Ready Capital Corp. (filed as Sutherland Asset Management Corporation) — FY2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016. The filing is an annual report, not a standalone Q4 filing; fourth-quarter data are presented in the unaudited quarterly table. The company began NYSE trading under ticker SLD on November 1, 2016 following its October 31 merger with ZAIS Financial.
Business context
The company is an externally managed mortgage REIT focused primarily on acquiring, originating, servicing and financing small-balance commercial loans. Its four reportable segments are loan acquisitions, SBC conventional originations, SBA originations/acquisitions and servicing, and residential mortgage banking. The ZAIS merger added GMFS’s residential mortgage origination platform and materially increased scale.
Key financial metrics
| Metric | FY2016 | FY2015 | Change |
|---|---|---|---|
| Total interest income | $137.0 million | $149.0 million | Down $11.9 million |
| Net interest income before loan-loss provision | $79.3 million | $101.1 million | Down $21.9 million |
| Provision for loan losses | $7.8 million | $19.6 million | Down $11.8 million |
| Net income | $53.4 million | $44.8 million | Up $8.6 million |
| Net income attributable to the company | $49.2 million | $40.4 million | Up $8.8 million |
| EPS, continuing operations | $1.93 | $1.62 | Up $0.31 |
| EPS, total | $1.85 | $1.59 | Up $0.26 |
| Core Earnings | $40.9 million, or $1.59 per share | $49.3 million | Down $8.4 million |
| Dividends declared | $1.61 per share as reported; $1.62 adjusted for the merger exchange ratio | $1.78 per share as reported | Lower on an unadjusted basis |
Reported net income benefited from a $15.2 million bargain-purchase gain related to the ZAIS merger, while Core Earnings excluded the bargain-purchase gain, merger costs, MBS and mortgage-servicing-rights fair-value changes and other nonrecurring items. The filing does not provide a single consolidated operating margin.
Fourth-quarter 2016 results
- Interest income was $32.7 million.
- Net interest income after loan-loss provision was $13.9 million.
- Net income from continuing operations was $27.9 million.
- Net income was $26.1 million and net income attributable to the company was $24.1 million.
- Basic and diluted EPS was $0.83.
Balance sheet, portfolio and liquidity
- Total assets were $2.61 billion, compared with $2.33 billion at December 31, 2015.
- Total stockholders’ equity was $552.1 million, compared with $480.2 million at year-end 2015; company equity was $513.1 million and non-controlling interests were $39.0 million.
- Total loans had unpaid principal balance of $1.97 billion and carrying value of $1.85 billion at December 31, 2016.
- The loan portfolio comprised approximately $1.03 billion of loan-acquisition assets, $140.9 million of SBC conventional-originations assets, $542.9 million of SBA assets and $130.0 million of residential mortgage assets, based on carrying value.
- Cash and cash equivalents were $59.6 million, restricted cash was $20.2 million, and short-term U.S. Treasury investments were $320.0 million.
- Borrowings included $326.6 million under credit facilities, $600.9 million under repurchase agreements, $492.9 million of securitized debt obligations, $390.6 million of guaranteed loan financing and $7.4 million under a promissory note.
- Debt-to-equity leverage was 2.6x, or 2.0x excluding $319.7 million of repurchase-agreement borrowings on U.S. Treasury securities. Management reported compliance with all debt covenants at year-end.
- Counterparty exposure under repurchase agreements and credit facilities was $159.4 million, or 6.1% of total assets. JPMorgan and Deutsche Bank represented 7.5% and 6.6%, respectively, of stockholders’ equity at risk.
Cash flow and material changes
- Operating activities provided $14.8 million of cash, investing activities provided $384.7 million, and financing activities used $381.5 million; cash increased by $18.0 million.
- Investing cash flow was driven primarily by $297.3 million of MBS sales and principal repayments and $481.9 million of loan dispositions and principal collections, partly offset by loan originations, loan purchases and MBS purchases.
- Financing cash use included $340.4 million of net repayments on borrowings and $46.9 million of common-stock dividend payments.
- Loan originations totaled $936.7 million, including $520.1 million of SBC loans, $43.8 million of SBA loans and $363.6 million of residential loans. Loan acquisitions totaled approximately $137.0 million in the MD&A discussion.
- Interest income declined as a result of MBS sales, lower discount accretion, lower originated-loan yields and principal paydowns. Interest expense increased because of higher securitization balances, financing costs and the LIBOR curve.
- The loan-loss provision declined as the credit-deteriorated portfolio contracted through liquidations and the company shifted toward originations.
- The company sold Silverthread, its real-estate brokerage subsidiary, in 2016 and reported a $2.2 million after-tax loss from discontinued operations for the year.
Outlook, unusual items and risks
Management expected continued growth in SBC, SBA and residential mortgage originations, loan acquisitions and servicing portfolios. It believed improving commercial real-estate values, rising property income and continued demand for small-balance commercial financing would support 2017 origination volumes. Management also stated that continued execution depends on access to debt and equity financing on favorable terms and that a prolonged credit-market downturn could require less attractive financing or changes to the business plan.
- On February 13, 2017, ReadyCap Holdings issued $75.0 million of 7.50% senior secured notes due February 2022, guaranteed by the company and specified subsidiaries.
- GMFS had a tolling agreement with a mortgage-loan purchaser concerning potential representations-and-warranties claims on approximately $1 billion of loans sold from 1999 through 2006. The tolling period was extended to May 15, 2017. Management believed litigation was probable absent settlement or further extension, but could not determine the likely outcome. A $2.8 million loan-indemnification reserve was recorded, and losses in excess of that reserve could be material.
- GMFS contingent consideration liability was approximately $14.5 million at year-end.
- Key risks include reliance on short-term repurchase and warehouse financing, margin calls, rising interest rates, credit losses, valuation uncertainty for Level 3 assets and mortgage-servicing rights, illiquidity, geographic and property-type concentration, regulatory and REIT qualification requirements, dependence on Waterfall Asset Management, and mortgage-loan repurchase or indemnification claims.
- Loans held-for-investment included $105.0 million of 90-day-or-more delinquent balances and $1.59 billion of carrying value. Acquired nonperforming loans represented 4.5% of total loan UPB and 2.3% of carrying value.
Most important facts for an investor to verify
- Reconcile reported net income with Core Earnings and isolate the $15.2 million merger bargain-purchase gain and $4.5 million of merger-related costs.
- Assess whether recurring earnings and cash generation support the dividend, given Core Earnings of $40.9 million versus declared dividends of approximately $43.5 million on common stock.
- Review the maturity, renewal and covenant terms of repurchase agreements, credit facilities and warehouse lines, including exposure to margin calls and higher LIBOR-based funding costs.
- Evaluate the potential magnitude and timing of GMFS representations-and-warranties litigation relative to the $2.8 million reserve and $14.5 million contingent-consideration liability.
- Validate the fair values and sensitivity assumptions for mortgage-servicing rights, loans held at fair value, Level 3 assets and collateral-dependent loans.
- Confirm the sustainability of REIT qualification, taxable REIT subsidiary limitations and the company’s ability to maintain its 1940 Act exclusion.
- Because the merger occurred late in 2016, avoid treating pre-merger ZAIS trading data or two-month residential-mortgage results as directly comparable to the company’s post-merger operating profile.