Ready Capital Corporation

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 Ahlborn. 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 to 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 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 Capasse.

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, relevering 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 I 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 Broadmark merger into our core strategies. Since the third quarter 2023 merger closed, 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 $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 OpEx 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.