Ready Capital Corp annual report, FY2018

Ready Capital Corporation — FY2018 Form 10-K Summary

Business context and reporting period

Ready Capital Corporation, formerly Sutherland Asset Management Corporation, is an externally managed mortgage REIT advised by Waterfall Asset Management. The company originates, acquires, finances and services small-to-medium balance commercial (SBC) loans, SBA 7(a) loans, residential mortgage loans and selected mortgage-backed securities. The filing covers the fiscal year ended December 31, 2018, including fourth-quarter results. The NYSE ticker changed from SLD to RC on September 26, 2018.

Operations are reported through Loan Acquisitions, SBC Originations, SBA Originations/Acquisitions/Servicing and Residential Mortgage Banking. Ready Capital intends to maintain REIT status and generally distribute at least 90% of REIT taxable income.

Key financial metrics

Metric	FY2018	FY2017	Change
Interest income	$169.5 million	$138.3 million	+$31.2 million
Interest expense	$109.2 million	$74.6 million	+$34.6 million
Net interest income before loan losses	$60.3 million	$63.7 million	-$3.4 million
Provision for loan losses	$1.7 million	$2.4 million	-$0.7 million
Non-interest income	$147.9 million	$141.2 million	+$6.7 million
Non-interest expense	$143.6 million	$154.9 million	-$7.2 million
Net income	$61.5 million	$45.8 million	+$15.6 million
Net income attributable to Ready Capital	$59.3 million	$43.3 million	+$16.0 million
Basic and diluted EPS	$1.84	$1.38	+$0.46
Core Earnings	$58.7 million	$47.0 million	+$11.7 million
Dividends declared per share	$1.57	$1.48	+$0.09

Fourth-quarter net income was $9.5 million, or $0.30 per share, compared with $11.3 million of Core Earnings, or $0.34 per share. The company declared a fourth-quarter dividend of $0.40 per share.

Total assets increased 20.3% to $3.04 billion from $2.52 billion.
Total stockholders’ equity increased 1.5% to $564.1 million.
Total loan portfolio carrying value was $2.53 billion, with $2.59 billion of unpaid principal balance and $2.57 billion of fair value.
Cash and cash equivalents were $54.4 million; restricted cash was $28.9 million.
Net cash provided by operating activities was $140.3 million; investing activities used $580.8 million; financing activities provided $444.5 million.
Cash, cash equivalents and restricted cash increased by $4.0 million during the year to $95.0 million.

Portfolio, originations and financing

2018 loan originations totaled $3.18 billion: $1.19 billion of SBC loans, $213.0 million of SBA 7(a) loans and $1.78 billion of residential loans.
The company acquired approximately $380.6 million of SBC loans during 2018.
At year-end, the portfolio was approximately 51% adjustable-rate and 49% fixed-rate by unpaid principal balance. Weighted-average ARM margin was approximately 3.5%; weighted-average fixed-rate coupon was approximately 6.2%.
Loan delinquencies were 1.8% for loans 30–89 days past due and 1.5% for loans 90 or more days past due. Non-accrual loans were 2.0% of total loan carrying value.
Non-performing acquired SBC loans represented approximately 4.3% of total loan UPB and 4.0% of carrying value; 376 non-performing loans had $112.6 million of current UPB and $100.7 million of carrying value.
Secured borrowings were $834.5 million and securitized debt obligations were $905.4 million at year-end. Additional principal debt included $180.0 million of 7.50% senior secured notes due 2022, $115.0 million of 7.00% convertible notes due 2023 and $50.0 million of 6.50% corporate notes due 2021.
Recourse debt-to-equity leverage was 2.1x at December 31, 2018. Management targets total debt-to-equity leverage of 3.0x–4.0x and recourse debt-to-equity leverage of 1.5x–2.5x.
The company reported compliance with its debt covenants and stated that it had satisfied all margin calls historically without selling assets in response to a margin call.

Material changes versus the prior comparable period

Net income rose 34.1%, while Core Earnings increased 24.9%.
Interest income increased 22.5%, primarily from growth in SBC originations, transitional loans and acquired SBC loans, but interest expense increased 46.3% as borrowing needs expanded.
Net interest income before loan losses declined 5.3%, reflecting higher funding costs and leverage.
Residential mortgage banking activities declined to $59.9 million from $83.4 million, principally because of lower residential loan sales and origination volumes. Lower variable expenses partially offset the revenue decline.
Net realized gains on financial instruments increased to $38.4 million from $19.3 million, while net unrealized gains declined to $4.9 million from $7.0 million.
The allowance for loan losses declined to $8.3 million from $11.7 million, reflecting portfolio paydowns, sales and a shift toward credit-stabilized performing loans.
Assets in consolidated variable-interest entities increased 45.2% to $1.25 billion, and securitized debt obligations increased 51.4% to $905.4 million.
The company issued $50.0 million of corporate debt and an additional $40.0 million of senior secured notes during 2018.

Guidance, outlook, commentary and unusual items

Management expects to continue growing through SBC, SBA and residential mortgage originations, SBC and SBA acquisitions, servicing growth and additional securitizations. Management believes improving commercial real estate values have increased loan payoffs and reduced credit exposure, while a moderate rise in interest rates should not materially deter borrowers with low coupons and rising property income. No formal earnings or dividend guidance was provided.

As of December 31, 2018, the stated pipeline totaled approximately $1.00 billion: $230.0 million of SBC acquisitions, $482.5 million of SBC originations, $167.7 million of SBA originations and $124.0 million of residential agency commitments. Pipeline transactions remain subject to capital availability, due diligence, approvals and market conditions.
In January 2019, the company completed a $399.2 million fixed-rate SBC loan securitization and issued $355.8 million of senior bonds at a 4.1% weighted-average pass-through rate.
Ready Capital agreed in November 2018 to acquire Owens Realty Mortgage in a stock-for-stock transaction estimated at $182.6 million. Closing was expected in the first quarter of 2019, subject to shareholder, regulatory and customary approvals. A purported ORM stockholder class action was filed in February 2019; Ready Capital stated that the claims were without merit.
Fourth-quarter earnings were affected by $11.1 million of unrealized derivative losses, compared with $8.5 million of unrealized derivative gains in the third quarter. Residential mortgage banking activity also declined sequentially.
Management fees to Waterfall were $8.2 million in 2018, and incentive fees were $1.1 million. The external management agreement includes a termination fee generally equal to three times recent average annual management fees.

Principal risks and contingencies

Leverage, short-term repurchase financing, margin calls, refinancing risk and covenant requirements could force asset sales or reduce distributions during market stress.
Rising rates may increase funding costs faster than asset yields, compress spreads and reduce the value of fixed-rate assets; hedges may be ineffective or generate significant mark-to-market losses.
Credit losses may increase because of borrower defaults, property-value declines, high LTV loans, geographic concentration and exposure to small businesses and transitional properties.
Illiquid SBC loans, mortgage-backed securities and Level 3 assets require significant valuation judgment and may not be saleable at recorded values.
The company depends heavily on Waterfall and faces conflicts of interest because Waterfall manages other funds and receives management and incentive compensation.
Failure to maintain REIT qualification or the exclusion from Investment Company Act registration could result in material taxes, forced asset sales, regulatory costs or changes to the business model.
Residential mortgage operations face repurchase, indemnification, consumer-protection, servicing, agency-approval and mortgage-servicing-rights valuation risks.
The company had $161.7 million of unfunded commitments on held-for-investment loans, $4.9 million on loans held for sale and $124.0 million of residential commitments at year-end. Total contractual obligations were $1.41 billion, including $488.9 million due within one year.

Most important facts for an investor to verify

Reconcile the reported $61.5 million of GAAP net income and $58.7 million of Core Earnings with the $50.6 million of common dividends declared, including the effects of non-cash and unrealized items.
Assess whether the increase in net interest income is sustainable after the substantially faster growth in interest expense and secured borrowings.
Review delinquency, non-accrual, LTV, charge-off, recovery and allowance trends, particularly for acquired SBC and SBA portfolios.
Examine maturity, renewal and collateral requirements for repurchase agreements and warehouse facilities, especially obligations due or renewable during 2019.
Evaluate the sensitivity of book value, earnings and liquidity to interest rates, derivative valuations, prepayments, property values and margin calls.
Confirm the timing, financing, shareholder approval, litigation status and expected dilution associated with the ORM merger.
Review Waterfall management fees, incentive distributions, related-party loan transactions and the terms for terminating the management agreement.
Verify REIT and Investment Company Act compliance, the tax treatment of taxable REIT subsidiaries and the expected effect of the current expected-credit-loss accounting standard.