Ready Capital Corp annual report, FY2017

Business Context and Reporting Period

The filing is a Form 10-K for the fiscal year ended December 31, 2017, filed March 16, 2018. The registrant named in the filing is Sutherland Asset Management Corporation, not Ready Capital Corp.; ReadyCap is used throughout the filing for major operating subsidiaries and platforms. The company is an externally managed mortgage finance REIT advised by Waterfall Asset Management, focused primarily on small-balance commercial loans, SBA loans, residential mortgage origination and servicing, and related securitizations.

The company reports four operating segments: Loan Acquisitions, SBC Originations, SBA Originations, Acquisitions and Servicing, and Residential Mortgage Banking. Historical comparability is affected by the October 31, 2016 merger with ZAIS Financial; the residential mortgage banking segment contributed only two months of results in 2016, versus a full year in 2017.

Financial Results and Key Metrics

Metric	2017	2016	Change
Interest income	$138.3 million	$137.0 million	+$1.3 million
Interest expense	$74.6 million	$57.8 million	+$16.9 million
Net interest income before loan-loss provision	$63.7 million	$79.3 million	-$15.6 million
Provision for loan losses	$2.4 million	$7.8 million	-$5.5 million
Non-interest income	$73.2 million	$40.1 million	+$48.3 million
Non-interest expense	$113.1 million	$71.1 million	+$42.0 million
Net income	$45.8 million	$53.4 million	-$7.6 million
Net income attributable to the company	$43.3 million	$49.2 million	-$5.9 million
Core Earnings	$47.0 million	$40.9 million	+$6.1 million
Basic and diluted EPS	$1.38	$1.85	-$0.47
Dividends declared per share	$1.48	$1.61	-$0.13

Fourth-quarter 2017 net income was $12.7 million, or $0.38 per share. Fourth-quarter Core Earnings were $12.4 million, or $0.37 per share, compared with a $0.37 dividend declared for the quarter.

The filing does not provide a conventional consolidated operating margin or return-on-average-assets measure. Net interest income before provision for loan losses declined to $63.7 million from $79.3 million, primarily because funding costs increased faster than interest income.

Balance Sheet, Portfolio and Liquidity

Total assets were $2.52 billion, down 3.1% from $2.61 billion.
Total stockholders’ equity was $555.5 million, up from $552.1 million.
Total loan portfolio UPB was $2.15 billion; carrying value was approximately $2.08 billion and fair value was approximately $2.14 billion.
Cash and cash equivalents were $63.4 million, and restricted cash was $11.7 million. Short-term Treasury investments declined from $320.0 million to zero as capital was redeployed into originations and acquisitions.
Approximately 96.5% of loan balances were current or less than 30 days past due; 1.4% were 90 or more days past due. Non-accrual loans represented approximately 1.9% of loan carrying value.
The allowance for loan losses declined to $11.7 million from $16.1 million. The company recorded a $2.4 million provision for 2017.
Loans were approximately 55% adjustable-rate and 45% fixed-rate by UPB. The weighted-average ARM margin was approximately 3.4%, and the weighted-average fixed-rate coupon was approximately 5.8%.

Debt and Financing

Secured borrowings were $631.3 million, including credit facilities and repurchase agreements.
Securitized debt obligations were $598.1 million, backed by approximately $1.9 billion of securitized assets.
Guaranteed loan financing was $293.0 million.
The company had $140.0 million of 7.50% senior secured notes due 2022 and $115.0 million of 7.00% convertible senior notes due 2023; their net carrying amounts were $138.1 million and $109.0 million, respectively.
Total debt-to-equity leverage was reported at 2.7x, with recourse debt-to-equity leverage of 1.6x. The filing also separately reports a 1.6x leverage ratio in its liquidity discussion; investors should reconcile the definitions.
The company stated that it was in compliance with all debt covenants at December 31, 2017 and had satisfied all margin calls historically without selling assets in response to a margin call.

Cash Flow

Operating cash flow was $352.5 million, compared with $14.8 million in 2016.
Investing cash flow was -$242.2 million, including $54.3 million invested in an SBC loan-pool joint venture and $14.4 million of MBS purchases.
Financing cash flow was -$106.4 million, reflecting $257.0 million of senior and convertible note proceeds, offset by secured-debt repayments, securitized-debt payments and dividends.
Cash increased by $3.9 million to $63.4 million at year-end.

Material Changes Versus Prior Comparable Period

Core Earnings increased 14.8%, while GAAP net income declined 14.2% because 2016 included a $15.2 million bargain-purchase gain from the ZAIS merger and $6.9 million of unrealized gains on residential mortgage servicing rights; 2017 included a $4.0 million unrealized MSR loss.
Interest expense rose 29.2%, driven by increased financing activity and the issuance of the senior secured and convertible notes.
SBC originations increased 51% to approximately $869.3 million, while SBA originations increased 213% to approximately $131.7 million. Residential mortgage originations totaled approximately $2.0 billion.
Residential mortgage banking generated $41.7 million of gains net of variable loan expenses in 2017, compared with $7.0 million in 2016, but the 2016 period included only two months of activity.
The company completed the $154.9 million SBC6 securitization and the $243.8 million RCMF 2017-FL1 CLO during 2017.
The company shifted capital from acquired, higher-yielding non-performing and credit-impaired loans toward originated and credit-stabilized performing loans. The acquired PCI SBC portfolio declined to $97.9 million from $120.5 million, while acquired SBA loans declined to $400.6 million from $532.7 million.
Residential MSR fair value increased to $72.3 million from $61.4 million, although 2017 included a $4.0 million unrealized loss from changes in interest rates.

Guidance, Outlook, Risks and Unusual Items

Management expects improving commercial real estate values, rising property incomes and continued loan demand to support 2018 origination volumes. It believes a modest increase in interest rates is unlikely to deter most borrowers.
The reported pipeline totaled approximately $682.0 million, including $223.2 million of potential SBC acquisitions, $16.0 million of potential SBA acquisitions, $159.8 million of SBC originations, $135.4 million of SBA originations and $147.6 million of residential agency commitments. Management cautioned that historically less than a majority of pipeline assets have been completed.
Key risks include rising short-term funding costs, interest-rate mismatches, fair-value volatility, loan defaults, property-value declines, illiquidity, margin calls, counterparty failures, refinancing and securitization availability, and covenant breaches.
The company is dependent on Waterfall for management, underwriting, servicing oversight and investment sourcing. The management agreement provides for a base management fee of 1.5% of stockholders’ equity up to $500 million and 1.0% above that threshold. 2017 management fees were $8.1 million; no incentive distribution was recorded for 2017.
The company settled historical GMFS loan-sale representation and warranty claims for $6.0 million in cash and 275,862 shares valued at approximately $4.0 million. The settlement did not result in a charge to earnings because it reduced contingent consideration owed in connection with the GMFS acquisition. Certain sellers did not consent to the settlement, so indemnification recovery remains uncertain.
The Tax Cuts and Jobs Act resulted in a $1.0 million tax benefit from remeasurement of deferred tax balances. Future tax effects include a lower corporate tax rate, limitations on interest deductions and potential earlier recognition of taxable income.
Subsequent to year-end, the company issued an additional $40.0 million of 7.50% senior secured notes, extended certain financing facilities, declared a $0.37 first-quarter 2018 dividend and completed a $165.0 million SBC securitization.

Investor Verification Checklist

Confirm the issuer identity and ticker because the filing is for Sutherland Asset Management Corporation, while the request identifies Ready Capital Corp.
Reconcile reported leverage metrics, including total debt-to-equity versus recourse debt-to-equity, and review applicable covenant definitions.
Assess liquidity after considering short-term financing maturities, collateral haircuts, margin-call requirements and restricted cash.
Evaluate whether Core Earnings and the $1.48 annual dividend were supported by recurring cash generation rather than fair-value gains or loan-sale activity.
Review credit performance, non-accrual loans, LTV concentrations, geographic exposure and the adequacy of the $11.7 million loan-loss allowance.
Analyze the sustainability and valuation sensitivity of the $72.3 million residential MSR portfolio, particularly to prepayment speeds, discount rates and servicing costs.
Review the GMFS settlement, remaining contingent consideration and any potential indemnification recovery from former sellers.
Verify completion rates for the $682.0 million pipeline and the availability and cost of securitization, warehouse and repurchase-agreement financing.