Thank you for standing by. This is the conference operator. Welcome to the Ready Capital Corporation Third Quarter 2020 Earnings Conference Call. [Operator Instructions]. I would now like to turn the conference over to Andrew Ahlborn, Chief Financial Officer. Please go ahead..

Thank you, operator, and good morning, and thanks to those of you on the call for joining us this morning. 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 upon 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 third quarter 2020 earnings release and our supplemental information.

Yesterday evening, we issued a press release with the presentation of our results along with our supplemental financial information presentation. These materials can be found in the Investor Relations section of the Ready Capital website and have been filed with the SEC. We plan to file our third quarter 2020 10-Q this evening.

In addition to Tom and myself, we are also joined by Adam Zausmer, our Head of Credit, on today's call. I will now turn it over to Tom Capasse, our CEO..

first, elevated demand for SBA 7(a) loans in the post-COVID recovery; second, additional stimulus programs embedded in a likely post-election CARES 2 Act. These include around 2 for PPP and resurrection of an enhanced 7(a) from the GFC, including an increase in the guarantee from 75% to 90% and waivers of the guarantee fee by the SBA.

And finally, following our second quarter beta testing, a full rollout of our SBA small loan, so-called Express program, leveraging our investment in fintech over the last 12 months. Historically, only 16% of our origination volume are small loans, which is relatively low compared to the 44% for total SBA originations.

As one of only a few active 14 nonbank SBA lenders, our business continues to evidence market leadership with the #1 year-to-date position among all nonbank SBA 7(a) lenders and a top 15 year-to-date position amongst all 7(a) lenders.

In our residential mortgage banking segment, historic low mortgage rates and growing nonbank market share boosted industry refi and purchase volume 63% and 27%, respectively.

As a result, in the quarter, GMFS originated $1.2 billion at margins averaging over 300 basis points with a similar 72% and 22% increases in refi and purchase volume year-over-year. Additionally, our 33% retention rate on our mortgage servicing rights in the quarter continue to exceed industry averages.

Going forward, we expect continued elevated demand. October represented the single highest production month in the company's history, with $425 million in originations and current commitments to originates stand at $738 million.

In our Freddie multifamily business, demand for loans on stabilized multifamily collateral has remained strong throughout the last 2 quarters. With Freddie Mac rates as low as 2.8%, originations reached $413 million year-to-date, representing 100% of total 2019 production. In 2020, expanding our agency presence was a key stated strategic objective.

The first step was completed in the quarter with the inking of 2 correspondence agreements that allow us to offer a full suite of commercial agency products to our customers. Over the next few quarters, we expect to further add to the existing infrastructure in our agency segment.

Finally, in addition to our gain on sale businesses, we are well along the path to normalize operations in our core SBC origination and acquisition businesses. In our origination business, our bridge lending business relaunched in the quarter, closing $17 million in September, and the current money up pipeline has grown to $98 million.

Additionally, our fixed rate and money up pipeline now sits at $22 million. Our origination efforts are focused on sectors with low exposure to an extended pandemic, including multifamily and industrial and focusing on sponsors with strong financial health and a history of success in prior downturns.

We're actively avoiding bridge-to-bridge cash-outs and unrealistic business plans. On the acquisition front, we continue to leverage our relationships to purchase seasoned performing loans from collapsing CMBS deals at mid-teens deals. In the quarter, we purchased $16 million and have a current pipeline in excess of $242 million.

We expect more products to come to market in the first half of 2020 as banks repositioned due to CECL and bid-ask spreads tightened. Ready Capital continues to outperform in terms of post-pandemic credit metrics versus the large balance commercial real estate lenders due to 3 factors.

First, SBC is more correlated with housing than large balance commercial real estate. As one metric in terms of 2020 property prices, Street consensus is for a 7% to 10% decline in the Moody's NCREIF large balance index versus our projection of a 0% to 3% decline in SBC property prices against a 5% increase in the Case-Shiller residential index.

Second, more conservative underwriting and a lower risk portfolio mix due in part to our less competitive pre-recession SBC niche. And finally, enterprise-wide special servicing capabilities associated with a 13-year track record buying nonperforming loans globally, providing COVID-ready asset management loss mitigation strategies.

Our portfolio of first lien assets, which consists of 5,400 SBC and SBA loans is highly diversified across both collateral type and geographies.

Within our SBC segment, our focus on conservative underwriting, a proprietary GEOtier model favoring superior markets and the avoidance of underperforming sectors has led to stable performance throughout the last few months.

Through the most recent payment date, 1.7% of our originated SBC loans, inclusive of Freddie Mac collateral, are 60 days plus delinquent, which remains stable from Q2 delinquencies and compares favorably to a large balance CMBS at 8%.

In our acquired SBC portfolio, which includes many nonperforming loans, 60-day plus delinquencies are 6.1%, down from 6.6% at June 30. Additionally, forbearance is down from the 8% COVID high point to 1.8%. Of loans that have rolled off forbearance, 90% have migrated to current status.

Now in terms of the current portfolio, it's important to reiterate a few key factors that highlights its strengths. In the SBC portfolio, exposure to sectors most affected by COVID is low with 4% and 15% in hospitality and retail, respectively.

Moreover, we're exposed to the better performing subsectors in hospitality to limited service hotels with a $2.8 million average balance that have experienced nationally 15% declines in RevPAR versus over 50% the luxury hotels.

Our retail exposure is also granular with an average loan size of $1.6 million and is collateralized by small multi-tenanted centers that serve local communities. Second, we have minimal single asset or single-tenant exposure with our largest loan representing only 1% of our total portfolio.

And finally, our average loan-to-value is 60%, which provides significant headroom when compared to our estimated declines in small balance property prices of approximately 3%. Within our SBA segment, which represents less than 11% of stockholders' equity, exposure to hotel and restaurants comprises 24% of the total SBA portfolio.

Delinquencies through the September payment declined to 4.2% from 5.4% at June month end while we do expect slight increases in delinquencies as SBA support through the CARES Act concludes. We expect to offer deferment as necessary and allowed by the SBA to provide small businesses a longer runway to normalized economic conditions.

Additionally, future government stimulus is expected to focus on additional support for small businesses, which will directly aid in the performance of the SBA portfolio. So with that, I'll now turn it over to Andrew to discuss financial results..

Thanks, Tom. The third quarter expands upon the second quarter's strong results, with GAAP earnings of $0.63 per share and core earnings of $0.57 per share. Our core earnings equates to a 15.7% return on average equity, and our annualized year-to-date return on equity equals 11.8%.

These results highlight the benefits of our diversified business model and showcase how our business is differentiated from the peer group.

Multiple business lines contributed to the company's strong financial results, with 38% of the revenue coming from net interest and servicing, 47% from mortgage banking revenue, 11% from our gain on sale operations and 4% from the recognition of deferred PPP revenue.

Stable net interest income and servicing income increased slightly to $36.4 million despite portfolio runoff, which is expected to be recaptured as origination and acquisition activities revert to normalized levels. Net mortgage banking revenue remained elevated at $44.6 million.

Origination volumes remained flat quarter-over-quarter and average margins remain elevated, exceeding 300 basis points. The $4.7 million decline in MSR valuation was due to a 90 basis points increase in CPR assumption, which was partially offset by a 33% retention rate and 11 basis point reduction in WACC.

Current commitments to originate are $739 million, and we believe elevated financial results to continue into the fourth quarter. Gain on sale revenue reached $10.4 million in the quarter, representing a new benchmark for the company. Elevated results were driven by record SBA volumes of $82.9 million and high average net sale premiums of 12%.

Strong Freddie Mac volumes and the inclusion of a $1.9 million gain on sale from our new fixed rate joint venture CMBS program.

We are excited about this program as it will allow us to bring our fixed rate product to market quicker, realize upfront gains reflective of market pricing and retaining interest in the subordinated bonds at attractive levels. Of the $14.5 million of deferred PPP revenue as of June 30, we recognized $2.6 million in the quarter.

The amount of PPP revenue that will be recognized in any given quarter will remain volatile and highly dependent on the speed at which loans are processed for forgiveness.

In addition to the remaining PPP revenue that will be recognized over the next few quarters, the company is well positioned to participate in additional stimulus programs that may come out of Washington in the upcoming weeks and months.

Absent unforeseen events such as the passing of additional government stimulus, we expect Q4 results to be lower than Q3 earnings due to a reduction in anticipated SBA volumes from Q3 records, the absence of gain on sale revenue from our CMBS joint venture activities and slightly lower margins in the residential mortgage banking segment.

Turning to the balance sheet. We continue to focus on balancing liquidity needs to manage stress scenarios with origination and acquisition opportunities in front of us. As of October 30, we have cash and available liquidity of $222 million. Our recourse leverage ratio improved to 2x.

Included in this ratio is $328 million of debt supporting our agency originations. And absent this balance, recourse leverage is at 1.6x. The loan portfolio continues to perform well despite a fair amount of economic uncertainty.

Total 60-plus day delinquencies within the CRE portfolio, inclusive of Freddie Mac collateral, remained stable at 2.3%, and forbearance levels remained low at 1.8%. Changes in our CECL reserve of $4.4 million were primarily driven by changes in macroeconomic assumptions in our model, offset by increases in specific reserves on nonperforming assets.

GAAP earnings include CECL recoveries of $7.2 million, which are not included in core earnings. Book value increased $0.38 per share due to retained earnings of $18 million in excess of the current quarter dividend and our share repurchase activities. In the quarter, we repurchased 932,000 shares at an average price of $9.96.

We will continue to utilize the share repurchase program as appropriate to generate value for our shareholders. As we have done previously, we have provided a supplemental earnings deck, which includes summary information on the company's earnings profile, various operating segments and key financial metrics.

Of note is the continued strength of the earnings profile on Slide 5, the reemergence of investment activities on Slide 6 and the continued delevering on Slide 16. I hope you and your loved ones continue to be well. I will now turn it over to Tom for closing remarks before we take questions..

Thanks, Andrew. Our diversified and differentiated business model has thus far proven itself resilient with stronger core earnings, stable liquidity and book value preservation that compares favorably to the peer group.

Although we remain cautious about the uncertainty that remains due to the pandemic, we are optimistic about the growth prospects for our company. Specifically, we will continue to increase origination volumes in our 3 government-sponsored businesses and redeploy excess liquidity into SBC originations and acquisitions.

Our resulting target is a healthy earnings mix of gain on sale contribution from our government businesses and net interest margin from the SBC segment.

To reiterate, while we did benefit in the last 2 quarters from the impact of COVID government stimulus on our gain on sale businesses, we are confident that the higher investment returns in our core businesses available in the post-COVID environment will support target ROEs at or greater than the pre-pandemic run rates.

A corollary to Ready Capital's earnings strength is the value of our discrete operating companies. Current public and private market valuations of direct competitors to each of our distinct operating companies indicate there is a significant valuation premium to the current book value included in our balance sheet.

We believe this embedded book value premium has yet to be fully appreciated by the market. We hope you all continue to remain safe and healthy. With that, operator, we'll now open it up to questions..

[Operator Instructions]. And our first question comes from the line of Crispin Love with Piper Sandler..

First, just a couple of questions on credit quality. I noticed in the presentation, there looks to be kind of a small migration in your risk ratings from bucket 3 to bucket 4.

So I'm just curious on what's driving that? And then also on credit quality in SBA, following businesses taking advantage of the 6 months of P&I and then having to start P&I following that grace period.

Are there any worries that you feel in the SBA segment following that 6 months?.

Sure. This is Adam Zausmer on the credit side. So the migration from bucket 3 to bucket 4, the majority of that is from forbearances that have rolled off. And there was a handful that became delinquent, and we're working closely with the sponsors to either extend the forbearance periods or provide some other relief. So that's the first piece.

Additionally, there's also some of the hospitality assets. We've added a few to the risk or 4 bucket. As Tom mentioned, our hospitality on the series side is less than 4%. We feel that those assets are strong, but we've elevated the risk scores that just heightened alert from our asset management team.

On the SBA side, correct, the 6 months of P&I has rolled off. So October is really the first month that the sponsors are going to be required to make payments. We're going through a process now of working closely with these individuals, evaluating their businesses, some of the progress that's been made.

So you see who's reopened, walk through some of the hardships that these folks are experiencing. And we're making strategic deferments as needed to give these businesses some additional time. About 4%, I believe, right now, is currently under review for deferments.

Specific focus is on the hospitality sector and then also the restaurant sector that we're paying particular attention to..

That's very helpful. And then just one more for me. So over the last 2 quarters, I think you've recognized about $26 million or $27 million of PPP fees.

Am I right to assume there should be an additional about $15 million of fees? And I know it's volatile and it's going to be coming in over the next few quarters, but is there any -- do you have any kind of view on the cadence of those fees coming in? Should it be over the next 2 quarters, 3 quarters, 4 quarters? Just any additional color there would be great..

Yes. So the remaining deferred PPP revenue today sits around $12.5 million. I would say that we -- the forgiveness process has been a little bit slower, not for something we've done internally, but just because the rate at which borrowers are requesting forgiveness is lower than we expected.

So our current internal projections is that the forgiveness process will pick up in 2021. So I'd say the majority of that deferred PPP revenue will probably be allocated in the New Year..

[Operator Instructions]. Our next question is from the line of Christopher Nolan with Ladenburg Thalmann..

It's Chris Nolan, Ladenburg Thalmann. Tom, in your comments, you mentioned about buying collapsed commercial real estate.

Do you intend to make that sort of a strategic focus at all? Or can you give a little color on that?.

Yes.

Just to clarify, that's been one of our core strategies since inception of the company, and that involves buying -- getting the call rights to legacy, mostly from the GFC that legacy small balance commercial securitizations and then collapsing the trust and buying them at par plus accrued interest and then repackaging those into a new securitization.

Very similar to, for example, what NRZ does on the residential side with legacy subprime deals..

Got you.

My real question is, do you intend to scale that up at all given everything going on?.

So the -- yes, there's -- yes and no. We're probably one of the more active buyers in that market, but there's limited collateral.

I would say that most of what we're going to -- you're going to be seeing in the acquisition business, in addition to that kind of steady flow is sales by banks that were starting to spring up on our acquisitions team due to, I'll call it, CECL compliance sales that they're contemplating either at year-end or definitely in the first quarter.

So I'd say you're going to see more of that than you will, the legacy GFC book, which is just naturally shrinking..

Okay.

And I guess, related to that, should we see an increase in discount accretion income or becoming a factor in your earnings at all?.

Mostly I think that's been....

[Indiscernible] on that. Yes. Go ahead, Andrew..

Yes. I think that's going to be highly dependent upon what the acquired pools look like. To the extent we're buying distressed product, you're certainly going to see an increase. But I think -- and there's a ways to go before we can quantify what additional accretion income will be and will be highly dependent upon what the future purchases look like..

Great. And then just a follow-up question. For Andrew, you mentioned that the mortgage banking was impacted by higher prepayment REITs.

What sort of CPRs are you seeing?.

So right now, we're modeling CPRs just under 15%, which is up quite a bit from where, obviously, from where we were last year..

Our next question is from the line of Mike Smyth with B. Riley Securities..

Just a follow-up on the resi business. I'm just wondering how our margin is looking for the month of November.

And kind of what's your expectation for when things will start to normalize there?.

Well, I just made a market comment -- go ahead. I was just -- as a backdrop to your -- what you're seeing in terms of the actual P&L. But yes, we definitely -- we were expecting more of a normalization in -- I would say starting in late this quarter, early first quarter. But the recent rally in the 10-year has kind of dialed that back.

So you'll probably see a continued I think between -- the best way to measure it is the primary versus secondary spreads, which typically are 100 basis points. And that's been running 150 to 175. I think this rally in the 10-year may buy us another quarter or two in the industry.

But I mean, Andrew, given that backdrop, what are you seeing on the -- in terms of actual profitability?.

Yes. I think we'll see how November shakes out, but you did see slight declines in margins from the beginning of Q2 to the end of Q3. And so we do expect margins to come down from the Q3, from the September 30, call it, 300 to 350 basis points, maybe down another 25, 50, over time..

That's helpful. And then just one more question from me. So last quarter, you mentioned you were looking at a few new initiatives. I think you mentioned fix and flip and single-family rental financing. And then you also mentioned you were seeing some distressed M&A opportunities.

So I was wondering if you could just provide any updates on how you're thinking about any potential strategic transactions..

Yes. On the new product front, we have continued to we -- for example, we restarted the origination on the Ireland -- Irish bridge business that we had committed to last in 2019, but had stops during the pandemic and now we've relaunched that. We're seeing other opportunities in Europe on the CRE side.

We did expand, as we said before, the agency licenses -- sorry, through via correspondent, thinking to correspondent agreements. I think on the SFR front, I think we're a little bit less -- the returns there are not as robust as we're seeing in the CRE space.

So I think we're continuing to look at other areas of commercial real estate, for example, the CPACE program assessed clean energy and some of the other products in the -- on the real estate side. I don't know, Andrew, if you would add to that..

Yes. We're also in the middle of exploring a USDA license which will help both in the SBA business as the product is very similar as well as on the commercial side. So we're well along the path to obtaining that license..

That's helpful. Sorry..

I was going to say what was the second part of your question. I'm not sure we answered it..

I think last quarter, you also mentioned you were seeing some stressed M&A opportunities. So just anything on that front as well..

Yes. No specific updates, but there's definitely potential opportunities that we're continuing to explore..

Our next question comes from the line of Jade Rahmani with KBW..

With the robust residential mortgage market continuing and the discrepancies in valuation that you noted in your intro comments, I was wondering if you are considering any strategies to unlock value within that segment, perhaps through combinations, spin-offs or some other strategy..

Nothing specific currently. Obviously, we've seen some very heightened valuations with the recent IPO activity in the space. And again, that underscores the significant premium to book value that some of these -- in particular, the GMFS and the SBA business and the of course, Freddie.

The Freddie license are all -- the pandemic has resulted in multiple expansions for -- because of the origination increases in the margin gapping out in most -- all 3 of those businesses. So that is not reflected in our book value. And one approach would be to undertake potential acquisitions or spin-offs.

I don't think the spin-off is something we would consider at this point, but we are exploring acquisitions to grow both -- to scale up both of those businesses. But even as is, there's a significant premium that's not really -- in terms of the value of those businesses, which are held at book, that's not currently reflected in our share price..

Right. In my experience covering diversified REITs, especially those that are externally advised, it does become difficult to unlock value within some of these discrete business lines when it's part of a diversified company that has an external management contract.

Is there anything structurally that you would consider changing? Or is there any time horizon over which a discount to fair value exists that you would consider taking additional actions?.

Nothing specific on -- it's currently being contemplated, but we have been evaluating various structures, including spin-offs and what have you to unlock value in the subsidiaries as appropriate. Or on the flip side, to bulk up those businesses through additional acquisitions..

I know that you've been through multiple cycles and Waterfall has a good track record in acquiring distressed assets across various real estate property types. I was very curious to hear, Tom, your views around the outlook for the office sector, particularly in dense or urban markets..

Yes. We're not obviously in the -- in Ready Capital, we have very limited exposure to office just because it's not really in CBD because by definition, there's very few $5 million office buildings in -- on Sixth Avenue.

But I would just say, looking from the lens more broadly from our global credit platform where we have -- we are a major -- a leading credit investor in CRE.

I think in terms of the K in this recession, there's still some additional paying in terms of office valuations because we do not believe that the vacancy rate -- if you will, the forward vacancy rates for 2021 reflect the repricing of occupancy based on the work-from-home planning that's going on from a corporate perspective.

So generally speaking, we're sector underweight CBD office for that reason..

And what magnitude of valuation decline would you expect? Some brokers have put out statistics that re-lease spreads are down about 15%. Some other people have postulated that rents in a market like New York could be down 20%.

What magnitude of office valuation decline would you expect? And at that point, do you think it's something Waterfall or Ready Cap would become interested in?.

Again, I think Ready Capital, we stick to our niche, which is small balance credit. We definitely are seeing some opportunities on the NPL space with the banks, as we did in the last crisis.

As it relates to more broadly, to answer your question, away from Ready Capital, our view of -- again, this kind of K divergence in this recession for the obvious affected asset classes.

So within the Moody's NCREIF, the subsector for office, we expect that price decline to -- by year-end 2021 to be somewhere in the 25% range, whereas multifamily might be up 5%.

So yes, that -- I think there's -- the implied forward pricing does not fully reflect the decline in rents and some distressed sales that will also recur in terms of the -- in the first quarter of next year. So we're, again, for that reason, we're very cautious in sector underweight office, CBD office..

And just lastly, the 60-day delinquency rate or 60-day plus delinquency rate, 2.3%, what was that last quarter?.

Adam, did you want to weigh in on it?.

Yes. Yes, it was flat at about 2%..

So it was 2% last quarter and 2.3% this quarter?.

Correct..

Okay.

So it increased 30 basis points?.

That's right..

[Operator Instructions]. And our final question comes from the line -- it's a re-question from Christopher Nolan with Ladenburg Thalmann..

Tom, what is the core ROE target that you guys are thinking about given the change in the interest rate environment, et cetera?.

Obviously, the pre-pandemic, we were targeting a 10% ROE, core ROE on book. Our view is with the -- obviously, we've had very strong quarters due to these gain on sale businesses and the stimulus.

But as the world normalizes, we expect a maybe some decline in residential mortgage banking, some continued strength in SBA where we were number one in the last -- nonbank, of the 14 nonbanks last quarter.

So that, along with the agency multifamily business, will continue to provide strong gain on sale revenues, but the real increase will be in the redeployment of excess liquidity into the core SBC origination and acquisition business.

So with that, we expect a normalization in 2021 of ROE at or slightly above pre-pandemic levels just because the reinvestment -- the ROE on the reinvestment opportunities like the transitional bridge lending are probably 100 to 300 basis points above where they were in fourth quarter of 2019, early 2020..

Great.

And then finally, I'm correct that there were no securitizations in the quarter, right?.

Andrew?.

The only securitization was the introduction of the new JV CMBS that we described. But no internal securitizations, that's right..

And we do have a follow-up question from the line of Jade Rahmani with KBW..

Just to make sure I didn't miss it. I believe you said that on the SBA side, volumes would be down in the fourth quarter sequentially, but there would be a positive 4Q earnings contribution on higher margins.

Overall, do you expect investment volumes across the -- origination volumes across the various business lines to be consistent quarter-over-quarter to be up? It sounds like there's momentum in some of the businesses, but not sure if you expect quarter-over-quarter there to be higher originations..

Andrew, I'll....

Yes. I think our....

Go ahead. Go ahead, Andrew..

Yes. Jade, in general, our pipeline is way up across all of our products. In the SBA segment, I do believe we are expecting a decline somewhere between $20 million and $30 million from the Q3 records, just because some portion of the Q4 pipeline was pulled forward due to the inclusion of P&I forgiveness in the CARES Act.

But we -- in terms of production, October acquisitions have exceeded total acquisitions for the third quarter. We are reemerging on the fixed rate business as well, which had been dormant for quite some time. And the transitional pipeline has really grown quite a bit.

So given all those, I think all channels with the exception of the SBA should be up quarter-over-quarter..

And there are no further questions on the line at this time. I'll turn the call back to Mr. Capasse for any closing remarks..

We appreciate everybody's continued support during these tough times, and look forward to our fourth quarter call. And hope everybody stays safe..

That does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines..