Business Context and Reporting Period
The filing is Sutherland Asset Management Corporation’s unaudited Form 10-Q for the quarter and six months ended June 30, 2017. The company, which later became associated with Ready Capital, is an externally managed REIT focused on acquiring, originating, servicing and financing small-balance commercial, SBA and residential mortgage loans, mortgage-backed securities and related servicing rights. Its four reportable segments were Loan Acquisitions, SBC Conventional Originations, SBA Originations, Acquisitions and Servicing, and Residential Mortgage Banking.
The company completed its merger with ZAIS Financial on October 31, 2016 and began trading on the NYSE under the SLD ticker on November 1, 2016. The merger added GMFS, the residential mortgage banking platform, to the business. The company had 31.996 million common shares outstanding as of July 31, 2017.
Key Financial Metrics
| Metric | Three months ended June 30, 2017 | Three months ended June 30, 2016 | Six months ended June 30, 2017 | Six months ended June 30, 2016 |
|---|---|---|---|---|
| Interest income | $33.2 million | $34.5 million | $67.1 million | $72.4 million |
| Interest expense | $17.2 million | $13.8 million | $33.7 million | $28.1 million |
| Net interest income before loan-loss provision | $16.0 million | $20.7 million | $33.5 million | $44.3 million |
| Provision for loan losses | $0.2 million | $2.0 million | $1.4 million | $4.2 million |
| Net income | $11.2 million | $8.6 million | $20.7 million | $17.8 million |
| Net income attributable to the company | $10.5 million | $7.9 million | $19.4 million | $16.3 million |
| Diluted EPS from continuing operations | $0.34 | $0.31 | $0.63 | $0.64 |
| Dividends declared per share | $0.37 | $0.45 | $0.74 | $0.45 |
Non-interest income was $18.2 million in the second quarter and $34.0 million year to date, compared with $2.6 million and $6.4 million, respectively, in the prior-year periods. Residential mortgage banking contributed $11.0 million in the quarter and $21.5 million year to date. Core Earnings, a non-GAAP measure, were $11.2 million, or $0.34 per share, in the quarter and $22.1 million year to date.
Second-quarter return on equity was 8.1% annualized, core return on equity was 8.1%, and reported dividend yield was 10.0% based on the June 30, 2017 closing share price of $14.85. Management reported a second-quarter total levered yield of 12.8% for the SBC and SBA investment portfolios, compared with 14.3% in the first quarter.
Balance Sheet, Debt and Liquidity
- Total assets were $2.447 billion at June 30, 2017, compared with $2.605 billion at December 31, 2016.
- Loans totaled $1.963 billion in carrying value, including $1.586 billion held for investment, $170.1 million held at fair value and $206.7 million held for sale.
- Cash and cash equivalents were $63.9 million, and restricted cash was $17.6 million. Short-term investments declined to zero from $320.0 million at year-end; $100.0 million of short-term investments pledged under repurchase agreements had been sold and was recorded as a receivable from third parties.
- Total stockholders’ equity was $552.8 million, substantially unchanged from $552.1 million at year-end. The company reported a debt-to-equity leverage ratio of approximately 2.3x.
- Debt included $317.0 million of credit-facility borrowings, $520.2 million of repurchase-agreement borrowings, $397.9 million of securitized debt, $332.8 million of guaranteed loan financing and $138.3 million of senior secured notes, net of issuance costs.
- ReadyCap Holdings issued $75.0 million of 7.50% senior secured notes in February 2017 and an additional $65.0 million in June 2017. The notes mature in February 2022 and are guaranteed by the company and specified subsidiaries.
- The company stated that it was in compliance with all debt, financing and senior-note covenants at June 30, 2017 and had satisfied all margin calls to date.
Six-month operating cash flow was $227.8 million, compared with $14.6 million in 2016. Investing cash flow was negative $84.9 million, and financing cash flow was negative $138.5 million. Cash increased by $4.4 million during the six months.
Material Changes Versus Prior Comparable Period
- Net income increased 29% in the quarter to $11.2 million and 17% year to date to $20.7 million, primarily reflecting the addition of GMFS, higher origination activity and the effects of 2016 securitizations.
- Interest income declined 4% in the quarter and 7% year to date, while interest expense increased 25% and 20%, respectively. Management attributed the higher funding cost to increased advance rates, securitization-related financing costs and higher LIBOR.
- Net interest income before loan-loss provisions declined to $16.0 million from $20.7 million in the quarter and to $33.5 million from $44.3 million year to date.
- The loan-loss provision declined substantially to $0.2 million in the quarter and $1.4 million year to date, versus $2.0 million and $4.2 million, respectively, primarily because the credit-deteriorated portfolio had declined and the company was emphasizing originations over secondary acquisitions.
- Non-interest expenses increased to $27.3 million in the quarter and $53.0 million year to date, driven mainly by employee compensation and servicing expenses associated with the acquired residential mortgage banking business.
- Loan originations were $811.6 million in the quarter, including $225.6 million of SBC loans, $26.0 million of SBA loans and $560.0 million of residential loans. Six-month originations totaled approximately $1.431 billion in the financial statements, while management separately reported $1.431 billion of aggregate loan originations and $1.021 billion of residential originations year to date.
- The loan portfolio’s carrying value increased from $1.848 billion at year-end to $1.963 billion, while residential mortgage servicing rights increased from $61.4 million to $66.8 million.
Outlook, Commentary, Risks and Unusual Items
Management intends to grow the portfolio through new SBC, SBA and residential mortgage originations, loan acquisitions and expansion of servicing activities. The reported pipeline included $89.0 million of SBC acquisitions, $197.4 million of SBC originations, $100.7 million of SBA originations and $203.5 million of residential agency-loan commitments. Management cautioned that pipeline transactions depend on capital availability, due diligence, approvals, market conditions and definitive documentation and may not close.
Management viewed improving commercial real estate values, economic growth and continued demand for small-balance commercial financing as supportive of 2017 origination volumes. It also noted that banks may be entering a credit-tightening cycle. No formal earnings or dividend guidance was provided.
- Interest-rate exposure is significant because many borrowings are floating-rate. The company estimated that an immediate 100-basis-point LIBOR increase would increase projected 12-month pretax net interest income by approximately $3.0 million, while a 100-basis-point decrease would reduce it by approximately $0.6 million, before considering broader economic effects or management actions.
- Repurchase agreements and credit facilities expose the company to margin calls, collateral haircuts, refinancing and rollover risk. Total counterparty exposure was $148.6 million, or 6.1% of total assets; JPMorgan and Deutsche Bank each represented more than 5% of stockholders’ equity at risk.
- Credit risk remains concentrated in real estate and SBA-related assets. At June 30, 2017, loans held for investment included $34.2 million of loans 90 or more days delinquent and $25.8 million 30–89 days delinquent. The allowance for loan losses was $10.4 million.
- Fair-value measurements are sensitive to prepayment rates, defaults, loss severity, property values, interest rates and market liquidity. Approximately $341.0 million of recurring fair-value assets were classified as Level 3.
- The company settled historical GMFS loan-sale representation and warranty claims for $10.0 million, consisting of $6.0 million in cash and 275,862 shares valued at approximately $4.0 million. The settlement had been recognized in the first-quarter 2017 financial statements and did not reduce second-quarter earnings. The counterparty has a right, beginning 24 months after the settlement, to require repurchase of its remaining shares at 65% of then-current book value per share.
- The company remains subject to REIT distribution and qualification requirements and generally must distribute at least 90% of taxable income. It declared a $0.37-per-share dividend for the second quarter, paid July 31, 2017.
Important Facts for Investors to Verify
- Reconcile the filing’s legal registrant, Sutherland Asset Management Corporation, with the requested Ready Capital company identity and subsequent corporate name or ticker changes.
- Assess whether growth in residential mortgage banking income and originations is sustainable and how much earnings depends on realized loan-sale gains, servicing-rights valuation and other fair-value items.
- Monitor funding costs, LIBOR sensitivity, repurchase-agreement maturities, collateral haircuts, margin-call requirements and refinancing capacity.
- Review delinquency, non-accrual, troubled-debt-restructuring and loan-to-value trends, particularly in SBA and small-balance commercial portfolios.
- Evaluate the quality and sensitivity of Level 3 assets, including residential mortgage servicing rights, loans carried at fair value and mortgage-backed securities.
- Confirm the terms and potential future cost of the GMFS settlement share repurchase right and any related indemnification claims against former GMFS sellers.
- Verify dividend coverage against taxable income, Core Earnings, GAAP earnings and available liquidity, recognizing that Core Earnings is a non-GAAP measure and may not be comparable with similarly titled measures used by other companies.