Ready Capital Corporation

Greetings and welcome to the Ready Capital first quarter 2023 earnings call. At this time, all participants are needless and 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 and then zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Andrew Ahlborn. Thank you, and you may proceed.

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 financial results prepared in accordance with GAAP. A reconciliation of these measures to the most directly comparable GAAP measure is available in our first quarter 2023 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 Zasmer, Reddy Capital's Chief Credit Officer. I will now turn it over to Chief Executive Officer, Tom Capasse.

Thanks, Andrew. Good morning, everyone, and thank you for joining the call today. Given the seemingly full-on recession in CRE, Reddy Cap was not immune to pressures we and others in the industry are navigating. That said, our core capital life, Reddy Mac SBL and SBA 7A originations and multifamily-centric credit metrics outperformed. While results did not quite achieve our 10% ROE target for the first time in 12 quarters, the business demonstrated its resiliency. Distributable earnings of 31 cents per share were pressured largely by non-recurring items, resulting in a 6 cent per share deviation compared to our 10% return on equity target. Approximately 50% of the shortfall was due to marked market losses on our opportunistic investment allocations, such as CRE equity, and an additional 25% was due to higher operating costs from the build-out of our small business FinTech platform. Of note, the mark-to-market losses did not result from credit impairment, but increases in valuation metrics such as cap rate assumptions. In our lower middle market CRE lending business, originations declined to $411 million. Our volume was 94% multifamily, including 67% in our Capital Life Freddie Mac SBL channel. Year-over-year decline in our bridge lending was due to two main factors. First, the unfolding CRE recession stoked by reduced demand stemming from an approximate 100 basis point increase in multifamily cap rates and a doubling in debt cost of 7% reflected in the first quarter over 50% decline in overall CRE transaction volume compared to the same period last year. Of note, the change in demand for multifamily is less than other CRE sectors due to an estimated 4 million unit housing shortage in the U.S., particularly in Ready Capital's affordable multi-family segment. Second, at this stage of the credit cycle, more defensive loan pricing in terms of spread, credit, and projects has emerged. For the quarter, our average loan spread was SOFR plus 600 basis points, translating to a mid to high teens retained yield at current CRE CLO execution versus low teens retained yield in the first quarter of 22. We continue to tighten credit with stabilized LTVs averaging 61% and debt yields increasing to 10%. Our ongoing focus is funding lower risk affordable multifamily projects in the strongest markets with experienced and well-capitalized sponsors. Another significant differentiator for ReadyCap is our lower risk credit profile versus the CREED peer group where current historic share price discounts to book value reflect fears of future book value erosion and dividend cuts from CECL reserves. Our first quarter credit metrics continue to outperform the industry. This is exemplified by 60 day plus delinquencies and four to five high risk assets in our originated portfolio, holding at only 2.7% and 5% respectively. This four to five higher risk asset exposure is currently only one fifth of the current industry average. Our stronger credit metrics relative to the peer group reflect the following. First, our mid-market multifamily focus now accounts for 81% of the current portfolio. Multifamily continues to perform well, supported by continued rent versus buy dynamics and the ongoing housing shortages. While we believe potential credit losses in the books to be low, we remain vigilant on mitigating maturity defaults should the broader landscape further weaken. Second, we have limited exposure to the most stressed CRE sectors, particularly the COVID poster child office, which is weighing on CRE sector valuations. The national office market will continue to experience heavy lease rollover with tenants vacating or downsizing space, specifically in older vintage Class B properties located in central business districts. The 10-year term of leases will result in a protracted period of defaults and foreclosures for the sector. Our office exposure is the second lowest in the peer group at under 5%, with an average balance of only 2.6 million. Of the 5% exposure, only 19% or 92 million of our non-performing office assets are located in CBDs, one in downtown Manhattan and two in Chicago. Expected losses on these assets equal 11 million and have already been included in our CECL reserves. The balance of our office holdings, given their small balance, avoid CBDs, which face the greatest challenges for the industry. Third is credit. In the fourth quarter of 21, we preemptively tightened credit guidelines. Specifically, we cut projected rent increases to 0% to 3%, lowered stabilized LTVs to 63%, and increased debt yields to over 9%. Our portfolio credit metrics provide a significant risk mitigation against maturity defaults, resulting from negative leverage in multifamily bridge loans where debt costs exceed cap rates and rent increases are under budget. This is an industry-wide credit issue for aggressive lenders in the 2021-22 vintage. Fourth, the granularity of the portfolio is unique relative to the sector. Our CRE portfolio is comprised of over 2,200 loans with an average balance of $4.3 million. The top 10 loans in the portfolio total only 10% of the loan book and excluding the loans from the 22 mosaic merger, only 7%. Recalls of the mosaic loans are covered by a contingent reserve equal to 15% of the remaining outstanding balances. This granularity reduces the statistical skewness faced by large balance lenders where a few large defaults can materially impact book value. Finally, portfolio concentration in strong CRE markets, the result of our proprietary geo-tier model, which scores MSAs one to five, one having the best theory fundamentals and five the worst. Currently, 89% of the portfolio is in one and two rated markets, specifically avoiding certain MSAs with overbuilding and multifamily. Now, turning to our small business lending segment. To review, the SBA 7A program features two basic segments, large loans, $350,000 to $5 million, and and small loans under $350,000 which are underwritten using a credit scoring model. In the third quarter of 22, we launched a unique dual large loan BDO and FinTech small loan model capitalizing on the SBA's mission to promote the small 7A program benefiting women and minority owned businesses. Our iBusiness funding division focuses on small loans and continues to invest heavily in their end-to-end lending software Lender AI, which is in addition to providing an origination edge for ReadyCap, may also generate fee income as a lending as a service product. We invested an incremental $10 million over the last 12 months versus the prior 12 and expect a lag in revenue recognition from the resulting rent and small loan originations. We firmly believe that this approach will advance our three-year 7A origination target of $750 million for a 2.5% market share. In the quarter, we originated $92 million in 7A loans, comprising 65% large and 35% small loans. While total volume declined 8% year-over-year, small loan volume grew 3x, reflecting payoff of our tech investments in high business. Average premiums on guaranteed loans increased 175 basis points, 9.5% in the quarter. We are ranked the number one non-bank and number five overall SBA 7A lender. In terms of the broader SBA landscape, the bank crisis will curtail conventional financing in favor of 7A loan financing. Industry expectations are that as rate hikes stabilize, overall 7A lending volume will increase 10% year over year. Now as we look forward, the company is well positioned to maintain a dividend consistent with our stated 10% target ROE while protecting book value. This is due to having strong credit metrics on the legacy multifamily book, but also the benefit of net interest margin accretion from reinvestment of $750 million in incremental liquidity. We were able to accomplish this due to two initiatives. First, the reinvestment of liquidity from the pending Broadmark merger which is expected to close May 31st into core lending products and acquisition of distressed bank commercial real estate portfolios. The Broadmark merger will provide operating leverage on an increased equity base reduce leverage races by over a full turn, and most importantly, provide $500 million of incremental liquidity supporting $1.5 billion of buying power. While our core direct lending products currently provide ROEs at 15%, another peer group differentiator is Ready Capital's counter-cyclical acquisitions business. Post the GFC, Ready Capital and predecessor funds were a top three buyer of small balance commercial loans from banks purchasing over $5 billion. In the strong CRE markets of recent years, bank asset sales were sparked. However, with the unfolding bank crisis, regional banks facing deposit uplifts are targeting sales of small balance CRE portfolios. One of the many benefits provided by our external manager, Waterfall, is that it sources acquisitions for ready capital with an acquisition pipeline of $750 million at 18% to 20% projected ROEs. The current bank's state of play is price discovery, with asset sales targeted for the second half of this year providing reinvestment opportunity for our second half pending liquidity. Second, we plan to move out of lower yielding non-core assets whose earning drag was compounded by the 22 rate rise and product lines over the next few quarters. These efforts are expected to generate $250 million of incremental liquidity and losses on dispositions of these non-core assets will be recaptured through the significant higher returns on new investments. Our expectation is that second quarter lending volume in capital-intensive products, and thus earnings, will remain lower on a year-over-year comparative basis. But the efforts described previously, along with the strength of our portfolio, position the company beyond the second quarter to deliver with consistency on our 10% target return. With that, I'll now hand it over to Andrew to discuss our financials.