Ready Capital Corporation

Greetings and welcome to Ready Capital's first quarter 2024 earnings conference call. At this time, all participants are on a listen-only mode. A 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. I would now like to turn the conference over to your host, Andrew Alborn. 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 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 GAAP measure is available in our first quarter 2024 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 Zausmer, Ready Capital's Chief Credit Officer. I will now turn it over to Chief Executive Officer Tom Capaci.

Thanks, Andrew. Good morning, everyone, and thank you for joining the call today. Persistence of higher rates and inflationary pressures continued away in the commercial real estate sector. At this point in the CRE credit cycle, RC's near-term ROE profile is impacted by three diverging trends. First, reduced ROE from credit impairment in the originated portfolio due to late cycle stress in the multifamily sector. Second, increased ROE from ongoing liquidation of the M&A portfolio, reduced operating expenses, and growth in our small business segments. The M&A portfolio comprises assets from the 22 Mosaic and 23 Broadmark acquisitions. And third, more aggressive liquidation of targeted non-performing loans in our portfolio. In the quarter, we transferred $655 million of loans into held for sale, taking $146 million valuation allowance against those loans. We have determined that the right path forward for this population, including all office loans without a short-term resolution, is to reposition the capital into market yielding and cash flowing investments. The NPV of repossessioning of this capital is greater than holding these assets through recovery and absorbing carry costs through the process. The book value for share decline of 4.5% will be recaptured through reinvestment and share repurchases. In this regard, for analytical purposes, we have bifurcated our $9.4 billion gross portfolio into the originated 87% of the total and M&A portfolios, which is 13%. Before we delve into credit metrics, it's important to reiterate that tail risk in our portfolio is mitigated by three factors. First, our concentration in multifamily and mixed use at 78% of our portfolio. Although overall market multifamily delinquencies increase in the first quarter, longer-term valuations are supported by demand, with the average median of home payment, $3,000, exceeding rent by 50%. The current distress in multifamily, particularly transitional loans, is a trifecta of higher rates, declining rent growth from oversupply in certain markets, and inflationary increases in OpEx. Compared to the peer group as it relates to rent growth, our 2020-22 vintages benefited from our proprietary geo-tier model, which ranks markets one through five, one being the best, with projected negative absorption a major factor. Recent data shows significant dispersion in rent metrics with supply influx in overbuilt markets causing mid-single-digit rent declines. As of March 31st, 91% of our originated portfolio is in markets ranked three or better. Overall, multifamily industry prices are down 16% from the 22P, with an additional 5% forecast for the 2024 bottom. Given our going-in LTV of 62%, These changes result in a portfolio mark-to-market under 100% versus office, where a 50% decline has created over 100% LTVs. We do not believe the increased delinquency in our multifamily portfolio is indicative of further principal loss. The financial effect will be short-term earnings pressure for the interim period between default and modification, forbearance, or refinance. Unlike other CRE sectors subject to the vagaries of the regional bank and CMBS markets, multifamily benefits from the government put with $150 billion of annual GFC allocation providing a pathway for takeout of bridge loans requiring additional time to execute a business plan. Across the $1.3 billion of our loans that reached initial maturity over the last 12 months, 42% paid off with 90% of the remaining loans qualifying for extension. Second, our concentration in lower to middle market loans. Our 9.4 billion dollar total portfolio includes approximately 1,800 loans with an average balance of 4.4 million, avoiding single asset concentration risk. In the broader multifamily sector, the disparity on refinance risk is wide, where 95% of loans under 25 million paid off at maturity compared to 55% of loans over 25. We've seen this in our originated portfolio, where 16% of loans over 25 million are 60 days delinquent compared to 7% of loans under 25. And last, limited office exposure. As of March 31st, our office portfolio consisted of 167 assets totaling $456 million, only 4.4% of our total portfolio. Further, only 11 of those loans had a balance of over $10 million and were concentrated in central business districts. 31% of the office loans are delinquent. We believe that recovery of the current stress in the office sector is long dated and the NPV of repositioning of this capital is greater than holding these assets through recovery and absorbing carry costs through the process. As such, 72% or 140 million of our delinquent office loans are included in the population transferred to held for sale. Post this transfer and liquidation, our office exposure will decrease to 3.3% of the population Next, an update on the credit metrics in the originated portfolio. Please refer to slide 11 in the deck where we present 60-day plus delinquencies, non-accrual, and four to five risk-rated percentages. Overall, 60-day delinquencies increased to 9.9%, resulting in a rise in the non-accrual loans to 7.2%. However, the four to five risk-rated loans, a leading indicator of future 60-day plus, exhibited positive migrations, improving 29% to 9.6%. 46% of our top 10 delinquencies, totaling $137 million, are included in our held for sale bucket and have been marked to expected liquidation values. Liquidity is being prioritized for capital solutions, including refinancing four or five rated loans and protecting our CLOs. As of April 30th, we had total liquidity of approximately $170 million. Year to date, we have either refinanced or repurchased $114 million of delinquent loans out of the CLOs with another $190 million in process. For example, in March, we refinanced a $68 million loan on a Class A multifamily property located in an Austin, Texas, sub-market, which went delinquent due to high operating costs and lower rents from oversupply. The 18-month extension provides a path to reach projected occupancy of 94% from 90% today and 5% annual rent increases to $16.91 a month. both highly probable given the strength of the submarket and flattening absorption. The as-is LTV on the new loan is 88%. Funds and interest reserve to cover the 18-month term was priced at SOFR plus 585, resulting in a retained yield of 18%. In terms of projected liquidity through year-end, accelerated asset sales will provide an additional $200 million for capital solutions. As of the April 25th remittance date, five of our CRE CLOs were in breach of either interest coverage or over-collateralization tests. To date, we have approved 161 million of loan modifications, with another 732 million in process and under review. We expect the cumulative effect of repurchases, refinance, and modifications to provide a path for compliance. One important factor to reiterate underlying Ready Capital's peer group comparison. We use a third-party special servicer which requires additional lag time and less flexibility to execute modifications. As such, our modification ratio is lower and delinquencies inflated versus the peer group. For example, according to a Deutsche Bank series CLO report on April remittances, the top three commercial mortgage REITs based on GAAP equity had average 71% modifications and under 1% 60-day delinquencies versus 5% and 11% for RC, the fourth largest. We continue to work with our existing special servicer to rectify this issue, and if unsuccessful, we'll implement alternatives, such as another servicer or obtaining our own special servicer rating. Furthermore, in our M&A portfolio, please refer to slide 11 in the deck, overall credit improved. 60-day plus decline, 9%, resulting in a 5.6% improvement in the non-accrual percentage. Meanwhile, a 16.5% decline in 4-5 risk rating loans suggests future improvement. Turning to earnings, as outlined in our fourth quarter earnings call, we continue to undertake five initiatives to improve ROE. First, reallocation of low-yield assets from the M&A portfolio into 15% plus levered ROE current yields, such as the 18% Austin refinance previously discussed. As of quarter end, the M&A portfolio had a levered ROE of 7.2%. As it relates to Broadmark specifically, which comprises 51% of the M&A portfolio, we liquidated an additional 50 million of assets, or 5% of the original portfolio, at our basis. Second is leverage. Current total leverage at quarter end was 3.4x, below our target of 4x. Target leverage will be achieved from both accessing the corporate debt markets and the leveraging of new investments at better advance rates and terms. In April, we closed a $150 million five-year private term loan pricing at SOFR plus 550. Third, the exit of residential mortgage banking. We continue to target the end of the second quarter to conclude our efforts to divest of our residential mortgage business. To that end, we are under contract to sell 40% of the MSRs with the remaining 60% currently marketed for sale with an expected July settlement. Distributable ROE in the business has lagged at 6.8%. Fourth, the growth of small business lending. Our stated long-term target for the platform is $1 billion in annual originations with $194 million in the first quarter, $47 million over the prior quarterly record. To support this growth, we appointed Gary Taylor as CEO of Small Business Lending to continue the dual strategy of large and small loan 7A originations through continued integration and of our FinTech iBusiness with the added benefit of cost efficiencies in loan origination and servicing. Additionally, we're excited to announce this week we signed a definitive purchase agreement to acquire the Madison One Companies, the nation's second largest USDA originator. The transaction is expected to generate over 300 million of USDA volume annually, expanding our government guaranteed small business offerings while increasing the company's gain on sale earnings. And last is OpEx. Given market conditions and expected activity levels, we reduced staffing 11% in April, resulting in annual savings of $8 million. Those reductions, in addition to $3 million and other fixed operating costs, results in a 46 basis point improvement to current ROE. The total 200 to 300 basis point ROE accretion from these five initiatives provides a significant offset to the ROE drag from an increased non-accrual percentage as the multifamily credit cycle matures. With that, I'll turn it over to Andrew.