Ready Capital Corporation (NYSE:RC) Q4 2023 Earnings Call Transcript
Ready Capital Corporation (NYSE:RC) Q4 2023 Earnings Call Transcript February 28, 2024
Ready Capital Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Greetings, and welcome to the Ready Capital Fourth Quarter 2023 Earnings Call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions]. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Andrew Ahlborn. Thank you, you may begin.
Andrew Ahlborn: Thank you, operator, and good morning to those of you on the call. Some of our comments today will be forward-looking statements within the meaning of the Federal Securities Laws. Such statements are subject to numerous risks and uncertainties that could cause actual results to differ materially from what we expect. Therefore, you should exercise caution in interpreting and relying on them. We refer you to our SEC filings for a more detailed discussion of the risks that could impact our future operating results and financial condition. During the call, we will discuss our non-GAAP measures, which we believe can be useful in evaluating the company’s operating performance. These measures should not be considered in isolation or as a substitute for our financial results prepared in accordance with GAAP.
A reconciliation of these measures to the most directly comparable GAAP measure is available in our fourth quarter 2023 earnings release and our supplemental information, which can be found in the Investors section of the Ready Capital website. In addition to Tom and myself on today’s call, we are also joined by Adam Zausmer, Ready Capital’s Chief Credit Officer. I will now turn it over to Chief Executive Officer, Tom Capasse.
Thomas E. Capasse: Thanks, Andrew. Good morning and thank you for joining the call today. Despite broader headwinds, Ready Capital enters 2024 with a resilient business model and a proven ability to navigate challenging periods. As we look to 2024 and beyond, the key drivers that we will focus on to return to a more historic level of earnings are less about current market conditions and the resulting credit pressures, but rather about our strategic capital redeployment from recent long-term value accretive M&A. While our prior acquisitions have led to short-term earnings impacts over recent quarters and we are cognizant it will take time to work through the persisting pressures, we believe executing our plan will generate meaningful long-term accretion.
To begin, a quick recap of 2023. Full year distributable return on average stockholders' equity was 8.6%. The shortfall versus our 10% target was primarily due to a 250 basis point drag in ROE from M&A and a 25 basis point drag from the underperformance of our residential mortgage banking business. Our expectation is that the sale of underperforming assets, relevering equity from M&A, and exiting our residential business will begin to provide material net interest margin accretion through reinvestment of the current levered ROEs exceeding 14%. On the investment side, we have remained active in both our lower middle market CRE and small business lending segments. On the CRE side, despite a year-over-year 68% decline in CRE industry transaction volume, we originated $1.7 billion across all products primarily comprising $1.3 billion of Freddie, small balance and multi-family affordable products and $333 million of bridge production.
On the small business lending side, we originated $494 million with contributions from both our legacy SBA business focused on large loans and our fintech business focused on small loans. This dual large small loan strategy uniquely positions our small business lending segment to achieve its target of $1 billion in annual production in the next two to three years. With only a 5% equity allocation, but an 18% full year distributable earnings contribution, the small business segment remains a material and we believe underappreciated aspect of our earnings profile. As we enter the back end of the CRE market cycle, our two primary areas of focus are credit and earnings growth. On the credit side, while not immune to the CRE macro environment, we are differentiated from the broader sector in terms of our concentration in lower middle market multi-family, more conservative vintage underwriting, and avoidance of both overbuilt markets and high-risk CRE sectors such as office.
As of December 31st, 60-day plus delinquencies in our originated and acquired CRE portfolios were 7.2% and 22.3% respectively. My comments will focus on our originated portfolio, which represents 73% of total loans. The acquired portfolio concentrated in Mosaic, which closed in the first quarter of 2022, and Broadmark, which closed in the third quarter of 2023, featured combined purchase discounts for non-performing assets of 28%. We have liquidated 29% of the total acquired portfolio at prices above the combined purchase discounts. The main drivers of our 60-day delinquency are first, multi-family which is 78% of the loan portfolio. At quarter end, multi-family 60-day plus delinquency was 6.6%, as certain properties experienced NOI reductions driven by flat rent growth and increases in operating and interest costs.
71% of the new delinquencies in the quarter were attributable to one large sponsor across four loans. As of February 25th, 60-day plus delinquencies have been reduced to 5.5% through payoffs or modifications, which in most cases require an equity infusion from the loan sponsor. Second is office, which is only 5% of the CRE portfolio, but accounts for 21% of total delinquencies. Eight loans are delinquent with an average balance of 15 million, and notably only two have a balance greater than 20 million, the largest loan is 44 million. Our office portfolio is granular across 165 assets with an average balance of 3 million, but 70% of the delinquencies are collateralized by larger CBD properties located in Chicago, Denver, and New York. Looking forward in the current higher-for-longer rate outlook, we are focused on refinancing our current maturity ladder, of which 45% or $2.8 billion in multifamily loans reached initial maturity in 2024 and 31% and $1.9 billion in the first half of 2025.
Historically, our core bridge strategy is to underwrite to take out our Freddie SBL license and 25 strategic partnerships, which provide access to all GSE multifamily channels. For example, in 2023, 64% of our bridge loans paid off at maturity, primarily via agency takeout, and 12% met the criteria for contractual extension. For the 11% of the multifamily portfolio currently rated 4 or 5, our asset management teams are executing modifications and extensions where supported by the business plans, and we are prioritizing on-balance sheet liquidity for related capital solutions. Notably with a mark-to-market LTV of less than 100% on this population, we do not expect any material erosion to book value from additional CECL reserves and modifications of 4% of the total originated portfolio remain comparatively low.
Now, a few observations on our CRE CLOs. Like most in our peer group, we have historically used CLO financing as one of our secured financing options. Over the last eight years, we've issued $7 billion with $5 billion outstanding, ranking number four with top quartile AAA spreads, largely a result of one of the most conservative and investor-friendly CLO structures. Specifically, our overcollateralization test is set at 1% versus the 3% average for the peer group, and our deals are static. Unlike managed deals, we are limited in our ability to swap collateral, prevented from repurchasing collateral until after 60-day delinquency is reached, and reliant upon the special servicer to manage decisions on asset resolution. This has three impacts versus the peer group.
First is said CRE CLOs trip test sooner. For example, our FL5, 9, 10, 12 deals have tripped their IC or OC tests. Secondly, credit quality metrics will be skewed versus managed deals where the issuer can preemptively swap in performing loans before a loan is delinquent. And finally, our path to asset resolution via repurchase or modification is longer due to both the 60-day trigger and need to obtain special servicer approval on our asset management decisions. As of the February 25th remittance date, there were 12 loans 60-day plus delinquent inside of our CLOs. Of those we expect 15% to pay off, 57% to qualify for modification, and 27% to enter for closure. Modifications will require new equity contributions provide a bridge for properties to stabilize and reach agency take up.
Expected principal losses on these loans have been accounted for in our current CECL reserve. We expect as of the March remittance date that FL 5, 9, and 12 will be above their IC and OC thresholds. On the earnings side, I want to lay out the bridge for increasing distributable ROE 250 basis points over the next two years, from the 7.5% in the fourth quarter to our 10% trailing seven-year average. First is reallocation of equity raised in the Broadmark merger into our core strategies. Since the third quarter 2023 merger close, 23% of the portfolio has liquidated of which the remaining 788 million at quarter end is yielding approximately 2.1% producing a current drag on ROE of 170 basis points. Currently we have actionable liquidations for 36% of the remaining portfolio with a budget to monetize the balance over the next four quarters.
The anticipated contribution margin to ROE from full reinvestment of this equity into our current investment pipeline is 250 basis points. Second leverage, current leverage of 3.3x and recourse leverage of 0.8x are at historical lows below our target leverage of 4x to 4.5x. We expect to raise incremental debt capital over the upcoming months, with the resulting increase in leverage contributing 125 basis points to ROE. Third, the exit of residential mortgage banking which based on current planning is targeted for full liquidation by the end of the second quarter. Due to current mortgage rates distributable TOE in this segment was laggard at 1.8% and we expect reinvestment of this capital to increase ROE 25 basis points. Fourth growth of small business lending.
The SBA 7(a) program continues to be the highest ROE segment where given its capitalized nature, growth in production does not require significant capital resources. But those stated long-term 7(a) origination target of doubling our current production to 1 billion every 100 million increase in volume adds an incremental 15 basis points to ROE. Last, cost structure. As part of the merger, we realize synergies on the OPEX side, cutting 19 million of Broadmark expenses. Given market conditions we expect to continue to right size the cost structure and staffing levels with a target 40 basis points ROE contribution. Probability weighting each of these actions with a total 455 basis points increase in ROE alongside focused credit management over the next 12 to 18 months of the series cycle, we believe will provide significant upside to the company's current earnings profile.
We appreciate the continued support, understand the work ahead of us, and firmly believe that the platform is built to both withstand current market pressure and grow earnings as we move forward. With that, I'll turn it over to Andrew.
Andrew Ahlborn: Thanks, Tom and good morning. Quarterly GAAP earnings and distributable earnings per share were $0.12 and $0.26, respectively. Distributable earnings of 48.5 million equates to a 7.5% distributable return on average stockholder’s equity. 2023 full year GAAP earnings and distributable earnings per share were $2.25 and $1.18, respectively equating to an 8.6% distributable return on average stockholder’s equity. On the balance sheet and income statement, residential mortgage banking has been accounted for as a discontinued operation with assets and liabilities consolidated into held for sale line items and net income included in discontinued operation. The main driver of the variance between our quarterly GAAP and distributable earnings were $3.2 million of the $6.7 million increase to our CECL reserve, a $20.7 million mark down of our residential MSR, a one-time $5.5 million termination fee related to the refinance of a Mosaic lending facility, and a $3.7 million unrealized loss.
The increase in our CECL reserve was due to a $15.8 million increase in specific reserves, offset by a release of reserves on our performing loan portfolio. The 7.5% distributable return on equity continues to be pressured by the effects of a decline in the retained yield of the portfolio as well as lower leverage. In the fourth quarter, the levered portfolio yield was 11.5% down 9% from the same period last year. The change is due to a 11% allocation into Broadmark assets, margin compression on the backbook, and increased REO from M&A. We expect levered yields to increase as the backbook moves into our securitization vehicles and the Broadmark assets are repositioned into market yields. Net interest income declined 6.4 million quarter-over-quarter.
The change was primarily due to a $5.5 million one-time charge upon the refinance Mosaic lending facility, the migration of 258 million of loans to non-accrual, and $2.6 million of interest expense related to the financing of non-performing Broadmark assets. Realized gains were up quarter-over-quarter due to increased SBA 7(a) production and sales with average premiums of 8.9% and 288 million of production in our Freddie Mac businesses. Servicing income increased 1 million quarter-over-quarter due to the recovery of previously booked impairment of our SBA and Freddie Mac servicing assets. Other income increased 14.2 million due to the recognition of ERC income. To date we have processed 62.9 million of ERC contracts recognizing net income of 42.8 million.
We expect this program to continue into 2024, albeit at a slower pace. The improvement in operating expenses was due to a reduction in staffing and related compensation expense, slightly lower servicing expenses as a result of lower advance reimbursement, and lower transaction volume. On the balance sheet, liquidity remains healthy with 139 million in total cash and over 1.5 billion in unencumbered assets. Recourse leveraging the business declined 0.8 times and mark-to-market debt equals 17% of total debt. The company's debt maturity ladder remains conservative, with no material debt maturities until 2025, and the majority maturing past 2026. On the leverage front, we continue to explore multiple avenues of raising corporate debt. Markets for new issues have improved since the beginning of the fourth quarter and we are confident in our ability to access the markets in the upcoming month.
Incremental capital raise will be deployed into our origination acquisition channels, which are witnessing opportunities in excess of current capital levels. Book value per share was $14.10. The changes due to a $0.09 per share markdown of the residential MSR, a $0.04 per share reduction in bargain purchase gain, and $0.06 of non-recurring items discussed previously. While we understand it will take time given current market conditions, we remain agile, creative and opportunistic to deliver differentiated credit solutions for our lower to middle market customers. As we execute on our strategy, we expect the power of our earnings to cover the dividend consistently and returns to migrate to historical levels. With that we will open the line for questions.
Operator: Thank you. [Operator Instructions]. The first question we have is from Crispin Love of Piper Sandler. Please go ahead.
See also 15 Countries with the Most Beautiful Castles in the World and 20 Countries That Read the Most in the World.
To continue reading the Q&A session, please click here.
