Q1 2022 Ready Capital Corp Earnings Call
Good morning, and welcome the ready Capital Corporation first quarter 2022 earnings Conference call.
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Today's presentation.
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I would 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 capacity.
Thanks, Andrew Good morning, everyone and thank you for joining the call today.
All per 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.
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 proportionately driving higher levered yields versus the fourth quarter 2021.
Additionally, our focus on strong sponsors and high quality properties in our lower middle market niche continues to provide significant equity cushion.
<unk> volumes were supported by $61 million of fixed and <unk> production as well as the $135 million in Freddie Mac small balance loans the market for fixed and <unk> products remain highly competitive and quarterly volume declines were due to us staying disciplined on yield markets and collateral type we.
We do expect to ramp up activity in this channel over the upcoming quarters.
In our Freddie SPL program quarterly volume declines were due to rate increases current Freddie FBL pricing in top tier markets for the quarter 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 <unk> products.
Redstone, 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 forward.
Pulling deals forward in the fourth quarter realized current year tax benefits.
And our small business lending.
Segment, SBA 700 production totaled $101 million.
This quarter marks the first time, we've exceeded $100 million in the absence of government stimulus programs.
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 rate lowered refi activity.
<unk> is better positioned than the peer group to whether the rate cycle with higher than average purchase and retail channels and its historic strategy of retaining mortgage servicing rights. This.
This is reflected in relative outperformance in the quarter with gain on sale premiums 50 to 100 basis points higher in volume declined 35% less than the peer group.
We believe the diversity of our business model, which provides full lifecycle financing.
Two SBC properties will allow us to deploy capital in response to the current <unk>.
<unk> market dynamics current pipelines remained strong at over $1 3 billion, which includes 875 and $200 million money up in our SBC and SBA channels respectively.
$350 million in April originations.
Record originations have resulted in portfolio growth of 99% year over year to $9 4 billion.
Today, two thirds of the portfolio is in high conviction defensive sectors, comprising multifamily and industrial. Additionally.
Additionally, 81% of the portfolio is floating rate with average LIBOR floors of 50 basis points with short term rates at or above 80 basis points, we've reached a point at.
We're upward movements and 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-19 credit outperformance versus our large balance commercial REIT peer group number.
A number of factors portfolio portfolio portfolio of granularity of the top 10 loans equaled only 8% of total loans.
Less competition in the SBC property market, resulting in strong credit parameters cap rates in that yield 100 to 200 basis points higher than large balance.
Finley and underwriting discipline targeting lower risk CRE sectors in the top msas using our proprietary geo tier scoring model.
Our unique risk overlay is our proactive asset management, which applies our nonperforming loan servicing capabilities to avoiding defaults on our performing portfolio.
Our <unk> portfolio, which is predominantly multifamily NOI growth from units stabilizing at market rents.
Outpacing rising rates.
Today with post pandemic returned to normalcy, our teams are prudently moving back into other property types and asset classes, but with a cautionary high 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 skewing.
Singular reliance on secondary offerings, adding $670 million of equity through the closing of the merger with mosaic and a secondary offering in January .
At the beginning of 2021 equity increased 135% to $1 9 billion ranking us as the sixth largest commercial mortgage REIT since <unk>.
2016, we have completed six M&A transactions, improving operating leverage and achieving a lower cost of debt capital for accretively them through the more typical secondary issuance Ruth.
We successfully completed the mosaic merger and welcome mosaic shareholders to ready capital.
The transaction further further is 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 two securitization and $120 million three year fixed and an unsecured bond offering since the start of the year.
Our securitization is included our largest CRE CLO to date of $1 $1 billion transaction, raising $150 million and 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 market 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 earnings profile of the business to continue to support our dividend through a combination of the growth of the loan portfolio increased activity in our gain on sale of 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 are.
Our investment strategies positions and balance to perform and bull and bear markets. For instance, we are capable pivoting with the credit cycle, including ramping our acquisition business in the event of higher nonperforming loan volumes as we did in the Dfc purchasing 5 billion SPC Npls.
On the growth front, we expect to pursue additional M&A opportunities and segments complementary 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.
Orderly GAAP earnings and distributable earnings per common share were <unk> 70, and 52, respectively.
Several earnings of $48 9 million roughly equates to a 13, 6% return on average stockholders 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 4500 loans totaling $9 4 billion at a weighted average coupon of four 6% and spread from 310 basis points spreads continued to widen in the quarter with new loans priced at an average rent of 350 basis points.
Our joint venture investments, which consists 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 <unk> loans held for sale.
Revenue increases were partially offset by a $9 $4 million reduction in gain on sale revenue due to both the origination declines in <unk>, Freddie Mac SPL and Redstone production.
And the roll off of the 90% guarantee stimulus in our <unk> business.
In the quarter, we sold 20% of SBA production for higher Io.
Io strips, resulting in no day, one gain on sale income.
Net income from residential mortgage banking declined 600000 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 $12 $9 million reduction into mortgage banking expenses due to a $10 million swing apparel fees.
Net income related to PPP declined 15% quarter over quarter to $13 7 million after considering the effects of tax.
Over a quarter reduction in PCP earnings was primarily driven by slower forgiveness range.
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 pretax 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 remains.
On the balance sheet 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 <unk>.
Oreo.
$460 million of equity.
In addition to the class B shares issued as upfront consideration and the merger.
There is an $84 $3 million contingent liability related to the contingent equity rate that was issued.
Total leverage as of March 31 declined to four four times and absent the PPP Lf to four one times the composition of our leverage also remains both conservative and constructive to the business.
As of quarter end recourse leverage was one four times.
Liabilities subject to full mark to market represented only 20% of our debt capitalization.
With that we'll now open the line for questions.
Well now begin the question answer session to ask a question you May Press Star then one on your Touchtone phone.
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This time, we'll pause momentarily to assemble the roster.
First question comes from Crispin Love with Piper Sandler. Please go ahead.
Thank you good morning.
So just on the return on.
On an equity outlook I know you've made some comments in recent quarters, but just looking for a little bit of an update there would you expect the ore.
ROE to remain elevated in the second quarter.
<unk> 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 pvp still being a decent sized contributor.
Hey, do you want to touch on that.
Yes, I do think the return profile is going to remain.
Elevated over the next couple of quarters when you look at.
The comp composition of this quarter, what you had was.
An increasing portfolio benefiting from rising rates.
But lower production.
And both Redstone, Freddie Mac and SBA, So we expect.
The net interest income in the portfolio to continue to decline.
But those gain on sale business is to also grow.
Which will add to that.
Add to that to the earnings profile and then additionally, the forgiveness rate.
Of the PPP loans.
Starting to stabilize.
So don't expect to see quarters.
Volatility in.
For the profitability for Pvp to remain fairly consistent with where it wasn't the first quarter.
So do we think it's going to be a couple of quarters of increased returns before normalizing to that 10.
<unk> hundred 11%.
Okay, great. Thank you.
And then just one on SBA more broadly there.
There is one competitor SBA competitor that commented on weaker.
SBA gain on sale margins for the second quarter. So just first curious if thats what youre seeing and then also just your expectations for originations on the SBA side for the year and then Tom I heard you mentioned the goal of 600 million run rate is that.
Our longer term goal is that like a 2023 or 2024 goal of trying to get there just a little bit more color on that would be great.
Yes, sure I mean, just on the premiums and Andrew chime in but the premiums we haven't seen 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 as far as the volume under our base case volume for this year is what $4 50.
Right.
Correct correct.
I'd say that the 600 is a long term but in the.
Within the next year.
Year or two.
<unk>.
And.
Im sorry the.
The third question Kristen.
I think you actually got them all.
That's mostly just on the margin the originations for 2022 and then.
Sarah.
You did touch on all of that thank you for taking my questions Tom.
No problem.
Thank you next question comes from Stephen Laws of Raymond James. Please go ahead.
Hi, good morning.
Tom when you.
You look across your business segments, a lot of volatility a lot a lot of things have changed in the last.
A 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 last few months.
Yes, it's interesting.
Yes, the shock to the to the.
The finance system is most dramatic in the mortgage banking space and that's all that's less than 10% of our risk out of our net asset alright, I'm, sorry of our equity allocation most of our equity allocation, 85% plus is in the.
The core SBC.
Program, where we do the lifecycle financing for construction to term so I would say I'd make two observations one is our core bridge product actually because we're in this lower middle market niche, which has less price elasticity compared to large balance.
Which is much more competitive.
So what we've seen there is the credit spreads the AAA spreads on our CRE CLO have widened about 75 basis points from the fourth quarter lows, but because of the relative price.
Limited price competition, we've actually been able to widen our lending spreads by equal to or more than that such that the vintage of.
CRE CLO debt.
Where.
We're originating today and 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 obviously leads us to continue to deploy capital there and then the other observation is.
Our lower middle market.
Multifamily focus because of the spike in rates and the impact on.
Affordability youre seeing more that's pushing more first time buyers into millennials.
Into apartments, so we continue to see strong demand there with.
With actually the NOI.
NOI increases at an exit of these projects is exceeding the impact of the rate increase.
So those are positive headwinds, we're continuing to allocate capital and I would say that one area that we're now looking to deploy additional capital as there is some level, we're seeing an emerging level of distress and some banks looking to sell portfolios.
And non banks and so.
As it relates to that where they're part of what we do is our acquisition business. So I would expect the acquisition business to increase over time as well.
I 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.
It was a 61 or 69, roughly two thirds of the business was purchased.
As you look back over <unk> history.
Is that mix then.
Rising mortgage rate environment, or do you see that going to $80 <unk> higher than that 90 10.
Seems like with capital appreciation will still be some level of non rate driven repayment activity, but.
I would love to get your thoughts on that and then any comments on margins across the.
Channels for resi banking.
Hi, Andrew.
We're just down in Louisiana, visiting with the <unk> team and thinking for the prospect. So I would say two things one is to answer your question.
And we would expect going at the peak of the rate cycle, probably more of an 80 20 mix they have a very strong.
Branding in their markets with homebuilders and Realtors and.
Believe it or not with video ads and some other things and they have a low customer acquisition cost. So I think that will persist for.
The next few.
More quarters and as far as margins, we expect them to stabilize where they are today.
Which Andrew was running what about 75 bps.
Yes, conventionals, probably around 60 FHA.
EMEA 85 was a protocol for answering the questions.
75 bps area. So we see good constant margins. The one area. They are looking to expand to know that it's not they're not alone as some of the non agency products that were considering that was.
That'll be a focal point going forward as well in terms of incremental revenue stream.
Great I appreciate the comments this morning.
Yep.
Thank you next question will be from Jade Ramani.
<unk>. Please go ahead.
Yes, thank you very much.
There are two aspects of cyclicality that I believe the market is concerned about with respect to certain mortgage REIT.
The first one is dependent 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.
Second is relating to the overall.
<unk> 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. Thanks very much.
Yes, Andrew.
Andrew maybe you could touch on.
The securitization, but I would.
And just in particular alternative forms of non recourse financing, we have with the banks as a fall back to a.
Any disruption in the securitization markets, but I will comment.
Preface to Andrew's remarks that.
We're viewed as.
One of the yes, basically probably the top five issuers of.
CRE CLO our spreads are on top of.
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.
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, Jay.
Yes, certainly over the last couple of quarters, we've been adding in.
Additional warehouse facilities that have longer terms.
Our nonrecourse in nature or non mark to market.
In the first quarter.
Added a $500 million non mark to market nonrecourse facility, we added another $200 million or sorry $250 million.
Partial recourse credit Mark only mark to market facility. So certainly we keep expanding.
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 sort of matches the duration of some of our assets.
That's what I would say there and then on the securitization front, obviously we've been.
Very active over the first couple months of the year, how do you think will be in the market shortly with another CRE CLO.
And our expectation is that we could have another two to three in the back half of the year. So certainly an important part of the business, but we continue.
We continue to expand.
The facilities that.
Support our lending channels on a non mark to market nonrecourse basis of longer duration.
And as far as the second question regarding the credit performance of our lower middle market niche in a.
In a recessionary scenario maybe.
Adam you could comment on that but I'll, just preface that with the fact that the due to the limited competition in our market.
Our debt.
Net yields and cap rates tend to be 100 to 100 up to 200 basis points higher than let's say a large balanced portfolio.
To provide some level of cushion but.
The other factor is 67% of our portfolio is lower data to a recession, which is affordable multifamily and industrial so it was Andrew with that backdrop, maybe how do you how do you and your team think about.
The potential for the credit performance of our niche versus the large balance market in a recession.
Yeah sure I mean.
Even given the fact that we're mostly.
Our multifamily lender.
The performance should do well during a recession.
Especially given the broader housing shortages nationwide in the extreme demand for that for that sector.
Plus the way that we are structuring our deals with stronger sponsors that are well capitalized.
We're originating.
At moderate leverage points are portfolios about 65% LTV, so that should provide.
Significant cushing in the downturn we.
We have other protections such as interest rate caps that are required to ensure the property cash flow and debt service coverage ratios remain adequate.
And then given the rising the rising rates and expectations for for rising cap rates.
Our our underwriters are.
Really underwriting to more conservative levels in terms of wider debt yields at stabilization.
So that we can properly assess.
The take out of that asset at more of a stress stress environment.
Thank you very much.
A follow up unrelated would be more on the strategic front.
In the commercial mortgage REIT space.
Seems to be a clear bifurcation between the larger names and the smaller names and then there are companies like ready capital that have 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 average loan sizes may be around $30 million.
Are any of those.
Interesting opportunities.
Yes, it's a good good question Jay.
Ed.
Obviously one of the.
The strategy, that's been a little bit unique about ready cap's as we've executed six.
M&A transactions, many of which were used to raise capital.
More accretive alternative two secondary offerings and yes, we continue to see a number of opportunities some of which may be the subject.
In the sub scale.
T REIT space I guess all lines was an example of that.
<unk>.
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.
Thanks, and just one follow up would be.
There's a lot of agency considerations with respect to corporate governance. Many of these are externally managed.
And there are various.
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 utilizing that to create some alignment and better alignment that would prompt maybe some unlocking of these transactions.
Yes, and yes.
Yes, we have considered.
We have done direct approaches in the past the <unk>.
Owens.
Examples of that.
It does involve.
<unk>.
<unk>.
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 we don't have.
Enter obviously entered to a dilutive transaction, but what we continue to.
Look at that template as a way to.
Potentially create value for our shareholders and the shareholders of the.
The subscale business in a way that is <unk>.
Aligned with both the external manager.
As well as the public shareholders of the externally managed REIT.
Thank you for taking the questions.
Okay.
Again, if you have a question. Please press Star then one.
Next question comes from Matthew Howlett of B Riley. Please go ahead.
Oh, Hey, guys. Thanks for taking my question could you just provide an update on Mosaiq now thats closed with.
Where the portfolio stands.
What you plan on doing with it if anything putting leverage on it.
Just an update there yes.
Yes, maybe you could touch on the.
Our current portfolio.
Positioning in terms of liquidations syndications and.
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 thats an important.
Nuance in look at and how to look at the.
Mosaiq exposure.
Yes, yes sure sure.
19, 90% of the portfolio.
It's fully performing today.
Two assets that are 60, plus delinquency and we have three oreos.
From from the merger.
There are.
About seven 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 is syndicated.
When I say syndicate that's up.
Of the total commitments.
The portfolio today remains moderately leveraged about about 70%.
Weighted average LTV.
Majority of the portfolio that remains.
About 90% of it.
Is in top tier markets specifically.
Tier one and two such as Los Angeles, Phoenix, Portland, Oregon.
Okay got some other things.
Worthwhile to discuss here, so about 40% of the portfolio from a property type perspective is mixed use.
40% is residential and that consists of multifamily.
And condominiums, and then roughly 10% of the hotel.
Exposure is hotel and land.
70% of the total commitment is construction.
And then the remainder is.
Between pre development and pre <unk>.
<unk> preferred equity I.
I'd say in terms of the asset management team and their focus certainly working working with the sponsors on.
The takeouts as these construction projects stabilize.
Certainly some refinance opportunities that exist.
For our CMV as fixed rate products bridge right products to be the takeout lender for these loans or there is some certainly some good synergies there.
And.
As we brought on some employees for mosaic.
We're certainly expanding.
Expanding into the construction space.
The specific focus on multifamily and industrial so we're starting to look at some opportunities now targeted to close some over the summer.
And.
Really getting fully up to speed.
With with their asset management capabilities.
And again, just working through the portfolio, but so far so good in terms of the integration with their team our team.
And continue to progress.
Okay.
Yes.
Go ahead.
No no. Please let me respond to the call and then I'll turn it over.
But just like the business and you want you want to grow the construction lending business.
Yes.
That's right.
Right.
It'll be a little bit.
Yes, some of our core asset classes lower balanced, but it's a great.
It's a good adjunct to what we're already doing on the on the heavy transitional bridge side.
As far as now we can.
Go to the same sponsor about two thirds of our lens or borrow.
Ours are repeat borrowers and now we can give them an option for ground up construction.
I'm sorry.
Let me touch on leverage and the C. The contingent equity reserve methodology.
Yes.
The balance sheet of mosaic.
For the most part was.
Unlevered rate, so 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.
Finance that section of the balance sheet I'd say, a limited portion of it is going to come from.
Putting certain assets on either new or existing warehouse lines.
Call it $50 million or so.
The real <unk>.
Leverage from that equity will probably come from.
Corporate markets.
In addition to the portfolio running off.
Excess liquidity too.
On growth.
And then in terms of the.
Contingent equity right.
<unk> equity right.
Allows for Mosaiq investors to recaptured 90%.
That initial discount.
Pending on.
The performance of the portfolio on a return of the original basis Rob.
Sort of a three year period or whenever the portfolio.
Wraps up based on our current projections and.
The history since we underwrote the deal at 930.
We do expect.
The CVR will be paid off.
And that valuation on our balance sheet today that 80.
$4 million contingent liability.
He is reflective our assumption that that will ultimately crystallized.
Got you and when you say the corporate markets. So you did the.
Tapping the senior unsecured market, you're referring to additional.
Additional issues on that front and then how about the preferred market with the growth of the common equity base.
How does that market I know it's wide.
Why did it just give me the thoughts of both hub.
Unsecured offerings in preferred.
Yes, certainly we continue to explore senior unsecured.
There is an opportunity to layer on senior secured given the fact that we do have.
A significant amount of.
Unencumbered collateral at this point.
Preferreds.
Certainly given the equity growth Theres room to keep.
Appropriate ratios of preferred equity.
And to add into that security, but I think we're also going to explore.
Some of the other markets in some of our larger peers continuously tap.
For us it will just be an exercise of.
Where we think we're getting the best execution.
Other markets being like term loans or.
This is a phone et cetera.
Yes in term loans great consumption.
Great. Thank you I appreciate it.
This concludes our question and answer session I would 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.
It has a good day.
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