Ready Capital Corporation
Q4 2016 Earnings Call Transcript

Published: 15 Mar 2017

[Operator:]

Good day and welcome to the Sutherland Asset Management Corporation Fourth Quarter Financial Results and General Business Update. Today’s conference is being recorded. And at this time I would like to turn the conference over the Chief Financial Officer, Mr. Rick Herbst. Please go ahead sir.

[Rick Herbst:]

Thank you, Tom, and good afternoon and thanks to those of you on the call for joining us this afternoon. Due the snowstorm today in New York City please be aware Tom and I are speaking from different locations in the event there are any technical issues, hopefully there won’t be any. Some of our comments there 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 defend materially from what we expect. Therefore you should exercise caution in interpreting and relying on them. We refer you to our SEC filings for 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 the fourth quarter 2016 earnings release and the supplemental information that’s provided. By now everyone should have access to our fourth quarter 2016 earnings release and the supplemental information. Both can be found in the Investor Section of the Sutherland website on the events page within the Investor Section. Our merger with ZAIS Financial Corp closed on October 31. We began trading on the New York Stock Exchange on November 1 under the ticker symbol SLD. Our financial statements include the operating results for the assets acquired in the merger, which consists primarily of GMFS, residential mortgage origination business acquired from ZFC. GMFS’ results for the November and December are included in our financial statement. And with that I’ll turn it over to Tom Capasse, our CEO.

[Tom Capasse:]

Thanks, Rick. Well the last few months have been transitional for our company with the completion of the merger transaction with ZFC and continued achievement of planned operational and financial objectives. Last month we closed the $75 million note offering which will provide funding capacity to increase our origination volume and selectively re-enter the acquisition market. Turning to results, our adjusted core earnings for the quarter were $ 11.1 million, a 10% increase over the third quarter. Core earnings adjusted for one-time items related to the merger transaction, changes in the fair market value of the residential mortgage servicing rights and discontinued operations. Rick will provide additional detail in a few minutes. While core earnings increased 10%, ROE improved slightly from the prior quarter, we remain committed to achieving double digit ROE and we have identified various steps in that regard that I’ll discuss in a few minutes. Now we won’t go through every slide, but I’d like to touch on some highlights. For those of you that are not as familiar with our business model Slide Number 2 provides an overview of our businesses. Sutherland is currently the only public, non-bank, specialty finance company providing loans to both investors and owner-occupants of small balance commercial or SBC properties in the U.S., which we generally define as properties with an appraised value of $5 million or less. Our captive SBC lending business has provided stable and growing source of net interest income to support our dividend. Our business is simple, with four primary lines. Number one, we acquired stressed loans from banks; number two, we already cap subsidiaries we offer investors and SBC properties, conventional financing for stabilized transitional or Freddie Mac eligible multifamily properties, and number three, we offer owner-occupants of SBC properties fall business administration loans as one of only 14 small business lending companies authorized by the SPA. Number four we also originate residential loans through our mortgage banking subsidiary, which we acquired with the ZFC merger. Slide 3 includes some highlights for the year. Of note is the 27% increase in our SBC loan volumes over 2015. In 2017, we will continue to increase loan origination volume through investment in technology, hiring new loan officers, particularly in our SBA business, and rolling out affinity programs. In terms of the broader market, strong SBC property fundamentals and demand for securitized products are tailwinds for our SBC lending businesses. A couple of data points, in terms of property price is a meaningful increase in institutional debt and equity capital boosted large balance, commercial real estate prices 8% in 2016 to 14% over the 2007 bubble peak. In contrast SBC property prices increased only 3% and remained 6% below the 2007 peak. Now in terms of debt markets, AAA commercial mortgage-backed securities spreads for which we benchmark our ready cap offerings, tighten from a high of 167 basis points in the first-quarter of 2016 to 85 basis points currently. Finally, premiums on secondary market sales of SBA loans continue to exceed 10%. These gains are a material competent of our SBA business and may provide significant earnings growth. Turning to Slide Number 5, this reconciles our gross leverage yield of 20.1% to our bottom line ROE of 8.4%. Both of these metrics reflect an improvement from the third quarter. As stated in our third-quarter call, our below target recourse debt leverage is a competitive advantage and we’re undertaking efforts to improve ROE through accretive issuance of recourse debt as we move through 2017. The successful completion of our $75 million note offering was the first installment which we believe will increase our gross levered ROEs as we redeploy these funds. With that summary I’ll turn it over to Rick, who will discuss the quarterly financial results.

[Rick Herbst:]

Thanks Tom. Before I cover some of the financial information, I do want to point out a unique item in this quarter’s results. Notably on a GAAP basis you’ll notice earnings for the quarter were $0.83 per share. Of this amount $0.48 per share related to what GAAP refers to as a bargain purchase gain, this is the difference between the fair market value of the individual assets acquired in the transaction and the market value of the ZAIS stock on the closing date. Absent this one-time item, GAAP earnings would have been $0.35 per share. We believe this provides a good sequential and year-over-year comparison as we move forward. Slides 6 thorough Slide 9 provide additional detail on each of our business lines. Slide 6 depicts our successful acquisition segment. Acquisitions this quarter consisted primarily of whole loans that we acquired in the ZAIS merger. The gross leverage yield was similar to last quarter and there were no significant change in the portfolio metrics. Due to capital constraints, we have stayed extremely disciplined in this segment of our business. Slide 7 summarizes our conventional [Audio Dip] with the lever deals here off slightly reflecting the change in portfolio mix. Other portfolio metrics are largely stable, given the rise in adjustable-rate mortgages as our variable rate transitional loan portfolio increases. Slide 8 summarizes our SBA business, which continues to provide exceptional leverage returns, of note is that we recently invested capital to expand our staff of new loan originators and we expect to benefit from these investments as we move through 2017. While our fourth-quarter volume of $13 million was on par with the third-quarter we’ve already closed over $20 million of loans in the first two months of 2017 and [Audio Dip] as we move through the year. Our pipeline remains strong and we’re very encouraged by the progress we’re making. Slide 9 [Audio Dip] mortgage business which originated $2.2 billion in residential mortgages last year and continues to produce strong results. As depicted in the graph on the right side of this page, the Mortgage Servicing Rights portfolio has been growing steadily which provides an increasing revenue stream for our business. The recent rise in interest rates resulted in increasing value of these servicing rights since the merger at the end of 2016 – at the end of October 2016. Slide 11 depicts the percentage of net interest margin contributed by each of the small balance commercial business segments, for the first time the net interest margin contributed by each of the origination businesses exceeds the net interest margin from the acquired business. This migration from capital gains on liquidation of distressed small balance commercial loans to stable net interest income from our lending business reflects a successful rollout of our origination platforms and the maturation of the credit cycle, where rebirth in lending historically has followed a recession. However, I’ll point out that the strength of our small balance commercial strategy is the ability to produce an attractive dividend across the credit cycle by pivoting from lending to acquisition based on the economic conditions at the time. The next few slides reflect the diversity of our loan pools geographically, by collateral type and the loan size. Slide 14 summarizes our current financing facilities and leverage. The key takeaway is that our leverage ratios remain fairly low. Now I’ll turn it over to Tom for some final thoughts.

[Tom Capasse:]

Thanks, Rick. Before we open up the call to questions, I’d like to discuss specific steps we’re taking to get ROE’s backup double-digit. These are highlighted on Slide 15 of the investor deck. The first item, leverage, in terms of achieving recourse and non-recourse debt targets consistent with our current BBB issuer rating, one of the benefits of being a public company is enhanced access to public capital markets. As I noted earlier, we recently closed on a five-year rated note offering as the first installment of planned recourse capital market issuance. Recourse debt issuance will be programmatic and match with our strong origination pipeline so we will be able to deploy these funds quickly, which should be an immediately accretive to earnings. In terms of non-recourse debt, we closed one securitization in the fourth quarter and are currently working on two more. The first is the securitization of acquired SBC owner occupied loans and the second a CRE collateralized loan obligation backed by our transitional loans, which are currently financed with bank debt. The securitized debt markets are currently very receptive to these type offerings and are working hard to complete each. Number two is taxes. We continue to work with our financial tax advisors to implement a strategy to reduce the level of taxes due at our profitable taxable REIT subsidiaries. Those reductions will have a dollar for dollar benefit to the company once implemented. Number three is origination. A primary focus this year will be on increasing new loan originations across all of our platforms. In this regard we’re investing in building out our teams and have planned to hire additional loan officers in our ReadyCap subsidiary. This will not only increase our net interest margin, but will be additive to earnings through gains on loan sales and given our policy of retaining servicing rights and all origination, creation of MSRs in our SBA, Freddie Mac and residential loan businesses. Our pipelines are strong and we’re confident we will be able to achieve significant increases in origination volume. Before opening up to questions, let me take a moment to underscore the opportunities that Sutherland has to build on our track record of success and to grow our platform and build value for our shareholders. We are a unique specialty finance company focused on the fragmented SBC market – mortgage market, with $600 billion in outstanding loans and $200 billion in annual origination, which given the tight credit box faced by community banks operating under the penal post-crisis bank regulations, provides superior risk-adjusted returns, particularly when compared to large balance commercial real estate lending. Further, our dual strategy of purchasing distressed loans or direct lending allows us to pivot across the credit cycle. In terms of where we are in the U.S. property market cycle, we believe the SBC property market is lagging the large balance market by three years, and as such are continuing to invest in our imbedded origination and servicing platforms with a focus on prudently growing origination volume. We are well positioned to drive long-term future growth, and while it will take time to gain additional scale, we are continuing to demonstrate our ability to successfully access cost effective financing through securitization in bank markets, which will enable us to support and fund our growing pipeline, which over time will allow us to create additional value for shareholders. So thanks for your confidence, we’ll now open up the line for questions.

[Operator:]

Thank you, sir. [Operator Instructions] We’ll take our first question from Jessica Levi-Ribner with FBR.

[Tim Hayes:]

Hey guys, this is Tim for Jessica. My first question would just be how you are thinking about prioritizing capital allocation over the course of the year, and you talked about getting back more into RPL and PL acquisitions, and now you have the GMFS platform and just between those two segments and SBC originations kind of what is priority?

[Tom Capasse:]

Basically in terms of the rank order to answer your question number one, GMFS is self-sufficient. They generate enough EBITDA to support investment in their MSRs, which is their current strategy, to provide for a hedged mortgage banking platform. Obviously for those that are not affiliated with the residential mortgage banking business, mature companies like GMFS will retain MSRs as a hedge for a decline in production because when the 10-year treasury rises, refinancing volume declines but the MSR value increases. So they are self-sufficient and currently represent roughly a little over a 10% capital allocation, which is where we expect them to remain for the foreseeable future. As far as the allocation of capital to the business is, number one priority is the origination business, and there the biggest capital user is the conventional stabilized product, the transitional business, where we’re seeing a lot more demand, particular in the stabilized business given the back up in the 10-year treasury so we’re more competitive with banks. So I would say that we would allocate capital on a first priority basis to the origination business, in particular stabilizing transitional given that the SBA business does not use a lot of capital. And secondarily, we are seeing a number of these re-performing loans, in the context of community banking it’s the old extend and pretend loans that they – where the sponsor for the property put in their own personal equity the banks allowed modifications but now the regulators, starting right around early 2016, have classified these loans, whereas previous they didn’t. So there’s a number of bank mergers we’re looking at some pools and that would be a secondary application of the new equity we raised through – I’m sorry, the new capital we’ve raise through recourse debt and securitization transactions.

[Tim Hayes:]

Got it. And as far as the RPR entailed segment goes, have you guys seen – has the pipeline been affected by the new Trump administration? Are you seeing banks more willing to kind of hold on to these assets, or have you seen no change to-date?

[Tom Capasse:]

No, no change to date. There’s nothing in the regulations – you may have seen that yesterday there was the FDIC came out with a Glass-Steagall 2.0. None of the aspects of the regulation have changed at all, the classification of troubled assets, there’s nothing. It’s more of bank capitalization and separation of Investment Banking from Commercial Banking, but we expect that we’ve heard through – we do a lot of business with the FBRs and the Sandler O’Neills in that context, we’ve heard from them that nothing will change materially in the context of the classification of troubled assets in the context of particular approval of bank M&A transactions.

[Tim Hayes:]

Got it. And then my final question, just as it relates to buybacks. I know you kind of, probably would have liked liquidity to be a little bit stronger, but given this deep discount the stock is trading at, the book value, kind of what point would you consider allocating capital to share repurchases?

[Tom Capasse:]

Rick, you want to –?

[Rick Herbst:]

As you know we have been capital constrained had to actually step out of the acquisition business and turn away really some of the traditional bridge loans we had to send to other funds. That issue was largely solved with a note offering. However, given what we believe will be fairly significant originations growth year over this year as opposed to last year, the $75 million that we raised in the note offering will be used primarily to fund that. One, if we’re able to raise more debt, recourse debt, towards later in the year, and we see the origination volumes leveling off and secretive to shareholders, we would definitely consider a buyback, but at this point just the capital we’ve raised is really being directed towards the operating businesses to build up the franchise and grow our revenue stream.

[Tom Capasse:]

Yes, and just to put that into a numerical context, what we do financially as we model out the accretion of a stock – for an incremental capital offering, we model out the accretion of a stock buyback versus the reinvestment – I’m sorry the investment of that incremental capital in the origination business, and a big factor now is operating leverage. Because we can almost double our originations with the existing fixed cost, so it’s very accretive to us to continue, as Rick said, to grow that at the margin. That said we are with the discount, post listing, we will constantly evaluate stock buybacks from a shareholder perspective.

[Tim Hayes:]

Got it. Thanks for the color, guys.

[Tom Capasse:]

Thanks Tim.

[Operator:]

And we’ll take our next question from Raj Patel with Farallon Capital.

[Raj Patel:]

Hi, guys, appreciate the – page 15, your strategic initiatives for 2017, but can you frame that a little bit similarly to what you did last quarter on the core ROE goals, which from memory is somewhere between 10% and maybe just under 13%, I think? What would your current range be on those same metrics now that you’re fast forwarding four or five months; and what does it look like if you get the two securitization done that you’re contemplating? I think those were on the original list for Q3?

[Rick Herbst:]

Yes I think – Raj, thanks for the question. I think the goals that we set out last quarter remain unchanged, and some of these initiatives are similar to we set out last quarter, the biggest one that we wanted to get done was this note offering which we did get done. I think probably the next biggest driver – so I’m not sure how much we referred to the last quarter, but increasing origination volumes fairly significantly, particularly in the SBA business. I mentioned last quarter we did, in the fourth quarter we did $13 million of originations, first two months alone we did $20 million and the gains, because those generate gains on sale and you saw in the guarantee piece, those gains fall to the bottom line pretty quickly, similar to Freddie Mac business in our conventional segment. So I think between the securitizations which we talked about last quarter providing additional liquidity to fund those origination volumes along with the $75 million secured note offering, where our goals are still where we thought they would be or targeted them to be last quarter, which is in that north of 10% at best, hopefully we get it to the 12% or so. But still need to work through these initiatives and then have the leverage effects of those driven through the earnings statement.

[Raj Patel:]

And again, are those – what’s the time frame in achieving those goals? Obviously, it’s hard to annualize it for the whole – to earn it for the whole year, but when does the balance sheet get to be…

[Rick Herbst:]

Secured note offering we closed in the middle of February, so we’ll start to see that now or as we haven’t deployed all those funds yet, but we think we will certainly have them deployed sometime in the second quarter. The origination volumes will ramp up over the course of the year, the securitizations, we are working on them now, hopefully they get done over the next, I’d like to say quarter or so, and the CLO one might take a little longer than that, the other one should be done in that timeframe. And the tax structure we are working on, it should be done fairly soon. So I think certainly by the third quarter, I would guess, most of these things assuming they do get implemented as we anticipate they will, by the third quarter you will – we would anticipate that by then you should see the impacts on the income statement.

[Raj Patel:]

Okay, will we see – there’s that dividend increases to match your progress on kind of the ROE?

[Rick Herbst:]

That will be our plan. I think the $0.37 dividend we announced today is certainly sustainable, as we achieve some of these objectives and assuming that gets driven through the income statement. As I suggested, our plan would be to raise the dividend accordingly. We want to try to keep, well we have to as a REIT, we have to pay out at least 90% of our taxable income when our goal would be to keep our dividend, pay out maximum that we should be paying out to taxable re-purposes, and hopefully drive up the returns for investors.

[Raj Patel:]

And Rick, that $0.40-some odd bargain purchase gain, that’s not a taxable – that’s not taxable earnings, right?

[Rick Herbst:]

That’s correct.

[Raj Patel:]

Okay. All right, great. Thanks, guys.

[Rick Herbst:]

Thanks, Raj.

[Operator:]

[Operator Instructions] We’ll take our next question from Jim Young with West Family Investments.

[Jim Young:]

Yes, hi. With respect to the SBA business that you’d mentioned, that you closed $20 million in the first two months, is that linear for both the complete the $10 million in the first month and $10 million in the second, or are they ramping? And have you given – have you provided an estimate as to what you expect to originate on an annualized basis in the SBA business? Thank you.

[Rick Herbst:]

I was linear, both months were around $10 million each give or take. We would expect that type of level, it’s going to bounce around a little bit month to month and quarter to quarter, but we would expect to maintain that level for this year.

[Operator:]

Mr. Young, any follow-up questions?

[Jim Young:]

I am all set, thank you.

[Operator:]

Thank you. And we’ll go next to Barry Prevor with New York Trust.

[Barry Prevor:]

Hi, guys. In your filing in November, you had mentioned a book value per share of $17.07, now this was a great quarter and the results are better for book value per share, but when you did the division you excluded the non-controlling interest, and therefore announced the book value of $16.80 as opposed to maybe north of $18. Is there any reason for that?

[Rick Herbst:]

We calculate the book value per share the same way, whether you include the equity, including the non-controlling interest and divide by the shares plus the OP units, or without them to get the same number. The reason it declined is we actually had two dividend declarations in the fourth quarter, subsequent to the pro forma number. The pro forma number was as of September 30, and we didn’t declare our third quarter dividend until sometime in October. So we had a $0.30 dividend in October, and then a $0.35 dividend declared December 31. So $0.65 came out of that, and then you add back in our earnings for the quarter, it was a little bit of math in there due to the conversion, but that’s why it went down by the $0.20. It’s really because the September 30 number did not include a deduction, so to speak, for the third quarter dividend. What we’re doing now – what we’ve done starting this quarter is we will always strive to declare our dividend in the quarter so we don’t get that distortion on a quarterly basis. Where one quarter does have a dividend and another quarter has two dividends, now on we’ll keep the dividend going each quarter in the current quarter.

[Barry Prevor:]

Okay. Thank you.

[Rick Herbst:]

Sure.

[Operator:]

Mr. Capasse, there are no further questions in the queue. I’d like to turn the call back over to you for any closing comments.

[Tom Capasse:]

Thanks, Tom. So we appreciate everybody’s participation on the call today, and we look forward to discussing first quarter results sometime in April of this year under hopefully less extenuating circumstances in terms of the weather, so again. Thanks for your participation in the call and continued support of Sutherland.

[Operator:]

Ladies and gentlemen, this does conclude today’s conference. We appreciate your participation.