Ready Capital Corporation
Q1 2017 Earnings Call Transcript

Published: 10 May 2017

[Operator:]

Good day and welcome to the Sutherland Asset Management's First Quarter 2017 Earnings Call. Today's conference is being recorded. And at this time, I would like to turn the conference over Rick Herbst, the Chief Financial Officer. Please go ahead.

[Rick Herbst:]

Thank you, Cynthia, and good afternoon, and thanks to those of you who are joining us on the call this morning. 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 defer 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 our first quarter 2017 earnings release and our supplemental information. By now everyone should have access to our first quarter 2017 earnings release and the supplemental information, both of which can be found in the Investor Section on the Sutherland website. And with that I'll turn it over to CEO, Tom Capasse.

[Thomas Capasse:]

Thanks Rick. We achieved some significant milestones since our last call and remained encouraged as we look forward. We successfully completed a $75 million note offering to fund our growing origination pipeline and anticipate that we will fully deploy the process by the end of the second quarter. Given the timing of the offering in the middle of the quarter and the resulting amount cash on balance sheet along with reduced gains from loan dispositions, our core ROE showed a slight decline of one half of one percent or $0.02 per share. Now half [ph] the funds for the net offering been fully deployed on the day we closed that transaction, our core ROE would have been at or above last quarter. Core earnings adjust for onetime income and expenses and changes in the fair market values of mortgage servicing rights. Rick will provide additional details in a few minutes. Our initiatives to boost SBC origination volumes as discussed previously resulted in origination volumes arising to 177 million, an increase of 13% compared to the last quarter. In addition, our SBC current pipeline, which is a leading indicator of volume, is over 275 million, its highest level ever. As of today, we have now deployed two thirds of the note offering proceeds. We remained committed to achieving double digit ROE through programs designed to hit target financial and operating leverage ratios. Financial leverage includes additional issuance of non-recourse debt, which will improve operating leverage by investing in increased originations to optimize our fixed cost base. We anticipate that future financial leverage would be added more gradually unless we have specific acquisitions in place, thereby minimizing earnings drag of having excess fund. Regarding operating leverage, we have increased our loan origination staff, while holding the line on support and services staff. In terms of the market backdrop, strong fundamentals in the SBC, investor property and small business markets continue to support the period risk adjusted returns in real estate lending, particularly in comparison to the more competitive large balance market. Recall that we defined at a small balance commercial real estate, has real estate with an appraised value of less than 5 million and under 50,000 square feet. Now season market observation, the help of the SBC property market is evidenced in the SBC quarter-end national vacancy rate of only 7%, which is 120 basis points below the pre-crisis low point due in part to new supply in terms of SBC completions recovering only to 25% of their pre-crisis peak. Despite these tight market conditions, SBC prices are still 5% below their pre-crisis peak as compared to large balanced prices which are 11% above the peak. With this backdrop, SBC originations reached a pre-crisis by 183 billion in 2016. In terms of the small business market, growth in small business loan demand is reflected in 17% average growth in FDA approved capacity since the 2009 crisis bottom to 26 billion in 2016 with 30% growth projected for the next two years. This market has remained highly fragmented with approximately 1,700 active SBA lenders, mostly community banks. Our SBA subsidiary is only one of 40 non-bank lenders of which four are active. Despite only restarting originations in the fourth quarter, a ready cap lending subsidiary is already in the top 3% of the SBA loan originators. With that I'll hand it off to Rick to discuss our financial results.

[Rick Herbst:]

Thanks Tom. I won't go through every slide, but I would like to highlight a few of them. Slide 3 reconciles our gross leverage yields both on a GAAP and core basis. On a core basis from 14 [ph], 7% to a bottom line core ROE of 7.9% for the quarter. We reconfigured the slide a little bit from the previous quarter to more accurately reflect the contribution from our residential mortgage banking unit. As Tom mentioned, our top line leverage returns reflect the fact that we use note offering proceeds to deliver our warehouse loans until those funds to be gradually deployed until new loan originations. We estimate the earnings drag during the quarter was about 50 basis points. Gains on asset dispositions were a bit lower, offset by a reduction in our effective tax rate. Slide 4 provide the metrics on our acquired loan portfolio. Gains from asset dispositions on this portfolio are lumpy based on resolution of larger loans and again this quarter were $300,000 lower than the last quarter. We acquired 11 million of new assets during the quarter. But as we've stated in the past, as we look to remain prudent with how we deploy capital, we have stayed extremely disciplined on acquisitions. Slide 5 summarizes our conventional investment lending business with the leverage yields here off a bit from last quarter. Lower fees earned on loans when they mature impacted the returns here. And in addition paying down our warehouse loans with proceeds from the note offering had the effect of de-levering this segment which in turn reduce the levered ROEs here. Furthermore, approximately 60% of the equity invested in a conventional loan business was allocated to warehouse inventory where leverage returns have generally lowered in the last aggregation period until the loans can be securitized. In addition to strong origination volumes this quarter, our pipeline is up 25% or over 40 million since last quarter. Importantly, the credit quality of this portfolio remains extremely strong. Slide 6 summarizes our SBA business, which continues to provide exceptional levered returns. The returns are a bit lower this quarter, due to higher prepayments of loans this quarter, which reduced the value of the related loan servicing rates. I'll also point out that as of March 31, approximately 16 million of our new loan originations were not fully funded and therefore, we carried on a cost. Once they are fully funded, they can be sold at premiums that have been running north of 10%. So these loans represent a good source of earnings in future quarters as those loans are completed and can be sold. We added five new loan offices this quarter and our originations more than doubled from last quarter. In addition, our pipeline is at a record high increasing over 20% from last quarter. Slide 7 summarizes our residential mortgage business, which continues to produce strong results. That operation joined us in November as part of the ZAIS merger. GMFS is a market leader in the southeast and retains mortgage servicing rates to hedge fluctuations in origination, due to changing interest rates. These retain MSRs provide an increasing revenue stream and you can see the increase in those MSRs depicted on the right side of this page. That said, despite a rally of the 10 year treasury posted [inaudible] GMFS' origination volume this quarter was up 6% over the first quarter of last year and we are aware that many mortgage companies have seen volume declines during the same period. Slide 8 shows this specific investment levels by type for the quarter, which provides perspective on where our funds were placed during the quarter. Compared to last quarter, Freddie Mac disbursements were up about 12 million and our core business and transitional loans combined were down about the same. Slide 9 depicts the net interest margin contributed by each of the origination businesses and the increasing net interest income from our lending businesses reflect the successful rollout of our origination platform and should provide a more stabilized net interest margin going forward. The next few slides reflect the diversity of our loan graphically by collateral type and by loan size and the slide summering our current financing facilities and leverage. Our leverage ratios are fairly low and we continue to seek opportunities to deploy official leverage to generate improved risk adjusted returns. Lastly, as we announced last week in a filing with the SEC, we entered into a settlement agreement with a counterparty, who certainly claims against GMFS regarding loans sold for the counterparty between 1999 and 2006. We were aware of into considerable diligence around this issue in advance of these major transactions and we are glad to have the settlement behind us. The settlement had no material financial impact as the settlement amount will be offset against contingent consideration payments that were previously accrued for. Now I'll turn it back Tom for some final remarks.

[Thomas Capasse:]

Thanks Rick. Before we open up the call for questions, I'd like to update you on our progress to improve our ROEs as highlighted on Slide 13. First, leverage. As discussed in our fourth quarter call, as a newly public company, our 550 million equity base provides access to accretive issuance of recourse debt such as notes and preferred stock. Our first step was a February note offering, which capital should be fully deployed by the end of the quarter. We continually evaluate the lowest marginal cost of capital alternatives and it currently receipted debt market. With recourse debt equity ratio of approximately one to one, we feel we have additional capacity currently available to us. So in terms of non-recourse or securitized debt, we are currently working on three additional securitizations in the near term. The first is, it is securitization of acquired SBC owner occupied loans. The second is a commercial real estate collateralized loan obligation or CLO backed by our transitional loans. And the third is a securitization of newly originated Freddie Mac SBC multi-family loans. ABS demand evidenced in market spreads where pre-crisis lows remain strong. We continue to make progress in bringing these deals to market. Now in terms of originations, as we've discussed in the past, our primary focus this year continues to be an increasing new loan originations across all of our products and platforms. As Rick mentioned, we hired five new loan officers since year-end bringing the total to 23 and are developing parallel affinity programs to generate repeatable origination volume. Finally, in terms of taxes, as discussed in the fourth quarter, we are implementing strategy to reduce the level of taxes do with our profitable taxable re-subsidiaries, the benefit of which is reflected in the quarter. In closing, we remained focused on our efforts to increase scale and grow the platform. The first quarter represents our first full quarter as a public company, post the merger last fall with additional investment in the infrastructure, we are beginning to see growth in the loan pipeline. As we have said before, the goal remains to create a nationwide non-bank small balance commercial lending and servicing platform which scale in a highly fragmented SBC market where regulatory constraints on bank has constrained the supply of credit to small investors in and on our occupants of SBC real estate. In our short time since the merger, we had made great strive in establishing the framework for our business for the years to come. Looking ahead, we remain excited about the prospects of Sutherland and the ability to create value for our shareholders. Thank you for your confidence in us and we'll now open up the line for questions.

[Operator:]

Thank you. [Operator Instructions] And we'll take our first question from Jim Young with West Family Investments.

[Jim Young:]

Yeah. Hi. Regarding the GMFS, how much equity is in this business, you'd look like you got common shareholders' equity of 511 million, but much of that attributable to GMFS at this time?

[Rick Herbst:]

The equity is between 60 million and 70 million, it fluctuates with the mortgage servicing valuation was approximately 12% of our total equity allocation.

[Thomas Capasse:]

Yeah, you could see that on Page 3 of the deck up left, where it shows the ROE of the business and the equity allocation in that quarter-end. That was 11% and 15% ROE as of the end of the first quarter.

[Jim Young:]

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

[Rick Herbst:]

No. We backed up the impacts of it, it wasn't settled, it's a couple of weeks ago, but the accounting requires that we back it up through March 31, so the effects were there and it really just a reclassification of liability from one line to another.

[Jim Young:]

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

[Rick Herbst:]

It's hard to give specific guidance. You know hopefully towards the end of the year, I think it's not going to happen this quarter, but we're looking for gradual improvement from where we've been in the last couple of course.

[Jim Young:]

Okay, and has there been - given the transitional nature of it, at this stage and its evolution, has there been any consideration in waiting some of the management fees, are there companies during similar periods have either eliminated management fees or have reduced management fees, is that something under consideration at this time?

[Rick Herbst:]

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

[Jim Young:]

Okay, so are all the questions at this time. Thank you.

[Operator:]

[Operator Instructions] We'll take our next question from Raj Patel with Farallon.

[Raj Patel:]

Hi guys, can you talk a little bit about your half way through this quarter at this point if you had a material - sorry material pickup in origination, so it connects with you the cash on the balance sheet?

[Rick Herbst:]

The originations to be at a rate kind of somewhere to where it been in the first quarter. The pipeline is much stronger. It's hard to project with much certainty how much of that flows through between now and the end of the quarter. Obviously with all that we'd be well above where we are with that unlikely I would say. But our projections for the originations have been running. And with the pipeline, we will deploy all of the term loan, we believe this quarter absent and it will be fall off some of the direction.

[Raj Patel:]

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

[Rick Herbst:]

No, it's really those funds where we use the funds to pay down warehouse line. So it kind of has a double effect on the leverage yield of those businesses. We are reducing leverage within that business and then we are paying down 4% less debt until we can redeploy there to more profitable loan origination.

[Thomas Capasse:]

But actually Raj to that point, if you look at Slide number 3 on the fall rate that the impact that Rick just referenced, the negative carry associated with the note offering that was reflected in the top line ROE. However - but I will also point out that exclusive of that in terms of improving the capital efficiency of the business, there is always flows on security, we only know all the MSRs on the loans we originated. It's part of our retail base strategy with our lending business. So there maybe liquidity by back lines and credits. So we've been working on reducing all of that and you could see at least in this quarter reduction cash in assets from 2.5 to 1.3.

[Raj Patel:]

Got you. 2.5 to 1.3 even though you have more cash drag that's even bigger on the non-earning assets, is that right?

[Thomas Capasse:]

Its cash drag, but it's really, we paid down the warehouse lines.

[Raj Patel:]

I got you.

[Thomas Capasse:]

It's kind - it affects the denominator, but it's a valid point in bringing up generally and we are very - we have that team that's focused on forecasting liquidity and trying to match any debt issuance with actual acquisitions or originations as well as trying to reduce the amount of non-earning cash for bank lines and other activities.

[Raj Patel:]

If you go back a couple of quarter like - that you put up in public that the pro forma ROE chart you started with Q3 core ROE and I think I go back to this every call since then I guess. You must have made this staff production by now and I think you stated that the transferring the taxable income that's already been done, is that right?

[Rick Herbst:]

Well the effect of that I have been recognized this quarter.

[Raj Patel:]

So you started with A3 in those - those things combined the first loans deterioration and this note offering, that's all been done. You've done most of those things other than I guess investment money, you had ROE is actually gone below where we started, just trying to reconcile what's been going on there?

[Rick Herbst:]

Since the gains have been little lower over the last couple of quarters and they have been prior, the term loan which is really the biggest driver, again that didn't map until February and it's not - that to be able to grad this quarter but we think it will be accretive back in the quarter. So the effects of that hadn't kicked in. The securitizations have taken a big longer than we thought that would have back in the fourth quarter we would have told you that we brought with this by now. We are getting much closer but they are not done yet. So we haven't seen the impact of that either.

[Raj Patel:]

So you had those securitizations done, do they just repay more expensive debt or put more cash in balance sheet that would then take sometimes in that anyway?

[Rick Herbst:]

No. It's - keep across the funds and generally higher.

[Thomas Capasse:]

Yeah, then we move - the only thing it does it reduces our re-course the third balances has reduces our re-course debt ratio.

[Raj Patel:]

Got you. Do you have more fire power to do the same thing again in quarter at later whenever you need to?

[Rick Herbst:]

Correct.

[Raj Patel:]

Okay, is there anything on the gain part, there is nothing negative to really be there, I mean that's just lumpy is going through same performance in that bucket that doesn't really, you just don't know when it's coming right?

[Rick Herbst:]

Correct.

[Raj Patel:]

Okay, alright, thanks. I guess one more thing, I think you just stated that the note proceed that line item will actually turn - be accretive for second quarter, that's the case even though you haven't maintained, you haven't deployed those funds?

[Rick Herbst:]

We deployed about two thirds of that as of now. That's actually deployed over the next month or so.

[Raj Patel:]

Okay. And with your - with the leverage yield, the two thirds is already accretive on average anyway.

[Rick Herbst:]

Yes.

[Raj Patel:]

Got it, okay. I look forward there is improvement in that bottom line ROE. Thank you.

[Rick Herbst:]

Okay. Thanks.

[Operator:]

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

[Thomas Capasse:]

Thanks. Again we appreciate everybody's continued support and we look forward to our earnings call next quarter.

[Operator:]

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