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spk08: Greetings and welcome to the Ready Capital fourth quarter 2022-23 earnings call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, take a star and name zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Andrew Auburn. Thank you. You may begin.
spk03: Thank you, operator, and good morning
spk04: 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 filing 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 Zausler, Ready Capital's chief credit officer. I will now turn it over to chief executive officer, Tom Cavassi.
spk13: 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 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 end of performance 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 ROE is exceeding 14%. On the investment side, we've 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 multifamily 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 multifamily, 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 .2% and .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 22 and Broadmark which closed in the third quarter of 23 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, multifamily which is 78% of the loan portfolio. At quarter end, multifamily 60 day plus delinquency was .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% 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 hire for longer rate outlook, we are focused on refinancing our current maturity ladder of which 45% or 2.8 billion in multifamily loans reach 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 SPL 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 Cecil reserves and modifications of 4% of the original 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 have 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 over-collateralization 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 that CRE CLOs will trip test sooner. For example, our FL5, 9, 10 and 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 foreclosure. 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 Cecil Reserve. We expect as of the March remittance date that FL5, 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 .5% in the fourth quarter to our 10% trailing 7-year average. First is reallocation of equity raised in the broad market 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, current leverage of 3.3x and recourse leverage of 0.8x are at historical lows below our target leverage of 4 to 4.5x. We expect to raise incremental debt capital over the upcoming months with a 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 ROE in this segment was laggard at .8% and we expect reinvestment of this capital to increase ROE 25 basis points. Fourth, growth of business lending. The SBA 7A program continues to be the highest ROE segment where, given its capital-light nature, growth in production does not require significant capital resources. With our stated long-term 7A 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 realized synergies on the up-x side, cutting 19 million of broad market 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 CRE 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.
spk04: Thanks, Tom, and good morning. Quarterly gap earnings and distributable earnings per share were 12 cents and 26 cents, respectively. Distributable earnings of 48.5 million equates to a .5% distributable return on average stockholders' equity. 2023 full year gap earnings and distributable earnings per share were $2.25 and $1.18, respectively, equating to an .6% distributable return on average stockholders' equity. On the balance sheet and income statement, residential mortgage banking has been counted for as a discontinued operation with assets and liabilities consolidated into -for-sale line items and net income included in discontinued operation. The main driver of the variance between our quarterly gap and distributable earnings were 3.2 million of the $6.7 million increase to our Cecil Reserve, a $20.7 million markdown of our residential MSRs, 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 Cecil Reserve was due to a $15.8 million increase in specific reserves offset by a release of underperforming loan portfolio. The .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 an 11% allocation into broad mark assets. Margin compression on the back book and increased REO from M&A. We expect levered yields to increase as the back book moves into our securitization vehicles and the broad mark 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 broad mark assets. Realized gains were up quarter over quarter due to increased SBA 7A production and sales with average premiums of .9% and $288 million of production in our Freddie Mac businesses. The 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 leverage in the business declined to 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 months. 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 change is due to a 9 cent per share markdown of the residential MSRs, a 4 cent per share reduction in bargain purchase gain, and 6 cents 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.
spk09: With that, we will open the line for questions. Thank you. We will
spk08: now be conducting a question and answer session. If you would like to ask a question, please press star and then one on a telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star and then two if you would like to remove your question from the queue. For participants using SPEQ equipment, it may be necessary to pick up your handset before pressing star keys. The first question we have is from Kristen Love of Piper Sandler. Please go ahead.
spk02: Thanks. Thanks. Good morning. Can you just talk a little bit about what recent credit trends could mean for potential losses? Still, even if these have increased, but what kind of losses do you believe that could lead to just based on what current debt service coverage ratios are and LTVs in the book and then how you might plan to work out some of the lower performing ones?
spk13: Andrew, do you want to touch on the loss reserves and Adam, you can maybe touch on the credit component?
spk03: Hey, good morning, Kristen. Yeah, on the losses, we look
spk04: at the book in two ways when we determine CISOL. There is a general overlay which accounts for roughly 50 percent of the reserve and then the asset management team is adding on specific reserves for those loans contained in our higher risk categories. We think the current CISOL reserves account for the expected losses on those assets in our higher risk buckets based on the detailed work, the asset management teams, current market LTVs, etc.
spk14: Hey, it's Adam. On the credit front, certainly seeing the linguities as you highlighted, increase quarter over quarter. We do feel that our basis is still healthy in the majority of our portfolio. We feel that if you look at the bridge delinquencies where there was a spike, you're certainly seeing, we think that the realized losses will be more at the equity level versus the debt level. As Andrew highlighted, we think that our reserves are certainly adequately sized. DSDR stress, LTVs are generally below 100 percent on the majority of the portfolio and really don't anticipate material losses. But some loans will certainly require some modifications or restructuring and certainly some time to resolve and have some time available for the market to rebound.
spk02: Great. Thank you. Appreciate the color there, Andrew and Adam. Then just one on the disposition of the REZE mortgage segment. Can you just detail why now and then are you able to provide any color on your confidence of the disposition being completed by June 30th, which was in the presentation? I assume that would likely involve a sale and likely gain just following the loss on discontinued operations this quarter.
spk13: Just one market observation. Andrew, you can comment on the process. But right now the majority of the equity in that business is in the MSRs, of which two-thirds are agency. We believe that right now MSR valuations have peaked. And just from a timing perspective in terms of valuation, that's one driver. But Andrew, do you want to touch on the process? Timing?
spk04: Yeah, so certainly we have a high degree of confidence of the transaction closing before the end of the second quarter. Part of the criteria of moving a segment into held for sale and discontinued operations is having that confidence level. The components of the process will be, as Tom mentioned, obviously a sale of the MSRs, which comprise the majority of the equity as well as the assumption of the assets and the liabilities of the company. And the consideration will most likely take the form of some up-front payment and then an earn-out of sorts. So I think at this point in time, based on where we are in the process, we
spk03: do believe this will close before the end of the second quarter.
spk09: Thank you. Appreciate you taking questions. Next question. The next question we have is from Stephen Laws of Raymond
spk08: James. Please go ahead.
spk06: Hi, good morning. Appreciate all the details in your prepared remarks, Tom. And if I got my notes down correctly, I think you said in the CLOs with defaulted loans, about 57%, so roughly 60% you expect to modify. But I believe you said you need the special service for approval. Can you talk a little bit more about that process and how you work with that special service? What are those mods primarily look like? Is it capital in for more time or are there other moving parts? Each one can be unique, but any general trends across those loans?
spk03: Yeah, Adam, can you come into that? Yeah, sure.
spk14: So in terms of the process on the mod, so borrowers have submitted relief requests for modification of their loans. Those then are under review by the special servicer. In the ordinary course, requests for a modification by the borrower, the special servicer would review, approve, and the special service would secure the delinquency with certainly our approval as the directing certificate holder. In several cases, the modification is a contractual bridge to a short term payoff. So an example being like a sponsor is refinancing the debt or selling the real estate and the modifications can then be executed. In terms of what they look like, certainly the preference is to have the sponsor bring a fresh equity injection to the modification. Given that more time is certainly needed in this market, we feel that about anywhere from 12 to 18 months is the right amount of time to modify these loans given the timing that's needed for the market to rebound. Additionally, there's cash management controls that are put in place on these modifications and in some cases we're requiring third party professional management to come in on behalf of the sponsors and kind of help maintain the asset, utilize capex to really provide the necessary maintenance of the asset.
spk06: Thanks. And Andrew, thinking about interest income, can you talk about the quality of interest income? How much is cash interest received? How much was recruited or maybe some type of PIC income? Can you give us any color on interest income quality?
spk04: Yeah, the majority of the interest income is cash paying. There is a small segment of loans that are accruing based on expected recovery on the loan, but it is a very small portion of the book.
spk06: Great. And then finally, if I may, returning capital shareholders, you closed, I believe, with a comment on the dividend that you think earnings can cover this. How do you think about the glide path of earnings coverage for the dividend as we move through the year and you execute these efforts to expand ROE in any consideration around stock repurchases given current valuation?
spk13: Thank you. Maybe unpack that two ways, Andrew. Maybe just comment on the, there's five measures we delineate it. Obviously, some of them are immediate like up-backs and some are longer term like the relevering of the broad market equity. So maybe comment on that and then the prioritization of cash on repurchase versus capital solutions for the existing portfolio. So,
spk03: yeah,
spk04: as Tom mentioned in his remarks, we believe that the totality of all of the options ahead of us is leads to roughly over a 400 basis point increase in earnings from their current level. That will certainly be incremental over the next four to six quarters. As Tom mentioned, things like up-back savings, which we anticipate will add 40 basis points, will be more immediate. The effects of leverage will be somewhat dependent upon the times at which we choose to access the market and the redeployment of that capital. And then the effects of the portfolio turnover will sort of be felt every quarter. I think Adam can elaborate on the plan for and the timing of liquidations, but that'll certainly bleed into earnings. So I think you will see sort of a glide path over the next four to six quarters. In terms of capital allocation, including the share repurchase program, we have today 80 million in capacity on our current program for share repurchases. I do believe we will be active in the repurchase program while also balancing the need to add net interest margin into the income statement in a market where yields are very attractive and putting long-term earnings into the income statement is important. So I think we will balance both of those. Given where the stock is trading, certainly the return for volume share repurchase is quite powerful. So I do anticipate we'll be
spk03: active in the coming months, at least at these levels. And then share repurchase strategy?
spk09: Yeah, no, that's sort of time that's what I just commented on. The next question we have is from Douglas Harder of UB Ace. Please go ahead.
spk03: Thanks.
spk12: I'm wondering if you could talk about the expected pace of putting new capital to work, how you see the opportunities set developing both in order to redeploy capital, but also to increase leverage?
spk13: Yeah, I'll just make a comment on the current investment opportunity pipeline and ROEs. Andrew, maybe comment again on the liquidation of the broad mark as well as the forward liquidity. But the current market in terms of we kind of look at it in three areas, sort of silos. One is our core bridge lending where for lower middle markets you're getting retained yields on really strong vintage underwriting in the area of 13.5 to 15.5%. That's up maybe call it 300, 400 basis points before the rate rise. That's silo one. Silo two, which is cyclical, is the capital solutions where we provide capital to opportunistic equity entering mostly the multifamily space and we'll provide senior, Mez, et cetera, in the context of restructuring. That's probably more in the call it the 15.5 to 18.5. And that's the other area. The third area is the acquisitions. And there we're seeing, we're starting to see, and this is from the external manager, a growing pipeline of sales by banks, which are I guess not unexpected. Those are more in the upper teens, low 20s with retained yields. So in short, you're seeing blended returns available to us well into the mid to upper teens, which is about a 400 or 500 basis point increase versus where we were prior to the turn in the rates. That's the opportunity set. So Andrew, maybe just comment again on that forward liquidity and deployment.
spk03: And certainly outside of
spk04: the portfolio runoff, specifically in Broadmark, there are a handful of larger liquidity items we expect to come through the balance sheet in the upcoming weeks and months here. Obviously the sale of the residential mortgage banking platform is expected to bring in on a net basis approximately $100 million. We are in the process of financing some of our retained positions from our CLOs. That's expected to bring in $130 million. And then I do believe we have line of sight into some corporate issuances. So outside of portfolio runoff, we expect there in the upcoming weeks and months to be roughly $300 million of additional liquidity coming in. Adam, you may just provide some commentary on the timing of the Broadmark liquidations and expected proceeds just to get a complete picture.
spk14: Yeah. So we expect to have about 50% of the Broadmark assets paid off within our basis by the end of the year 2024. I think this is a conservative estimate. This excludes current loans where several we expect will pay off during this period. And then secondly, there's more opportunity to liquidate other assets in the portfolio that aren't currently flagged for a payoff. Just kind of the velocity of these payoffs, I'll just kind of give the historical perspective since the merger closed. So about 50 loans paid off for about $250 million. It's about 23% of the portfolio. We have pending payoffs of about 30 assets. And those are the ones that I mentioned would pay off by the end of the year. That's about another call it about $250 million. So that's another 28% of the portfolio. So all in all, we should be out of about $500 million by year end. The liquidity from a UPB perspective would be about $250 million of UPB. Obviously, some of that is levered today. And then certainly a slew of other payoffs that we're expecting in the Broadmark portfolio that we're currently working through via loan sales, sponsors that are giving indications that they're working on refinances and sale of assets.
spk03: So just in sum, I think what differentiates us
spk13: versus the peer group to some extent is apart from the concentration in lower middle market multifamily, which has less credit volatility, we do have because of the delivering from Broadmark, we have this path to step function and growing liquidity towards the back end of this year, which will result in deployment at spreads which we don't believe this is a 2020 pandemic flash in the pan with a snapback. So we see the name accretion being very significant over the especially the back half of this year into 25.
spk09: Great. Thank you. So the next question we
spk08: have from Jake Romani of KBW. Please go ahead.
spk10: Thank you very much. Just on the credit side with Broadmark and Mosaic, you said 28% purchase discount. Do you believe that that's sufficient to absorb losses and therefore from those two portfolios, they would have no further deterioration on book value?
spk03: Henry, want to comment?
spk04: Yes, maybe we will break it down into two components. On the Mosaic side, I feel was structured with a contingent equity right. We that was at those approximately $90 million. We do not expect to exceed that contingent equity right. On the Broadmark side, as we mentioned in the remarks, the discount applied to the NPLs, we still continue to believe is enough to cover expected principal losses. I think what you will see over the next two quarters is movement, you know, I would call them immaterial movements around the bargain purchase gain in both directions as sort of values get finalized. But yes, we do believe the purchase discounts in both those mergers will prevent future principal losses.
spk10: And then on the multifamily side in the bridge portfolio, you mentioned 70% of the delinquencies due to one borrower. Do you believe that we are at peak delinquencies or do you expect it to be lumpy and there will be further deterioration? I mean, I personally do not see why we would now be at peak delinquencies considering the staggering of maturities and the 2021-2022 vintage originations. I think that there probably will still be some deterioration. Do you agree with that?
spk13: I think we do agree with that from a broad market perspective, in particular, large balance or upper middle mark, I am sorry, upper the larger sponsors in the Sunbelt markets, for example, where there is significant negative absorption that has to be a period of negative absorption as new supply hits over the next year, year and a half. But our portfolio is very differentiated. And we look at this in terms of roll rates and negative migration. So Adam, maybe could you comment on how you are looking at the Arbridge portfolio versus, you know, in terms of its lower middle market focus and what you are seeing with those sponsors?
spk03: Yeah,
spk14: you know, specific to our multifamily bridge portfolio, you mentioned that the largest asset had defaulted. So in sum, I mean, our two largest sponsors have actually already defaulted. And we are working through asset solutions, modifications, -to-bridge solutions that we hold today. The majority of our small and middle market sponsors, we feel, have greater liquidity and funding to temporarily cover the interest shortfalls. We think that Q1 may see a spike as we execute some of the modifications and -to-bridge strategy on our existing delinquency. But we expect, you know, really negative migration to peak weight and, you know, call it Q1 or Q2, which is really due to the granularity of our remaining portfolio.
spk10: And geographically, how would you describe the concentration? Is it largely unbalanced?
spk13: Well, just to add to this, Adam, you can comment on it, but if you recall, Jade, one of the kind of one of our credit bibles is our GeoTier model, which uses regression analysis from GFC on lower middle market, mostly multifamily. So we basically, in that model, we look at forward negative absorption as one of the big drivers. As a result of that, markets like Austin, San Francisco, et cetera, and in particular, some of the heat map of the Sunbelt where there's a lot of supply coming, we've avoided that. But, you know, given that overlay, Adam, what have you seen in terms of our concentrations in those markets?
spk00: Yeah,
spk14: you know, markets such as the positive net migration and strong demos. And, you know, as you know, our focus is really on workforce housing, and we still expect that there's tremendous demand for these units, specifically for good quality, affordable housing. And, you know, given the, really given the positive net migration, we feel that where our assets are located will remain strong markets. You know, our top MSAs in our bridge portfolio, Dallas, Texas being the largest, which represents about 25% of the overall portfolio, Atlanta comes in second at about 15%, and then the Phoenix markets about 13%. You know, Charlotte, Houston, Chicago, kind of round out the remaining of where our big exposures are.
spk10: Thank you. On the office, can you talk to the character of the collateral? Because there's huge differentiation in the market between skyscrapers and CBD versus suburban office parks versus owner occupied, you know, where, say, a law firm owns the building and sublease two floors. So how would you characterize the office? Because I'm surprised that there's, you know, delinquencies in, you know, small loans, you know, sub 15 million type loans.
spk14: Yeah, so, you know, offices, as Tom highlighted in his opening remarks, right, so it's about 5% of the total portfolio. You know, our average balance on our office portfolio is about $3 million. You know, it's about 160 individual assets. You know, the small balance nature of these office assets, you know, a lot of it is, you know, focused on, you know, stable, like medical office type properties, and really just smaller assets, which, you know, again, it's a lot easier to lease up, you know, a lot of this is on short term leases, but, you know, given the amount of space that needs to be leased up in these small projects, you know, the ability of our sponsors to do that isn't as challenging as you highlight when you have these larger office buildings and CBDs. And that's really where the majority of our office delinquencies are located, which is in the US, and also Los Angeles. So, I think, again, you know, just given that granularity, we feel that, you know, we're certainly insulated from, you know, a lot of the headlines around the office sector. And it's also, you know, it's also from a liquidation asset management perspective, also more efficient to work through and liquidate these smaller assets.
spk13: Yeah, just at a high level, it's 70% of our 5% office is, you know, is the large balance, and they account for 70% of delinquencies. So, it's a handful of small CBD properties in a handful of cities that we have to originate, but for which we have, we believe, very strong Cecil reserves. So, I think, if you will, the tail risk in our book versus the sector is very, very limited to CBD office.
spk09: Thank you for taking the questions.
spk08: Next question we have is from Steve Delaney of Citizens JMP. Please go ahead.
spk05: Good morning, everyone, and thanks for taking the question. Andrew, if I could start with you, you mentioned leverage, some opportunities looking forward. Should we assume that would be a new CLO and under your existing shelf? And could we see that as soon as two Q or three Q of this year? Thanks.
spk04: Yeah, it's certainly continuing to use ourselves as a core financing strategy will be important. I do expect us to issue in the CLO market this year, most likely a Q3 event. I think when you look at increasing leverage across the business, it's certainly that is one component, but adding on additional corporate debt for reinvestment will be a key part of that as well.
spk05: And usually try to target about a $300 million offering under your program?
spk04: Typically, our CLOs are between 750 and a billion. So, they're a little larger in size. Some of our other shelves are smaller, such as our SPA shelf, our acquisition shelf, et cetera. But our CLO offerings tend to be larger in size. Thank you for that.
spk13: Just to add to that, since the inception of the market, we're the fourth largest overall issuer. We've issued $7 billion, $5 billion is outstanding, so we do larger new issue sizes. And just one point on that. Our spreads on the AAAs historically are on top of even the best names in the sector. And a big part of that is our structures are the most investor-friendly in terms of over-clotterization triggers, which are one versus the industry at three, and the deals being static. So, that does present versus the peer group a skewness in our delinquency metrics and the time it takes for us to buy loans out of the trust, or what have you. So, I just wanted to highlight that. And that does give us access to the market, even in times when there's liquidity constraints in the primary ABS market.
spk05: That's good color. Thank you. And either one of you, I guess, or maybe Adam, 12, I made a note, 12 loans that were 60 days delinquent, and then you laid out how many payoffs, mods, or foreclosure. Of those 12 loans, I didn't get the total UPB and how much specific reserve may be against those 12 loans. Thank you.
spk14: Yeah, so those 12 loans is roughly 500 million. There's no specific reserve against them beyond Cecil. And I think the highlights are, I think you have 15% of that we expect to pay off in the next two quarters. 60% is under pending modification where we're strategically working with the sponsors. And then about 30 of them will likely go through a foreclosure process.
spk05: Yeah, and that 30 would then get fair value at the time it goes to REO, correct?
spk14: That's right.
spk05: Yep. Okay, great. And just one final thing, Tom, I guess I'll throw this out to you. I know you're busy running your own company, but you probably have heard about these short sellers out there on CLO issuers. They've obviously hit Arbor. They've hit Blackstone as well. You never mentioned in terms of what you look at and how you look at the performance of the loans, I didn't hear you mention trustee 10-day late payment data as being an early warning signal. You know which borrowers are making payments and which are not, but just your thoughts about, I know it's a market question and not an RC specific, but you're not mentioning that data. You mentioned your 30-day and 60-day DQs. I'm just curious what your thoughts are about any value in that trustee data.
spk13: You're referencing the special service reports on the
spk05: yes, the payment data that you, you know, USB and others put out, the CLO special service is correct.
spk13: Oh, the CRESC reporting. Yeah, Andrew, you want to comment on that? I think, you know, because we just view the, and I know that's a differentiator from our perspective is we do have, we do work with an external special servicer, but our, Adam and his team are managing all of the actual disposition asset management strategies and we do have an early warning indicators that is embedded in our fortified model, I'm sorry, our risk rate system. So Adam, maybe just comment on that in the context of the broader market linkage between looking at CREC LO reporting, CRESC reporting versus how we manage it in terms of just looking at it as on balance sheet.
spk05: Thanks, Tom.
spk14: Yeah, I mean, you know, given we're DCH on our deals, you know, we have a... Sorry, I'm
spk13: sorry, Adam, DCH to find that?
spk14: Yeah, the direct and secure certificate holder, which is, you know, we're the first loss holder on our CLOs. So given our position, right, so we have our asset management team that works closely with the special servicers. You know, there's a portfolio management team, first off, that, you know, is really acts as a liaison between the sponsor and the special servicers in terms of, you know, the draw process, updates on asset level updates, and, you know, so we're in constant connection with the sponsors and the special servicers to work through solutions. You know, the special servicer is certainly, you know, working closely with the sponsors and then they're making recommendations to us. And I think, you know, our robust team with the overlay of the special servicer, I think, provides us a unique strategic advantage in the market. Does that answer your question?
spk09: That's helpful. Thank you, Adam and Tom. The next question we have is from Christopher
spk08: Nodal of Leidenberg, Thumbnail. Please go ahead.
spk07: Hey, guys. Rent stable, excuse me, multifamily. Do you have any rent stabilization apartment exposure in New York City?
spk14: We have about, I think we have about 175 million of multifamily exposure in New York City. The vast majority of it is unregulated. So the answer is no, there's very little.
spk07: Okay, great. And Tom, in past calls you indicated broad mark is expected to be EPS accretive by fourth quarter of 2024. Is that still hold?
spk03: Andrew, in the context of the, what the bridge we laid out, maybe comment on that? Yeah, we do expect by the fourth
spk04: quarter, the transaction certainly to be accretive to and as we move into 2025, we expect the full impact of the various items that Tom laid out, including broad mark to sort of reach their totality. So I think the ultimate earnings accretion based on where we are running in the few quarters leading up to broad mark probably happens in the late stages of and mid stages of 2025.
spk07: Okay, so it's fair to say that the excuse me, the accretion to the strip of RWE that you guys are outlining earlier is going to be backloaded in the second half of 2024. And we're really not going to see the full effect of it in 2025, correct?
spk03: I think that's a fair statement.
spk07: And so for 2024, we should see probably a distributed RWE somewhere below your 10% target. Is that fair?
spk04: Yeah, I think that's fair. We expect that the cumulative earnings of the company over the full year to cover the dividend. So, you know, you will, what we are expecting is a ramp up from where we're at today to something towards the back half of the year that is covering the current 30 cents. And then the growth in earnings from that level into our historical return target to happen in as we move into 2025.
spk09: Okay, that's it for me. Thank you very much. The next question we have
spk08: is from Sarah of BTIG. Please go ahead.
spk01: Hey, everyone. Thanks for taking the question. So you just gave some dividend coverage commentary. Thanks for that. Just quickly, a follow up on the topic of CLO performance. Sounds like we should see stronger IC and OC coverage come March. But could we expect to see some further downside to DE on the residual income side of the interest income equation from Q4 levels? Can you give any guidance on the potential Q1 earnings impact there before those loans are resolved?
spk03: Yeah, so certainly there's
spk04: a couple impacts of tripping these tests. The first one, as you mentioned, is cash flow gets diverted away from our residuals to sort of de-level the seniors. The way it'll work in the financials is you'll see to the extent loans hit non-accrual status, you'll see interest compression there, and you'll see some of the effects of the de-levering of these securities. So it won't, because of how we consolidate, it's not going to show up in the bonds themselves. The total cash flow sort of diverted over this period where the tests have been tripped has been roughly $8.5 million. I think the other financial impact is during this period where the tests are tripped, the funding accounts that sit inside these deals are diverted away from repurchasing loans we have funded on balance sheet and diverted through the waterfalls of the structure. And so you have a component of loans, roughly $80 million today, that are sitting on balance sheet unlevered, so you'll have some yield compression there. Those loans eventually will get repurchased into the deals at these right sides, but for that period of time you do have what I'll call marginal yield compression. So those will be the sort of the main effects.
spk01: Okay, thanks for the color there. And then I think you mentioned that 27% of the delinquencies are likely to foreclose. Will those remain in the CLOs as real estate owned?
spk03: Adam, you want to come up? Yeah, I think those, you know, we're,
spk14: historically as loans, you know, have become REO that we have had in securitizations, we have purchased them out. So that's certainly something we will consider as we work through these. But to date there's been very limited REOs that we have within our CLOs. So today it's not material, but as we kind of work through these assets, you know, something that we'll certainly evaluate.
spk01: Okay, and then just really quickly, sorry if I missed this at the beginning, but can you remind me if you gave us a target for your volumes in the Freddie Mac and SBA verticals this
spk13: year? Yeah, Adam, you want to come up? Well, on the SBA front we've been running at about five, a little under $500 million over the last three years. And we, back around second quarter of last year, we, our Fintech implemented a small loan and microloan strategy. Just to recap, SBA has five, three tiers, 350 to 5 million is large loan, mostly real estate secured. And below that there's small and micro, which are two different tiers, I think below 50,000 is micro. And those are loans that the SBA allows a credit score methodology, which obviously is a very adaptive to what we've been developing with our Fintech in Florida, which was one of the leading providers in the PPP program. So we've retrofitted that tech to a strategy whereby we're using that to small loans. I think we were running, Andrew, what, about $33 million in the last, you know, called $30, $40 million run rate looking at over the next couple of months and ramping. So, and then that's part of the initiative of the Biden administration to promote loans to minority women-owned businesses, of which that tier, that lower tier is a big chunk of that. So with that, the combination of the large loan, continued growth there, we've been poaching a lot of, you know, we've been seeing opportunities to take on loan officers that are exiting, from banks that are exiting the SBA business. And the Fintech, that leads us to a target of 500 to 750 for this year and a billion over the next couple of years, which is very creative, given the premiums that you have on these loans and which, you know, are usually north of 10 points in the secondary market and the fact that it utilizes very limited capital. So I think, again, that's something that is a differentiation in the peer group that's a little bit underappreciated. So that's the SBA. And, Adam, you want to just comment on how you're positioning the business from the standpoint of the, you know, the core bridge and the other related construction and other products? Yeah, I think,
spk14: just to answer the question, I think the question was around the cap, you know, our capital, I, Freddie, Freddie businesses on the multifamily side, I think, you know, the volumes they're expecting about, you know, we're targeting a billion dollars for 2024. And those capital light multifamily programs are split between our small balance loan program, where we have the license through Freddie Mac, and then separately our affordable multifamily business, which is the tax exempt business, which makes up the, you know, the billion dollar target for 2024.
spk01: Great. Thanks for all the detail there.
spk09: Appreciate it. Thanks, Sarah. The next question we have is from Matt
spk08: Harlett of the Aradi Securities. Please go ahead.
spk11: Oh, hey, thanks for checking my question. Hey, Tom, you mentioned, I think you said high gains to low 20% yields on the, potentially on the acquired channel with some of the banks. Are those unlevered? That's the first question too. Can you just walk me through some of the economics of those? I mean, where you're buying it, what type of discounts, what type of paper it is?
spk13: Yeah, these are lower middle market, usually stabilized loans that
spk00: are
spk13: usually end up criticized. They're not in default. They're what we call scratch and dent. But from a bank regulatory standpoint, they get criticized usually due to the response because of DSCR be approaching that kind of below one threshold. And that's great, you know, from our perspective, because we like, we utilize in our asset management strategies for acquired portfolios. You know, we were one of the larger buyers of these smaller balanced loans after the GFC. We bought nearly 5 billion and we worked out 5,000 loans. So we have a track record. And so in short, answer your question, the scratch and dent portfolios trade probably at low 90s to low 80s to unlevered yields. Adam, we're looking what high single, low double. They many times come with staple financing or we can, you know, we have more with, interesting is we have more offers for credit on a secured lending basis, term lending with limited market from the banks given the Basel III changes which favor loan on loan, real estate being a lot better than making direct loans. So anyways, with that, either the staple financing from the seller and or the third party financing from banks, that gets us to levered IRRs on that high single, low double to that kind of upper teens area loss adjusted.
spk14: Yeah, and we've also done, you know, since inception, we've done 11 standalone securitization of this strategy. So that's just another layer in terms of, you know, getting higher returns on that portfolio.
spk13: Yeah, that's important point. Good point. We do have access. It's our RCMT shelf. Is that right, Adam? It's SCMT. SCMT. Sorry, SCMT shelf. So that's where we have historically utilized purchase of these portfolios in the secondary market, which is a bit, again, a differentiator from us in the peer group to buy these pools from banks or out of securitization trusts to then finance them in the ABS market. But again, right now, what's very unique versus the last credit cycle, GFC, is the availability of bank financing on a longer term secured basis with limited market to market.
spk11: Gotcha. On the bigger packages you see from the New York Community Bank Corp, would you get together a waterfall and bid on those or is that something that Reddy looks at?
spk13: Oh, you know, the external manager has a significant trading desk and sources these deals. And so we definitely look as part of our acquisition silo and the services provided by the external manager to bid jointly and allocate equity accordingly. Yeah, we've done that in a number of transactions over the last decade.
spk11: Great. Thanks. Just final question. I'll get on the buyback. I think you feel like the $14 book is pretty good with what I'm hearing you say. I mean, what would be, is there a sense of urgency given what would be an improvement in the ROE and probably the dividend over time, you feel like to act sooner with the buyback than later, where does that stack up and list the priorities? Thanks a lot.
spk03: Andrew?
spk04: Yeah, certainly, certainly where the shares are trading. I think it will be a priority for us coming out of earnings. Again, you know, there is the need to balance using the liquidity on the balance sheet today for that purpose versus taking advantage of, you know, new investment that will provide sort of longer term earnings power for the company. I will say, you know, given some of the liquidity events we laid out earlier in the call, I think, you know, those items will provide a lot more flexibility to be more aggressive in the share repurchase program should, you know, shares
spk09: hang
spk04: around these
spk09: levels. Great. Thank you. The last question we have
spk08: is a follow up from Derek Romani of APWD. Please go ahead.
spk10: Thank
spk08: you very much.
spk10: Yeah, I find all the questions about shared buybacks pretty interesting at this point in the cycle where there is clearly very high delinquencies in the portfolio and a lot of credit uncertainty in the outlook. It seems to me, you know, a better use of capital would be defensive. So I just wanted to ask about the corporate debt issuance. What kind of issuance is being contemplated? Do you have a range of size you're thinking about and what the cost might be?
spk03: Yeah, so I think there are a variety of options.
spk04: I think you may see, you know, a combination of private placements, potentially some of the retail channels that have been open across a couple of deals since the Q4 be an option for us. In terms of sizing, I would expect them to be, you know, more measured anywhere from 75 to $150 million. I think the cost for those issuances today is somewhere in the range of, you know, 9 to 10% all in yield.
spk10: Wow. And so what's the use of proceeds? You're going to lever that capital rather than pay off capital elsewhere. Is any of this used to cure deficiencies or to pay off secured debt, secured leverage elsewhere?
spk04: Yeah, certainly, you know, the combination of all the liquidity will be used for a variety of the things you just mentioned. Some of it will be to manage some of the problem areas in the portfolio, whether that be refi, repurchasing from CLOs, etc. A large majority of that will be used for reinvestment in, you know, our origination channels and acquisition channels. And then some of that liquidity will be used in the share repurchase program. We certainly agree with you that having ample amount of liquidity on the balance sheet to manage uncertainty across this cycle continues to be the priority. And certainly balancing those other areas of capital uses, including the repurchase and new investments, will be done so with that top priority in mind. So, you know, we do agree with you that carrying increased liquidity amounts, lower leverage throughout the cycle is important and will continue to be the way we manage the business.
spk13: Yeah, just to, from a more macro perspective to add on what Ann was saying, we're looking at the wall of liquidity we have coming in on the back end of, you know, kind of phased in through this calendar year, where you're clearly prioritizing defensive use in asset management strategies like strategic refis, because we strongly believe that our lower middle market sponsors, the big guys across the vintage have already experienced stress and work out. But we have a lot of lower middle market sponsors with more workforce housing that are covering some of the stress in DSCR. And there's a bridge to agency takeout, just like some of our some of the other reads that are focused in the multifamily small balance base. And we believe, strongly believe that if you look at the forward curve and rent growth over the next 24 months, that that will provide a better use of capital than, let's say, immediate repurchases of shares over the next,
spk09: you know, 18 months. Thank you. And with that, I would like
spk08: to turn the floor back over to Tom Capate for closing remarks.
spk13: Yeah, we appreciate everybody's time
spk09: today and look forward to the next quarter's joining call. Ladies and gentlemen, that concludes today's conference. Thank you for joining us. You may now disconnect your lines.
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