Ready Capital Corporation
Q3 2017 Earnings Call Transcript

Published: 11 Nov 2017

[Operator:]

Go to everyone, and welcome to the Sutherland Asset Management Corporation Third Quarter 2017 Earnings Conference Call. Today's conference is being recorded. At this time, I'd like to turn the call over to Rick Herbst, Chief Financial Officer. Please go ahead, sir.

[Frederick Herbst:]

Thank you, Jenny, and good morning, and thanks to those of you on the call for joining us. 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 this 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 third quarter 2017 earnings release and our supplemental information. By now, everyone should have access to our third quarter earnings release and that supplemental information. Both can be found in the Investors section of the Sutherland website. And now, I'll turn it over to Tom Capasse, our CEO.

[Thomas Capasse:]

Thanks, Rick. We are pleased with the progress we are making in execution of our strategic objectives with a significant focus in the first 3 quarters of 2017 on raising capital to fund the ramp in our small balance commercial loan originations. And just to remind you, we define small balance as loan secured by a first mortgage on properties valued under $5 million with under 50,000 square feet. There are a few highlights for the quarter. Earnings of 37% per share compared to $0.34 last quarter. Originations of small balance commercial loans grew 26% over the second quarter to a record $318 million, which includes 24% growth in small balanced commercial investor loans and a robust 50% increase in small business administration loans. We also reached our 2017 capital-raising goal of $250 million, comprising of $150 million of convertible notes issued in August and $140 million of term notes issued earlier this year. Together, these offerings provide ample liquidity to fund our loan growth through the first quarter of next year. Now, in terms of capital deployment, 100% of the June note proceeds and 10% of the convertible note proceeds have been deployed as of quarter-end on a fully levered basis. Appending $54 million small balance commercial pool acquisition, expected to close next week, will result in 60% deployment of the convert proceeds. We estimate the undeployed cash from the convert had a drag on earnings this quarter of 80 basis points. We currently have no plans to issue additional debt this year unless we can immediately reinvest in small balance commercial loan pool acquisition. To that point, we are evaluating a number of potential opportunities. As discussed in our last call, we completed our budget securitizations for 2017, closing 2 more securitizations in the third quarter where the market continues to be very receptive. No more secularizations are planned for this year, but we anticipate 1 or 2 more in the first half of 2018. Notably, we have now demonstrated the liquidity of our balance sheet by securitizing assets in every major lending vertical. Deployment of this capital, levered yields, consistent with our historical rates, provides incremental net interest margin, which falls right to the bottom line, increasing return on equity towards our target levels. Now a few comments on the continued strength in the small balance commercial property market, which underpins our senior secured lending strategy. Market fundamentals are balanced, with declining net absorption offset by a lower rate of completions. This has resulted in a flattening of small balance commercial loan delinquencies for the fourth quarter in a row and near precrisis low as it's less than 5%. Meanwhile, as with the housing markets comprised [indiscernible] small balance commercial properties remains tight, which is reflected in increases in both rent and property prices from approximately 2% in the third quarter. Now, one sector of particular note is retail. The financial press is awash with stories on the adverse impact of e-commerce on overleverage malls and big-box stores. In direct contrast to this, the small-cap service-oriented retail ramps, the properties in which we lend grows almost 6% year-over-year. The primary reason for this was that small-cap tenants cater to consumers' everyday needs, liquor stores, nail salons, gourmet food, and have been resilient to growth in online sales. Their product offering is experiential and has benefited from growth in consumer expenditures. It's for this reason that we lend to this segment of the market. If you illustrate the difference, the average large balance retail loan is $20 million, while ours is only $1.6 million. The average square footage of a large balance retail loan is nearly 200,000 square feet, while ours is only 15,000. Finally, in terms of credit quality, 90% of large balance retail loans are in special servicing, while we have 1 retail delinquency on our -- in our loan book, representing less than 0.5% of our originated retail loans. Another high-conviction sectors throughout this small balance multi-family. Recall that Ready Cap is one of 11 Freddie Mac's small balance lenders. The chronic undersupply in affordable housing, a democratic shift to rentals is reflected in the 3% third quarter increase in rent and a record low 4.4% vacancy rate with BNC apartment buildings with 40 [indiscernible] units.In the small business sector, we can see it continuing to see strong loan demand. The Small Business Administration saw a 5% increase in loan originations or over $25 billion for the fiscal year ended September 30. Although we restarted FDA lending only late last year, we are already a top-50 lender, and our third quarter volumes will put us in the top 25. As discussed in prior earnings calls, with the correlation with the small balance commercial market and housing and the tailwinds therein, we believe our strategy offers solid diversification as a part of the commercial real estate debt asset class. With continued signs of growth indicative of the market earlier in the economic cycle, we think the risk/reward of small balance -- of the small balance asset class compares favorably with that of the large balance commercial real estate, where indicators suggest a later stage in the economic cycle. So with that, I'll hand it off to Rick to discuss financial results.

[Frederick Herbst:]

Thanks, Tom. I'll take a few minutes to touch on the few of the highlights on some of the slides included in the supplemental information deck. Slide 3 reconciles our growth leverage yields of 16.2% to a bottom line return on equity of 8.9% for the quarter on a GAAP basis. We have changed the presentation a bit on this slide so we believe better reflects the recurring nature of gains generated by our increased originations of Freddie Mac and Small Business Administration loans, both of which are originated for sale. Realized gains on these products are included in the top section of this table now as not all of the economics from these business lines went through just the net interest margin. While we are pleased with the upward trajectory of the gross return on equity, as Tom mentioned, there was an 80 basis point drag from the undeployed proceeds of the debt offerings Tom mentioned earlier. The increase in operating expenses this quarter was primarily attributable to a write-down of 2 foreclosed properties, lower recoveries of advances on delinquent loans and increased origination expenses due to higher volumes. This was offset by a decrease in the tax provision due to financial structuring and utilization of a net operating loss carryforward. Slide 4 speaks for itself and clearly demonstrates our increase in loan volumes in every segment of our small balance commercial loan business. Our volume growth is due to improved market penetration, and we've added loan officers along with more effective affinity programs with our other financial [indiscernible] partners. Despite the success we've enjoyed, we are still just scratching the surface as our loan volume represents just 0.5% of the small balance commercial lending market. Slide 5 summarizes our conventional investor lending business. As I mentioned a moment ago, we've modified the presentation of leverage returns to include realized gains from Freddie Mac loans. As Freddie Mac loan volumes increase, we will see a higher component of the small balance commercial segments earnings being derived from gains of Freddie Mac sale. These are normal recurring gains, and we believe this presentation more accurately depicts the earnings generated from this segment. The credit quality of this loan portfolio continues to be extremely strong, with less than 0.2% delinquency. Slide 6 summarizes our Small Business Administration business, which continues to provide exceptional levered returns. Similar to the previous slide, we've included gains on loans held for sale to accurately reflect the total returns from this segment of the business, which continue to be in the 30% range. We are extremely pleased with the 50% increase in loan volumes during the quarter, and our pipeline is up 14% over last quarter. We are now the third-largest nonbank, Small Business Administration lender in the country. Slide 7 shows some summary information for the acquired portfolio. Levered returns remain fairly stable in this business line as new acquisitions were slower in recent quarters. However, we are closing on a $54 million loan from last week and another $15 million Small Business Administration loan through acquisition is expected to close in December. These acquisitions will utilize a good portion of the remaining excess liquidity generated from the convertible note offering. Slide 8 summarizes our residential mortgage business. Our strategy has been to repay the servicing rights on loans sold, which increase in value in a rising interest rate environment when new loan production levels generally decline. Our new loan volumes are down this quarter as compared to the third quarter last year, consistent with the broader residential mortgage industry. However, the value of the loan servicing portfolio could increase by $2 million. Slide 9 shows the specific investment levels by type for the quarter, which provides perspective on where our funds were placed during the quarter. Virtually every product line showed improvement in the quarter. These new loan origination volumes reflect the successful rollout of our origination platform. Slide 10 shows the increase in contribution to net interest income of our new loan originations businesses. The next few slides reflect the diversity of our loan pools geographically, by collateral size, by loan size and a slide summarizing our current financing facilities and leverage. You'll note on slide 14 that the recourse leverage is comparable to last quarter despite the fact that we added $158 million convertible term loan that was closed in August. This was due to converting recourse debt to nonrecourse debt as a result of the securitizations. One final comment you may notice in our segment reporting included in the back of the press release, that breaks that [indiscernible] corporate overhead as a separate column in this disclosure to more accurately reflect the individual business line. Now I'll turn it over to Tom for some final thoughts before we take some questions.

[Thomas Capasse:]

Thanks, Rick. We believe we have made significant progress in our 2017 business plan, utilizing the capital we have raised from accretive growth in our loan origination franchise. As we move forward, our focus will continue to be to deploy our capital as efficiently as possible in order to generate higher returns for shareholders. In addition to higher loan origination volumes, we have reentered the loan pool acquisitions market. Moving into 2018, with the recent hiring of a Chief Operating Officer and Chief Technology Officer, our focus will be on operations and achieving cost efficiencies in our loan origination process due to the application of technology, marketing the Ready Cap platform and expanding our brand awareness across product lines. We look forward to continued growth in our franchise, and we thank you once again for your confidence in our company and for your continued support. With that, Jenny, we'd like to now open up the line for questions.

[Operator:]

[Operator Instructions]. And I'll take our first question from Jade Rahmani with KBW.

[Jade Rahmani:]

I was wondering if you could comment on the state of competition in the market? And with the debt capital markets having heated up, competition increasing in other sectors, I was wondering if you could comment on whether you're seeing similar trends.

[Thomas Capasse:]

All right. This is segment-specific, so I'll just deal first with the -- our investor loan business in -- based in Dallas. Basically, with that product, [indiscernible] stabilized loans on small balance commercial properties that's better executed in the CMBS-like securitization structure. So that market really -- we -- there are not -- there are very few nonbank entrants at this point, but what we do see is, in certain regional areas, aggressive competition by community banks that, let's say, they recently raised an equity offering. And so it's spotty and one-off, but there is no nonbank competition there. In the Freddie Mac business, that's -- there's no significant change there, there is no -- there's somewhat a various entry in that market since Freddie has limited that to 11 lenders. I think we're in the middle of the pack there as far as ranking within the Freddie Mac product. The transitional loan product, there have been, I'd say, a marginal increase in competition with some nonbank private lenders going downstream to our market. But Freds there have held there pretty solid, maybe narrowing 10 to 15 basis points over the last year. And finally, in the SBA sector, we have -- again, there's only really 3 of the 11 non -- sorry, 3 of the 14 nonbank lenders that are -- or 3 or 4 are active. And we've seen no increase in competition there because the banks tend of stick to their -- the more of, A if you will, higher credit quality loans, whereas we're looking at more real estate secured loans that banks typically would not approach. So there, we've continued to see, as evidenced by the increase in loan volume of around -- I think it was 50% quarter-over-quarter, we see relatively limited competition there. So I think, on balance, there is -- we don't see any -- at this point, there's been no nonbank -- significant nonbank lender that has entered the space, so competition has been limited. And on the debt capital market side, you definitely have -- the spreads are pretty much approaching 2007 precrisis lows, so we've taken advantage of that by issuing most of our secularizations through the secured -- the third quarter. And that has resulted in a widening in our net interest margin through lower interest costs.

[Jade Rahmani:]

In terms of the level of competition, could you say whether you're being approached by other entities in the space maybe looking to add origination to their platform and move into the small balance space? And whether that could present an M&A type of opportunity?

[Thomas Capasse:]

I don't see that in terms of the M&A side of the equation. What we see it more is in the affinity program, with special services that are looking for refinancing on loans below $20 million -- sorry, or $10 million, a number of credit unions, for example, not originating FDA loans. So it's really more of what we're seeing in terms of strategics is the ability to grow affinity programs over time, which is big focus for our loan origination team moving into 2018.

[Jade Rahmani:]

And is that basically other pools' capital leveraging your originations force or the reverse?

[Thomas Capasse:]

It's the former there. They are looking, for example, let's say, a credit union that doesn't -- that hasn't lot of small business depository relationships, but doesn't have lending. So they'll refer to us a FDA loan or it could be a bank that is doing a lot in multi-family high-quality type. But yes, let's say, a certain A+ product in the small balance multi-family space, we would look at doing a turndown program with a bank with respect to the types of credits that we would look at, which are more story credits that the bank otherwise would make. So these are the lenders that -- larger lenders that are leveraging their origination platform by having an -- either a private-label program or a referral program with our various small balance conventional lending verticals.

[Jade Rahmani:]

In terms of your originations capacity, just on the small balance side, leaving aside residential, what is the capacity in terms of maybe quarterly or annual production volumes that you can achieve?

[Frederick Herbst:]

We're, obviously, very pleased with these volumes in the third quarter. We believe that's sustainable. Obviously, quarter-to-quarter, some of them going to be a little higher, some of them going to be a little lower. We're still finalizing our plans for next year. But I think the volume you saw in the third quarter was representative. We, hopefully, next year see some growth over that. I don't think we're going to get to $2 billion a year anytime soon. But certainly next year, we'd like to think we're going to be over $1 billion.

[Thomas Capasse:]

And just in terms of the macro picture, just to remind you that the -- this year, there will be about $175 billion of small balance commercial investor loans; SBA, 25 billion, so that's $200 billion. Maybe there's $600 billion outstanding, which represents little under 1/5 of total CRE credit. But our goal over the next 3 to 5 years is to be -- maybe have 1% market share in that space.

[Jade Rahmani:]

Okay. In terms of the loan pools and FDA acquisition in December, so these 2 closings, could you put a range around what potential earnings accretion might be? And also could you talk about the duration of those investments? How long a life do they have?

[Frederick Herbst:]

The larger pool is relatively short, it's probably 2 to 3 years average duration of those assets. Both acquisitions are kind of low-teens returns. They're both next year are performing and nonperforming. Pretty much right in line with what we've done historically.

[Operator:]

[Operator Instructions]. And we'll go next to Jessica Levi-Ribner with B. Riley FBR.

[Jessica Levi-Ribner:]

On the expense side, you made a comment, Tom, I think that you are focused on cost cutting. Do you have any goals there or targets?

[Frederick Herbst:]

Historically, we've been running around 8%. We are looking to reduce that over time. This quarter was a little bit higher and we had a couple of -- I don't want to say onetime items, but kind of unusual items that pumped those number up. So we'd like to keep it under 8, and get as low as we can. And I'm not sure it's realistic to say it's going to add 100 basis points. But it's something we're certainly looking at the moment.

[Jessica Levi-Ribner:]

Okay. The SBC pipeline looks like it's down, but should we still expect kind of a similar lending quarter in the fourth quarter?

[Frederick Herbst:]

The pipeline is down a little bit. Based on what we're seeing, I'm not sure we're going to hit the same level. I think we're going to have a strong quarter. I'm not sure it will be sequentially up from this quarter at this point. It depends. A lot of things can happen at year-end where deals either fall off for whatever reason or others get accelerated for tax purposes or other reasons. So December is always kind of a tough month to predict exactly what's going to happen. So that's about as much color as I can give you. But certainly, long term, we think the current rate is sustainable.

[Jessica Levi-Ribner:]

Okay. And what kind of asset are you targeting? I know at the beginning of the call, Tom, you made some comments about retail. Maybe you can give us an idea of what areas you think are the most attractive today? And also how your hiring is going across both the SBC and SBA platform?

[Thomas Capasse:]

We in the investor product, we look at sectors which have -- we believe, have a low beta to a recession. By that, we mean the least volatility with respect to net operating income. So currently, we're focused on mixed use retail -- I'm sorry, yes, retail in a sense of the small strip malls and what have you, the NOIs in that product are very -- the cap rates are very strong and debt yields, which is the ratio of the net operating income to the loan balance. So we're focused very heavily on those sectors and in our investor business. And then in -- with respect to the SBA business, there we have models that we have [indiscernible] coming back literally a decade, which enable us to predict the verticals where we believe we have a very strong, again, resiliency to a -- to these small businesses in terms of default rates in the recession. So we tend to focus on businesses like daycare or -- we just hired a team last quarter in Ohio that was about 4 loan officers that focus on dentists, doctors, et cetera. So along with the way of saying, we have risk-management malls that are predictive and will pivot from 1 asset class to another, whereby, we see strong, again, resiliency to an economic downturn. So in terms of the second question, hiring loan officers, we did hire 2 new loan officers in the third quarter in the SBA business, and none in the SB -- the investor business. But our goal record to achieve by year-end, roughly 20 -- yes, 20 loan officers in total. And next year, we probably add another 10, maybe 15 in the -- to support the growth. And it's very linear. Each of these loan officers typically have years of experience, they produce anywhere from $5 million to $20 million depending upon the product line. So that's the way with the fixed cost in our -- in terms of our lending business at this point, we see this as very accretive because we're adding -- we're essentially adding net interest margin through hiring individual loan officer that we know has a strong track record in their local market.

[Frederick Herbst:]

I'll just add one thing, Tom. The new loan officers we've hired in the SBA business have delivered loans quicker than we would have otherwise assumed perhaps. Sometimes it takes little while to build out the book or transfer those in process. The loans -- the officers we hired recently have already delivered product into our system when they closed the loan. So that's been positive.

[Jessica Levi-Ribner:]

And are you still hiring from some of the larger banks? Where are those loan officers coming from?

[Thomas Capasse:]

It's interesting, yes, basically, it's talented loan officer that are frustrated with the tight credit box that banks, because of the regulatory constraints, have in this asset class, and that's both on the investor side and then, in particular, on the SBA side. We thought we tempted hire recruiters. And actually, we -- the people -- the loan officers, they are typically teams or high producers have been coming to us because they see they can originate more loans with a more expanded credit box that we, as a nonbank lender, provide them with. So it's been really more of a migration from loan officers that are constrained both financially and otherwise in terms of the credit box of banks, coming to us as the only nonbank lender that does both waivers in terms of investor loans and small business loans.

[Operator:]

And we'll take our next question from Scott Valentin with Compass Point.

[Scott Valentin:]

Just with regard to the ROE, I think you guys posted kind of adjusted ROE of 8.9%, and I think you mentioned it was 80 basis point drag from some of the excess cash from some of the convert. So your normalized [indiscernible] at 9.7%. If you assume some cost reduction, you get to 10%. Is it possible to push past 10% do you think with, say, in the first half of '18?

[Frederick Herbst:]

I don't want to put a time frame on it, but the 80 basis points represents just basically the interest cost of cash sitting on our balance sheet before able to deploy that cash and our leverage returns that have been running 15%, 16%, that the earnings power, that excess cash rises dramatically. So it's more than just the 80 basis points. The 80 basis points was just the flat interest cost of cash. So I guess that answers your question, as we think over time, we can get over 10%. But again, I can't put a time frame on it, but it shouldn't take -- as we deploy that cash, and as we've mentioned earlier on the call, after these acquisitions, we will report about 60-or-so percent of it. And then with the new originations coming out rest of the quarter, we should be deploying the vast majority of it here into the first quarter.

[Scott Valentin:]

Okay. That's helpful. And then in terms of Freddie Mac, you mentioned the, kind of, the change in how do you account for realized gains, given SBA and Freddie Mac, that's kind of a welcome bonus [indiscernible] of the business. For Freddie Mac, how should we think about those gains? I know SBA has been a long kind of history of SBA, we can figure out what the gains on with loans. But how should we think about the Freddie Mac loans in terms of maybe an average type of gain on sale level?

[Frederick Herbst:]

Generally, between 1% and 1.5% every time we originate a loan. And just to clarify, we didn't change the accounting, we've always accounted for it that way. What we changed was the presentation in the return because the way we had done it previously just included the net interest margin, and we realized in talking with folks, folks like you, Scott, it wasn't as clear as to what the contribution from those gains were by product line as well as it's recurring part of the core business. So the presentation there includes those, but the accounting for GAAP purposes always -- has always been a thing.

[Scott Valentin:]

And then just one final question on asset quality, still very strong. I think you mentioned you're running some very, very low rates of delinquencies in the portfolio. How should we think about provisioning going forward? I know you guys mentioned you use -- I forgot which rating agency it is, but you use one of the rating agency to kind of what they use for loss expectation as your guidepost. How should we think about maybe the seasoning of the portfolio as it seasons and the provisions for loans going forward, provisions for losses?

[Frederick Herbst:]

Yes, it's a little different, depend on whether that's acquired or originated. On the acquired, we do kind of a loan-by-loan analysis for cash flows and discounted back. And it's very loan-specific. On the originated pool, you're losing those the [indiscernible] agencies, assume something that falls in their models. For accounting purposes, we do something similar, though it is based on statistical analysis of our history. The good news is, we've originate over $2 billion of loans. We have -- currently, we have 2 loans that are delinquent, out of that less than $2 million of just real modest amount. And so we factor that in as well as loan to values, the latter values, that type of thing. We do a statistical analysis based on our history, based on the market, based on rating agencies. It's kind of a blended approach given where we've been in the cycle.

[Scott Valentin:]

And then one final question. On tax, you mentioned the NOL this quarter, it pushed you to a tax benefit. How should we think about tax going forward? I think it was running, call it -- maybe it was around high single-digit 8 percentage. Is that a good rate?

[Frederick Herbst:]

Yes, it was running around 8% to 10%. I think that's a fair estimate going forward. We did have a benefit this time using the NOL, and we've done a lot of financial engineering to come in [indiscernible] efficient and optimize capacity as much as much as we can. But -- and I think you're right, around kind of a 8% to 10% is reasonable.

[Operator:]

And we'll take our final questions today from Jade Rahmani with KBW.

[Jade Rahmani:]

I was wondering if you could touch on the residential mortgage originations business. Just how much equity is invested in that? And if it's still viewed as a core vertical for Sutherland?

[Frederick Herbst:]

Yes, I'll take the first part. The core equity is around 15%. It's grown a little bit because the servicing value continues to rise, and if you keep adding to that book, it's been a very profitable business for us. And the returns there -- those returns are a little lower this quarter. There -- volumes were not quite what they had been in the second quarter, again, due to rising interest rate environment. But the servicing rights portfolio was the bulk of their asset is in those servicing rights, $68 million value as of September 30.

[Thomas Capasse:]

And strategically, we like the business, it's solid. We improved the management team with 15 years' operating history, dominant position in the Louisiana, Alabama market, 50% purchase. So their very -- there's a much less volatility in their earnings as compared to other mortgage banking entities. And also we are cross-selling the regulated products through -- via the residential subsidiary in Louisiana, where we don't -- currently do not have a footprint, and that, in particular, is the SBA loans and the Freddie Mac multi-family.

[Jade Rahmani:]

The 15%, is that as a percentage of common equity or total capital?

[Thomas Capasse:]

This is around a little over $80 million

[Jade Rahmani:]

Okay. Do you have any views on tax reform and the impact on your addressable market? Positive, negative, neutral?

[Thomas Capasse:]

For the small balanced commercial market, it's probably mildly positive to neutral because, in particular, the interest deduction will remain for mortgage debt, which is, obviously, a big -- it's similar to the significant factor in small balance commercial loans. Our LTD's are about 5, 10 points lower, so the leverage factor in terms of your total return from an equity -- real estate equity investment is not a big issue. So I think other than that, there's really no -- there's really nothing of import that affects the investment profile of these small balanced properties. On the small balance, in terms of small businesses, on the SBA side, there's 30% cap on the interest deductibility for -- in terms of 30% of EBITDA, that can have some incremental impact. But generally speaking, businesses are not as levered and don't rely as much on the interest deduction as, let's say, a large Fortune 500 company. So I guess, on balance, it's neutral to mildly positive.

[Frederick Herbst:]

I would add, Jade, maybe not specifically to your question, but the -- if there is a reduction in the corporate tax rate, I think we probably have more earnings from our CRSs than maybe other RIET assets that holds other assets. But [indiscernible] as we have been, the franchises, the loan, the operating companies assuming the -- if the tax rate -- corporate tax does get lowered, obviously, that would increase the ability for those CRSs to retain income so, to the extent, we do not distribute it up to the REIT and not distribute it to shareholders, that would mean we have retained book value above and beyond where our dividend is. Obviously, it will depend on where the rates end up and where our numbers are, whether or not we want to distribute that up, but it would give us additional flexibility in terms of managing those CRS earnings.

[Thomas Capasse:]

Yes, we would argue that more broadly, operating REITs like Sutherland have -- given the CRS [indiscernible] book value at a lower marginal cost of after-tax capital, have a lot more flexibility in terms of how to manage earnings and grow post the implementation of the tax reform.

[Jade Rahmani:]

In terms of the earnings cadence, based on the timing originations, the acquisitions that you mentioned you plan to make next week and in December. Should we expect earnings to be on upward trajectory or there are other headwinds on the expense side or in terms of loan repayment?

[Frederick Herbst:]

Not aware of any headwinds. Obviously, what fluctuates from quarter-to-quarter that we can't control are marks on certain assets. But everything else being equal as the capital is deployed and put to work, and there's a lag, obviously, along -- just put on the books today, we don't see the earnings [indiscernible] tomorrow and going forward. So everything else being equal as we add to the book and deploy the capital, the earnings would be in an upward trajectory. But again, marks on MSRs and other fair value type. We don't have a lot of assets that are fair valued, but those marks fluctuate, they could go up or down. We just don't have a perfect visibility on that.

[Thomas Capasse:]

Yes, I think maybe some of headwinds you might be intimating are what you're seeing. For example, on large balance commercial transitional lending with respect to the number of large REITs that are focused on that sector, you're seeing in this last quarter a very rapid increase of take-out financing into these markets, taking out these -- those transitional loans a lot earlier than expected. And so you're seeing a lot of repayment and margin compression and reinvestment issues. We face the -- a more of a head -- tailwind in the sense that we have more capitals than we have -- I'm sorry, more investment opportunities in our origination platform and the acquisition business than we have capital. So we tend to cherry pick -- grow the business by -- in a sense that there is a low loan origination, we would just pivot to reinvest that capital, as you saw quarter, into the loan acquisitions, where the community banks continue to sell assets at -- even at this stage in the credit cycle.

[Jade Rahmani:]

So you're not seeing originated loans repaid faster and higher-yielding loans payoff? And has that problem of reinvesting capital at lower returns?

[Thomas Capasse:]

Absolutely not. No, the stabilized loans, prepayment rates are coming in terms of the modeled demand -- modeled number of, let's say, constant prepayment rate of, let's say, high singles, they're coming in maybe at high low doubles, at low teens. There's no material impact on our MSRs there. The transitional loan business, there's been a little bit of increased competition, but not to the point where you're seeing some of these very large projects. We're talking hundreds of million dollars, where as our average balance is probably only, let's say, at $1 million, and our stabilized loans and our transitional loans at $10 million. So even there, we're not seeing any sort of increase in prepayments or -- and/or margin compression. In the SBA business, the only time -- I've been doing this since the 1980s, the only time we ever saw a unexpected increase in the SBA prepayments, which tends to run about -- they run from 5% to 9%, was in the -- just before the credit crisis suddenly spiked to 25% because of all these nonbank lenders coming in with -- on a very aggressive basis. So anyways, long way [indiscernible] of saying that our little mitch in the commercial real estate debt market tends to be really driven by banks. And banks, at this point, are maintaining in this asset class a very conservative stance that hence we don't see the issue that you're seeing right now in a large balance space in terms of rapid prepayments due to competition and then reinvestment issues due to the compression and the lending spreads on those large loans.

[Frederick Herbst:]

And if I could add one thing we are a bit excited about, this quarter for the first time are SBA. We acquired a large portfolio couple of years ago. And that portfolio, obviously, runs down as those loans pay off. In the third quarter, for the first time, with new originations in the month of August outpaced the runoff in the portfolio. So we're seeing -- and our goal for this year was to get to the point where the new originations would outpay the runoff in the servicing portfolios. So we see an upswing on that. But it happened for the first time in August, so more of a right track there in terms of the placing, the runoff and the large pool that we acquired several years ago.

[Jade Rahmani:]

And just in terms of the asset class itself, something is fairly new to investors and myself in particular, small balanced. Let's say commercial real estate prices began to soften, like in 5% range, investment tails volumes were already down this year and there's a bid/ask spread. So let's say, at least to decline in commercial real estate next year, but its modest. What would you anticipate the impact of small balance would be? I know in the past you've said it's more correlated to the housing market, which seems pretty on a strong footing right now.

[Thomas Capasse:]

As you saw with the box of beans last quarter, the correlation to large balance commercial real estate the [indiscernible] index as compared to the -- we actually have it on page 20 of our deck in this current slide deck. But you could see that, that the correlation -- trailing 36 month correlation with the large balance index is 0.1, but has increased to 0.5 [indiscernible]. So that's just 1 quantitative way of saying that the -- these small properties are much more driven by the local housing markets than they are large balance. Large balance is concentrated -- I forget the index, but it's over half in cities, whereas ours is in more smaller cities and/or suburban-type location. So we would expect that -- and we believe that we are late in the economic cycle with respect to large balance, but we would expect about a 3-year lag in CRE in small balance market, but the -- with the caveat that housing from the -- housing -- that housing has decoupled from the traditional relationship with the economic cycle due to the impact of the credit crisis in terms of creating a supply/demand imbalance in the housing market, which is going to, we believe, result in reversion to the mean in home price, which is about, let's say, 1%, 2% over inflation. So with that, you're going to see a less -- a lower beta in terms of correlation between commercial -- large balance commercial real estate and small balance in this cycle.

[Operator:]

And we do have a question from Raj Patel with Farallon.

[Rajiv Patel:]

Can you hear me?

[Thomas Capasse:]

Yes. Yes, Raj.

[Frederick Herbst:]

Yes, Raj.

[Rajiv Patel:]

I think when talking about earnings and core earnings and the dilution from the recent financing, when you add it all up, will the recent financings be accretive for Q4? I'm playing with all the numbers and seems like it could be pretty close to it actually fairly quickly? I mean, not spend it all but the part you spend would be accretive, right?

[Frederick Herbst:]

Yes. I mean, it should be a positive and not a drag. Yes, I mean, there'll still be -- we're not going to deploy 100% of it, but we will have deployed more than we have not deployed. So yes, it'll be positive.

[Rajiv Patel:]

Okay. And then when will you need to raise money again? And since you have these -- the 2 loans out in the market, can you do smaller chunks so that we don't see this ebb and flow on dilution and accretion, so you can kind of get these things neutral in the quarter you're issued?

[Frederick Herbst:]

Yes, our goal now is to -- we realize we did have a couple of big chunks. We took advantage of the market in August, which we still believe it was a good trade and good for the long-term prospects for the company. Going forward, one, we're not -- unless there's some largely accretive deal or big transaction, we're not going to raise equity capital below book value. We do have the opportunity, if we had some acquisitions, and there are some in the pipeline, we believe we have the opportunity to give back in to either the secured notes or the converts, but they would be much smaller chunks of what we've done in the previous rounds, [indiscernible] was a big transaction. The kind of the baby bond market, which mainly is $25 million to $50 million issuances is available to us, we believe. We're not going to access any of those markets unless we have an immediate need for the capital. So to answer your question, yes, the chunky raises are -- at least we don't anticipate having any, and -- but we do believe the market is available to us, should we need a smaller piece of capital to fund either an accretive acquisition or just originations.

[Rajiv Patel:]

And then what is your thought on -- now that there the earnings at the -- and it always confuses me, should we focus on ROE? Or the core ROE? But either way, the earnings, $0.37 or $0.38 this quarter, have caught up with the dividend and it looks like all -- as you said, all else being equal the earnings should be rising sequentially. And hopefully, going forward, for a longer period of time than the next 1 or 2 quarters. How are you guys thinking about increasing the dividend and getting that kind of track record out there as a new company?

[Frederick Herbst:]

Yes, what we did this year and my guess is what we'd do next year is, obviously, we'll make recommendations to the board. But this year, we set the dividend at beginning of the year for the year and announced that we thought it was sustainable for the whole year. We're a couple of pennies short for the year. So my guess is, and again we haven't -- we're not there yet, but the fourth quarter, my sense would be the dividend would likely be around the same as it is now because we have to make up for a couple of pennies from the previous quarters. It also depends on where the taxable earnings, which we're, obviously, projecting out. But what we'll do is we'll do the same thing next year. And for the first quarter dividend, we will analyze where we think we will be for the whole year. We'll make a presentation to the board, and make a recommendation on the minimum sustainable -- what we believe is the minimum sustainable dividend for the year, and then if the numbers get better, as the year goes on, we'd be open to raising that dividend.

[Operator:]

That does conclude our conference and answer session. At this time, I'd like to turn the call back to you, Mr. Capasse, for any additional or closing remarks.

[Thomas Capasse:]

Thanks, Jenny. We appreciate everybody's support and look forward to reengaging again in the early next year.

[Operator:]

Thank you. And that does conclude today's conference. We do thank you for your participation. Please have a great day.