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2/28/2024
Greetings and welcome to the Ready Capital fourth quarter 2023 earnings call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, do express 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.
Thank you, operator, and good morning to those of you on the call. Some of our comments today will be forward-looking statements within the meaning of the federal securities law. 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 conditions. 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 investor's 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 Capaci.
Thanks, Andrew. Good morning, and thank you for joining the call today. Despite broader headwinds, Ready Capital enters 2024 with a resilient business model and a proven ability to navigate challenging periods. As we look to 2024 and beyond, the key drivers that we will focus on to return to a more historic level of earnings are less about current market conditions and the resulting credit pressures, but rather about our strategic capital redeployment from recent long-term value accretive M&A. While our prior acquisitions have led to short-term earnings impacts over recent quarters, and we are cognizant it will take time to work through the persisting pressures, we believe executing our plan will generate meaningful long-term accretion. To begin, a quick recap of 2023. Full-year distributable return on average stockholders' equity was 8.6%. The shortfall versus our 10% target was primarily due to a 250 basis point drag in ROE from M&A, and a 25 basis point drag from the underperformance of our residential mortgage banking business. Our expectation is that the sale of underperforming assets, re-levering equity from M&A, and exiting our residential business will begin to provide material net interest margin accretion through reinvestment at the current levered ROEs 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 7.2% and 22.3% respectively. My comments will focus on our originated portfolio, which represents 73% of total loans. The acquired portfolio concentrated in Mosaic, which closed in the first quarter of 22, and Broadmark, which closed in the third quarter of 23, featured combined purchase discounts for non-performing assets of 28%. We've 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 6.6% as certain properties experienced NOI reductions driven by flat rent growth and increases in operating and interest costs. 71% of the new delinquencies in the quarter were attributable to one large sponsor across four loans. As of February 25th, 60-day plus delinquencies have been reduced to 5.5% through payoffs or modifications, which in most cases require an equity infusion from the loan sponsor. Second is office, which is only 5% of the CRE portfolio, but accounts for 21% of total delinquencies. Eight loans are delinquent with an average balance of $15 million, and notably only two have a balance greater than $20 million. The largest loan is $44 million. Our office portfolio is granular across 165 assets with an average balance of $3 million, but 70% of the delinquencies are collateralized by larger CBD properties located in Chicago, Denver, and New York. Looking forward in the current Hire for Longer rate outlook, we are focused on refinancing our current maturity ladder of which 45% or $2.8 billion in multifamily loans reached initial maturity in 2024 and 31% and $1.9 billion in the first half of 2025. Historically, our core bridge strategy is to underwrite to take out our Freddie SBL license and 25 strategic partnerships which provide access to all GSE multifamily channels. For example, in 2023, 64% of our bridge loans paid off at maturity, primarily via agency takeout, and 12% met the criteria for contractual extension. For the 11% of the multifamily portfolio currently rated 4 or 5, our asset management teams are executing modifications and extensions where supported by the business plans, and we are prioritizing on-balance sheet liquidity for related capital solutions. Notably, with a mark-to-market LTV of less than 100% on this population, we do not expect any material erosion to book value from additional CECL reserves and modifications of 4% of the total originated portfolio remain comparatively low. Now, a few observations on our CRE CLOs. Like most in our peer group, we have historically used CLO financing as one of our secured financing options. Over the last eight years, we've issued $7 billion with $5 billion outstanding, ranking number four with top quartile AAA spreads, largely a result of one of the most conservative and investor-friendly CLO structures. Specifically, our overcollateralization test is set at 1% versus the 3% average for the peer group, and our deals are static. Unlike managed deals, we are limited in our ability to swap collateral, prevented from repurchasing collateral until after 60-day delinquency is reached, and reliant upon the special servicer to manage decisions on asset resolution. This has three impacts versus the peer group. First is 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 past asset resolution via repurchase or modification is longer due to both the 60-day trigger and need to obtain special service or 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 to provide a bridge for properties to stabilize and reach agency take-up. Expected principal losses on these loans have been accounted for in our current CECL reserve. We expect, as of the March remittance date, that 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 7.5% in the fourth quarter to our 10% trailing seven-year average. First is reallocation of equity raised in the broad mark merger into our core strategies. Since the third quarter 2023 merger close, 23% of the portfolio has liquidated, of which the remaining $788 million at quarter end is yielding approximately 2.1%, producing a current drag on ROE of 170 basis points. Currently, we have actionable liquidations for 36% of the remaining portfolio with a budget to monetize the balance over the next four quarters. The anticipated contribution margin to ROE from full reinvestment of this equity into our current investment pipeline is 250 basis points. Second, leverage. Current leverage of 3.3x and recourse leverage of 0.8x are at historical lows below our target leverage of 4 to 4.5x. We expect to raise incremental debt capital over the upcoming months with the resulting increase in leverage contributing 125 basis points to ROE. Third, the exit of residential mortgage banking, which based on current planning, is targeted for full liquidation by the end of the second quarter. Due to current mortgage rates, distributable ROE in this segment was laggard at 1.8%, and we expect reinvestment of this capital to increase ROE 25 basis points. Fourth, growth of small business lending. The SBA 7 program continues to be the highest ROE segment where, given its capital-like nature, growth in production does not require significant capital resources. With our stated long-term 7A origination target of doubling our current production to one 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 OPEC 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.
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 7.5% 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 8.6% distributable return on average stockholders' equity. On the balance sheet and income statement, residential mortgage banking has been accounted for as a discontinued operation with assets and liabilities consolidated into held for sale line items and net income included in discontinued operations. 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 CECL 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 CECL reserve was due to a $15.8 million increase in specific reserves offset by a release of reserves on our performing loan portfolio. The 7.5% distributable return on equity continues to be pressured by the effects of a decline in the retained yield of the portfolio, as well as lower leverage. In the fourth quarter, the lever portfolio yield was 11.5%. down 9% from the same period last year. The change is due to a 11% allocation into Broadmark assets, margin compression on the 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 Broadmark assets are repositioned into market yields. Net interest income declined $6.4 million quarter over quarter. The change was primarily due to a $5.5 million one-time charge upon the refinance Mosaic Lending Facility. The migration of $258 million of loans to non-accrual and $2.6 million of interest expense related to the financing of non-performing Broadmark assets. Realized gains were up quarter over quarter due to increased SBA 7A production and sales with average premiums of 8.9% and $288 million of production in our Freddie Mac businesses. Servicing income increased $1 million quarter over quarter due to the recovery of previously booked impairment of our SBA and Freddie Mac servicing assets. Other income increased $14.2 million due to the recognition of ERC income. To date, we have processed 62.9 million of ERC contracts, recognizing net income of 42.8 million. We expect this program to continue into 2024, albeit at a slower pace. The improvement in operating expenses was due to a reduction in staffing and related compensation expense. slightly lower servicing expenses as a result of lower advance reimbursement and lower transaction volume. On the balance sheet, liquidity remains healthy with $139 million in total cash and over $1.5 billion in unencumbered assets. Recourse leverage in the business declined to .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 raised will be deployed into our origination and 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.
With that, we will open the line for questions.
Thank you.
We will 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 turn 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 speaker equipment, it may be necessary to pick up your handset before pressing star keys. The first question we have is from Crispin Love of Piper Sandler. Please go ahead.
Thanks. Thanks. Good morning. Can you just talk a little bit about what recent credit trends could mean for potential losses? Delegancies 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 loans?
Andrew, you want to touch on the loss reserves and Adam, maybe touch on the credit component?
Hey, good morning, Christopher. Yeah, on the loss reserve, you know, we look at the book in two ways when we determine CECL. There is a general overlay which accounts for, you know, roughly 50% of the reserve. And then the asset management team is adding on specific reserves for, you know, those loans contained in our higher risk categories. So we think the current CECL reserves account for the expected losses on those reserves. those assets in our higher risk buckets based on the detailed work, the asset management teams, current market LTVs, et cetera.
And then, hey, it's Adam. On the credit front, certainly seeing delinquencies, as you highlighted, increase quarter over quarter. We do feel that our basis is still healthy in the majority of our portfolio. You know, we feel that, you know, if you look at, you know, the bridge delinquencies where there was a spike, you're certainly seeing, you know, we think that the realized losses will be more at the equity level versus the debt level. So, you know, as Andrew highlighted, you know, we think that our reserves are certainly adequately sized. You know, DSDR stress, LTVs are generally, you know, below 100% on the majority of the portfolio and really don't anticipate material losses Um, you know, but some loans will certainly require, you know, some modifications or restructuring, um, and certainly some, some time to resolve and, you know, kind of, you know, have, have some time available for the, uh, you know, the market to, to rebound.
Great. Thank you. I appreciate the color, Larry, Andrew and Adam, and then just one on the disposition of the resi mortgage segment. Can you, can you 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. And I assume that would likely involve a sale and likely gain just following the loss on discontinued operations this quarter.
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 – a timing perspective in terms of valuation, that's one driver. But Andrew, do you want to touch on the process, timing?
Yeah, so certainly we have a high degree of confidence of the transaction closing before the end of the second quarter. You know, part of the criteria of moving a segment into held for sale and discontinued operations is having that confidence level. That's 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 upfront payment and then an earn out of sorts. I think at this point in time, based on where we are in the process, we do believe this will close before the end of the second quarter.
Thank you. I appreciate you taking the questions. Next question.
The next question we have is from Steven Laws of Raymond James. Please go ahead.
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? I know each one can be unique, but any general trends across those loans?
Yeah, Adam, can you comment on that? Yeah, sure.
So, you know, in terms of the process on the mod, so, you know, borrowers, you know, have submitted relief requests for modification of their loans. Those then are under review by the special servicer. In the ordinary course, you know, requests for a modification by the borrower, the special servicer would review you know, prove and cure the delinquency, with certainly our approval as the directing certificate holder. You know, in several cases, the modification is a contractual bridge to a short-term payoff. So an example being like a sponsor's refinancing the debt or selling the real estate, and the modifications, you know, can then be executed. You know, in terms of what they look like, certainly the preference is to have the sponsor bring, you know, 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.
And Andrew, thinking about interest income, can you talk about the quality of interest income? How much is cash interest received? How much was accrued or maybe some type of PIC income? Can you give us any color on interest income quality?
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.
Great. And then finally, if I may, you know, returning capital shareholders, you know, you closed, I believe, with a comment on the dividend that you think earnings can cover this. You know, how do you think about the glide path of earnings coverage for the dividend as we move through the year and you execute these challenges efforts to expand ROE in any consideration around stock repurchases, given the current valuation.
Thank you. Maybe unpack that two ways, Andrew. Maybe just comment on the, you know, there's five measures. We delineate it. Obviously, some of them are immediate, like UPX, and some are longer term, like the relevering of the broad market equities. Maybe comment on that and then the prioritization of cash on repurchase versus capital solutions for the existing portfolio.
Yeah, as Tom mentioned in his remarks, we believe that the totality of all of the options ahead of us leads to roughly over a 400 basis point increase in earnings from their current level. That'll certainly be incremental over the next four to six quarters. As Tom mentioned, things like OpEx 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 Walmart liquidations, but that'll certainly bleed into earnings. So I think you will see... you know, sort of a glide path over the next four to six quarters. In terms of, you know, 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, you know, be active in the repurchase program while also balancing the need to add, you know, net interest margin into the income statement in a market where yields are, you know, 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, you know, the return-provided share repurchase is quite powerful.
So I do anticipate we'll be active in the upcoming months, at least at these levels. And then share repurchase strategy.
Yeah, no, that's sort of time. That's why I just commented on just the, you know. The next question we have is from Douglas Harder of UBS. Please go ahead.
Thanks.
I'm wondering if you could talk about the expected pace of putting new capital to work, how you see the opportunity set developing both in order to redeploy capital, but also to increase leverage.
Yeah, I'll just make a comment on the current investment opportunity pipeline and ROEs. And Andrew, maybe comment again on the liquidation of the Broadmark, as well as the forward liquidity. But the current The current market in terms of, we kind of look at it in three areas or 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 since 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, mezz, et cetera, in the context of restructuring. That's probably more in the, call it the 15 and a half to 18 and a half. And that's the other area. The third area is the acquisitions. And there 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 yield. 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 liquidity, forward liquidity and deployment.
Certainly outside of 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. I do believe we have line of sight into some corporate issuances. So, you know, outside of portfolio runoff, we expect there in the upcoming weeks and months here to be, you know, roughly $300 million of additional liquidity coming in. You know, Adam, you may just provide some commentary on the timing of the Broadmark liquidations and expected proceeds just to get a complete picture.
Yeah, so we expect to have about 50% of the Broadmark assets paid off within our basis by year-end 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's perspective, it 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 BoardMark 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.
So just in sum, I think what differentiates us versus the peer group to some extent is, apart from the focus, 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 these spreads, which we don't believe this is a 2020 pandemic flash in the pan. with a snapback. So we see the NIM accretion being very significant over, you know, especially the back half of this year into 25.
Great. Thank you.
The next question we have is from Jake Romani of KBW. Please go ahead.
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?
Anyone want to comment?
Yes, maybe we'll break it down into two components. On the mosaic side, that deal was structured with a contingent equity rate. We, that was at close approximately $90 million. We do not expect to exceed that contingent equity rate. On the broad mark 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 game in both directions as sort of values get finalized. But yes, we do believe the purchase discounts in both of those mergers will prevent future principal losses.
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're at peak delinquencies or do you expect it to be lumpy and there will be further deterioration? I mean, I personally don't 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?
I think we do agree with that from a broad market perspective, in particular, large balance or upper middle market. I'm sorry, upper, the larger sponsors in the Sunbelt markets, for example, where there's 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're looking at our bridge portfolio versus, you know, in terms of its lower middle market focus and what you're seeing with those sponsors?
Yeah.
You know, specific to our multifamily bridge portfolio, again, You mentioned that the largest asset had defaulted. So in sum, our two largest sponsors have actually already defaulted. And we are working through asset solutions, modifications, bridge-to-bridge finances, et cetera, through the special servicers and through loans that we hold today. The majority of our small and mid-market sponsors you know, we feel have greater liquidity and funding to temporary, you know, cover the interest shortfalls. You know, we think that Q1 may see a spike as we execute, you know, some of the modifications and bridge-to-bridge strategy on our existing delinquency. But we expect, you know, really negative migration to peak late and, you know, call it Q1 or Q2, which is really due to the granularity granularity of our remaining portfolio.
And geographically, how would you describe the concentration? Is it largely sun-balanced?
Well, just to add to this, and Adam, you can comment on it, but if you recall, Jade, one of the, kind of one of our credit bibles is our geo-tier 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, in the heat map of the Sun Belt where there's a lot of supply coming, we've avoided that. But given that overlay, Adam, what have you seen in terms of our concentrations in those markets?
Yeah, markets such as the Carolinas in Texas, where we have heavy concentration, these markets have positive net migration and strong demos. And 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 given the... Really, given the positive net migration, we feel that where our assets are located will remain strong markets. 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 market's about 13%. You know, Charlotte, Houston, Chicago kind of round out the remaining of where our bigger exposures are.
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 they 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.
Yeah, so office, as Tom highlighted in his opening remarks, it's about 5% of the total portfolio. Our average balance on our office portfolio is about $3 million. It's about 160 individual assets. The small balance nature of these office assets, a lot of it is focused on stable medical office type properties. and really just smaller assets, which, again, it's a lot easier to lease up. A lot of this is on short-term leases, but given the amount of space that needs to be leased up in these small projects, the ability of our sponsors to do that isn't as challenging as you highlight with these larger office buildings and CBDs, and that's really where the majority of our office delinquencies are located, which is in the CBD, specifically in Chicago, New York, where those delinquencies are, and also Los Angeles. So I think, again, just given that granularity, we feel that we're certainly insulated from a lot of the headlines around the office sector. And it's also, from a liquidation asset management perspective, also more efficient to work through and liquidate these smaller assets?
Yeah, just at a high level, it's 70% of our 5% office is the large balance, and they account for 70% of delinquency. 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 CECL reserves. So I think, if you will, the tail risk in our book versus the sector is very, very limited to CBD office.
Thank you for taking the questions.
Thanks, Jay.
The next question we have is from Steve Delaney of Citizens J&P. Please go ahead.
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 under your existing shelf, and could we see that as soon as 2Q or 3Q of this year? Thanks.
Yeah, certainly continuing to use our shelves 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, you know, adding on additional corporate debt for reinvestment will be a key part of that as well.
And do you usually try to target about a $300 million offering under your program?
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 SBA shelf, our acquisition shelf, etc. But our CLO offerings tend to be larger in size.
Okay, thank you for that. 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, you know, just one, Stephen, one point on that. Our spreads on the AAAs historically are on top of even the, you know, the best names in the sector. And a big part of that is our structures are the most investor-friendly in terms of IC over-cloudalization triggers, which are at one versus the industry at three, and the deals being static. So that does present... Yeah, so that does present versus the peer group a skewness in our delinquency metrics and the time we take 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.
That's good color. Thank you. And either one of you, I guess, or maybe Adam, 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.
Yeah, so those 12 loans is roughly $500 million. There's no specific reserve against them beyond CECL. 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.
Yeah. And that 30 would then get fair value at the time it goes to REO, correct?
That's right.
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. I guess 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. And I'm just curious what your thoughts are about any value in that trustee data. You're referencing the special servicers reports on the – Yes, the payment data that you – USB and others put out. The CLO, special servicers, correct?
Oh, the Cresti reporting. Yeah, Ben, do you want to comment on that? I think, you know, because we just view the, and I know that's the 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 four to five 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 CRE, CLO reporting, CRSE reporting versus how we manage it in terms of just looking at it as on balance sheet.
Thanks, Tom.
Yeah, I mean, given we're DCH on our deals,
You know, we have a... Sorry, Andrew, I'm sorry, Adam, did DCH define that?
Yeah, the direct and 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, 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 our robust team with the overlay of the special service, I think, provides us a unique strategic advantage in the market. Does that answer your question?
That's helpful. Thank you, Adam and Tom. Sure.
The next question we have is from Christopher Nolan of Leidenberg Thalmann.
Please go ahead.
Hey, guys. Rent stable, excuse me, multifamily, do you have any rent stabilization apartment exposure in New York City?
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, very little.
Okay, great. And Tom, in past calls, you indicated Broadmark is expected to be EPS accretive by fourth quarter of 2024. Does that still hold?
Andrew, in the context of the bridge we laid out, maybe comment on that?
Yeah, we do expect by the fourth quarter, the transaction certainly to be accretive to current EPS. We expect it to drive earnings past our current dividend levels. And as we move into 2025, we expect the full impact of the various items that Tom laid out, including you know, Broadmark 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, you know, Broadmark probably happens in the late stages of and mid-stages of 25.
Okay. So it's fair to say that the EPS, excuse me, the accretion to distributable ROE that you guys were outlining earlier is It's 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?
I think that's a fair statement.
And so for 2024, we should see probably a distributable ROE somewhere below your 10% target. Is that fair?
Yeah, I think that's fair. We expect that the cumulative earnings of the company over the full year to cover the dividend. what we're 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 as we move into 2025.
Okay, that's it for me. Thank you very much.
The next question we have is from Sarah Borgum of BTIG.
Please go ahead.
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?
Yeah, so certainly there's a couple impacts of tripping these tests. The first one, as you mentioned, is cash flow gets diverted away from our resides to sort of de-lever 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, the effects of the de-levering of these securities. So it won't, because of how we consolidate, it's not gonna 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 waterfall 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 main effects.
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?
Adam, you want to comment?
Yeah, I think those, you know, historically as loans, you know, have become REO that we have had in securizations, 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, some things that we'll certainly evaluate.
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 year?
Yeah, I mean, on the SBA front, we've been running at about 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 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 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 originate small loans. I think we were running, Andrew, what, about 33 million the last, you know, call it 30, 40 million run rate, looking at it over the next couple of months. 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, and 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 this 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 core bridge and the other related construction and other products?
Yeah, I think just to answer the question, I think the question was around our Capital A Freddie businesses on the multifamily side. I think the volumes there we're expecting about We're targeting a billion dollars for 2024, and those capitalized 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 billion-dollar target for 2024.
Great. Thanks for all the detail there.
Appreciate it. Thanks, Sarah.
The next question we have is from Matt Howlett of the O'Reilly Securities. Please go ahead.
Oh, hey, thanks for checking in on my question. Hey, Tom, you mentioned, I think you said high teens to low 20% yields 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 are you buying it? What type of discounts? of a paper it is?
Yeah, these are lower middle market, usually stabilized loans that are 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 And that's great from our perspective because we utilize in our asset management strategies for acquired portfolios. 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, to answer your question, these 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 stapled financing, or we can, you know, we have more, what's interesting is we have more offers for credit on a secured lending basis, term lending, with limited mark-to-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 stapled financing from the seller or the third-party financing from banks, that gets us to levered IRRs on that high single load double to that kind of upper teens area, loss adjusted.
Yeah, and we've also done, since inception, we've done 11 standalone securitization of this strategy. So that's just another layer in terms of getting higher returns on that portfolio.
Yeah, that's an important point, a 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 little 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 mark-to-market.
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 else that Reddy looks at?
Oh, yeah. No, we have... 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. 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 will be an improvement in the ROE and probably the dividend over time? Do you feel like to act sooner with the buyback than later? And where does that stack up in the list of priorities?
Thanks a lot. Andrew?
Yeah, certainly where the shares are trading, I think it will be a priority for us coming out of earnings. Again, there is the need to balance using the liquidity on the balance sheet today for, for that purpose versus taking advantage of, you know, new investment that'll 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, those items will provide a lot more flexibility to be more aggressive in the share repurchase program should, you know, shares, um, hang around these levels.
Great, thank you.
The last question we have is a follow-up from Derek Romani of ABW. Please go ahead. Thank you very much.
Yeah, I find all the questions about share buybacks pretty interesting at this point in the cycle where there's clearly very high delinquencies in the portfolio and a lot of credit uncertainty in the outlook. It seems to me 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?
Yeah, so I think there are a variety of options.
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% long yield.
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?
Yeah, certainly. 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 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. 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.
Yeah, just from a more macro perspective, to add on to what Anthony was saying, Jade, 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. Were you clearly prioritizing defensive use in asset markets? 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 or in workup, 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 REITs that are focused in the multifamily small balance space. And we 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 18 months.
Thank you. And with that, I would like to turn the floor back over to Tom Capace for closing remarks.
Again, we appreciate everybody's time today and look forward to the next quarter's earning call.