Ready Capital Corporation

Greetings, and welcome to the Ready Capital Corporation second quarter 2022 earnings conference 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, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Andrew Alborn, Chief Financial Officer. Thank you, sir. 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 laws. Such statements are subject to numerous risks and uncertainties that could cause actual results to differ materially from what we expect. Therefore, you should exercise caution in interpreting and relying on them. We refer you to our SEC filings for a more detailed discussion of the risks that could impact our future operating results and financial condition. During 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 gap measure is available in our second quarter 2022 earnings release and our supplemental information, which can be found in the investor section of the Ready Capital website. In addition to Tom and myself on today's call, we are also joined by Adam Zausmer, Ready Capital's Chief Credit Officer. I will now turn it over to Chief Executive Officer Tom Capacic.

Thanks, Andrew. Good morning, everyone, and thank you for joining the call today. To start, I want to highlight how Ready Capital is tactically addressing the macro headwinds of historic inflation, widening credit spreads, and a potential recession. First, liquidity. Current liquidity stands at $238 million. Given our resilient and proven business model of direct lending through the credit cycle and being an opportunistic buyer of distressed assets in adverse times, we will focus on the deployment of capital into the highest-yielding investments, commensurate with the unfolding of this economic cycle. The increase in liquidity was a result of our continued access to both the corporate and securitized debt markets. Since April 1st, we completed the following offerings, generating over $280 million in combined net proceeds. First, two securitizations, a $277 million securitization of legacy fixed-rate small-balance commercial or SBC originations, and our ninth CRE CLO for $754 million. Also, two corporate bond offerings, a $120 million, 6.8% three-year unsecured, and $80 million, 7.3% five-year senior unsecured notes. Yet again, our position as a top-tier ABS and corporate issuer ensured capital markets access in periods of market volatility. This contrasted with the numerous credit funds we compete with in the SBC market, which temporarily ceased lending at different points this year. Second is credit. Our credit metrics are rock solid with a portfolio loan-to-value of 65%, average portfolio debt service coverage ratio of 1.4 times, and a 78% concentration in low beta, multifamily, and mixed-use properties. Our focus on affordable multifamily stands to benefit from the looming affordability crisis in single family, creating a floor on growth in rental income and property prices. Additionally, since the fourth quarter of 21, we preemptively tightened credit guidelines and recently widened target ROEs by approximately 300 basis points. Note that since inception, Ready Capital has originated 15 billion in commercial real estate loans with less than five basis points in realized losses. Third is operating expenses. While our OpEx ratio has improved 300 basis points to 8.1% since the fourth quarter of 2021, we continue to manage fixed costs to projected originations across our various operating segments. For example, in our residential mortgage banking business, we executed headcount reductions of 21% consistent with a projected reduction in originations. Fourth is optimization of capital. The Mosaic merger increased stockholders' equity to $1.9 billion. With the strong post-COVID credit performance of the construction loan portfolio and the 17% CER discount, there are no credit concerns. That said, we are experiencing a drag on net interest margin from the de-levering and a 28% allocation of the portfolio to lower-yielding assets, which will be a core focus through year-end. As of today, the Mosaic portfolio accounts for close to 25% of stockholders' equity and above our targeted allocation of 10% into construction lending. We expect the relevering of Mosaic and the repositioning of lower yielding assets into our higher yielding core products to be accretive to go forward earnings as we enter 2023. Now turning to the quarter. 1.3 billion of capital is deployed across our SBC and small business lending segments. In our SBC segment, originations totaled 1.2 billion with bridge loans making up 78% of that amount. Second quarter SBC spreads averaged 402 basis points with an additional 78 basis point widening in the current pipeline of 771 million to 480 basis points. Quarter over quarter, we have grown lending spreads by 50 basis points over funding costs, thereby increasing the target ROE 200 basis points to over 13%. The rise in target ROE has been paired with tightened credit guidelines consistent with our expectation of a mild 2023 recession. Assumptions around multifamily rent growth and takeout of interest rates remain conservative, with current bridge production targeting loan-to-costs up to 70% to 75% and stabilized debt yields of 7.8% to 8.25%. Now, quarterly net fundings of $700 billion increased the total SBC loan portfolio to $9.5 billion at quarter end. The portfolio consists of over 2,400 loans, retains strong credit metrics with 60-day delinquencies below 2.5%, and the high-risk or 4 or 5-rated asset percentage holding at 5%. Additionally, 83% of the portfolio is floating rate with average LIBOR floors at 59 basis points, which will benefit earnings from rising rates. Now looking at the second half, we marginally paired target originations in core SBC channels, conserving liquidity in the current economic environment for product and geographic expansion in lending alongside potential higher yield investment opportunities in distressed acquisitions. Our lead new product, stemming from the Mosaic merger, is construction lending with a $200 million current pipeline, but tailored to our more conservative SBC niche. We are focused on smaller loans, 25 million average balance in top locations using our proprietary GO tier scoring model in lower risk multifamily and industrial sectors to sponsors with long and proven track records. We also continue our expansion in Europe with our third relationship. We recently announced a partnership with Stars Real Estate, a pan-European commercial real estate lending platform to fund up to 300 million of senior CRE loans across Europe and expect continued expansion in Europe with a long-term goal of 10% to 20% asset allocation. In our small business lending segment, 7A production totaled $129 million, marking steady progress to reaching our $600 million annual target. We split 7A originations into large loans, mostly real estate secured, which posted $111 million in originations, 16% quarter-over-quarter growth in our largest quarter by volume in a non-COVID stimulus period. Our FinTech-driven small loan 7A business added $18 million. This program leverages technology investments in our past PPP success and will continue to be a significant differentiator in the competitive SBA market, with few lenders cracking the code on small loans to date. Pricing of new production averaged prime plus $180 in the quarter, and our current 7A pipeline is $135 million. Our residential mortgage banking business, GMFS, continues to be impacted by lower refinancing volume with originations of $750 million for the quarter, of which 78% was purchase loans. Margins in the business average 75 basis points. Despite lower originations and margins, GMFS continues to perform in the top quartile of the peer group and remains profitable due to our strategy of retaining servicing and right-sizing costs. Over the upcoming quarters, we plan to pursue initiatives which may include strategic transactions, additional leverage on or sales of MSRs, mortgage servicing rights, and additional product offerings to counteract market pressures. Now, in terms of the outlook after record outperformance through the COVID pandemic, we do expect the post-COVID normalization of earnings to stabilize at or above pre-pandemic levels, which ran in the 10% range. As discussed in prior calls, we expect a post-COVID handoff of gain-on-sale earnings led by PPP to the core capital-heavy CRE strategies, which comprise 90% of stockholders' equity. The 250 basis points of expected improvement in ROE on new originations alongside potential higher-yielding distressed acquisitions and the growth in our gain-on-sale businesses, SBA and Freddie, should offset the broader market volatility and a more cautious outlook on capital deployment. These factors position Ready Capital to continue to deliver one of the most attractive earnings profiles in the peer group. With that, I'll turn it over to Andrew.