Edited Transcript of SLD earnings conference call or presentation 11-May-20 12:30pm GMT

In phase 1 of the COVID recession, we initiated a sequential 3-pronged focus on liquidity, meaning successfully meeting all margin calls to date, book value preservation through preemptive asset management offering forbearance to 10% of our borrowers to date and profitability with an emphasis on our 3 government-sponsored businesses, which I’ll discuss below. In phase 2, which we believe will be a prolonged economic recovery as the COVID restrictions ease, our all-weather business strategy of acquiring distressed, small balance, commercial, or SBC loans, along with gain on sale income from our government-sponsored lending businesses and gradual reemergence of SBC direct lending provide a path to profitability at higher post COVID ROEs.

In the commercial real estate lending segments, which include our stabilized fixed rate and floating bridge loan products, originations remain minimal as we remain highly disciplined in the deployment of capital.

These lending segments face 2 current challenges: First is the difficulty in underwriting property cash flows in the uncertain environment; second is the dislocation in the capital markets making securitization execution difficult. Accordingly, we shifted focus from front office production to proactive asset management and book value preservation for which we repurpose staff. The current portfolio consists of $4.2 billion of loans with pre-COVID weighted average LTVs of 60%. This low loan-to-value squares well with our 2020 forecast for SBC property price declines of 5% to 10%, which correlates to a 5% projected decline in residential home prices. As of today, 90% of the portfolio is contractually current compared to 97% at year-end. We will continue to proactively work with borrowers to help them get through the challenges presented by COVID, working to find mutually beneficial solutions.

In our government-sponsored lending segments, which includes SBA 7(a), Freddie Mac small balance multifamily and residential mortgage banking, lending volumes are strong. These businesses require modest capital to operate and generate healthy gain on sale revenue.

Our SBA lending segment continues to originate 7(a) loans to businesses that remain operational, and the secondary market remains open and will benefit from inclusion in the pending Fed’s TALF program. In addition, our normal 7(a) activities — in addition to our normal 7(a) activities, Ready Capital has been active in the treasury’s Paycheck Protection Program, or PPP, which provides for forgivable loans to small businesses in need. As 1 of 14 SBA approved nonbank lenders, when Congress passed the legislation in early April, we committed to do everything we could to provide financial support to small business owners across America during a time when they need it most. Many small businesses we interact with nationally were likely not to have been accepted in round 1 of PPP as traditional bank lenders generally focused on existing clients and large businesses.

In our signing on to the program, we did not prioritize existing customers or new customers. Our mission was and remains to help as many true small businesses as possible, such as local delis, nail salons and local shop owners. The challenge of underwriting these smaller borrowers was significant and often dealt with changing program requirements. However, from the start, our goal is to help the smallest of the small without prejudice. In round 1 of PPP, Ready Capital approved approximately 40,000 applications approaching $3 billion. While there have been some challenges outside our control that have caused some delays in the distribution of funds, we have facilitated the funding of $2.1 billion through last Friday and are actively working through the remaining population to disperse funds as quickly as possible. Ready Capital was in a neat position not only of having more PPP loan applications to fund than any other financial institution in round 1, but also the smallest average balance with 50% under $25,000 and over 20% comprising sole proprietors.

Now activity in our Freddie Mac multifamily segment remains elevated above prior year’s level due to the decline in the 10-year treasury to 70 basis points making Freddie’s SBL rates more competitive with banks rates tied to more inelastic deposit rates. Year-to-date, we have closed approximately $200 million with the current money up pipeline in excess of $175 million. We expect with rates down nearly 50 basis points that origination levels will continue to remain elevated.

Our residential mortgage banking segment, which continues to perform well despite economic uncertainty, is benefiting from refinancing volume from the first quarter decline in the 10-year U.S. treasury. The quarterly $691 million in — of first quarter volume was supported by a record $317 million in March, topped by April production of $422 million. With demand in excess of production capacity, margins have remained elevated, which is reflected in the $9 million quarterly increase in net mortgage banking income.

In March, Ginnie Mae and the FHFA instructed servicers to implement mandatory 6-month forbearance on existing mortgage-backed securities for which the servicer must continue to advance various amounts of principal and interest and corporate expenses.

To reduce the advance burden, Ginnie Mae announced a servicer advance facility and the GFEs curtailed the advance obligation from 12 to 4 months. As of April month end, approximately 1% of our loans were in forbearance, below national averages, and we believe we have adequate liquidity to meet peak projected forbearance.

As some of our long-term shareholders may know, Ready Capital’s beginnings were rooted a decade ago in the acquisition of over $5 billion in distressed small balance commercial loans post the last recession. We believe that the current economic climate will lead to opportunities that leverage that skill set. These distressed loan acquisitions typically lead to higher ROEs and require minimal fixed overhead. We will continue to increase liquidity so that we are able — we are in a position to take advantage of the opportunities as they arise.

In addition to the continued operations of the business, management of liquidity and the reduction of mark-to-market liabilities remains important. As of May 8, the company had total liquidity of approximately $100 million consisting of cash and availability in undrawn committed warehouse lines.

Additionally, unencumbered assets of $296 million may provide additional liquidity as we work to pledge them to existing facilities or selectively market for sale. Since the start of the COVID pandemic, the company has met all obligations related to its mark-to-market liabilities. These obligations, which consist of margin calls and additional funds needed to roll short-term repurchase obligations, have totaled $96 million.

In addition to liquidity management, we have focused our efforts on reducing short-term liabilities, which has included selling securities when pricing levels have been favorable. Since the December 31 balance sheet, we have reduced the net settlement amount of our short-term repo 35% to $191 million. We will continue efforts to reduce risk in the portfolio and continue to evaluate capital raising efforts to fund growth opportunities.

Finally, I would like to discuss the status of our loan portfolio and funding sources. Unlike our large balance peers, our loan portfolio is granular with strong collateral coverage. The current $4.2 billion portfolio held for investment consists of over 4,500 loans with an average balance of approximately $900,000. 99% of the portfolio are first liens with a 60% average loan-to-value.

Further, exposure to COVID-sensitive sectors is relatively modest. In our SBC segment, collateralized by investor-owned properties where we have invested 52% of shareholders’ equity, retail is 21% and hospitality is 6% of our total gross loan portfolio. The average balance of our SBC retail exposure is only $1.5 million, reflective of the company’s limited exposure to malls and big box retail.

In our SBA segment, where we’ve invested approximately 10% of shareholders’ equity, total exposure to hospitality and restaurants is approximately 40%. On the funding side, 64% of the loan portfolio is funded with nonrecourse securitizations, and the earliest maturity of our corporate debt is April 2021.

In May, the new issue market for commercial mortgage-backed securities and CRE collateralized loan obligations is gradually reopening. As such, in addition to this channel, we are exploring ways to fund our existing warehouse lines on a non-mark-to-market term basis, including delevering through asset sales.

We continue to focus substantial resources on proactive asset management and have robust procedures in place for monitoring watch list assets and migration of loans between risk buckets. These efforts include processing hardship and forbearance requests, frequent communication and updates from borrowers, lender updates, reporting and liquidity management. We currently use a risk model which buckets loans in categories between 1 and 5. Buckets 4 and 5 represent the riskiest assets in the portfolio and currently comprise only 9% of total collateral, including those supporting unconsolidated mortgage-backed security positions.

So with that, I’ll now turn it over to Andrew.

——————————————————————————–

Andrew Ahlborn, Ready Capital Corporation – CFO & Secretary [4]

——————————————————————————–

Thank you, Tom. Beginning with earnings, our results were significantly impacted by the current COVID economic climate. GAAP losses were $0.98 per share. The quarterly loss was driven by a $35 million reserve related to the Q1 implementation of CECL, a $12 million mark-to-market decline in held-for-sale CMBSs and a $16 million decline in the valuation of our residential mortgage servicing rights.

Core earnings were $0.01 per share. Core earnings has been adjusted to exclude both the CECL reserve and the decline in residential MSR values, but includes the mark-to-market loss on CMBS and specific reserves on nonperforming loan collateral. Absent these 2 items, core earnings would have been $0.32 per share. Beginning on January 1, 2020, we adopted CECL, the new accounting standard which requires us to estimate and record a noncash provision for future credit losses against all loans in the portfolio, not otherwise subject to fair value accounting. To determine the CECL reserve, we supplemented our historical track record of 0 losses with securitized loan data licensed from Trepp. Although the Trepp data is not a perfect match given the small balance focus of our business, we were able to tailor the model to be insightful into our portfolio.

The CECL reserve on the March 31 balance sheet contains 2 components, which include the initial reserve on January 1 and the change in that reserve on March 31. The impact of COVID-19 has caused this allowance to increase during the first quarter, reflecting the current economic environment.

On January 1, we recorded initial reserve of $6.6 million, or a $0.13 per share reduction in book value. At March 31, our assumptions on the economic indicators changed significantly, resulting in an additional $35 million reserve or $0.68 cents loss per share. To be clear, I want to make the point that this is a noncash allowance. The portfolio subject to CECL did not incur any losses during the quarter, and we suspect that over time our CECL reserve may migrate back to levels consistent with our initial implementation on January 1.

The significant decline in the value of our available-for-sale CMBS securities was in part driven by the current liquidity in the market, inflamed by periods for selling. Based on our analysis, we believe the underlying collateral will support valuations above these distressed marks as liquidity returns to the markets over time.

In fact, we have selectively sold a handful of positions after quarter end at average premiums of 21% to the March 31 month end mark. The $16 million decline in the market value of our residential MSRs was driven by the historic low tenured U.S. treasury and an increase in our CPR assumptions, which was mitigated by an industry-leading 40% retention rate.

We believe that in comparison to prior rate rallies, the convexity profile of our current MSR book is superior due to the low absolute level of the 10-year U.S. treasury and limited production and servicing capacity in the mortgage banking industry. Near term, this limits further downside with prospects for improved valuation even with modest rate increases. Longer term, the dislocation in the mortgage banking industry from COVID-19 and GMFS’ eligibility as an MSR purchaser from all 3 agencies presents attractive distressed MSR acquisition opportunities.

Away from CECL accounting and the MSR declines, profitability from net interest margin gain on sale revenue and mortgage banking activities continue to be robust. Interest income increased $5 million quarter-over-quarter. Gain on sale revenue in the 7(a) and Freddie Mac businesses totaled $2.4 million supported by strong volumes and stabilized sale premiums. Mortgage banking income reached record levels due to high demand and elevated margins. On the balance sheet, recourse leverage is 2.8x. The quarterly increase is due to draws on available borrowing basis and a reduction in stockholders’ equity, primarily due to noncash CECL reserves and unrealized losses on fair value assets. The portfolio subject to mark-to-market liabilities totals $1.5 billion, including $775 million of bridge loans and $200 million of fixed rate loans, both slated for securitization before COVID impacted the new issuance markets.

Book value per share declined $1.60 to $14.52 per share. This decline was driven by CECL, unrealized losses and the quarterly dividend. As we have done in previous quarters, the supplemental deck provided this morning includes summary information on the company’s earnings profile, various operating segments and key financial metrics. Instead of taking you through the deck, I would like to draw your attention to Slide 3 and 5.

Slide 3 outlines the various ways in which our business has been affected by COVID and the strategies we are undertaking to ensure the long-term health of the business. Slide 5 provides additional insight into the CECL reserve implemented in the quarter.

Before turning it back to Tom, I would like to echo his previous comments. I hope you’re all safe and sound, and my thoughts are with all who have been impacted by the COVID pandemic. Tom?

——————————————————————————–

Thomas Edward Capasse, Ready Capital Corporation – Chairman & CEO [5]

——————————————————————————–

Even in these unprecedented times, Ready Capital continues to originate and deploy capital across our diverse platform. As discussed, we continue to successfully navigate phase 1 of the COVID recession with adequate liquidity and small relative declines in book value. In subsequent quarters, we will strategically position the company for Phase 2 of the COVID recovery, where our all-weather business model providing for potential net interest income from acquisition of distressed SBC assets along with gain on sale income from our capital-light government-sponsored lending segment represents unique earnings potential.

It will certainly take time for the country to emerge from this crisis, but our focus will remain on the areas of the business we can control, and we’ll work as a team to navigate and emerge in a position that builds on past success. We appreciate your patience and support, and hope everyone remains healthy and safe.

So with that, operator, we’ll now open it up for questions.

================================================================================

Questions and Answers

——————————————————————————–

Operator [1]

——————————————————————————–

(Operator Instructions) The first question comes from Tim Hayes with B. Riley FBR.

——————————————————————————–

Timothy Paul Hayes, B. Riley FBR, Inc., Research Division – Analyst [2]

——————————————————————————–

Tom and Andrew, I hope you’re both doing well. My first question, Andrew, you mentioned some select asset sales so far in the second quarter. Can you maybe just size that up for us, what you’ve been selling at what type of discounts to your basis? And the — and maybe just how you’ve been able to deleverage in light of those asset sales so far?

——————————————————————————–

Andrew Ahlborn, Ready Capital Corporation – CFO & Secretary [3]

——————————————————————————–

Yes. Tim, the majority of the sales is focused in the CMBS book. They have been selective sales, meaning we are not in a position for selling any parts of the balance sheet at least today. It’s been relatively small, focused on one particular series thus far. It’s totaled around $35 million in sales and the — as we said in the script, they were sold at premiums roughly 20% above the March month end balance sheet mark, but closer to our historical basis. We continue to explore other securities in the portfolio, including CUSIP and whole loans. And if we see pricing that we believe to be accretive to the business, we may choose to further sell down parts of both of those books.

——————————————————————————–

Timothy Paul Hayes, B. Riley FBR, Inc., Research Division – Analyst [4]

——————————————————————————–

Okay. Got it. So far not too much on that front. So I guess the second part of that question was just kind of a quarter — quarter-to-date update on leverage at this point. But I — sounds like maybe not — haven’t moved too much since period end?

——————————————————————————–

Andrew Ahlborn, Ready Capital Corporation – CFO & Secretary [5]

——————————————————————————–

Yes. I mean, the 2.8x leverage at March month end is a little deceiving. We had material increases in our available-for-sale loan portfolios in GMFS and Freddie. Both those are financed at 100%. So there’s — that number is going to fluctuate. The secured borrowings number is going to fluctuate a lot based on how those 2 businesses perform.

What I will say is, as we are rolling repos, haircuts are getting slightly wider, thus delevering that book. And we are — we’ll continue to explore ways, whether it’s through selective paydowns here and there or taking securities off of repo or trying to convert current mark-to-market liabilities into sort of term nonrecourse facilities. We are going to continue to utilize those tools to delever the recourse portion of our balance sheet.

——————————————————————————–

Timothy Paul Hayes, B. Riley FBR, Inc., Research Division – Analyst [6]

——————————————————————————–

Okay. That’s helpful. And then moving over to just the forbearance activity you’ve seen, I guess, 10% of the commercial book in forbearance so far, 7% on the resi side. What measures have you taken to provide forbearance and how have you seen requests continue to increase in May? I’m just curious if there’s like an internal estimate of where you might see these forbearance rates go on either the commercial or resi side?

——————————————————————————–

Thomas Edward Capasse, Ready Capital Corporation – Chairman & CEO [7]

——————————————————————————–

Yes. Actually we have Adam — Andrew, go ahead.

——————————————————————————–

Andrew Ahlborn, Ready Capital Corporation – CFO & Secretary [8]

——————————————————————————–

Yes. So Tim, we actually have [Adam Zausmer] on the call with us today. He runs credit for all of Ready Capital. So he’s probably best positioned to answer that question. So I’m going to turn it over to him.

——————————————————————————–

Unidentified Company Representative, [9]

——————————————————————————–

Tim, so we continue to proactively work with our clients to help get them through these challenges. Client discussions have been collaborative, and we recognize that operational and cash flow disruption, especially in the hospitality and retail properties, given the nationwide shutdowns, not the fault of our clients, right? But as Tom and Andrew mentioned, the 10% that are currently evaluating the hardship requests. We’ll likely execute those forbearance agreements, most of them are 3 months. Our team of asset managers continues to evaluate loan by loan. So as COVID-19 impacts operations and cash flow, in general, we’re just looking to ensure that the collateral is well positioned during this period of disruption. We may allow sponsors to utilize reserves for debt service payments and some other creative things. But in general, call it between 10% and 15% is what we are kind of potentially going to execute forbearances on. There’s 4,500 loans in our portfolio. As you know, the majority is small balance. So we do expect that. It could increase slightly, but I think towards the end of March, early April, is where we saw the biggest wave. So we’re just getting through that now working with the servicers to get them executed.

——————————————————————————–

Thomas Edward Capasse, Ready Capital Corporation – Chairman & CEO [10]

——————————————————————————–

I just want to add one thing Adam to that. In our script, there was a reference to forbearance on the GMFS side, it’s not 1%, it was 7%, but that’s consistent with on the residential MSRs, and that’s consistent with the current national average, and we have adequate liquidity currently to fund those advances.

——————————————————————————–

Timothy Paul Hayes, B. Riley FBR, Inc., Research Division – Analyst [11]

——————————————————————————–

And Tom, do you have an estimate — I know Fannie May put an estimate out there for where they see forbearance rates going, which, I guess, is kind of the high end of what Adam’s comments were broadly, but just curious if you have an estimated capital need for those advances if we do kind of hit that estimate?

——————————————————————————–

Thomas Edward Capasse, Ready Capital Corporation – Chairman & CEO [12]

——————————————————————————–

Sorry, estimate for GMFS as it relates to their peak projected advances?

——————————————————————————–

Timothy Paul Hayes, B. Riley FBR, Inc., Research Division – Analyst [13]

——————————————————————————–

Yes, correct.

——————————————————————————–

Thomas Edward Capasse, Ready Capital Corporation – Chairman & CEO [14]

——————————————————————————–

Are you talking about the market? Yes. Andrew, you want to add — I think our — for their market, Southeast is probably more like in the 15% area. So Andrew, do you have a view in terms of sizing for the — go ahead.

——————————————————————————–

Andrew Ahlborn, Ready Capital Corporation – CFO & Secretary [15]

——————————————————————————–

Yes. Tim, it’s going to be hard to put an estimate out there based on just the level of uncertainty in the number. So we’re probably going to hold off on putting out an estimate at this time.

——————————————————————————–

Timothy Paul Hayes, B. Riley FBR, Inc., Research Division – Analyst [16]

——————————————————————————–

Okay. That’s fine. I know it’s a fluid situation. So we’ll just look for updates as they come across.

——————————————————————————–

Operator [17]

——————————————————————————–

The next question comes from Steve Delaney with GMP Securities.

——————————————————————————–

Steven Cole Delaney, JMP Securities LLC, Research Division – MD, Director of Specialty Finance Research & Senior Research Analyst [18]

——————————————————————————–

Tom and Andrew, and first, thank you for your strong and patriotic support of the PPP program. A question on that is how much continuing opportunity beyond the $3 billion and reported applications do you see? And can you disclose what the fee revenue opportunity was for Ready Capital in participating in that program?

——————————————————————————–

Thomas Edward Capasse, Ready Capital Corporation – Chairman & CEO [19]

——————————————————————————–

Andrew, I can comment on the program more broadly, and then maybe you can talk about the second part of Steve’s question. But as it relates to the PPP program, it has evolved very significantly based on feedback from small businesses and what have you. And so round 1 went — as everybody knows, went very quickly. Round 2, I think, Andrew, has around 40% left, and it’s been much slower and a lot of that had to do with the concern that you may have seen in the broader press about the methodology for the forgiveness, application and forgiveness, which we’re still waiting, which were — there’s pending guidance from the SBA. So I think that significantly slowed down the volume in round 2 in large part because of the conundrum of the small business that may have to retain staff today, but not sure if they get reopened tomorrow. So anyways, Andrew, I just made that broad observation in terms of the program, maybe you just comment on in terms of the cost involved in this program.

——————————————————————————–

Andrew Ahlborn, Ready Capital Corporation – CFO & Secretary [20]

——————————————————————————–

Yes. Steve, so what I would say is in the program there, the gross fees that are prescribed in the program docs are going to get shared amongst a variety of partners. Those include agents who referred loans, they will include financing costs, which include both the cost of the carry as well as some split of the upfront economics on the fee as well as split on the fee in the event we have sold loans. So it’s hard for me to pin down the exact number just given that the population is moving and the methods in which we’ve chosen to fund these loans is diverse. But what I can say to you is, I think, the gross fees will be materially cut down to the net economics that ultimately results on the Ready Capital Q2 income statement.

——————————————————————————–

Steven Cole Delaney, JMP Securities LLC, Research Division – MD, Director of Specialty Finance Research & Senior Research Analyst [21]

——————————————————————————–

Got you. Well, you did the right thing and hopefully, it wasn’t about a profit opportunity. You did the right thing. And hopefully, you’ll at least breakeven or make a little bit out of it for your efforts, and we appreciate it. My follow-up question would be — go ahead, Andrew, I’m sorry.

——————————————————————————–

Andrew Ahlborn, Ready Capital Corporation – CFO & Secretary [22]

——————————————————————————–

Yes, Steve, this is — So I just — just to clarify, I do expect that Ready Capital will earn revenue through this program. So I don’t want to give the impression it’s been a sort of a breakeven effort. Based on some of the information we’ve put out there, one can deduce that gross fees on that population of loans is in excess of $100 million. That $100 million, what I’m saying is going to be materially reduced over the next — when we get to the final numbers, but certainly don’t want to give you the impression that is a breakeven number for us.

——————————————————————————–

Steven Cole Delaney, JMP Securities LLC, Research Division – MD, Director of Specialty Finance Research & Senior Research Analyst [23]

——————————————————————————–

Okay. Thanks for that clarification. You mentioned you had remaining short-term repo of $190 million. I assume that was a March 31 figure. Two questions on that. I mean, can you give us an updated — I think you have sold some — you mentioned you had sold some securities, $35 million. Can you give us a current up-to-date figure for short-term repo? And just generally describe what the nature of the collateral would be underneath that repo?

——————————————————————————–

Andrew Ahlborn, Ready Capital Corporation – CFO & Secretary [24]

——————————————————————————–

Yes. So the majority of securities we have on repo include retained bonds from our fixed rate program. Freddie Mac securities from our SBL program and some selective bonds we’ve acquired over the years. The $191 million is a net settlement amount today, so the gross loan amount net, whatever margin we paid since the last roll. As I said earlier, we have selectively paid down or sold certain securities, which has also further reduced that number. What I’ll say is that, that number has decreased through April just due to haircuts widening in — when those securities roll. And so the number — the net number probably is around $175 million today just based on the delevering in April from the natural rolls.

——————————————————————————–

Operator [25]

——————————————————————————–

The next question comes from Jade Rahmani with KBW.

——————————————————————————–

Jade Joseph Rahmani, Keefe, Bruyette, & Woods, Inc., Research Division – Director [26]

——————————————————————————–

Hope you’re all well and in good health. I wanted to ask, just high level, do you expect Ready Capital to be profitable for the next — for the year, perhaps excluding the noncash charges in the first quarter?

——————————————————————————–

Andrew Ahlborn, Ready Capital Corporation – CFO & Secretary [27]

——————————————————————————–

Yes. So Jade, obviously, the noncash charges in the first quarter were significant. Absent those, we do suspect, and it’s clearly very uncertain. And a lot of it will depend on how the economic recovery unfolds. But given strong gain on sale business activity, given PPP economics and given our projections on where we think sort of portfolio defaults will go, we do believe that Ready Capital will be profitable in 2020.

——————————————————————————–

Jade Joseph Rahmani, Keefe, Bruyette, & Woods, Inc., Research Division – Director [28]

——————————————————————————–

Okay. And the $100 million in fee earnings that you referenced, was that with respect to SBA originations? Then that would be a gross revenue number. Can you give any sense for what the net profit contribution might be?

——————————————————————————–

Andrew Ahlborn, Ready Capital Corporation – CFO & Secretary [29]

——————————————————————————–

Yes. So to be clear, the $100 million I referenced is specifically related to the PPP. So within the PPP program, the gross fees on those originations range from 5% to 1% depending on loan size, 5% being paid for loans that are under $350 million. Based on Tom’s comments earlier, the majority of our portfolio falls in that bucket. So the gross fee earned is going to be that 5% on the balance of PPP loans originated.

Now there are prescribed agent fees in the program that come right off the top, if that loan was referred into ready capital. And then there are various ways in which that fee after the agent is paid is being allocated amongst all the partners who are contributing within our population to get those funds in the hands of the small business. So that’s how that number is going to come down off of that $100 million number I referenced, it’s hard for me to pin down at this time what that net number is going to be. So I’m going to hold off on commenting there. But I suspect it’s going to be in the range of, let’s call it, 35% to 50% of that number.

——————————————————————————–

Jade Joseph Rahmani, Keefe, Bruyette, & Woods, Inc., Research Division – Director [30]

——————————————————————————–

The $100 million, is that a fee revenue number? Is that an originated balance under the PPP program?

——————————————————————————–

Andrew Ahlborn, Ready Capital Corporation – CFO & Secretary [31]

——————————————————————————–

That is a fee revenue number.

——————————————————————————–

Jade Joseph Rahmani, Keefe, Bruyette, & Woods, Inc., Research Division – Director [32]

——————————————————————————–

Okay. So potentially, earnings from that program in the second quarter could be 35% of the $100 million?

——————————————————————————–

Andrew Ahlborn, Ready Capital Corporation – CFO & Secretary [33]

——————————————————————————–

That’s correct.

——————————————————————————–

Jade Joseph Rahmani, Keefe, Bruyette, & Woods, Inc., Research Division – Director [34]

——————————————————————————–

Okay. Can you go through a range of perhaps cash sources and uses for the balance of the year? And if you expect the company to be cash flow positive?

——————————————————————————–

Andrew Ahlborn, Ready Capital Corporation – CFO & Secretary [35]

——————————————————————————–

Yes. So certainly, we’ve made the decision over the last 6 weeks to really curtail any lending or investing opportunities that require use of capital. So we have not originated bridge or fixed loans during this period of time and suspect that we will continue to be highly selective in when we choose to do so over the next few months until we have more certainty in the economy.

Our other business segments are those gain on sale businesses. They don’t require any capital. The 7(a) is cash neutral, Freddie is cash neutral, GMFS is cash neutral. And so our active lending activities are not requiring use of the balance sheet. Continued uses of cash will include fixed operating expenses, including our employees, rent, things like that, which we will continue to adjust and rightsize to the business activities and then management of our mark-to-market liabilities. On the sources side, it’s going to continue to be revenue generated from active lending segments as well as just the normal P&I from the company. Additionally, in the event we see the right opportunities to do so, we will evaluate selling certain parts of our portfolio to generate liquidity.

——————————————————————————–

Jade Joseph Rahmani, Keefe, Bruyette, & Woods, Inc., Research Division – Director [36]

——————————————————————————–

Okay. In terms of margin call risk, could you give a number with respect to the value of loan balances subject to the margin calls? And secondly, if there’s also any cash management triggers within the CLOs that you’ve issued?

——————————————————————————–

Andrew Ahlborn, Ready Capital Corporation – CFO & Secretary [37]

——————————————————————————–

Yes. So right now, we have around $1.5 billion of loans on warehouse. So that’s the number that’s — of exposure there on the loan portfolio. What I’ll say you is our lenders have been very constructive in our conversations and continue to be supportive of their involvement in the SBC space. Maybe I’ll turn it over to Adam to talk a little bit about how we’re managing those relationships and then your question on the CLO.

——————————————————————————–

Unidentified Company Representative, [38]

——————————————————————————–

Yes. So yes, I mean, I think in regards to our warehouse lenders, certainly transparency is key, walking them through loan level assessment that we have of each of the assets on the line. So we’ve been having a really good dialogue with our partners. A lot of good Q&A regarding updates that we’re getting from clients, our thoughts around value of the assets. So certainly, we’re going to maintain that and produce whatever is required from our warehouse partners to help through this challenging time.

In regards to your question on the CLO, as you know, these loans are — there’s a lot of structuring that goes into these loans, there’s cash flow suites, there’s interest reserves. So depending on the situation that asset managers go through, there could be situations where there could be a cash flow sweep, and we’re applying the — we’re applying the funds to debt service to make the monthly payment.

——————————————————————————–

Andrew Ahlborn, Ready Capital Corporation – CFO & Secretary [39]

——————————————————————————–

Yes. Jade, sorry, there are no cash triggers in our deal.

——————————————————————————–

Jade Joseph Rahmani, Keefe, Bruyette, & Woods, Inc., Research Division – Director [40]

——————————————————————————–

Okay. Just lastly, on the dividend, I’m not sure if you could comment high level expectations or just policy meetings? And if you could specifically say whether you believe the management and Board’s preference should be toward suspending the dividend for conservatism sake or to pay dividends through stock — pay stock dividends. Personally, I think suspending the dividend would be preferable than stock dividend, but wanted to hear what you are thinking.

——————————————————————————–

Thomas Edward Capasse, Ready Capital Corporation – Chairman & CEO [41]

——————————————————————————–

Andrew, why don’t you — this was obviously a very important Board topic. So Andrew, why don’t you kind of walk through Jade’s question regarding the dividend.

——————————————————————————–

Andrew Ahlborn, Ready Capital Corporation – CFO & Secretary [42]

——————————————————————————–

Yes. So Jade, in terms of a dividend amount, I think a lot of that is going to be dependent on the performance of the business, rightsizing the dividend to taxable income as well as core performance is probably the path going forward.

What I can say is we do not plan on issuing stock dividends going forward. Now I can’t predict every event in the future. So that may change, but it is not our intention nor do we plan on issuing stock dividends in subsequent quarters. With that being said, given our desire to maintain liquidity and even increase liquidity, I think we’ll reevaluate or the Board will reevaluate the dividend amount as we get closer to quarter end to see how the business has performed and to reset expectations of how the business will perform in the future. So although we can’t put a number on it today, what I can tell you is, I do not anticipate stock dividends being part of it.

——————————————————————————–

Operator [43]

——————————————————————————–

The next question comes from Stephen Laws with Raymond James.

——————————————————————————–

Stephen Albert Laws, Raymond James & Associates, Inc., Research Division – Research Analyst [44]

——————————————————————————–

Following up on the PPP questions, as far as fundings that you’ve seen, are these loans that were round 1 overflow? Or how much of the fundings were actually new applications post round 1?

——————————————————————————–

Thomas Edward Capasse, Ready Capital Corporation – Chairman & CEO [45]

——————————————————————————–

Yes. So thanks for the question. Our round 2 activities have been more muted than our round 1 efforts. So although that is subject to change given that the velocity of round 2 funds has been much, much lower than round 1. At this time, the amount of round 2 applications we have taken in is much, much lower than our round 1 activity.

——————————————————————————–

Stephen Albert Laws, Raymond James & Associates, Inc., Research Division – Research Analyst [46]

——————————————————————————–

Great. And then I think that in the prepared remarks, you said $3 billion approved of $2.1 billion funded, which I assume is getting us to that roughly $105 million at 5% on the gross revenue contribution. Should we expect the remaining $95 million or an incremental $45 million of potential gross revenue to fund this quarter? Or how much of the remaining $900 million approved do you expect to fund?

——————————————————————————–

Thomas Edward Capasse, Ready Capital Corporation – Chairman & CEO [47]

——————————————————————————–

Yes. We expect to fund a large percentage of that. There will be some fallout from the population, but we suspect we will fund the majority of that population over the upcoming days.

——————————————————————————–

Stephen Albert Laws, Raymond James & Associates, Inc., Research Division – Research Analyst [48]

——————————————————————————–

Great. And then lastly, I think on that topic that I have, so we know the fees you’re entitled to, at least at the gross level. When do you actually receive those fees and they hit your balance sheet as cash?

——————————————————————————–

Thomas Edward Capasse, Ready Capital Corporation – Chairman & CEO [49]

——————————————————————————–

Yes, it’s probably going to be 45 to 60 days out. There are some forms that need to be filed with the SBA. There’s other arrangements we’ve made with our counterparties in this transaction that affect the timing of that, but I think 45 to 60 days in a good estimate.

——————————————————————————–

Stephen Albert Laws, Raymond James & Associates, Inc., Research Division – Research Analyst [50]

——————————————————————————–

And I guess as a follow-up to that, just to be sure you don’t — they don’t receive their cut of the fees until you do, correct? You don’t have to advance or front any of that.

——————————————————————————–

Thomas Edward Capasse, Ready Capital Corporation – Chairman & CEO [51]

——————————————————————————–

Correct.

——————————————————————————–

Stephen Albert Laws, Raymond James & Associates, Inc., Research Division – Research Analyst [52]

——————————————————————————–

Great. Okay. Fantastic. Shifting to — let me hit on advances real quick. Do you have a breakdown of your advanced obligations across the GSEs and any non-agency or maybe a better preferred way would be how much of your interest in principal advances are on a scheduled versus actual basis?

——————————————————————————–

Andrew Ahlborn, Ready Capital Corporation – CFO & Secretary [53]

——————————————————————————–

So I don’t think we’ve put out — go ahead, Tom.

——————————————————————————–

Thomas Edward Capasse, Ready Capital Corporation – Chairman & CEO [54]

——————————————————————————–

I was going to say just we haven’t put out any specific quantitative analysis around each of the Fannie, Freddie, Ginnie. But Ginnie, you have to advance 80% of P&I, and there is an availability of a facility for that. And then for Fannie and Freddie, there’s — they’ve curtailed the advance obligation on P&I to — from 12 to 4 months. So we feel, if you size it up, let’s say, it doubles from the current 7 they have — GMFS has availability under the current warehouse lines as well as the Ginnie Mae facility if it was required. So we feel comfortable in terms of the adequacy of liquidity for that on a peak advance basis. And Andrew, if you’d add to that?

——————————————————————————–

Andrew Ahlborn, Ready Capital Corporation – CFO & Secretary [55]

——————————————————————————–

No. I don’t think of any, Tom.

——————————————————————————–

Stephen Albert Laws, Raymond James & Associates, Inc., Research Division – Research Analyst [56]

——————————————————————————–

Okay. Great. And lastly, just wanted to touch on the financing facilities. I appreciate the disclosure on Page 16 of your supplement. A number of maturities here in 3 to 12 months, I believe. Do these have extensions at your option? Or can you talk about how those discussions on renewing those facilities are going? Or given the changes in the business, are there different facilities that you need to put in place to support the strength in the business lines you’re seeing today and some of these other facilities maybe are no longer necessary. So any comments around additional color on Page 16 would be great.

——————————————————————————–

Thomas Edward Capasse, Ready Capital Corporation – Chairman & CEO [57]

——————————————————————————–

Yes. So it certainly depends facility by facility. There are certain facilities where it’s at our option, there’s other facilities where it’s not. What I will say is that our talks to date with our existing lenders have been highly constructive and supportive. We continue to believe that they are in the business of SBC and SBC asset class long term. So we have not got indications that continued talks would not be positive. With that being said, our goal over time is to figure out ways in the absence of the new issuance market, which we hope will rebound shortly. But in the absence of that, exploring ways to move, recourse that to nonrecourse. And so we are continuing to explore what that may look like. So that’s sort of the way that we’re in right now.

——————————————————————————–

Stephen Albert Laws, Raymond James & Associates, Inc., Research Division – Research Analyst [58]

——————————————————————————–

Great. And 1 last question. On the residential mortgage origination business, maybe at the higher level, how much of those approvals are automated or even if not fully automated, how much is recent development is going to impact the processing time line and how that pipeline is approved when you consider things like potential employment gaps or taking unemployment under one of these government programs or some other help that maybe would have been an instant approval type refi, pre COVID is now something that’s going to get kicked out and need of a one-off approval. Any comments around the impacts of that on processing the loan applications going forward?

——————————————————————————–

Andrew Ahlborn, Ready Capital Corporation – CFO & Secretary [59]

——————————————————————————–

Yes. So — no, Tom.

——————————————————————————–

Thomas Edward Capasse, Ready Capital Corporation – Chairman & CEO [60]

——————————————————————————–

Yes, I think the industry data, which was — go ahead. Sorry. I was going to say to process — yes, in terms of processing times, industry-wide, we did get guidance in terms of — in the last 2 weeks from the GSEs on both how to process self-verification of employment, given the obvious increase in unemployment; and secondly, somewhat related, the forbearance now being not a — the forbearance accrual now being put on the back end of the loan deferred as opposed to being a payment shock in the — at the end of the 6-month period.

So I think to answer to your first question, it’s, let’s say, application times were maybe 2 weeks, now it’s doubled on that basis. And as a result of that, the — that will extend the time lines, reduce the production amount by very small amounts. But I will say that the most fascinating thing, around many years in this industry, is the profitability on the production side due to the fact that the demand far exceeds the production capability of the mortgage banking industry. And as a result, you’re seeing that in the secondary — the profit margins on new production have — are up 2x to 5x, depending upon the month, week and the product type.

——————————————————————————–

Operator [61]

——————————————————————————–

(Operator Instructions) Next question comes from Crispin Love with Piper Sandler.

——————————————————————————–

Crispin Elliot Love, Piper Sandler & Co., Research Division – Director [62]

——————————————————————————–

Hope you’re doing well and staying safe. So 1 question on loan acquisition. So you guys seem to be pretty bullish on loan acquisition opportunities. Do you think those opportunities will be 2020 events or are likely more pronounced in 2021 as kind of the market kind of moves through what we’re going through right now? And then also, are there any specific areas in loan acquisitions where you expect to see the most opportunities?

——————————————————————————–

Thomas Edward Capasse, Ready Capital Corporation – Chairman & CEO [63]

——————————————————————————–

Yes, I would just say, first to answer your question, I would say it’s really more of a — it will — unlike the last financial crisis, which was more driven by bank — 800 banks had significant issues that required loan sales. This is more of a capital market, nonbank lending has taken a big slug of the SBC market. So I’d say the opportunity set will probably emerge late third quarter through 1Q 2021, and you’ll see 3 channels. One will be the banks. Obviously, the — a lot of the — in particular, hospitality and what have you will be affected on their balance sheets. So we’re already starting to see pools aggregate for sale there at discount. The second channel will be these nonbank lenders on the transitional loan side. At the peak, I think we were tracking roughly over 200 lenders including the large commercial mortgage REITs. And yes, a significant chunk, maybe 1/3 of those are in our wheelhouse in terms of loan size. So we’re seeing a lot of potential sales on the transitional loan side at a discount. And the third is SBA. A lot of SBA lenders that we think this recession will create a shakeout in some lenders that were relatively aggressive on underwriting, we’re very conservative in terms of our expected losses versus some of our competitors. So we also see opportunities in the secondary market for SBA portfolios as well. So those 3 channels, we expect to emerge probably starting in late 3Q through 4Q into 1Q 2021.

——————————————————————————–

Crispin Elliot Love, Piper Sandler & Co., Research Division – Director [64]

——————————————————————————–

Okay. And then on the accounting treatment of the PPP loans, will all the net fees show up in net interest income? Or will they actually show up in the noninterest income side of the income statement? And then also, how long do you expect the loans to be on the balance sheet, the PPP loans?

——————————————————————————–

Thomas Edward Capasse, Ready Capital Corporation – Chairman & CEO [65]

——————————————————————————–

Crispin, I think the majority of the economics will probably flow through the other bucket of the income statement. And we do not suspect to carry much of production on the balance sheet at all. So a very small portion will retain on the balance sheet. The majority of it will be sold off balance sheet.

——————————————————————————–

Crispin Elliot Love, Piper Sandler & Co., Research Division – Director [66]

——————————————————————————–

Okay. Great. And then can you just talk a little bit about the kind of the health of the small businesses in your portfolio? Do you have any data on kind of how many have closed temporarily for right now? Or how many are kind of starting to reopen? And then also if any of the small business have actually closed permanently?

——————————————————————————–

Thomas Edward Capasse, Ready Capital Corporation – Chairman & CEO [67]

——————————————————————————–

Adam, are you on?

——————————————————————————–

Unidentified Company Representative, [68]

——————————————————————————–

Yes. So anywhere from 20%, 25% to 50% of of the businesses are closed, right? Obviously, like the restaurants that are having curbside pickup delivery remain open, majority of the hotels remain open. I’d say we think the Paycheck Protection Program is certainly going to help these businesses. And the SBA is also from a loss mitigation standpoint, they want to magnify this kind of pay print — principal interest in fees for 6 months. And then after that, RC is — Ready Capital is actually going to be able to process 3 months of deferment without SBA approval and then longer periods, if we go to the SBA. But I’d say where — we haven’t heard of businesses that have shut down completely and will not come back. But there’s still obviously a lot of uncertainty. In terms of businesses opening back up, obviously, that’s slowly happening as states are implementing some of the reopening. But I think the highlight, there’s still a ton of uncertainty out there. And I think these government programs, we kind of have to wait to kind of see how that plays out, but we do expect that these program is going to help our clients significantly.

——————————————————————————–

Thomas Edward Capasse, Ready Capital Corporation – Chairman & CEO [69]

——————————————————————————–

Adam, 1 question. What were the 2 specific programs the SBA is rolling out? One is the emergency direct lending program, which they implement themselves, and we obviously refer our borrowers to. What was the second one, the P&I deferrals?

——————————————————————————–

Unidentified Company Representative, [70]

——————————————————————————–

Yes. Well, at one-time was the economic injury disaster loans, obviously, the PPP. And then just the regular way deferments program. So as an SBA lender, we’re able to offer the 3-month deferment.

——————————————————————————–

Operator [71]

——————————————————————————–

The next question comes from Christopher Nolan of Ladenburg Thalmann.

——————————————————————————–

Christopher Whitbread Patrick Nolan, Ladenburg Thalmann & Co. Inc., Research Division – EVP of Equity Research [72]

——————————————————————————–

The loan loss reserve, are you guys targeting a loan loss reserve ratio?

——————————————————————————–

Andrew Ahlborn, Ready Capital Corporation – CFO & Secretary [73]

——————————————————————————–

No. So certainly, we’re not targeting anything specific. We will continue to, one, evaluate loans on a specific basis. So Adam and his team are going through the portfolio on a continuous basis to identify sort of problem or watch-list loans that warrant specific reserves. And then in addition to that, we will continue to use the Trepp data some of the assumptions around the more macroeconomic climate to drive sort of the general CECL reserve. So although we’re not targeting a specific number, I do suspect that as things move around and as we get more certainty on the portfolio, whether it be on the downside or the upside, the reserve number will change. Based on the current performance of the loans that have been included in the CECL reserve as of March 31, as the economy reopens, I suspect that, that reserve will revert back to a lower number. But it’s hard to tell just given the uncertainty in the general climate right now.

——————————————————————————–

Crispin Elliot Love, Piper Sandler & Co., Research Division – Director [74]

——————————————————————————–

Okay. So the reserve rate — yes, go ahead, please.

——————————————————————————–

Unidentified Company Representative, [75]

——————————————————————————–

Yes. And Andrew — yes — no, I was just going to stress that it would take a significant decline in collateral value to see losses on the portfolio just given that the weighted average loan-to-value on our collateral is 60%. But obviously, certainly, assessing case-by-case and the initial assessment that we did for Q1. Obviously, there’s going to be some follow-up to that as we get updates from our clients. But again, we feel that the portfolio is well protected, especially at the low leverage ratios and the structure that we have on it as well.

——————————————————————————–

Christopher Whitbread Patrick Nolan, Ladenburg Thalmann & Co. Inc., Research Division – EVP of Equity Research [76]

——————————————————————————–

I guess a follow-up question in terms of how well the loans are covered. If everything is closed, including courts and so forth, how do you guys intend to recover anything if there’s no judicial process working at the moment?

——————————————————————————–

Unidentified Company Representative, [77]

——————————————————————————–

Yes. I think there’s several — there’s really several — go ahead. I will follow up.

——————————————————————————–

Thomas Edward Capasse, Ready Capital Corporation – Chairman & CEO [78]

——————————————————————————–

No, Adam, please.

——————————————————————————–

Unidentified Company Representative, [79]

——————————————————————————–

Yes. I think we’re still several months away. These 4 — the majority of hardship requests that are coming up, there’s going to be — for the majority of the 3-month forbearances. So we’re really looking at 3 months, these loans will remain current, the ones that are having some of these issues, whether it’s business closures, we have a significant amount of nonessential tenants in retail centers, the hospitality assets. We have limited exposure to hospitality, but obviously, those assets have fairly low occupancy right now. As the market starts to rebound, states open up, and we believe that in 3 months, call it, July 1 through August is when to the extent that sponsor is unable to make a payment post the forbearance period, that’s when workouts could start, although we expect a limited amount given that we’ve got a lot of confidence in Fannie’s business plans. So in terms of courts opening, again, I think that’s something that we’re going to have to assess in 3 months from now. But currently, from a 60-plus delinquency standpoint, the portfolio was still right around 1%. So there’s not many workouts in our portfolio right now where we’re going to have to run-up against that. The limited issues that we’ve had in our portfolio, a handful of foreclosures that we’ve had through historical loan acquisitions, for instance, the court that we’ve spoken to, the process continues. We have receivers in place. So the world hasn’t stopped completely from a recovery standpoint. But again, just to highlight, I think that’s really something that we’re going to be dealing with in 3-month potential.

——————————————————————————–

Christopher Whitbread Patrick Nolan, Ladenburg Thalmann & Co. Inc., Research Division – EVP of Equity Research [80]

——————————————————————————–

Great. Final question is, what’s your recourse leverage target or threshold, I should say, in terms of the ratio?

——————————————————————————–

Andrew Ahlborn, Ready Capital Corporation – CFO & Secretary [81]

——————————————————————————–

Yes. So historically, we’ve targeted 2x. As I said earlier, this quarter was a little bit of an anomaly, given material increases on gain on sale production, corresponding with a significant reduction in stockholders’ equity. So over time, our goal continues to target that 2.0x ratio. And the increases this quarter as the marks in the securities and the MSR and CECL revert to more normal levels, that will, in part, drive that ratio further down.

——————————————————————————–

Christopher Whitbread Patrick Nolan, Ladenburg Thalmann & Co. Inc., Research Division – EVP of Equity Research [82]

——————————————————————————–

Okay. So we should expect the recourse leverage ratio to drift downward rather than upward?

——————————————————————————–

Andrew Ahlborn, Ready Capital Corporation – CFO & Secretary [83]

——————————————————————————–

Yes. It’s our intent to always manage the business to that 2.0x. So we’re actively taking steps to try and reduce that number. And surely, given that we have a large inventory of newly originated bridge and fixed rate product that was pretty far along in the securitization process. Should the new issuance markets open up, roughly $1.1 billion of assets on warehouse will immediately be converted into nonrecourse debt.

——————————————————————————–

Operator [84]

——————————————————————————–

This concludes the question-and-answer session. I would like to turn the conference back over to Thomas Capasse, CEO, for any closing remarks.

——————————————————————————–

Thomas Edward Capasse, Ready Capital Corporation – Chairman & CEO [85]

——————————————————————————–

Thank you for everybody’s support during the challenging time, and we look forward to next quarter’s earnings call.

——————————————————————————–

Operator [86]

——————————————————————————–

This concludes today’s conference call. You may disconnect your lines. Thank you for participating. And have a pleasant day.