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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good morning and welcome to the Ready Capital Corporation's First Quarter 2022 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions]. After today's presentation, there will be an opportunity to ask questions. Please note that this event is being recorded.
I would like to turn the conference over to Mr. Andrew Ahlborn, Chief Financial Officer. Please go ahead.
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 2022 earnings release and our supplemental information, which can be found in the Investor Relations section of the Ready Capital website.
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 a volatile quarter featuring rising loan rates and widening credit spread, our performance in terms of both stable earnings and book value, underscore the benefits of our diversified business model in times of market uncertainty.
To begin, lending activity in our small balance commercial or SBC segment remained at record levels, with over $2.2 billion originated. Our bridge lending business led the way with $1.9 billion originated, 95% of which was multifamily. In response to wider credit spreads in the CRE CLO market, pricing on the asset side has increased proportionally driving higher levered yields, versus the fourth quarter of 2021. Additionally, our focus on strong sponsors and high quality properties in our lower middle market niche continues to provide significant equity cushion.
High bridge volumes were supported by $61 million of fixed and CMBS production, as well as $135 million in Freddie Mac small balance loans. The market for fixed and CMBS products remain highly competitive, and quarterly volume declines were due to us staying disciplined on yield, markets, and collateral type. We do expect to ramp up activity in the channel over the upcoming quarters.
In our Freddie SBL program quarterly volume declines were due to rate increases. Current Freddie SBL pricing in top tier market is 4.25 up 150 basis points since year-end. We expect slight volume declines in the program heading into the third quarter as the product becomes less competitive with fixed and CMBS products.
Red Stone, our affordable tax exempt lender originated $62 million representing a large quarterly decline, which was anticipated due to seasonality. Affordable housing typically experienced as lower first quarter loan volume due to developers pulling deals forward in the fourth quarter and realized current year tax benefits.
In our Small Business Lending segment, SBA 7(a) production totaled $101 million. This quarter marks the first time we've exceeded $100 million in the absence of government stimulus programs and as a significant step in achieving our goal of a $600 million annual run rate. We expect growth in this segment from the continued development of our small loan lending segment now the 11th largest in the country, and the realization of front-end investments made in 2021.
On the residential side as expected volumes decreased 12% to $769 million in the quarter, as higher rate, lower refi activity. GMFS is better positioned than the peer group to weather the rate cycle, with higher than average purchase and retail channels and its historic strategy of retaining mortgage servicing rights. This is reflected in relative outperformance in the quarter with gain on sale premiums 50 to 100 basis points higher and volume declined 35% less than peer group.
We believe the diversity of our business model which provides full lifecycle financing and to SBC properties will allow us to deploy capital as we sponsor to current changing market dynamics. Current pipelines remain strong at over $1.3 billion, which includes $875 million and $200 million money up in our SBC and SBA channels respectively, and $350 million in April originations.
Record originations have resulted in portfolio growth of 99% year-over-year to $9.4 billion. Today, two-thirds of the portfolio is in high conviction defensive sectors comprising multifamily and industrial. Additionally, 81% of the portfolio is floating rate with average LIBOR floors of 50 basis points with short-term rates at or above 80 basis points we have reached a point at where upward movements can positively impact earnings. The remaining portfolio is either hedged or match funded through securitization.
Credit metrics have returned to healthy pre-pandemic levels with a 60-day plus delinquency under 2%. Our continued post-COVID credit outperformance versus our large balance commercial REIT peer group, [Technical Difficulty] a couple of factors. Portfolio granularity the top 10 loans equal only 8% of total loans; less competition in the SBC property markets resulting in strong credit parameters; cap rates and debt yield a 100 to 200 basis points higher than large balance; finally an underwriting discipline targeting lower risk CRE sectors in the top MSAs using our proprietary geo tier scoring model.
A unique risk overlay is our proactive asset management which applies our non-performing loan servicing capabilities to avoiding defaults on our performing portfolio. In our bridge portfolio, which is predominantly multifamily, NOI growth from units stabilizing of market rent is outpacing rising rates.
Today with the post-pandemic return to normalcy, our teams are prudently moving back into other property types and asset classes, but with a cautionary high on potential economic weakness in 2023 at this stage in the credit cycle.
In the quarter, we continued our strategy of funding growth through accretive M&A assuming a singular reliance on secondary offerings, adding $670 million of equity through the closing of the merger with Mosaic and a secondary offering in January. Since the beginning of 2021, equity increased 135% to $1.9 billion, ranking us as the sixth largest commercial mortgage REIT.
Since 2016, we have completed six M&A transactions, improving operating leverage, and achieving a lower cost of debt capital, more accretively done through the more typical secondary issuance Group.
We successfully completed the Mosaic merger and welcomed Mosaic shareholders to Ready Capital. This transaction furthers Ready Capital's competitive advantage via a seamless expansion in our product mix from heavy transitional bridge to construction lending. In addition, we have been active in the debt capital markets completing two securitizations, and a $120 million three-year 6.125% unsecured bond offering since the start of the year. Our securitizations included our largest CRE CLO to-date of $1.1 billion transaction raising $115 million in net capital, and a $277 million fixed rate securitization. Even in a stressful quarter characterized by widening credit spreads and terminated offerings, our continued access to the capital markets is testimony to the quality of our assets and the depth of our investor base in the ABS market.
Finally, in terms of the outlook, we expect the earning profiles of business to continue to support our dividends through a combination of the growth of a loan portfolio, increased activity in our gain on sale businesses, and the continued accretion of PPP income.
Broader market volatility may dampen record origination volumes, but our platform is made for times such as these. Our investment strategy is positioned and balanced to perform in bull and bear markets. For instance, we are capable of pivoting with the credit cycle, including ramping our acquisition business in the event of higher non-performing loan volumes, as we did in the GFC purchasing $5 billion NSCC NPLs.
On the gross front, we expect to pursue additional M&A opportunities in segments complementary to our core competencies, capture market share in core markets and expand our presence in Europe.
I'll now turn it over to Andrew.
Thanks, Tom.
Quarterly GAAP earnings and distributable earnings per common share were $0.70 and $0.52 respectively. Distributable earnings of $48.9 million equates to a 13.6% return on average stockholders' equity. The quarterly earnings absent the effects of PPP were driven by increased net interest income, earnings from our joint venture investments and movement in our hedges with offsets coming from increased activity in our gain on sales segments.
Net interest income grew 20% quarter-over-quarter to $47.2 million. The increase was driven both by a 28% increase in portfolio size and a push past of 50 basis point average LIBOR floor in the portfolio. As Tom mentioned earlier, we expect increased earnings as short-term rates rise. As of quarter end, the portfolio consisting of over 4,500 loans totaling $9.4 billion at a weighted average coupon of 4.6% and spread of 310 basis points. Spreads continue to widen in the quarter with new loans priced at an average rate of 350 basis points.
Our joint venture investments, which consists primarily of CRE equity investments, experienced significant increased profitability of $5.7 million quarter-over-quarter due to the rent stabilization in key properties, resulting in market value gains.
Interest rate hedges were up $23 million in the quarter offsetting markdowns of CMBS loans held-for-sale.
Revenue increases were partially offset by $9.4 million reduction in gain on sale revenue due to both origination declines in 7(a) Freddie Mac SBL and Red Stone production in the rollout of the 90% guarantee stimulus in our SBA business.
In the quarter, we sold 20% of SBA production for higher IO strips, resulting in no day one gain on sales income.
Net income from residential mortgage banking declined $600,000 quarter-over-quarter, revenue from mortgage banking declined $13.5 million due to a 12% decline in production, and a 5% decline in average margins, which now stood at 70 basis points. Declines in revenue were offset by $12.9 million reduction in mortgage banking expenses due to a $10 million swing in payroll fees.
Net income related to PPP declined 15% quarter-over-quarter to $13.7 million after considering the effects of tax. The quarter-over-quarter reduction in PPP earnings was primarily driven by slower forgiveness rate. This income which continues to add to our outperformance is likely to remain a significant contributor to earnings over the next few quarters.
As of quarter end, we had $45.5 million of pre-tax revenue remaining to be accreted into earnings and $10.2 million of reserves against those fees. As of last week, 23% of the original portfolio remains.
On the balance sheet, the quarter was most impacted by the closing of the merger with Mosaic. The transaction added $750 million of assets consisting of cash, construction loans, preferred equity, and REO against $460 million of equity. In addition to the Class B shares issued as upfront consideration in the merger, there is an $84.3 million contingent liabilities related to the contingent equity rate that was issued.
Total leverage as of March 31, declined to 4.4x and absent of PPPLF to 4.1x. The composition of our leverage also remains both conservative and constructive to the business. As of quarter end, recourse leverage was 1.4x and liability subject to full mark-to-market represented only 20% of our debt capitalization.
With that, we will now open the line for questions.
We'll now begin the question-and-answer session. [Operator Instructions].
First question comes from Crispin Love of Piper Sandler. Please go ahead.
Thank you. Good morning. So first off just on the return on equity outlook. I know you've made comments in recent quarters, but I'm just looking for a little bit of an update there. Would you expected the ROEs to remain elevated in the second quarter, and then start to trend towards that 10% to 11% target in the second half or is there even upside to that to the second half given the rate sensitivity you mentioned and then also PPP still being a decent size contributor?
Andrew, do you want to touch on that?
Yes. So I do think the return profile is going to remain elevated over the next couple of quarters. When you look at the composition of this quarter, what you had was an increasing portfolio, benefiting from rising rates to lower production in both Red Stone, Freddie Mac, and SBA. So we expect the net interest income in the portfolio to continue to climb, but those being on sale businesses to also grow, which will add to that -- add to the earnings profile.
And then additionally, the forgiveness rate of the PPP loans is starting to stabilize. So don't expect to see quarters of volatility. And for the profitability from PPP has remained fairly consistent with where it was in the first quarter. So do you think it's going to be a couple quarters of increased returns before normalizing to that 10% or 11%.
Okay, great, thank you. And then just one on SBA more broadly, there was one competitor the SBA competitor that commented on weaker SBA gain on sale margins for the second quarter. So just first curious if that's what you're seeing. And then also, just your expectations for originations on the SBA side for the year. And then, Tom, I heard you mention the big goal of $600 million run rate. Is that that's a longer-term goal. Is that like a 2023 or 2024 goal of trying to get there just a little bit more color on that would be great?
Yes, sure, I mean just on the premiums and Andrew can chime in. But the premiums we haven't seen made any significant change in the secondary market premiums, maybe about a half of point or so. So we don't expect any significant margin compression on our end and our cost of origination based on channel has remained constant. And the -- as far as the volume, Andrew our base case volume for this year is what $450 million roughly?
Correct.
So I'd say that the $600 million is a long-term, but within the next year or two. And I'm sorry, the third question, Crispin was?
I think you actually got them all. Yes, mostly just on the margin, the origination for 2022, and then the $600 million.
Okay.
So you did touch on all of that. Thank you for taking my question, Tom.
No, no problem.
Thank you. Next question comes from Stephen Laws of Raymond James. Please go ahead.
Hi, good morning. Tom, when you look across your business segments, a lot of volatility, a lot of things have changed in the last few months. And you look to reallocate or deploy capital, where are you seeing the best opportunities today? I know some may be a little growth constrained, but kind of how are you repositioning or reallocating capital if you are in response to how the markets have changed the last few months?
Yes, it's interesting. The -- yes, the shock to the finance system is most dramatic in the mortgage banking space. And that's less than 10% of our risk of our net asset -- I'm sorry, of our equity allocation. Most of our equity allocation 85% plus is in the core SBC program where we do the lifecycle financing from construction to term.
So I would say I'd make two observations. One is our core bridge product, actually, because we're in this lower middle market niche, which has less price elasticity compared to large balance, which is much more competitive. So what we've seen there is the credit spreads, the AAA spreads on our CRE CLOs have widened about 75 basis points from the fourth quarter lows. But the -- because of the relative price, limited price competition, we've actually been able to widen our lending spreads by equal to or more than that, such that the vintage of CRE CLOs that we're originating today in the second -- going into the second quarter is actually a 50 basis point plus higher ROE than where we were in the fourth quarter of last year. So that's one observation, which will obviously lead us to continue to deploy capital there.
And then the other observation is on our lower middle market multifamily focus, because of the spike in rates and the impact on affordability, you're seeing more of that -- that's pushing more first time buyers in Millennial Z into apartments. So we continue to see strong demand there with actually the NOI. The NOI increases on exit of these projects is exceeding the impact of the rate increase. So those are positive headwinds, we're continuing to allocate capital. And I would say that one area that we're now looking to deploy additional capital is there's some level of, we're seeing an emerging level of distress in some banks looking to sell portfolios, and non-banks. And so, as it relates to that, where they're part of what we do is our acquisition business. So I would expect the acquisition business to increase over time as well.
Appreciate those comments. And of course, my second question is about the business. It's a smaller piece of the capital. But on the resi mortgage business, 60, it was 61 or 69, roughly two-thirds of the business was purchased. As you look back over GMFS history, where is that mix been in a rising mortgage rate environment or do you see that going to 80:20, higher than that 90:10, seems like with capital appreciation will still be some level of non-REIT driven, repayment activity, but we'd love to get your thoughts on that. And then any comments on margins across the channels for resi banking?
Honestly, Andrew and I were just down in Louisiana, visiting with the GMFS team and thinking for the prospects. I would say two things. One is to answer your question, we would expect going at the peak of the rate cycle, probably more of an 80:20 mix, they have a very strong branding in their markets with homebuilders and realtors, and believe or not with [indiscernible] and some other things, and they have a low customer acquisition cost. So I think that'll persist for the number -- the next few or more quarters. And as far as margins, we expect them to stabilize at where they are today which Andrew was running, what about 75 bps.
Yes, conventional was probably around 60 FHA, 90 VA, 85 USDA of course.
So kind of 75 bps areas, so we see good constant margins, one area they are looking to expand to now that, it's not been our loan, is some of the non-agency products that we're considering, that was a -- and that'll be a focal point going forward, as well as in terms of incremental revenue stream.
Thank you. Next question will be from Jade Rahmani, KBW. Please go ahead.
Yes, thank you very much. There are two aspects of cyclicality that I believe the market is concerned about, with respect to certain mortgage REITs. The first one is dependence on securitization. So Ready Capital has historically been a very successful and prolific issuer of securitizations. I was wondering if you could touch on that as a durable form of capital and how management would adapt to volatility in the capital markets. The second is relating to the overall commercial real estate asset class with deal sizes below say $15 million. Could you comment on the credit profile of how that would behave in a recession? Thanks very much.
Andrew maybe if you could touch on the securitization. But I would just in particular alternative forms of non-recourse financing, we have with the banks as a fallback to a, any disruption in the securitization market. But I will comment as a preface to Andrew's remarks that we're viewed as one of the basically probably the top five issuers of CRE, CLOs, our spreads are on top of the blue chip names like Blackstone et cetera and have a very deep in terms of number of investors and the depth of those investors, we would expect to be able to continue access albeit at wider spreads the securitization market. But Andrew maybe just comment on in a volatile market some of the alternative financing sources we have for the bridge product.
Yes, good morning, Jade. So and certainly over the last couple of quarters, we've been adding in additional warehouse facilities that have longer-terms are non-recourse in nature are non-mark-to-market. In the first quarter, we added $500 million non-mark-to-market recourse facility. We added another $200 million, or sorry, $250 million partial recourse, better mark only mark-to-market facility. So certainly we keep expanding our various lenders in the warehouse side, separately from that I think we continue to explore ways in the corporate markets to raise that capital, that's rematches the duration of some of our assets. And so that's what I would say there.
And then on the securitization front, obviously, we've been very active over the first couple of months of the year. I do think we will be in the market shortly with another CRE CLO. And our expectation is that we could have another two to three in the back half of the year. So certainly an important part of the business, but we continue to expand the facilities that support our lending channels on a non-mark-to-market non-recourse basis of longer duration.
And as far as the second question regarding the credit performance of our lower middle market niche in a recessionary scenario, maybe, Adam, if you can comment on that, but I just preface that with the fact that the -- due to the limited competition in our market, our debt yields, and cap rates tend to be 100 to 100 -- up to 200 basis points higher than, let's say a large balanced portfolio, which provides some level of cushion. But another fact is 67% of our portfolio is lower beta to a recession, which is affordable multifamily, and industrial. So as Andrew with that backdrop, maybe how do you and your team think about the potential for the credit performance of our niche versus a large balance market in a recession?
Yes, sure. I mean given the fact that we're mostly a multifamily lender, the performance should do well, during a recession, especially given the broader housing shortages nationwide and the extreme demand for that sector plus the way that we're structuring our deals with stronger sponsors that are well capitalized, we're originating at moderate leverage points, our portfolio is about 65% LTV, so that should provide significant cushion in the downturn. We have other protections such as interest rate caps, that are required to ensure that property cash flow and debt service coverage ratios remain adequate. And then given the rising rates and expectations for rising cap rates, our underwriters are really underwriting to more conservative levels in terms of wider debt yields at stabilization so that we can properly assess the takeout of that asset at more of a stress environment.
Thank you very much. A follow-up, unrelated would be more on the strategic front, in the commercial mortgage REIT space, there seems to be a clear bifurcation between the larger names and smaller names. And then there are companies like Ready Capital that have unique business models and a real compelling value proposition in our view. But there still is a handful of these, I would call them subscale small to mid-sized commercial mortgage REITs, they don't play exactly in the space you are playing. It's more in the middle market, average loan sizes, maybe around $30 million. Are any of those interesting opportunities?
Yes, it's a good question, Jade. I mean, obviously, one of the strategies that's been a little bit unique about Ready Caps is we've executed six M&A transactions, many of which work out used to raise capital as a more accretive alternative to secondary offerings. And, yes, we continue to see a number of opportunities, some of which may be the -- in the subscale mREIT space. I guess Owens is an example of that back a number of years ago, but yes, we continue to look at M&A opportunities, not just in the public space, but in the private space along the lines of Mosaic.
Thanks. And just one follow-up would be, there's a lot of agency considerations with respect to corporate governance. Many of these are externally managed. And there are various offsetting considerations that the underlying either management teams or boards have in mind. Have you considered approaching any of the companies directly yourself and perhaps with waterfall as a platform, utilizing that to create some alignment and better alignment that would prompt maybe some unlocking of these transactions?
Yes, we have considered the -- we have done direct approaches in the past. The mREIT and the Owens are examples of that. And yes, it does involve the complexity of the payment of the termination fee to the external manager, which I think we've managed very well in terms of benchmarking that versus the cost of secondary. So we don't have any enter -- obviously entered to a diluted transaction. But what we continue to look at that template as a way to potentially create value for our shareholders and the shareholders of the subscale business in a way that is aligned with both the external manager, as well as the public shareholders of the externally managed REIT.
[Operator Instructions].
Next question comes from Matthew Howlett of B. Riley. Please go ahead.
Hey guys, thanks for taking my question. Could you just provide an update on Mosaic now that's closed? Where the portfolio stands? What you plan on doing with it, many saying putting leverage on it. And just an update there? Thanks.
Yes, maybe Andrew you can touch on the current portfolio positioning terms of liquidations, syndications and just and then Andrew, maybe just the financing of the strategy for the portfolio. And then just an update on the CER mechanism, because I think that's an important nuance in looking in how to look at the Mosaic exposure.
Yes, sure, sure. 90% of the portfolio is fully performing today. There's two assets that are 60 plus delinquent, and we have three REOs from the merger. There are about seven deals have paid off at par since the merger discussions began, I think in the middle of last year. We now have over 50% of the portfolio syndicated. And when I say syndicated, that's of the total commitments. The portfolio today remains moderately leveraged about 70% weighted average LTV, majority of the portfolio that remains that 90% of it is in top tier markets, specifically Tier 1 and 2 such as Los Angeles, Phoenix, Portland, Oregon. Some other things that are worthwhile to discuss here.
Yes, so about 40% of the portfolio, from a property type perspective is mixed use. Another 40% is residential, and that consists of multifamily and condominiums and then roughly 10% of the hotel exposures is hotel and land. 70% of the total commitment is construction, and then the remainder is between pre-development and preferred equity. I'd say in terms of the asset management team and their focus, certainly working with the sponsors on the take-outs as these construction projects stabilize certainly some refinance opportunities that exist for our CMBS fixed rate products, fixed rate products to be the take-out lender for these loans. So there's certainly some good synergy there. And as we brought on some employees from Mosaic, we're certainly expanding into the construction space with a specific focus on multifamily and industrials are starting to look at some opportunities now targeted to close some over the summer and really getting fully up to speed with their asset management capabilities. And again, just working through the portfolio. But so far so good in terms of the integration with their team, our team and continue to progress.
Okay. Well certainly. You go ahead.
No, no, no, please Tom why don't you respond to a follow-up and then I'll chime in another.
Just that you'd like to business and you want to grow the construction lending business?
Yes. That's right. It'll be a limit on some of our core asset classes, lower balance, but it's a great it's a good adjunct to what we were already doing on the heavy transitional bridge side. As far as now we can go to the same sponsor about two-thirds of our borrowers are VP borrowers. And now we can give them an option for ground-up construction. I'm sorry, and Andrew maybe touch on leverage and the continued contingent equity reserve methodology.
Yes, so the balance sheet of Mosaic, for the most part was unlevered. Right, so much lower leverage profile than our existing balance sheet, which is part of the reason for driving down our ratios in the quarter. As we look to finance that section of the balance sheet, let's say a limited portion of it is going to come from putting certain assets on either new or existing warehouse lines, call it $50 million or so. But the real leverage from that equity will probably come from the corporate markets so that -- that's how we'll, in addition to the portfolio running off excess liquidity to fund growth.
And then in terms of the contingent equity REIT, the contingent equity REIT allows for Mosaic investors to recapture 90% of that initial discount, depending on the performance of the portfolio on a return of the original basis over the shorter of a three-year period, or whenever the portfolio wraps up. Based on our current projections and the history since we underwrote the deal at 9/30 we do expect that the CRE will be paid off in that valuation on our balance sheet today that $4 million contingent liability is reflective of our assumption that that will ultimately crystallize.
Got you. And when you say the corporate market, so you did the capping the senior unsecured market? Are you referring to additional issues on that front? And then how about the preferred market with the growth of the common equity base how is that market, I know it's obvious, it's widened. Just give me the thoughts of both unsecured offerings and preferred?
Yes, certainly, we continue to explore senior unsecured there's an opportunity to layer on senior secured given the fact that we do have a significant amount of unencumbered collateral at this point. On preferred, certainly, given the equity growth, there's room to keep appropriate ratios of preferred equity in line and to add into that security. But I think we're also going to explore some of the other markets that some of our larger peers continuously tap. And for us, it will just be an exercise of where we think we're getting the best attribution.
Other markets being like this term loans or just some other --?
Yes, term loan et cetera. Yes, term loan, et cetera.
This concludes our question-and-answer session. I would like to turn the call back over to the management for closing remarks.
We appreciate everybody's time on the call today and look forward to next quarter's call. Everybody have a good day.
Conference is now concluded. Thank you for attending today's presentation. You may now disconnect.