M&A transactions, improving operating leverage and achieving a lower cost of debt capital more accretively than through the more typical secondary issuance route. We successfully completed the Mosaic merger and welcomed Mosaic shareholders to Ready Capital. The transaction furthers Ready Capital's competitive advantage via a seamless expansion in our product mix from heavy transitional bridge to construction lending. In addition, we have been active in the debt capital markets, completing 2 securitizations and a $120 million 3-year 6.125% unsecured bond offering since the start of the year. Our securitizations included our largest CRE CLO to date, a $1.1 billion transaction raising $150 million in net capital, and a $277 million fixed rate securitization. Even in a stressful quarter characterized by widening credit spreads and terminated offerings, our continued access to the capital markets is testimony to the quality of our assets and the depth of our investor base in the ABS market.

Finally, in terms of the outlook, we expect the earning profiles of business to continue to support our dividend through a combination of the growth of the loan portfolio, increased activity in our gain on sale businesses and the continued accretion of PPP income. Broader market volatility may dampen record origination volumes, but our platform is made for times such as these. Our investment strategy is positioned and balanced to perform in bull and bear markets. For instance, we are capable of pivoting with the credit cycle, including ramping our acquisition business in the event of higher non-performing loan volumes, as we did in the GFC, purchasing $5 billion in SBC NPLs. On the growth front, we expect to pursue additional M&A opportunities in segments complementary to our core competencies, capture market share in core markets and expand our presence in Europe. I'll now turn it over to Andrew.

Thanks, Tom. Quarterly GAAP earnings and distributable earnings per common share were $0.70 and $0.52, respectively. Distributable earnings of $48.9 million equates to a 13.6% return on average stockholder's equity. The quarterly earnings absent the effects of PPP were driven by increased net interest income, earnings from our joint venture investments and movement in our hedges, with offsets coming from decreased activity in our gain on sale segments. Net interest income grew 20% quarter-over-quarter to $47.2 million. The increase was driven both by a 28% increase in portfolio size and a push past the 50 basis point average LIBOR floor in the portfolio. As Tom mentioned earlier, we expect increased earnings as short-term rates rise. As of quarter-end, the portfolio, consisting of over 4,500 loans totaling $9.4 billion, had a weighted average coupon of 4.6% and spread of 310 basis points. Spreads continued to widen in the quarter, with new loans priced at an average spread of 350 basis points.

Our joint venture investments, which consist primarily of CRE equity investments, experienced significant increased profitability of $5.7 million quarter-over-quarter due to the rent stabilization in key properties resulting in market value gains. Interest rate hedges were up $23 million in the quarter, offsetting markdowns of CMBS loans held for sale. Revenue increases were partially offset by a $9.4 million reduction in gain on sale revenue due to both origination declines in 7(a), Freddie Mac SBL and Red Stone production and the roll-off of the 90% guarantee stimulus in our SBA business. In the quarter, we sold 20% of SBA production for higher IO strips, resulting in no day 1 gain on sale income. Net income from residential mortgage banking declined $600,000 quarter-over-quarter. Revenue from mortgage banking declined $13.5 million due to a 12% decline in production and a 5% decline in average margins, which now sit at 70 basis points. Declines in revenue were offset by a $12.9 million reduction in mortgage banking expenses due to a $10 million swing in payroll fees.

Net income related to PPP declined 15% quarter-over-quarter to $13.7 million after considering the effects of tax. The quarter over quarter reduction in PPP earnings was primarily driven by a slower forgiveness rate. This income, which continues to add to our outperformance, is likely to remain a significant contributor to earnings over the next few quarters. As of quarter-end, we had $45.5 million of pre-tax revenue remaining to be accreted into earnings and $10.2 million of reserves against those fees. As of last week, 23% of the original portfolio remained.

On the balance sheet, the quarter was most impacted by the closing of the merger with Mosaic. The transaction added $750 million of assets consisting of cash, construction loans, preferred equity and REO, against $460 million of equity. In addition to the class B shares issued as upfront consideration in the merger, there is an $84.3 million contingent liability related to the contingent equity right that was issued. Total leverage as of March 31st declined to 4.4x, and absent the PPPLF to 4.1x. The composition of our leverage also remains both conservative and constructive to the business. As of quarter-end, recourse leverage was 1. and liability subject to full mark-to-market represented only 20% of our debt capitalization. With that, we'll now open the line for questions.

(Operator Instructions) First question comes from Crispin Love, Piper Sandler.

So first off, so just on the return on equity outlook. I know you have made some comments in recent quarters, but I am just looking for a little bit of an update there. Would you expect the ROEs to remain elevated in the second quarter and then start to trend towards that 10% to 11% target in the second half? Or is there even upside to that for the second half, given the rate sensitivity you mentioned, and then also PPP still being a decent-sized contributor.

Andy, do you want to touch on that?

Yes, so I do think the return profile is going to remain elevated over the next couple of quarters. When you look at the composition of this quarter, what you had was an increasing portfolio benefiting from rising rates, but lower production in both Red Stone, Freddie Mac and SBA. So we expect the net interest income in the portfolio to continue to climb, but those gain on sale businesses to also grow, which will add to that, add to the earnings profile. And then additionally, the forgiveness rate of the PPP loans is starting to stabilize. So I don't expect to see quarters of volatility and for the profitability for PPP to remain fairly consistent with where it was in the first quarter. So I do think it's going to be a couple quarters of increased returns before normalizing to that 10% or 11%.

Okay, great. And then just one on SBA more broadly, there was one competitor -- SBA competitor that commented on weaker SBA gain on sale margins for the second quarter. So just first, curious if that's what you are seeing, and then also just your expectations for originations on the SBA side for the year. And then Tom, I heard you mention the goal of $600 million run rate. Is that a longer-term goal. Is that like a 2023 or 2024 goal of trying to get there? Just a little bit of more color on that would be great.

Yes, sure. I mean just on the premiums, and Andrew can chime in, but the premiums we have not seen made any significant change in the secondary market premiums, maybe off a half point or so. So we don't expect any significant margin compression on our end and our cost of origination based on channel has remained constant. And the, as far as the volume, Andrew, our base case volume for this year is, what, $450 million roughly?

Correct.

So I would say that the $600 million is a long term, but within the next year or 2. And I'm sorry, the third question, Crispin, was..?

I think you actually got them all. Yes, it is mostly just on the margin, the originations for 2022 and then the return. So you did touch on it a little bit. Thank you for taking my questions, Tom.

Next question comes from Stephen Laws of Raymond James.

Tom, when you look across your business segments, a lot of volatility, a lot of things have changed in the last few months, and you look to reallocate or deploy capital, where are you seeing the best opportunities today? I know some may be a little growth constrained, but kind of how are you repositioning or reallocating capital, if you are, in response to how the markets have changed the last few months?

Yes, it's interesting. The shock to the finance system is most dramatic in the mortgage banking space, and that is less than 10% of our risk cap -- of our net asset -- I'm sorry, of our equity allocation. most of our equity allocation, 85% -- plus, is in the core SBC program, where we do the life cycle financing from construction to term. So I would say -- make 2 observations. One is our core bridge product actually, because we are in this lower middle market niche which has less price elasticity compared to the large balance, which is much more competitive, so what we have seen there is the credit spreads, the AAA spreads on our CRE CLOs, have widened about 75 basis points from the fourth quarter lows, but because of the relative price -- limited price competition, we have actually been able to widen our lending spreads by equal to or more than that, such that the vintage of CRE CLOs that we're originating today in the second -- going into the second quarter is actually a 50 basis point plus higher ROE than where we were in the fourth quarter of last year.

So that's one observation, which will obviously -- leads us to continue to deploy capital there. And then the other observation is on our lower-middle market multifamily focus, because of the spike in rates and the impact on affordability, you are seeing more -- that's pushing more first time buyers into -- millennials, Zs, into apartments. So we continue to see strong demand there with actually the NOI -- the NOI increases on exit of these projects is exceeding the impact of the rate increase. So those are positive headwinds. We are continuing to allocate capital. And I would say that one area that we are now looking to deploy additional capital is there's some level of -- we're seeing an emerging level of distress in some, you know, banks looking to sell portfolios, and non-banks, and so as it relates to that, where they are -- part of what we do is our acquisition business, so I would expect the acquisition business to increase over time as well.

Appreciate those comments. And of course my second question is about the business. It's the smaller piece of the capital, but on the resi mortgage business, 60% -- what was it, 61% or 69%, roughly 2/3 of the business was purchased. You know, as you look back over GMFS history, where is that mix been in a rising mortgage rate environment, or you know, do you see that going to 80-20, higher than that, 90-10? It seems like with capital appreciation, there will still be some level of non-rate driven repayment activity, but would love to get your thoughts on that, and then any comments on margins across the channels for resi banking.

Andrew and I were just down in Louisiana visiting with the GMFS team and thinking for the prospects. So I would say 2 things: one is, to answer your question, we would expect going at the peak of a rate cycle probably more of an 80-20 mix. They have a very strong branding in their markets with home builders and realtors, and, you know, believe it or not, radio ads and some other things, and they have a low customer acquisition cost. So I think that will persist for the next few or more quarters. And as far as margins, we, we expect them to stabilize at where they are today, which, Andrew, is running. What about 75 bps?

Yes. Conventional is probably around 60 FHA, 90 VA, 85. Those are probably the ranges of [question].

So, so kind that 75 bps area. So we see constant margins. The one area they, they are looking to expand to now, and they are not alone, is some of the non-agency products that we are considering. That was a -- and that'll be a focal point going forward as well as in terms of incremental revenue stream.

Next question will be from Jade Rahmani, KBW.

There are 2 aspects of cyclicality that I believe the market is concerned about with respect to certain mortgage REITs. The first one is dependence on securitization. So Ready Capital has historically been a very successful and prolific issuer of securitizations. I was wondering if you could touch on that as a durable form of capital and how management would adapt to volatility in the capital markets. The second is relating to the overall commercial real estate asset class with deal sizes below, say, $15 million. Could you comment on the credit profile of how that would behave in a recession?

Yes. Andrew, maybe you could touch on the securitization, but I would -- and just in particular alternative forms of nonrecourse financing we have with the banks as a fallback to any disruption in the securitization market, but I will comment as a preface to Andrew's remarks that we are viewed as one of the basically probably the top 5 issuers of CRE CLOs. Our spreads are on top of, you know, the blue chip names, like Blackstone, et cetera. And we have a very deep -- in terms of number of investors and the depth of those investors, you know, we would, we would expect to be able to continue access, albeit at wider spreads, the securitization market. But, but Andrew, maybe just comment on -- in a volatile market, some of the alternative financing sources we have for the bridge product.

Yes, Good morning, Jade. So certainly over the last couple quarters we have been adding in you know, additional warehouse facilities that have longer terms, are nonrecourse in nature, are non-mark to market. You know, in the first quarter we added a $500 million non-mark to market nonrecourse facility. We added another $200 million -- or sorry, $250 million partial recourse, [credit market only] mark to market facility. So certainly we keep expanding, you know, our various lenders on the warehouse side. Separately from that, I think we continue to explore ways in the corporate markets to raise debt capital that matches the duration of some of our assets. So that is what I would say there.

And then on the securitization front, obviously we have been very active over the first couple months of the year. I do think we will be in the market shortly with another CRE CLO. And our expectation is that we going to have, you know, another 2 to 3 in the back half of the year. So certainly an important part of the business, but we continue to expand the facilities that support our lending channels on a non-mark to market nonrecourse basis at longer durations.

And as far as the second question regarding the credit performance of our lower middle market niche in a in a recessionary scenario, maybe, and Adam, you could comment on that, but I just preface that with the fact that due to the limited competition in our market, our debt yields and cap rates tend to be 100 basis points -- up to 200 basis points higher than let's say a large balance portfolio, which provides some level of cushion. But, and another fact is 67% of our portfolio is lower beta to a recession, which is affordable multifamily and industrial. So Andrew, with that backdrop, maybe how do you, how do you and your team think about the potential, the credit performance of our niche versus a large balance market in a recession?

Yes, sure. I mean, you know, given the fact that we are mostly a multifamily lender, the performance should do well during a recession, you know, especially given the broader housing shortages nationwide and the extreme demand for that sector. Plus, you know, the way that we're structuring our deals with stronger sponsors that are well capitalized. You know, we're originating at moderate leverage points, our portfolio is about 65% LTV. So that should provide significant cushion in a downturn. You know, we have other protections such as interest rate caps that are required to ensure that property cash flow and debt service coverage ratios remain adequate. And then, you know, given the rising—the rising rates and expectations for rising cap rates, you know, our underwriters are really underwriting to more conservative levels in terms of wider debt yields at stabilization so that we can properly assess, you know, the takeout of that asset at more of a stress, a stress environment.

A follow up, unrelated, would be more on the strategic front. In the commercial mortgage REIT space, you know, there seems to be a clear bifurcation between the larger names and the smaller names. And then there are companies like Ready Capital that have, you know, unique business models and a real compelling value proposition, in our view. But there still is a handful of these, I would call them, subscale small to mid-sized commercial mortgage REITs. They don't play exactly in the space you all play in, it's more in the middle market, you know, average loan size is maybe around $30 million. Are any of those interesting opportunities?

Yes, it's a good, good question, Jade. I mean, obviously one of the strategies that's been a little bit unique about Ready Cap's is, you know, we have executed 6 M&A transactions, many of which were used to raise capital as a more accretive alternative to secondary offerings. And yes, we continue to see a number of opportunities, some of which may be the sub -- in the, you know, in the subscale CREIT space, I guess Owens was an example of that back a number of years ago. But yes, we continue to look at M&A opportunities, not just in the public space, but in the private space along the lines of Mosaic.

And just one follow up would be, you know, there's a lot of agency considerations with respect to corporate governance. Many of these are externally managed and there are various, you know, offsetting considerations that the underlying either management teams or boards have in mind. Have you considered approaching any of the companies directly yourself and perhaps with waterfall as a platform, you know, utilizing that to create some alignment, better alignment that would prompt maybe some unlocking of these transactions?

Yes. So, and yes, we have considered the -- we have done direct approaches in the past. The Anworth and the Owens are examples of that. And yes, it does involve the, you know, the complexity of the payment of the termination fee to the external manager, which I think we've managed very well in terms of benchmarking that versus the cost of a secondary. So it's, we don't have, obviously, want to enter into a dilutive transaction. But what we -- we continue to look at that template as a way to, you know, potentially create value for our shareholders and the shareholders of the subscale business in a way that is aligned with both the external manager as well as the public shareholders of the externally managed REIT.

(Operator Instructions) Next question comes from Matthew Howlett of B. Riley.

Could just provide an update on Mosaic now that it's closed? Where the portfolio stands, what you plan on doing with it, (inaudible), putting leverage on it. Just an update there.

Yes. Maybe, Adam, you could touch on the current portfolio positioning in terms of liquidations, syndications, and, you know, just -- and then Andrew, maybe just the financing of the strategy for the portfolio and then just an update on the CER mechanism. Because I think that's an important nuance in how to look at the Mosaic exposure.

Yes, yes, sure, sure. 90% of the portfolio is fully performing today. There's 2 assets that are 60-plus delinquent, and we have 3 REOs from the merger. There are about 7 deals have paid off at par since the merger discussions began in the middle of last year. We now have over -- 50% of the portfolio syndicated. And when I say syndicated, that's of the total commitments. The portfolio today remains moderately leveraged, about 70% weighted average LTV. Majority of the portfolio that remains, about 90% of is in top-tier markets, specifically, you know, GEOtier I and II, such as Los Angeles, Phoenix, Portland, Oregon, among some other things that, that are worthwhile to discuss here.

So, you know, about 40% of the portfolio from a property type perspective is mixed use. Another 40% is residential and that consists of multifamily and condominiums. And then roughly about 10% of the hotel exposures is hotel in the land. 70% of the total commitment is construction, and then the remainder is between pre-development and preferred equity. I'd say, you know, in terms of the asset management team and their focus, certainly, you know, working with the sponsors on the takeouts as these construction projects stabilize, certainly some refinance opportunities that exist for our CMBS fixed-rate products, bridge rate products, to be the takeout lender for these loans.

So there is certainly some good synergies there. And, you know, as we brought on some employees from Mosaic, we are certainly expanding into the construction space, with a specific focus on multifamily and industrial. So we are starting to look at some opportunities now, targeted to close some over the summer and, you know, really getting fully up to speed with, with their asset management capabilities. And again, just working through the portfolio. But, you know, so far so good in terms of the integration with their team, our team, and continue to progress.

And then in terms of...

Go ahead.

No, no, please, Adam -- (inaudible)

Well, just that you like the business and you want to grow the, you know, the construction lending business.

Yes, that's right.

It'll be a little bit focused on some of our core asset classes, lower balance, but it's a great, it's a -- it's a good adjunct to what we're already doing on the heavy transitional bridge side. As, as far as now, we can go to the same sponsor, about 2 thirds of our borrowers are repeat borrowers. And now we can give them an option for ground up construction. I'm sorry. Andrew, maybe touch on leverage in the C -- the contingent equity reserve methodology.

Yes. So the, you know, the balance sheet of Mosaic for the most part was unlevered, right? So a much lower leverage profile than our existing balance sheet, which is part of the reason for driving down our ratios in the quarter. As we look to, you know, finance that section of the balance sheet, I'd say a limited portion of it is going to come from, you know, putting certain assets on either new or existing warehouse lines, call it $50 million or so. But the real leverage from that equity will probably come from the corporate markets. So I think that's how we'll -- in addition to the portfolio running off excess liquidity to fund growth. And then in terms of the contingent equity right, the contingent equity right allows for Mosaic investors to recapture 90% of that initial discount, depending on the performance of the portfolio on a return of the original basis over a short -- over a 3 year period, or whenever the portfolio wraps up. Based on our current projections and the history since we underwrote the deal at 9/30, we do expect that the CER will be paid off. And that valuation on our balance sheet today, that $84 million contingent liability, is reflective of our assumption that that will ultimately crystallize.

Got you. When you say that the corporate markets -- you know, you did tap in the senior unsecured market, are you referring to additional, you know, additional issues on that front? And then how about the preferred market with the growth of the common equity base? How's that market? I know it's obvious [it's wide], and just give me the thoughts on both the unsecured offerings and preferred.

Yes, certainly we continue to explore senior unsecured. There is an opportunity to layer on senior secured, just given the fact that we do have a significant amount of unencumbered collateral at this point. Preferreds certainly, you know, given the equity growth there is room to keep appropriate ratios of preferred equity in line and to add into that security. But I think we're also going explore some of the other markets that some of our larger peers continuously tap. And for us, it'll just be an exercise of where we think we're getting the best execution.

Other markets being like, is it term loans, or just something of that nature, or…?

Yes. Term loan, et cetera. Yes. Term loans, [converts], et cetera.

This concludes our question and answer session. I'd like to turn the call back over to the management for closing remarks.

We appreciate everybody's time on the call today and look forward to next quarter's call. Hope everybody has a good day.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.