Ready Capital Corporation (RC) Earnings Call Transcript & Summary

Greetings, and welcome to the Ready Capital Fourth Quarter 2023 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Andrew Ahlborn. Thank you, you may begin.

Thank you, operator, and good morning to those of you on the call. Some of our comments today will be forward-looking statements within the meaning of the Federal Securities Law. Such statements are subject to numerous risks and uncertainties that could cause actual results to differ materially from what we expect. Therefore, you should exercise caution in interpreting and relying on them. We refer you to our SEC filings for a more detailed discussion of the risks that could impact our future operating results and financial 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 fourth quarter 2023 earnings release and our supplemental information, which can be found in the Investors section of the Ready Capital website. In addition to Tom and myself on today's call, we are also joined by Adam Zausmer, Ready Capital's Chief Credit Officer. I will now turn it over to Chief Executive Officer, Tom Capasse.

Thanks, Andrew. Good morning and thank you for joining the call today. Despite broader headwinds, Ready Capital enters 2024 with a resilient business model and a proven ability to navigate challenging periods. As we look to 2024 and beyond, the key drivers that we will focus on to return to more historic level of earnings are less about current market conditions and the resulting credit pressures, but rather about our strategic capital redeployment from recent long-term value accretive M&A. While our prior acquisitions have led to short-term earnings impacts over recent quarters and we are cognizant it will take time to work through the persisting pressures, we believe executing our plan will generate meaningful long-term accretion. To begin, a quick recap of 2023. Full year distributable return on average stockholders' equity was 8.6%. The shortfall versus our 10% target was primarily due to a 250 basis point drag in ROE from M&A and a 25 basis point drag from the underperformance of our residential mortgage banking business. Our expectation is that the sale of underperforming assets, relevering equity from M&A, and exiting our residential business will begin to provide material net interest margin accretion through reinvestment of the current levered ROEs exceeding 14%. On the investment side, we have remained active in both our lower, middle market CRE and small business lending segments. On the CRE side, despite a year-over-year 68% decline in CRE industry transaction volume, we originated $1.7 billion across all products primarily comprising $1.3 billion of Freddie, small balance and multi-family affordable products and $333 million of bridge production. On the small business lending side, we originated $494 million with contributions from both our legacy SBA business focused on large loans and our FinTech iBusiness focused on small loans. This dual large small loan strategy uniquely positions our small business lending segment to achieve its target of $1 billion in annual production in the next 2 to 3 years. With only a 5% equity allocation, but an 18% full year distributable earnings contribution, the small business segment remains a material and we believe underappreciated aspect of our earnings profile. As we enter the back end of the CRE market cycle, our 2 primary areas of focus are credit and earnings growth. On the credit side, while not immune to the CRE macro environment, we are differentiated from the broader sector in terms of our concentration in lower middle market multi-family, more conservative vintage underwriting and avoidance of both overbuilt markets and high-risk CRE sectors such as office. As of December 31st, 60-day plus delinquencies in our originated and acquired CRE portfolios were 7.2% and 22.3%, respectively. My comments will focus on our originated portfolio, which represents 73% of total loans. The acquired portfolio concentrated in Mosaic, which closed in the first quarter of '22, and Broadmark, which closed in the third quarter of '23, featured combined purchase discounts for non-performing assets of 28%. We have liquidated 29% of the total acquired portfolio at prices above the combined purchase discounts. The main drivers of our 60-day delinquency are, first, multi-family, which is 78% of the loan portfolio. At quarter end, multi-family 60-day plus delinquency was 6.6%, as certain properties experienced NOI reductions driven by flat rent growth and increases in operating and interest costs. 71% of the new delinquencies in the quarter were attributable to one large sponsor across 4 loans. As of February 25th, 60-day plus delinquencies have been reduced to 5.5% through payoffs or modifications, which in most cases require an equity infusion from the loan sponsor. Second is office, which is only 5% of the CRE portfolio, but accounts for 21% of total delinquencies. 8 loans are delinquent with an average balance of $15 million, and notably only 2 have a balance greater than $20 million, the largest loan is $44 million. Our office portfolio is granular across 165 assets with an average balance of $3 million, but 70% of the delinquencies are collateralized by larger CBD properties located in Chicago, Denver and New York. Looking forward, in the current higher-for-longer rate outlook, we are focused on refinancing our current maturity ladder, of which 45% or $2.8 billion in multifamily loans reached initial maturity in 2024 and 31% and $1.9 billion in the first half of 2025. Historically, our core bridge strategy is to underwrite to take out our Freddie SBL license and 25 strategic partnerships, which provide access to all GSE multifamily channels. For example, in 2023, 64% of our bridge loans paid off at maturity, primarily via agency takeout, and 12% met the criteria for contractual extension. For the 11% of the multifamily portfolio currently rated 4 or 5, our asset management teams are executing modifications and extensions where supported by the business plans, and we are prioritizing on-balance sheet liquidity for related capital solutions. Notably with a mark-to-market LTV of less than 100% on this population, we do not expect any material erosion to book value from additional CECL reserves and modifications of 4% of the total originated portfolio remain comparatively low. Now, a few observations on our CRE CLOs. Like most in our peer group, we have historically used CLO financing as one of our secured financing options. Over the last 8 years, we've issued $7 billion with $5 billion outstanding, ranking number 4 with top quartile AAA spreads, largely a result of one of the most conservative and investor-friendly CLO structures. Specifically, our overcollateralization test is set at 1% versus the 3% average for the peer group, and our deals are static. Unlike managed deals, we are limited in our ability to swap collateral, prevented from repurchasing collateral until after 60-day delinquency is reached, and reliant upon the special servicer to manage decisions on asset resolution. This has 3 impacts versus the peer group. First is that CRE CLOs will trip test sooner. For example, our FL5, 9, 10 and 12 deals have tripped their IC or OC tests. Secondly, credit quality metrics will be skewed versus managed deals where the issuer can preemptively swap in performing loans before a loan is delinquent. And finally, our path to asset resolution via repurchase or modification is longer due to both the 60-day trigger and need to obtain special servicer approval on our asset management decisions. As of the February 25th remittance date, there were 12 loans 60-day plus delinquent inside of our CLOs. Of those, we expect 15% to pay off, 57% to qualify for modification and 27% to enter foreclosure. Modifications will require new equity contributions provide a bridge for properties to stabilize and reach agency takeup. Expected principal losses on these loans have been accounted for in our current CECL reserve. We expect as of the March remittance date that FL5, 9 and 12 will be above their IC and OC thresholds. On the earnings side, I want to lay out the bridge for increasing distributable ROE 250 basis points over the next 2 years, from the 7.5% in the fourth quarter to our 10% trailing 7-year average. First is reallocation of equity raised in the Broadmark merger into our core strategies. Since the third quarter 2023 merger close, 23% of the portfolio has liquidated of which the remaining $788 million at quarter end is yielding approximately 2.1% producing a current drag on ROE of 170 basis points. Currently we have actionable liquidations for 36% of the remaining portfolio with a budget to monetize the balance over the next 4 quarters. The anticipated contribution margin to ROE from full reinvestment of this equity into our current investment pipeline is 250 basis points. Second leverage, current leverage of 3.3x and recourse leverage of 0.8x are at historical lows below our target leverage of 4x to 4.5x. We expect to raise incremental debt capital over the upcoming months, with the resulting increase in leverage contributing 125 basis points to ROE. Third, the exit of residential mortgage banking which based on current planning is targeted for full liquidation by the end of the second quarter. Due to current mortgage rates, distributable ROE in this segment was laggard at 1.8% and we expect reinvestment of this capital to increase ROE 25 basis points. Fourth, growth of small business lending. The SBA 7(a) program continues to be the highest ROE segment where given its capital light nature growth in production does not require significant capital resources. With our stated long-term 7(a) origination target of doubling our current production to $1 billion every $100 million increase in volume adds an incremental 15 basis points to ROE. Last, cost structure. As part of the merger, we realize synergies on the OpEx side, cutting $19 million of Broadmark expenses. Given market conditions, we expect to continue to right size the cost structure and staffing levels with a target 40 basis points ROE contribution. Probability weighting each of these actions with a total 455 basis points increase in ROE alongside focused credit management over the next 12 to 18 months of the series cycle, we believe, will provide significant upside to the company's current earnings profile. We appreciate the continued support, understand the work ahead of us and firmly believe that the platform is built to both withstand current market pressure and grow earnings as we move forward. With that, I'll turn it over to Andrew.

Thanks, Tom and good morning. Quarterly GAAP earnings and distributable earnings per share were $0.12 and $0.26, respectively. Distributable earnings of $48.5 million equates to a 7.5% distributable return on average stockholder's equity. 2023 full year GAAP earnings and distributable earnings per share were $2.25 and $1.18, respectively, equating to an 8.6% distributable return on average stockholder's equity. On the balance sheet and income statement, residential mortgage banking has been accounted for as a discontinued operation with assets and liabilities consolidated into held-for-sale line items and net income included in discontinued operation. The main driver of the variance between our quarterly GAAP and distributable earnings were $3.2 million of the $6.7 million increase to our CECL reserve, a $20.7 million mark down of our residential MSRs, a onetime $5.5 million termination fee related to the refinance of a Mosaic lending facility, and a $3.7 million unrealized loss. The increase in our CECL reserve was due to a $15.8 million increase in specific reserves, offset by a release of reserves on our performing loan portfolio. The 7.5% distributable return on equity continues to be pressured by the effects of a decline in the retained yield of the portfolio as well as lower leverage. In the fourth quarter, the levered portfolio yield was 11.5%, down 9% from the same period of last year. The change is due to a 11% allocation into Broadmark assets, margin compression on the back book and increased REO from M&A. We expect levered yield to increase as the back book moves into our securitization vehicles and the Broadmark assets are repositioned into market yields. Net interest income declined $6.4 million quarter-over-quarter. The change was primarily due to a $5.5 million onetime charge upon the refinanced Mosaic lending facility, the migration of $258 million of loans to non-accrual and $2.6 million of interest expense related to the financing of non-performing Broadmark assets. Realized gains were up quarter-over-quarter due to increased SBA 7(a) production and sales with average premiums of 8.9% and $288 million of production in our Freddie Mac businesses. Servicing income increased $1 million quarter-over-quarter due to the recovery of previously booked impairment of our SBA and Freddie Mac servicing assets. Other income increased $14.2 million due to the recognition of ERC income. To date, we have processed $62.9 million of ERC contracts recognizing net income of $42.8 million. We expect this program to continue into 2024, albeit at a slower pace. The improvement in operating expenses was due to a reduction in staffing and related compensation expense, slightly lower servicing expenses as a result of lower advance reimbursement and lower transaction volume. On the balance sheet, liquidity remains healthy with $139 million in total cash and over $1.5 billion in unencumbered assets. Recourse leverage in the business declined to 0.8x and mark-to-market debt equals 17% of total debt. The company's debt maturity ladder remains conservative, with no material debt maturities until 2025, and the majority maturing past 2026. On the leverage front, we continue to explore multiple avenues of raising corporate debt. Markets for new issues have improved since the beginning of the fourth quarter and we are confident in our ability to access the markets in the upcoming month. Incremental capital raise will be deployed into our origination and acquisition channels, which are witnessing opportunities in excess of current capital levels. Book value per share was $14.10. The change is due to a $0.09 per share markdown of the residential MSR, a $0.04 per share reduction in bargain purchase gain and $0.06 of non-recurring items discussed previously. While we understand it will take time given current market conditions, we remain agile, creative and opportunistic to deliver differentiated credit solutions for our lower to middle market customers. As we execute on our strategy, we expect the power of our earnings to cover the dividend consistently and returns to migrate to historical levels. With that, we will open the line for questions.

[Operator Instructions] The first question we have is from Crispin Love of Piper Sandler.

Can you just talk a little bit about what recent credit trends could mean for potential losses, delinquencies have increased, but what kind of losses do you believe that could lead to just based on what current debt service coverage ratios are and LTVs in the book, and then how you might plan to work out some of the lower performing loans?

Andy, do you want to touch on the loss reserves and Adam, maybe touch on the credit component?

Hey, good morning, Crispin. Yes, on the loss reserve, we look at the book in two ways when we determine CECL. There is a general overlay, which accounts for roughly 50% of the reserve and then the asset management team is adding on specific reserves for those loans contained in our higher risk category. So we think the current CECL reserves account for the expected losses on those assets in our higher risk buckets based on sort of the detailed work, the asset management teams, current mark-to-market LTVs, et cetera.

And then hey, it's Adam. Yes, on the credit front, certainly seeing delinquencies as you highlighted increase quarter-over-quarter. We do feel that our basis is still healthy in the majority of our portfolio. We feel that if you look at the bridge delinquencies, where there was a spike, you're certainly seeing -- we think that the realized losses will be more at the equity level versus the debt level. So, as Andrew highlighted, we think that our reserves are certainly adequately sized. DSCR distress, LTVs are generally below 100% on the majority of the portfolio, and really don't anticipate material losses, but some loans will certainly require some modifications or restructuring, and certainly some sort of time to resolve and kind of have some time available for the marketer to rebound.

Great. Appreciate the color there, Andrew and Adam. And then just one on the disposition of the resi mortgage segment. Can you just detail why now and then are you able to provide any color on your confidence of the disposition being completed by June 30, which was in the presentation, and I assume that would likely involve a sale and likely gain just following the loss on discontinued operations this quarter?

Just one market observation and Andrew you can comment on the process but right now the majority of the equity in that business is in the MSRs of which 2/3 are agency. We believe that right now MSR valuations have peaked. And just from a timing perspective, in terms of valuation, that's one driver. But Andrew, do you want to touch on the process timing?

Yes, so certainly, we have a high degree of confidence of the transaction closing before the end of the second quarter. Part of the criteria of moving a segment into held-for-sale and discontinued operations is having that confidence level that -- the components of the process will be, as Tom mentioned, obviously, a sale of the MSRs which comprise the majority of the equity as well as the assumption of the assets and the liabilities of the company, and the consideration what will most likely take the form of some upfront payment and then an earnout of sorts. So, I think at this point in time based on where we are in the process, we do believe this will close before the end of the second quarter.

The next question we have is from Stephen Laws of Raymond James.

Appreciate all the details in your prepared remarks Tom, and if I have got my notes down correctly I think you said in the CLOs of defaulted loans about 57%, so roughly 60% you expect to modify and I believe you said you need the special service for approval. Can you talk a little bit more about that process and how you work with that special service? What are those mods primarily look like, is it capital in for more time or are there other moving parts, each one can be unique, but any general trends across those loans?

Yes, Adam, can you comment on that?

Yes, sure. So, in terms of the process on the mod, so borrowers had submitted relief requests for modification in their loans. Those then are under review by the special servicer. In the ordinary course, request for a modification by the borrower, the special servicer would review, approve and cure the delinquency, with certainly our approval as the directing certificate holder. In several cases, the modification is a contractual bridge to a short-term payoff. So an example being like a sponsor is refinancing the debt or selling the real estate, and the modifications can then be executed. In terms of what they look like, certainly, the preference is to have the sponsor bring a fresh equity injection to the modification given that more time is certainly needed in this market. We feel that about anywhere from 12 to 18 months is the right amount of time to modify these loans given the timing that's needed for the market to rebound. Additionally there is cash management controls that are put in place on these modifications. And in some cases, we're requiring third party professional management to come in on behalf of the sponsors and kind of help maintain the asset, utilize CapEx to really provide the necessary maintenance of the asset.

And Andrew, thinking about interest income, can you talk about the quality of interest income, how much is cash interest received, how much was approved or maybe some type of PIK income, if there's any, can you give us any color on interest income quality?

Yes, the majority of the interest income is cash paying. There is a small segment of loans that are accruing based on expected recovery on the loan, but not paying but it is a very small portion of the book.

Great. And then finally, if I may, returning capital to shareholders -- you closed I believe with a comment on the dividend that you think earnings can cover this. How do you think about the glide path of earnings coverage for the dividend as we move through the year and you execute these challenges -- these efforts to expand ROE and any consideration around stock repurchases given the current valuation?

Maybe unpack that two ways, Andrew. Maybe just comment on -- there's 5 measures we delineated, obviously, some of them are immediate like OpEx and some are longer term, like the re-levering of the Broadmark equities. Maybe comment on that and then the prioritization of cash on repurchase versus capital solutions for the existing portfolio.

Yes, as Tom mentioned in his remarks, we believe that the totality of all of the options ahead of us leads to roughly over a 400 basis point increase in earnings from the current level. That'll certainly be incremental over the next 4 to 6 quarters. As Tom mentioned, things like OpEx savings, which we anticipate will add 40 basis points will be more immediate. The effects of leverage will be somewhat dependent upon the times in which we choose to access the market and the redeployment of that capital. And then the effects of the portfolio turnover will sort of be felt every quarter. I think, Adam can elaborate on the plan for and the timing of Broadmark liquidations, but that'll certainly bleed into earnings. So I think you will see, sort of a glide path over the next 4 to 6 quarters. In terms of capital allocation, including the share repurchase program, we have today 80 million in capacity on our current program for share repurchases. I do believe we will be active in the repurchase program while also balancing the need to add net interest margin into the income statement in a market where yields are very attractive and putting long-term earnings into the income statement is important. So, I think we will balance both of those. Given where the stock is trading certainly, the return [ profile on ] share repurchase is quite powerful. So I do anticipate we will be active in the upcoming months, at least at these levels.

And then share repurchase strategy?

Yes, that's sort of -- Tom, that's what I just commented on...

The next question we have is from Douglas Harter of UBS.

I'm wondering if you could talk about the expected pace of putting new capital to work, how you see the opportunity set developing both in order to redeploy capital, but also to increase leverage?

Yes, I'll just make a comment on the current investment opportunity pipeline and ROEs and Andrew, maybe comment again on the -- or Adam on the liquidation of the Broadmark as well as the forward liquidity. But the current market in terms of -- we kind of look at it in 3 areas, sort of silos. One is our core bridge lending, where for lower middle market you're getting retained yields on really strong vintage underwriting in the area of 13.5% to 15.5%, that's up maybe call it 300 basis points to 400 basis points since -- before the rate rise. That is silo 1. Silo 2, which is cyclical is the capital solutions, where we provide capital to opportunistic equity, entering mostly the multifamily space, then we will provide senior mezz, et cetera, in the context of restructuring, that's probably more in the, call it the 15.5% to 18.5%. And that's the other area. The third area is the acquisitions. And there we're seeing -- we're starting to see, and this is from the external manager, a growing pipeline of sales by banks, which are not -- I guess, not unexpected, those are more in the upper teens, low 20s with retained yield. So in short, you're seeing blended returns available to us, well into the mid to upper teens, which is about a 400 basis point or 500 basis point increase versus where we were prior to the turn in the rates. But that's the opportunity sets. Andrew, maybe just comment again on the liquidity -- forward liquidity and deployment.

Certainly outside of the portfolio runoff, specifically in Broadmark, there are a handful of larger liquidity items we expect to come through the balance sheet in the upcoming weeks and months here. Obviously, the sale of the residential mortgage banking platform is expected to bring in, on a net basis, approximately $100 million. We are in the process of financing some of our retained positions from our CLOs that's expected to bring in $130 million. And then I do believe we have line of sight into some corporate issuances. So, outside of portfolio runoff, we expect there in the upcoming weeks and months there to be roughly $300 million of additional liquidity coming in. Adam, you may just provide some commentary on the timing of the Broadmark liquidations and expected proceeds just to get a complete picture.

Yes, so we expect to have about 50% of the Broadmark assets paid off within our bases by year-end 2024. I think this is a conservative estimate. This excludes current loans where several we expect will pay off during this period. And then secondly, there's more opportunity to liquidate other assets in the portfolio that aren't currently flagged for a payoff. Just kind of the velocity of these payoffs, just kind of given the historical perspective since the merger close, so about 50 loans paid off for about $250 million to about 23% of the portfolio. We have pending payoffs of about 30 assets, and those the ones that I mentioned would pay off by the end of the year. That's about another, call it about $250 million. So that's another 28% of the portfolio. So all-in-all, we should be out of about $500 million by year-end. The liquidity from a UPB's perspective would be about $250 million of UPB. Obviously, some of that is levered today. And then, certainly a slew of other payoffs that we are expecting in the Broadmark portfolio that we're currently working through by loan sales, sponsors that are giving indications that they're working on refinances and sale of assets.

Just, it's Tom, I think what differentiates us versus the peer group to some extent is apart from the focus, the concentration in lower middle market multifamily, which has less credit volatility, we do have -- because of the delevering from Broadmark, we have this path to step function and growing liquidity towards the back end of this year, which will -- this result in deployment at these spreads, which we don't believe this is a 2020 flashing -- pandemic flash in the pan with a snapback. So we see the NIM accretion being very significant over especially the back half of -- this year into '25.

The next question we have is from Jade Rahmani of KBW.

Just on the credit side with Broadmark and Mosaic, you said 28% purchase discount. Do you believe that that's sufficient to absorb losses, and therefore from those 2 portfolios, they would have no further deterioration on book value?

Andy, do you want to comment?

Yes, maybe we will break it down into 2 components. On the Mosaic side, that deal was structured with a contingent equity, right? That was at close -- approximately $90 million. We do not expect to exceed that contingent equity revenue. On the Broadmark side, as we mentioned in the remarks, the discount applied to the NPLs, we still continue to believe is enough to cover expected principal losses. I think what you will see over the next 2 quarters is movement -- I would call them, immaterial movements around the bargain purchase gain in both directions, as sort of values get finalized. But yes, we do believe the purchase discounts in both of those mergers will prevent future principal losses.

And then on the multifamily side, in the bridge portfolio you mentioned 70% of the delinquencies due to one borrower. Do you believe that we're at peak delinquencies or do you expect it to be lumpy and there will be further deterioration? I mean, I personally don't see why we would now be at peak delinquencies considering the staggering of maturities and the 2021-2022 vintage originations, I think that there probably will still be some deterioration, do you agree with that?

I think we do agree with that from a broad market perspective, in particular large balance or upper middle market -- I'm sorry, upper -- the largest sponsors in the Sunbelt markets, for example, where there's significant negative absorption, that has to be a period of negative absorption as new supply hits over the next year, 1.5 years. But our portfolio is very differentiated. And we look at this in terms of roll rates and negative migration, so, Adam, maybe could you comment on how you're looking at our bridge portfolio versus in terms of its lower middle market focus and what you're seeing with those sponsors?

Yes, specific to our multifamily bridge portfolio, you mentioned that the largest asset had defaulted. So, in sum, I mean, our 2 largest sponsors have actually already defaulted. And we are working through asset solutions modifications, bridge to bridge finances, et cetera through the special servicers, and through loans that we hold today. The majority of our small middle-market sponsors, we feel had greater liquidity and funding to temporary cover the interest shortfalls. We think that Q1 may see a spike as we execute some of the modifications and bridge-to-bridge strategy on our existing delinquency. But we expect really negative migration to peak late and call it Q1 or Q2, which is really due to the granularity of our remaining portfolio.

And geographically how would you describe the concentration, is it largely Sunbelt?

Well just to add to this and Adam, you can comment on it. But if you recall, Jade, one of the -- kind one of our credit Bibles is our GEOtier model, which uses regression analysis from GFC on lower middle market, mostly multifamily. So we basically, in that model, we look at forward negative absorption as one of the big drivers. As a result of that, markets like Austin, San Francisco, et cetera and in particular, some of the -- in the heat map of the Sunbelt, where there's a lot of supply coming, we've avoided that. But given that overlay, Adam, what have you seen in terms of the -- our concentrations in those markets?

Yes, markets such as the Carolinas and Texas, where we have heavy concentration, these markets have positive net migration and strong demos. And, as you know, our focus is really on workforce housing and we still expect that there's tremendous demand for these units, specifically for good quality affordable housing. And given the -- really given the positive net migration, we feel that where our assets are located will remain strong markets. Our top MSAs in our bridge portfolio, Dallas, Texas being the largest, which represents about 25% of the overall portfolio, Atlanta comes in second at about 15% and then the Phoenix market is about 13%. Charlotte, Houston and Chicago, kind of round out the remaining of where our big exposures are.

On the office, can you talk to the character of the collateral because there's huge differentiation in the market between skyscrapers and CBD versus suburban, office parks versus owner occupied where, say a law firm owns the building, and they sublease 2 floors. So how would you characterize the office because I'm surprised that there's delinquencies in small loans, sub $15 million type loans?

Yes, so offices as Tom highlighted in his opening remarks, right. So it's about 5% of the total portfolio. Our average balance on our office portfolio is about $3 million. It's about 160 individual assets. The small balanced nature of these office assets, a lot of it is focused on stable, like medical office type properties and really just smaller assets which again it's a lot easier to lease up, a lot of this is on short-term leases. But given the amount of space that needs to be leased up in these small projects, the ability of our sponsors to do that isn't as challenging as you highlight when you have these larger office buildings and CBDs. And that's really where the majority of our office delinquencies are located, which is in the CBD, specifically in Chicago, New York, where those delinquencies are, and also Los Angeles. So I think, just given that granularity, we feel that we're certainly insulated from a lot of the headlines around the office sector. And it's also from a liquidation asset management perspective, also more efficient to work through and liquidate these smaller assets.

Yes, just at a high level, it's 70% of our 5% office is -- that is the large balance and that may account for 70% of delinquency. So it's a handful of small CBD properties in a handful of cities that we have to originate but for which we have we believe very strong CECL reserves. So I think, if you will, the tail risk in our book versus the sector is very, very limited to CBD office.

The next question we have is from Steve Delaney of Citizens JMP.

Andrew, if I could start with you, you mentioned leverage some opportunities looking forward. Should we assume that would be a new CLO under your existing shell and could we see that as soon as 2Q or 3Q of this year?

Yes, it's certainly continuing to use our shells as a core financing strategy will be important. I do expect us to issue in the CLO market this year most likely a Q3 event. I think when you look at increasing leverage across the business, it certainly -- that is one component, but adding on additional corporate debt for reinvestment will be a key part of that as well.

And usually try to target about a $300 million offering under your program?

Typically, our CLOs are between $750 million and $1 billion, so they're a little larger in size. Yes, some of our other shells are smaller, such as our SBA shell, or acquisition shell, et cetera. But our CLO offerings tend to be larger in size.

Yes, just to add to that, since the inception of the market, we were the fourth largest overall issuer, issued $7 billion, $5 billion is outstanding so that we do larger new issue sizes. And, just one -- Steven one point on that, our spreads on the AAAs historically are on top of the even the best names in the sector and a big part of that is our structures are the most investor friendly, in terms of IC, over collateralization triggers, which are one versus the industry at 3 and the deals being static. So that does present versus the peer group a skewness in our delinquency metrics and the time it takes for us to buy loans out of the trust or what have you, so just wanted to highlight that. And that -- that does give us access to the market even in times when there's liquidity constraints in the primary ABS market.

That's good color. And either one of you, I guess, or maybe Adam, 12 -- I made a note, 12 loans that were 60 days delinquent, and then you laid out how many payoffs, mods or foreclosure. I didn't get the -- of those 12 loans, I didn't get the total UPB and how much specific reserve may be against those 12 loans?

Yes. So those 12 loans is roughly $500 million. There's no specific reserve against them beyond the CECL. And I think the other highlights are -- I think you have -- 15% of that we expect to pay off in the next 2 quarters, 60% is under -- pending modification where we're strategically working with the sponsors. And then about 30 of them will likely go through a foreclosure process.

Yes, and that 30 would then get fair value at the time it goes to REO, correct?

That's right.

Yes. Okay, great. And just one final thing. Tom, I guess I'll throw this out to you. I know you're busy running your own company but you probably have heard about these short sellers out there on CLO issuers. They've obviously hit Arbor, they have hit Blackstone as well. You never mentioned in terms of what you look at and how you look at the performance of the loans. I didn't hear you mention trustee 10-day late payment data as being an early warning signal. I guess you know which borrowers are making payments and which are not, but just your thoughts about, I know it's a market question and not an RC specific, but nobody -- you're not mentioning that data, you mentioned your 30-day and 60-day DQs and just curious what your thoughts are about any value in that trustee data?

You're referencing the special servicers reports on the...

Yes, the payment data that USB and others put out, the CLO special servicers, correct.

Oh, the CREFC reporting. Yes, Andrew, do you want to comment on that? I think -- because we just view the -- and that's the differentiator about from our perspective is we do have -- we do work with an external special servicer, but our -- Adam and his team are managing all of the actual disposition asset management strategies. And we do have an early warning indicators that is embedded in our 4 to 5 model -- I would say our risk rate system. So Adam, maybe just comment on that in the context of the broader market linkage between looking at CRE, CLO reporting, CREFC reporting versus how we manage it, in terms of looking -- just looking at it as on balance sheet.

Yes, I mean given we're DCH on our deals, we have a...

Sorry -- I'm sorry, Adam. DCH, define that.

The direct certificate holder which is -- we're the first loss holder on our CLOs. So, given our position, right, so we have our asset management team that works closely with the special servicers. There's a portfolio management team first off that really acts as a liaison between the sponsor and the special servicers in terms of the draw process, updates on -- asset level updates. And, so we're in constant connection with the sponsors and the special servicers to work through solutions. The special servicer is certainly working closely with the sponsors and then they're making recommendations to us. And I think our robust team with the overlay of the special servicer, I think, provides us a unique strategic advantage in the market. That answer your question?

That's helpful.

The next question we have is from Christopher Nolan of Ladenburg Thalmann.

Rent stable -- excuse me, multifamily, do you have any rent stabilization apartment exposure in New York City?

We have about -- I think we have about $175 million of multifamily exposure in New York City. The vast majority of it is unregulated. So the answer is no, there's very, very little.

Okay, great. And Tom, in past calls you have indicated Broadmark is expected to be EPS accretive by fourth quarter 2024, does that still hold?

Andrew in the context of the -- the bridge we laid out, maybe comment on that.

Yes, we do expect by the fourth quarter the transaction certainly to be accretive to current EPS. We expect it to drive your earnings past our current dividend levels. And as we move into 2025, we expect the full impact of the various items that Tom laid out, including Broadmark to sort of reach their totality. So I think the ultimate earnings accretion based on where we are running in the few quarters leading up to Broadmark probably happens in on the late stages of -- and mid stages of '25.

Okay, so it's fair to say that the EPS -- excuse me, the accretion to distributable ROEs that you guys were outlining earlier is going to be backloaded in the second half of 2024 and we're really not going to see the full effect of it until 2025, correct?

I think that's a fair statement.

And so for 2024, we should see probably a distributable ROE somewhere below your 10% target, is that fair?

I think that's fair. We expect that the cumulative earnings of the company over the full year to cover the dividend. So, you will -- what we are expecting is a ramp up from where we're at today to something towards the back half of the year, that is covering the current $0.30. And then the growth in earnings from that level into our historical return target to happen in as we move into 2025.

The next question we have is from Sarah Barcomb of BTIG.

So you just gave some dividend coverage commentary. Thanks for that. Just quickly, a follow-up on the topic of CLO performance. Sounds like we should see stronger IC and OC coverage come March. But could we expect to see some further downside to DE on the residual income side of the interest income equation from Q4 levels, can you give any guidance on the potential Q1 earnings impact there before those loans are resolved?

So certainly there's a couple impacts of tripping these tests. The first one, as you mentioned, is cash flow gets diverted away from our resid to sort of delever the seniors. The way it'll work in the financials as you go see to the extent of loans hit non-accrual status, you'll see interest compression there, and you'll see some -- the effects of the delevering of the securities. So it won't because of how we consolidate, it's not going to show up in the bonds themselves. The total cash flow sort of diverted over this period where the tests have been tripped has been roughly $8.5 million. I think the other financial impact is during this period where the tests are tripped, that the funding accounts that sit inside these deals are diverted away from repurchasing loans we have funded on balance sheet and diverted through the waterfall of the structure. And so you have a component of loans roughly $80 million today that are sitting on balance sheet unlevered. So you'll have some yield compression there. Those loans eventually will get repurchased into the deals as these right size. But for that period of time, you do have what I'll call marginal yield compression. So those will be the sort of the main effects.

Okay, thanks for the color there. And then I think you mentioned that 27% of the delinquencies are likely to foreclose. Will those remain in the CLOs as real estate owned?

Adam, you want to comment?

Yes, I think those were -- historically as loans have become REO that we have had in securitizations, we have purchased them out. So that's certainly something we will consider as we work through these. But to date, there's been very limited REOs that we have within our CLOs. So today it's not material, but as we kind of work through these assets, some things that we will certainly evaluate.

Okay, and then just really quickly, sorry if I missed this at the beginning, but can you remind me if you gave us a target for your volumes in the Freddie Mac and SBA verticals this year?

Yes, I mean, on the SBA front, we've been running at about 5, a little under $500 million over the last 3 years. And we -- back around second quarter of last year we -- our FinTech implemented a small loan and micro loan strategy. Just to recap, SBA has 5 -- 3 tiers. $350,000 to $5 million is large loan, mostly real estate secured. And below that, there's small and micro, which are 2 different tiers. I think below $50,000 is micro, and those are loans that the SBA allows a credit score methodology, which obviously is very adaptive to what we've been developing with our FinTech in Florida, which was one of the leading providers in the PPP program. So we've retrofitted that tech to a strategy whereby we're using that to originate small loans. I think we were running, Andrew, right about 33 million in the last -- yes, call it 30 million to 40 million run rate of looking at it over the next couple of months, and ramping. And then that's part of the initiative of the Biden administration to promote loans to minority women-owned businesses, of which, that tier, that lower tier is a big chunk of that. So with that the combination of the large loan continued growth there, we've been poaching a lot of -- we've been seeing opportunity to get take on loan offers that are exiting work -- from banks that are exiting the SBA business. And there's FinTech, that leads us to a target of $500 million to $750 million for this year and $1 billion over the next couple of years, which is very accretive given the premiums that you have on these loans, and which are usually north of 10 points in the secondary market and the fact that it utilizes very limited capital. So I think, again, that's something that is a differentiation in the peer group that's a little bit underappreciated. So that's the SBA. Adam, you want to just comment on how you're positioning the business from the standpoint of the core bridge and the other related construction and other products?

Yes, I think just to answer -- I think the question was around the cap -- our capital-light Freddie businesses on the multifamily side, I think the volumes they're expecting about -- we're targeting a $1 billion for 2024. And those capital-light multifamily programs are split between our small balance loan program, where we have the license through Freddie Mac, and then separately our affordable multifamily business, which is the tax exempt business, which makes up the $1 billion target for 2024.

The next question we have is from Matt Howlett of B. Riley Securities.

Hey, Tom, you mentioned, I think you said high teens to low 20% yield on -- potentially on the acquired channel with some of the banks, are those unlevered? That's the first question. So could you just walk me through some of the economics of those, I mean, where are you buying it, what type of discounts, what type of paper it is?

Yes, these are lower middle market usually stabilized loans that are usually end up criticized. They're not in default. They're what we call scratch and dent. But from a bank regulatory standpoint, they get criticized, usually due to response because of DSCR approaching that kind of below 1.0 threshold. And that's great from our perspective, because we like -- we utilize in our asset management strategies for acquired portfolios. We were one of the larger buyers of the smaller balance loans after the GFC. We bought nearly $5 billion and we worked out 5,000 loans. So we have a track record. And so in short to answer your question, the scratch and dent portfolios trade probably low 90s to low 80s to unlevered yields. Adam, we're looking what high single, low double, they many times come with staple financing or we can -- we have more -- interesting as we have more offers for credit on a secured lending basis. Term lending with limited mark-to-market from the banks given the Basel III changes, which favor loan-on-loan real estate being a lot better than making direct loans. So anyways, with that, either the staple financing from the seller and/or the third party financing from banks, that gets us to levered IRRs on that high single, low double to that kind of upper teens area loss adjusted.

Yes, and we have also done, since inception, we've done 11 stand-alone securitization of this strategy. So that's just another layer in terms of getting higher returns on that portfolio.

That's important point, a good point. And we do have access. It's our RCMT shell, is that right, Adam?

It's SCMT.

SCMT, sorry, SCMT shell. So that's where we have historically utilized purchase of these portfolios in the secondary market, which is a little bit a differentiate -- again, a differentiator from us in the peer group to buy these pools from banks or out of securitization trusts to then finance them in the ABS market. But again, right now, what's very unique versus the last credit cycle GFC is the availability of bank financing on a longer-term secured basis with limited mark-to-market.

Got you. On the bigger packages you see from the New York Community Bancorp, I mean, would you get together a waterfall and bid on those or is that something that Ready looks at?

The external manager has a significant trading desk and sources these deals. And so we definitely look as part of our acquisition silo. And the service is provided by the external manager to bid jointly and allocate equity accordingly. Yes, we've done that in a number of transactions over the last decade.

Just final question, I'll get on the buyback. I think you feel like that the $14 book is pretty good, what I'm hearing you say. What would be -- is there a sense of urgency or given the -- what will be an improvement in the ROE and probably the dividend over time, you feel like to act sooner with the buyback than later and where does that stack up in list of priorities?

Andrew?

Yes, certainly where the shares are trading, I think it will be a priority for us coming out of earnings. Again, there is a need to balance using the liquidity on the balance sheet today, for that purpose versus taking advantage of new investments that will provide sort of longer-term earnings power for the company. I will say, given some of the liquidity events we laid out earlier in the call, I think, those items will provide a lot more flexibility to be more aggressive in the share repurchase program should shares hang around these levels.

The last question we have is a follow-up from Jade Rahmani of KBW.

Yes, I find all the questions about share buybacks pretty interesting at this point in the cycle where there's clearly very high delinquencies in the portfolio and a lot of credit uncertainty in the outlook. It seems to me a better use of capital would be defensive. So I just wanted to ask about the corporate debt issuance. What kind of issuance is being contemplated? Do you have a range of size you're thinking about and what the cost might be?

Yes, so I think there are a variety of options. I think you may see a combination of private placements, potentially some of the retail channels that have been open across a couple of deals since Q4 will be an option for us. In terms of sizing, I would expect them to be more measured anywhere from $75 million to $150 million. I think the cost for those issuances today is somewhere in the range of 9% to 10% on yield.

Wow. And so what's the use of proceeds, you are going to lever that capital rather than pay off capital elsewhere, is any of this used to cure deficiencies or to pay off secured debt, secured leverage elsewhere?

Yes, certainly, the combination of all the liquidity will be used for a variety of the things you just mentioned. Some of it will be to manage some of the -- the problem areas in the portfolio, whether that be refi, repurchasing from CLOs, et cetera. A large majority of that will be used for reinvestment in our origination channels and acquisition channels. And then some of that liquidity will be used in the share repurchase program. We certainly agree with you that having ample amount of liquidity on the balance sheet to manage uncertainty across this, the cycle continues to be the priority. And certainly balancing those other areas of capital uses, including the repurchase and new investments will be done so with that top priority in mind. So, we do agree with you that carrying increased liquidity amounts, lower leverage throughout the cycle is important and will continue to lead the way we manage the business.

Yes, just from a more macro perspective, to add on what Andrew is saying, Jade, we're looking at the wall of liquidity we have coming in on the back end of -- kind of phased in through this calendar year where we are clearly prioritizing defensive use within asset management strategies like strategic refi's. Because we strongly believe that our lower middle market sponsors, the big guys have crossed the -- the vintage have already experienced stressors in workout. But we have a lot of lower middle market sponsors with more workforce housing that are covering some of the stress in DSCR. And there's a bridge to agency takeout, just like some of our -- some of the other REITs that are focused in the multifamily small balance space, and we believe -- strongly believe that look at the forward curve and rent growth over the next 24 months that that will provide a better use of capital than let's say immediate repurchases of shares over the next 18 months.

Thank you. And with that, I would like to turn the floor back over to Tom Capasse for closing remarks.

Yes, I appreciate everybody's time today and look forward to the next quarter's earnings call.

Ladies and gentlemen, that concludes today's conference. Thank you for joining us. You may now disconnect your lines.