Business Context and Reporting Period
Sutherland Asset Management Corporation, the registrant that later became associated with Ready Capital, filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2017. The company is an externally managed REIT focused on acquiring, originating, servicing and financing small-balance commercial loans, SBA loans, residential mortgage loans and related securities. Its reporting segments were Loan Acquisitions, SBC Originations, SBA Originations, Acquisitions and Servicing, Residential Mortgage Banking, and Corporate-Other.
The company completed its merger with ZAIS Financial Corp. on October 31, 2016, with the combined public company retaining the Sutherland accounting history. Residential Mortgage Banking results therefore were not included in the historical September 2016 consolidated results, although pro forma information was provided.
Key Financial Metrics
| Metric | Q3 2017 | Q3 2016 | 9M 2017 | 9M 2016 |
|---|---|---|---|---|
| Interest income | $35.0 million | $31.9 million | $102.2 million | $104.3 million |
| Interest expense | $19.9 million | $14.1 million | $53.6 million | $42.0 million |
| Net interest income before loan-loss provision | $15.1 million | $17.8 million | $48.6 million | $62.2 million |
| Provision for loan losses | $0.5 million | $0.5 million | $1.9 million | $4.7 million |
| Net income | $12.4 million | $9.6 million | $33.1 million | $27.3 million |
| Net income attributable to the company | $11.8 million | $8.8 million | $31.2 million | $25.1 million |
| Basic and diluted EPS | $0.37 | $0.34 | $1.00 | $0.97 |
| Core Earnings | $12.9 million | $10.1 million | $35.0 million | $29.8 million |
| Dividends declared per share | $0.37 | $0.45 | $1.11 | $0.90 |
Q3 2017 net income increased 29% year over year, while Core Earnings increased approximately 28%. The filing reports a 3Q return on equity of 8.9%, Core Return on Equity of 9.3%, and dividend yield of 9.4% based on the September 29, 2017 share price of $15.70.
| Balance sheet metric | September 30, 2017 | December 31, 2016 |
|---|---|---|
| Total assets | $2.50 billion | $2.61 billion |
| Loans, net | $892.9 million | $1.01 billion |
| Loans, held for sale, at fair value | $200.3 million | $181.8 million |
| Total loan portfolio, including consolidated VIEs and held-for-sale loans | $2.00 billion | $1.85 billion |
| Cash and cash equivalents | $70.6 million | $59.6 million |
| Restricted cash | $16.1 million | $20.2 million |
| Secured short-term borrowings | $522.8 million | $927.5 million |
| Securitized debt obligations of consolidated VIEs | $680.3 million | $492.9 million |
| Guaranteed loan financing | $313.4 million | $390.6 million |
| Senior secured notes, net | $138.1 million | None |
| Convertible notes, net | $109.4 million | None |
| Total stockholders’ equity | $555.1 million | $552.1 million |
For the nine months ended September 30, 2017, operating activities provided $248.2 million of cash, investing activities used $141.1 million, and financing activities used $96.0 million. Cash and cash equivalents increased by $11.0 million to $70.6 million. Cash flow was heavily influenced by the origination and sale of residential mortgage loans and short-term investments.
Material Changes Versus Prior Comparable Period
- Net income increased by $2.8 million in Q3 and $5.8 million for the nine-month period, primarily from higher origination activity, securitization benefits and the acquired residential mortgage banking business.
- Net interest income before loan-loss provisions declined by $2.7 million in Q3 and $13.6 million for the nine months because interest expense grew faster than interest income. The increase in financing costs reflected portfolio growth, new debt and higher funding needs.
- SBC Originations segment net income increased to $8.8 million in Q3 from $6.1 million and to $18.5 million for nine months from $10.0 million, supported by higher loan originations and fair-value gains.
- Loan Acquisitions segment net income declined to $0.2 million in Q3 from $5.4 million and to $9.7 million for nine months from $17.7 million, reflecting the lower acquired-loan portfolio as capital was redeployed to originations.
- SBA segment net income increased to $4.6 million in Q3 from $2.4 million but was broadly stable for nine months at $12.8 million versus $11.9 million. The business shifted toward originating and selling SBA loans rather than retaining acquired loans.
- Residential Mortgage Banking contributed $0.9 million of Q3 net income and $3.4 million for nine months. The segment originated $490.9 million of residential agency loans in Q3 and $1.53 billion for nine months.
- Total loan delinquency remained broadly stable: 95.7% of loans were current or less than 30 days past due at September 30, 2017, compared with 95.4% at December 31, 2016. Non-accrual loans declined to $46.3 million from $47.7 million.
- The company reduced secured short-term borrowings by $404.7 million from year-end, while increasing securitized debt by $187.3 million. The filing reports a debt-to-equity leverage ratio of 2.3x.
- New financing included $140.0 million of 7.50% senior secured notes due 2022 and $115.0 million of 7.00% convertible senior notes due 2023. The convertible notes had an initial conversion price of approximately $16.67 per share.
- The company implemented a segment realignment beginning in Q3 2017, moving securitization activity into the applicable origination segment and presenting Corporate-Other separately. Prior periods were revised for comparability.
Guidance, Outlook, Risks, Contingencies and Unusual Items
Management did not provide formal earnings guidance. Its stated strategy is to grow the investment portfolio through SBC, SBA and residential mortgage originations, loan acquisitions and expansion of servicing assets, while seeking attractive risk-adjusted returns primarily through dividends.
- Management cited improving commercial real estate values, rising interest rates, continued loan demand and constrained competition in certain SBC markets as supportive of 2017 origination volumes.
- The reported acquisition and origination pipelines were $307.0 million of SBC loans, $15.0 million of SBA loans, $159.7 million of SBC originations, $114.0 million of SBA originations and $193.4 million of residential agency commitments. These opportunities were not committed results and may not close.
- Interest-rate exposure remains significant because many borrowings are floating-rate. The filing estimates a positive pretax net-interest-income impact of $336,000 from an immediate 25-basis-point LIBOR increase, compared with a $156,000 positive impact from a 25-basis-point decrease under the stated assumptions.
- Liquidity risks include margin calls, lender discretion to renew repurchase agreements, collateral haircuts, short-term funding maturities and the potential need to sell illiquid assets at discounts. The company stated that it had satisfied all margin calls to date and was compliant with debt covenants as of September 30, 2017.
- Credit risks include borrower defaults, property-value declines, higher loss severities, SBA repair or denial claims, and deterioration in commercial real estate or residential mortgage markets. The allowance for loan losses was $12.7 million at September 30, 2017.
- Fair-value measurements are materially judgmental. Level 3 assets totaled $363.8 million, including loans at fair value, mortgage-backed securities, residential mortgage servicing rights and derivatives.
- Residential mortgage servicing rights carried at fair value totaled $68.8 million and were sensitive to prepayment speeds, discount rates and servicing costs. A 20% adverse change in the discount rate was estimated to reduce value by $5.5 million.
- The company settled legacy GMFS mortgage representations-and-warranties claims for $10.0 million, consisting of $6.0 million in cash and approximately $4.0 million in common stock. The filing states the settlement did not adversely affect reported earnings, but indemnification recovery from former sellers was uncertain.
- The company had $85.8 million of unfunded loan commitments, $193.4 million of residential loan-origination commitments and a $2.8 million loan-indemnification reserve. Management stated that no other material contingencies required accrual or disclosure.
- The company remained in compliance with REIT requirements, and management concluded that disclosure controls and procedures were effective.
Investor Verification Checklist
- Confirm the registrant’s legal name, ticker and post-merger corporate identity, since this filing is presented under Sutherland Asset Management Corporation rather than the requested Ready Capital name.
- Reconcile GAAP net income, Core Earnings and the effect of excluding fair-value changes, MSR gains or losses and other reconciling items.
- Assess whether dividend distributions are supported by recurring cash earnings after funding costs, loan losses and required REIT distributions.
- Review maturity, renewal and collateral terms for repurchase agreements, warehouse facilities and other short-term borrowings, including potential margin-call exposure.
- Monitor the performance, delinquency and non-accrual trends of SBA, acquired and transitional loan portfolios, including geographic and collateral concentrations.
- Evaluate Level 3 valuation assumptions for loans, mortgage-backed securities, servicing rights and contingent consideration.
- Track dilution and refinancing risk from the $115.0 million convertible notes, including the $16.67 initial conversion price and future settlement elections.
- Verify the status of the GMFS settlement indemnification claims, residential loan repurchase exposure and related reserves.