Ready Capital Corporation (RC) Earnings Call Transcript & Summary

Greetings. Welcome to Ready Capital's First Quarter 2025 Earnings Conference Call. [Operator Instructions] Please note, this conference is being recorded. I'll now turn the conference over to Andrew Ahlborn, Chief Financial Officer. Mr. Ahlborn, you may begin your presentation.

Thank you, operator, and good morning to those of you on the call. Some of our comments today will be forward-looking statements within the meaning of the federal securities laws. Such statements are subject to numerous risks and uncertainties that could cause actual results to differ materially from what we expect. Therefore, you should exercise caution in interpreting and relying on them. We refer you to our SEC filings for a more detailed discussion of the risks that could impact our future operating results and financial condition. During the call, we will discuss our non-GAAP measures, which we believe can be useful in evaluating the company's operating performance. These measures should not be considered in isolation or as a substitute for our financial results prepared in accordance with GAAP. A reconciliation of these measures to the most directly comparable GAAP measure is available in our first quarter 2025 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, everyone, and thank you for joining the call today. In terms of the first quarter macro backdrop, while the recovery in the CRE market has been affected by tariffs and increased recession risk, the impact on our core multifamily sector has been muted. Deliveries appear to have peaked in '24 with excess demand resulting in a 1% increase in rents in 1Q '25. With this context, in the fourth quarter, we initiated a defensive late-cycle posture and reset the balance sheet. In the first quarter, we made progress on several fronts, including stabilizing book value per share, completing targeted liquidations, closing the UDF merger at accretive economics and successfully raised liquidity through capital markets execution, including debt issuance and collapsing existing CLOs. To start, book value per share quarter-over-quarter was flat at $10.61 per share. We benefited this quarter from an $0.11 per share increase in the repurchase of 3.4 million shares and $0.14 per share from the closing of the UDF merger. When accounting for the UDF merger, the dividend shortfall was primarily due to a reduction in net interest income as assets in the noncore portfolio transitioned to nonaccrual status. We have provided additional transparency to aid in evaluating the recovery in our net interest margin or NIM. To this point, we have bifurcated our $7.1 billion total CRE loan portfolio into a $5.9 billion core higher-yield, better credit bridge loans and $1.2 billion noncore comprising 2 segments: $740 million of low-yield distressed credit bridge loans and our $430 million Portland, Oregon mixed-use asset segment. Payoffs from bridge loans resulted in a 5% decline in the core portfolio to $5.9 billion at quarter end, comprising 1,400 loans with 78% concentration in multifamily. Credit metrics remained healthy with little negative migration. 60-day-plus delinquencies remained relatively low at 4%, a $117 million increase quarter-over-quarter. Our expectation is that 52% of the quarter 1 additions are resolved in the second quarter. Risk rated 4 and 5 loans increased to 7.5% of the total, and underlying property fundamentals remained strong with a rated average debt yield of 7%. In the core portfolio, we modified 5 loans totaling $312 million, increasing the percentage of modified loans to 18%. The 5 mods comprised 3 short-term forbearances, providing borrowers a bridge to a longer-term modification, and 2 with current pay reductions. We believe the core portfolio earnings profile provides the foundation for starting to rebuild NIM in the coming quarters. A levered yield of 10.2% generated $43.4 million of net interest income or $0.26 per share, 80% of which is current pay. In our noncore bridge loan portfolio, largely comprised of assets where the net present value of sale exceeds on-balance sheet management strategies, we surpassed first quarter liquidation targets by close to 2x. We liquidated $51 million at a 102% premium to our mark, generating $28 million of liquidity and reducing the noncore portfolio by 6% to $740 million. In the second quarter, we expect to additionally reduce the noncore portfolio to approximately $270 million via an additional $470 million of liquidations. The target for year-end 2025 is a further reduction to $210 million through in-place asset management strategies. The cumulative go-forward earnings impact from these sales will be $0.24 per share, 70% from a reduction in negative carry and 30% from the reinvestment of sale proceeds. Our noncore portfolio includes the Portland mixed-use asset, a construction project completed in October 2023, where Ready Capital held a $516 million senior loan. The property features premier hospitality, retail, office and residential offerings in Portland with each component now moving to stabilization. In the fourth quarter, the position was marked down to $426 million, and we are currently working to obtain title, after which we intend to move aggressively to stabilize the asset and generate upside from our current mark. In the quarter, RevPAR in the hotel improved 11% to $209. Leasing of the combined office and retail remain at 28% and additional 2 condos were sold. The financial effect of the asset moving from performing construction loan to nonaccrual was a quarter-over-quarter $0.13 per share reduction in earnings with a current carry expense in the quarter of $0.05 per share. We expect to sequentially exit the 3 components as they stabilize and remain fully committed to support the project, both financially and operationally. In our SBA business, fourth quarter volumes remained high at $343 million. While we anticipate moderation in volume ahead, we view recent policy updates from the SBA as constructive towards reinforcing the program's long-term strength and integrity. Ready Capital continues to deliver performance above industry benchmarks. Our 12-month default rate was 3.2% versus the industry average of 3.4%, and our 5-year charge-off rate has now declined for the fourth consecutive quarter, reflecting the strength of our credit and servicing practices. Additionally, our 12-month repair and denial rate reached a historic low. As the most established and active nonbank SBA lender, we remain confident in our ability to navigate a shifting policy landscape. Our current platform origination capacity is between $1.5 billion to $2 billion. Given current capital constraints, which include $175 million of additional warehouse capacity currently waiting SBA approval, we expect 2025 volume to come under that $1.5 billion mark. However, adoption by Ready Capital to the new SBA underwriting guidelines and the proposed Made in America Finance Act legislation, which would increase the SBA loan cap from $5 million to $10 million for manufacturing facilities, provides the path to higher origination volume. In terms of the outlook, as we mentioned earlier, we put in place a balance sheet repositioning plan in the fourth quarter wherein liquidation of the noncore book would provide liquidity for reinvestment in the core portfolio to reinstate NIM to peer group levels. We believe the plan will be executed in 2025 with accretion in 2026. This assumes the continuation of the high current rate stressed economic environment, offset by the strong bid for our multifamily noncore assets, benefiting from the influx of opportunistic capital to the sector. In addition, upside exists from lower short or long rate, quicker stabilization of the Portland asset and faster implementation of the SBA changes. As such, absent further material deterioration in the macro environment, we expect our dividend to remain at its current level until the earnings profile warrants an increase. With that, I'll turn it over to Andrew to go through the quarterly results.

Thanks, Tom. First quarter GAAP earnings per common share were $0.47, while distributable earnings were a loss of $0.09 per common share and $0.00 excluding realized losses on asset sales. The following factors impacted our quarter earnings. First, as expected, net interest income declined to $14.6 million in the quarter. The reduction was primarily due to the movement of noncore assets to nonaccrual status, which generated a cash yield of 1.3%. In the core portfolio, the interest yield was 8.4% and the cash yield was 6.7%. In the quarter, $7.5 million of interest income recorded was noncash and primarily relates to loans acquired in the UDF merger and certain modified loans. Second, gain on sale income, net of variable costs, decreased $835,000 to $20.1 million. This income was driven by the sale of $254 million of guaranteed SBA 7(a) loans at an average premium of 10.1% and the sale of $43.3 million of Freddie Mac loans at premiums of 1.1%. Realized gains from normal operations were offset by $20.1 million of realized losses from the sale of assets, all of which were adequately reserved for in previous quarters. Third, operating costs from normal operations were $55.4 million, a 7.5% improvement from the previous quarter. Employee costs, professional fees and other operating expenses improved $8 million. These savings were partially offset by incremental servicing advances of $3.4 million. Fourth, the combined provision for loan loss and valuation allowance declined $9.9 million. The recovery was primarily due to a $16.8 million release of reserves on liquidations, offset by the addition of $6.9 million of reserves on loans held as of March 31. And last, we booked a bargain purchase gain of $102.5 million related to the closing of the UDF IV merger. The bargain purchase gain represents the difference between the fair value of the assets acquired and the market value of the stock consideration issued at closing. Overall, the transaction added $167.1 million of equity to the balance sheet and it was 1.3% accretive to book value per share. The portfolio was booked at a weighted average price of 55.9% and included $97 million of performing assets and $61 million of credit impaired assets. The transaction has generated $96 million of liquidity via payoffs and financing since closing. It is important to note that the earnings profile for UDF will include both PIK interest as contractually defined in the loan terms and the accretion of discount given our basis in the asset. On the balance sheet, book value per share was unchanged at $10.61 per share at quarter end and total leverage declined to 3.5x. Key balance sheet items included: first, the transfer of $722.8 million of loans to held for sale. These loans are slated for sale in the second quarter and are 75.7% noncore. There were no additional allowances taken on these loans. Second, we collapsed 3 CRE CLOs totaling $1.2 billion of loan collateral. The collapse resulted in a reduction in securitized debt of $756 million and an increase in warehouse debt of $834 million for net liquidity of $78 million. We expect to collapse 2 additional deals either at the end of the second quarter or beginning of the third quarter. Performance in the remaining CLOs remained under pressure with 3 deals currently failing interest coverage test, but we expect improvements as the asset repositioning is executed. And last, we continue to reduce our short- to medium-term debt maturities. In the quarter, we closed a $220 million senior secured offering and subsequent to quarter end, increased the offering by $50 million. Proceeds were used to pay off our $120 million April 2025 maturity and retire $111 million of 2026 maturities. As of today, we have a total of $650 million of corporate debt maturing through 2026, including current maturities of $131 million. We are focused on extending that maturity over the upcoming quarters. Liquidity remains healthy with unrestricted cash at over $200 million and $1 billion of total unencumbered assets. With that, we will open the line for questions.

[Operator Instructions] Our first question today is from the line of Doug Harter with UBS.

You've highlighted that you're expecting a large portion of kind of the noncore book to kind of pay off in the second quarter. Can you talk about any impact to those expectations on April's volatility and kind of how those conversations are going?

Andrew or Adam, do you want to comment on that?

Yes. So the loan sales, we're talking to various parties on, one, liquidations, but then also just normal course of certain loans paying off from the borrowers, whether it's selling an asset or getting a refinance. In terms of the volatility in April, I don't expect that it's going to have much impact on our exits that are in progress. The parties that we're dealing with have been through due diligence periods and are working on various strategies. We're in purchase and sale agreement with various parties, so I think things are certainly moving in the right direction. And we don't expect any material diversion from kind of where those exits are strike from a price perspective or from a timing perspective.

Yes. Doug, just to add to that, the highlight in terms of the macro volatility as we comment in the earnings call script, but basically, the multifamily sector is a relative outperformer just given the fundamentals with peak deliveries having been reached in 2024 and rents, actually because of excess demand, increased 1% in the first quarter. And on the heels of that, if you look at the inflows of opportunistic capital into the dislocation real estate -- CRE real estate equity trade, you're definitely seeing a lot of excess capital flowing into that sector. And we see that in terms of inbound inquiries and trades that are occurring with distressed bridge loan portfolios from private debt lenders in the secondary market. So there's a very active trading market, which is a little bit divorced from the overall tariffs and macro factors.

The next question is from the line of Crispin Love with Piper Sandler.

You took a lot of decisive actions in the fourth quarter, but you did see delinquencies increase in the first in both the core and the noncore portfolios, but you did call out the macro and some pressure out there broadly. But can you share your near-term expectations for the distributable earnings trajectory and when you believe that you could begin covering the $0.125 dividend and get back to your target ROEs?

Crispin, so the real catalyst for a change in direction of where we were at in the first quarter really relates to the repositioning of the assets we outlined in the prepared remarks. When you look at the financial effects of those currently, they're fairly pronounced. The interest expense of carrying those on the balance sheet today is roughly $0.17 -- $0.16, $0.17. The equity reinvested at market yields is roughly $0.07. So I think post the exit of the majority of that in the second quarter and the reinvestment, which may take a handful of months, then you'll start to see material movement the other way. Now there are several other items that are currently impacting or putting pressure on earnings. For example, in a lot of the operating companies we own, the operational expense that we're carrying today supports origination volumes substantially above where we're at. And so as those operating companies rebound, whether it'd be the USDA business or our affordable business, you'll start to see the rightsizing of the revenue through the OpEx play out. I'd say some of the headwinds we face are potential declines in SBA volume, at least in the short term as we navigate some of the policy changes that Tom mentioned, as well as just the cost of potentially the refinance of our corporate debt. So I'd say the second quarter earnings profile is going to be similar to what we experienced in the first quarter and that the upward trend really will start upon reinvestment of that equity I just described.

Great. I appreciate all that color. And then second for me, you did repurchase shares in the quarter. But can you just discuss your current views and philosophy on repurchasing shares versus preserving liquidity in this type of environment and how you've thought about that decision and expect to over the next few quarters or at least over the near term?

Yes. We certainly, on a consistent basis, are weighing the financial benefits and long-term benefits of repurchasing shares with the outstanding maturity ladder we have today, which is roughly $650 million as we described. Now I think we have demonstrated and continue to demonstrate that we have the ability to access the capital markets. So we feel confident in our ability to refi out a lot of that upcoming debt, half of which is unsecured, but we have a lot of unencumbered assets and collateral available to do secured deals if necessary. And then the other item that is obviously important given the current balance sheet and earnings profile is reestablishing the net interest income. And so we'll continue to balance the benefits of share repurchases with those other 2 items.

Our next question is from the line of Christopher Nolan with Ladenburg Thalmann.

First of all, I want to congratulate you. You took some hard actions in the last quarter, and it's not easy, but definitely reset the table. And I think the first quarter results, while still a little bumpy, showed much improvement. So kudos to you guys. And following the last question, are you guys continuing to do repurchases in this quarter?

Yes, we'll reevaluate where we're at post earnings here and go from there. With that being said, liquidity remains extremely healthy, and there's several liquidity initiatives that will generate additional cash coming into the business, whether that be the upcoming collapses of 2 additional CLOs or the continued financing of the UDF's portfolio. So we certainly think there's adequate liquidity to balance the 3 items I talked about previously.

And then on the collapse CLO, 2 things. One is you mentioned they weren't doing the interest coverage. What's the catalyst for that? Are rents coming in lighter than expected? And two, will there be any impact from these collapses on your leverage ratios? That's it for me.

I'll take the second one and then let Adam talk about the first one. So in terms of the leverage ratio, they tend to have slight upticks in leverage as we take the advance rates from the CLOs to warehouse advance rates. So just as an example, the Q1 collapses went from a low-60s advance rates to a low-70s advanced rates. So you see that movement, and you also see the movement to some degree from nonrecourse to recourse. So that will be the effects on leverage. Now the benefit is that they obviously generate a significant amount of liquidity and the yield profile on that pool of assets improves on the collapse. I'll let Adam talk about the first one.

Chris, yes, I mean, listen, NOIs are certainly continuing to be impacted by the current environment, rates remaining elevated. And we're certainly seeing a higher degree of modifications in our portfolio, which is coupled with pressure on business plans as well, which is why you're kind of seeing that increased stress within the CLOs.

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

On the Portland asset, will the position be held unlevered? And is there any contemplation of exiting the position? What's the decision behind holding it? It seems like it's going to be a big earnings drag.

Jade, this is Adam. So the position is levered today, and it will remain levered once we obtain title to the project. And then secondly, our decision to obviously pursue title here is that from -- it's really the best economic outcome for the firm will be -- for a public REIT to get the keys to this asset. We'll give confidence to prospective condo buyers, prospective office tenants where there's tenant improvement dollars that are needed at the project. And the plan is to -- as we work to stabilize the 3 components of the assets, would be sequentially exit those 3 components. So specifically, as the hospitality stabilizes, the office stabilizes, we'll look to the market to see and really have like a pricing discovery and see where we can exit those assets. But it's certainly going to require some time for us to hold it, operate it. We are certainly committed from a capital perspective and from an operational perspective to see this asset through. It's a trophy asset in the Portland market, certainly very important for the city and members of the community. And the plan is really for Ready Cap take title and see this asset through and get this thing to a much better position than it's in today.

And I guess, how much dollars are needed? And over what time period are we looking? I mean there were 2 condo sales in the quarter. I'm assuming this is all going to take years, we're talking.

Yes, it will take -- to reach stabilization, certainly, the office and the hospitality will be stabilization first with the condos taking -- I think to fully sell those condo units, we're pegging anywhere from 2 to 3 years. Clearly, the interest rate environment is causing stress on that sector. But the city of Portland has certainly shown tremendous signs of improvement. So we feel good there.

I think, Adam, it's important to point out the basis in the most liquid components, The Ritz Hotel and the office is what as a percentage of the total?

Yes, Tom, it's around 70%.

Yes. So Jade, the large -- the 2 largest slugs will have a shorter fuse in terms of stabilization. And obviously, they're relatively liquid markets for that scaled Ritz and as well as most of the office tenants in that -- it's really A+ office in that sector. So we got some law firms, et cetera, for tenants. So we're -- we expect the front-loaded exit of the -- those 2 components with a linear sale of the condos, which tends to pick up once the hotel stabilize as well, if you're familiar with the Ritz residence concept.

I am. On the SBA business, considerable uncertainty in that space, and you all have invested heavily building up the originations capabilities. Could you talk about what level of moderation in volumes you expect? I think you said below the $1.5 billion, but if you could provide any additional color. And then gain on sale margins also, which were 10.1% in the first quarter, what do you expect there going forward?

Yes, just a broader comment. With the SBA, like a number of government agencies, has had a significant reduction in staff. I think they publicly stated around a little over 40%. And so that has, in terms of normal administrative product process, has extended time lines, et cetera. But from a policy perspective, there has been a reassessment of, in particular, small loans and some of their credit guidelines, of which we are fully supportive and have active dialogue with the SBA. We're the fourth largest SBA lender and, by far, the largest nonbank. And so again, we're very constructive on it and supportive of the SBA changes. And so we currently are working with the SBA to modify our origination guidelines. And I'll point out that we did preemptively reduce our credit standards for small loans well in excess. I think it was -- Andrew, was it third quarter of last year? And so -- and our relative credit metrics compare favorably with the peer group. So I think, Jade, there's a transition period for the industry, not just Ready Cap, but a number of other lenders to recalibrate with the policy changes that are currently underway with some administrative delays due to the staffing issues. But to -- so putting all that down, I think we would be, and Andrew, feel free to chime in, we'd be at the low end of the -- our platform has the capacity of $1.5 billion to $2 billion. I would say it'd be at below that $1.5 billion range for at least a couple of quarters. I don't know, Andrew, if you want to add to that.

No, I think that's right. I think, Jade, when we look at the outlook, at least in the short term, I don't think it would be unreasonable for the company to run in that $1 billion to $1.2 billion range in terms of total small business lending. And then on the premium side, they've historically averaged, even previous to the Biden era sort of stimulus items, right around that 10% range. You may see some movement as the mix in our originations change. So for example, the threshold for our small loans was reduced. Those loans typically are priced higher and have higher premiums. You may see some movement just based on the portfolio mix. But that -- the historical average has always been right around that 10% mark.

That's helpful. Freddie Mac has been -- that's a real asset for the company. The volume was pretty muted in the first quarter. A lot of noise out of the FHFA. So just wanted to check in on what you expect for that business.

Jade, it's Adam again. Yes, certainly, our Freddie Mac volume was down in Q1. I think, really, I think the key piece of that is Ready Capital, our Freddie business, the majority of our loans are sourced through mortgage bankers. And so the Freddie Mac has -- given fraud that was in the market specifically from Meridian, as you probably recall, they have tightened up the process that mortgage brokers and the lenders go through. And so what happened is a lot of the brokers and the clients look to other sources of capital for these small balance loans and specifically banks and credit unions that have similar rate and term, and it just makes for an easier process. And also, many of these borrowers, brokers are also tapping into Freddie -- sorry, to Fannie's platform where they control the process. And then Freddie rates are really just okay, which is why I think folks are kind of pivoting to banks and credit unions and Fannie. So we're certainly seeing a decrease in Freddie Mac SBL volume. Our Q2 pipeline is certainly more robust somewhere around $40 million, $45 million today. And then on the affordable side, volume also down there, but pretty healthy pipeline of about a little bit north of $200 million as we go into the second half of the year. So strong pipeline there, although down versus historical numbers. There's been some equity raise for capital into that business, which should help improve the pipeline as we enter the second half.

Okay. I just have a couple of others and these are investor questions. But is the full pro forma share count for UDF IV 172.5 million? I just want to make sure we're not ignoring any M&A -- transaction-related additional shares or timing effects.

That's right, Jade. The only item that may influence future shares would be the CVR, which converts into shares if it is earned at book value. But that's a couple of years out, but your pro forma today is correct.

And how many shares would that be?

Well, it's hard to put a number on it today because it's dependent upon the actual execution of the CVR. So it really depends on performance going forward. So it's not a defined number.

And lastly, do you have operating cash flow for the quarter, if possible, excluding loan sales?

Yes. So the total operating cash flow for the quarter was 89 -- or sorry, $80 million. Included in that was $99 million related to loan sales. Some of that is realized gains. So it's closer to breakeven than it has been running, Jade.

Okay. Great. Sorry, I should ask one last one, which is receptivity of the debt capital markets today. I think there's probably been improvement the last couple of days, but definitely been choppy. So what are your thoughts around that?

Yes. So certainly, we were in the markets over the last couple of weeks and months where we had a successful execution on the secured side. Based on the conversations we've been having in the markets, we feel pretty comfortable about the ability to refinance out the outstanding debt we have. Now the one thing I'll point out is with the exception of the $350 million at the end of next year, a lot of that is unsecured debt. And so we certainly think in the absence of being able to refinance all of that in the unsecured debt markets, that the collateral, the unencumbered asset pool we have plus the excess collateral on existing secured deals provides a significant amount of room to refi some of that out into secured debt. And so we are going to continue to prioritize extending those maturities and feel good about our ability to do so.

At this time, we've reached the end of the question-and-answer session. I'll turn the call over to Mr. Capasse for closing remarks.

Again, I appreciate everybody's time on this quarterly call and look forward to the second quarter call.

Thank you. This will conclude today's conference. You may disconnect your lines at this time. Thank you for your participation. Have a wonderful day.