Thank you for standing by. This is the conference operator. Welcome to the Ready Capital Corporation Second Quarter 2020 Earnings Conference Call. [Operator Instructions]. I would now like to turn the conference over to Andrew Ahlborn, Chief Financial Officer. Please go ahead.

Thank you, operator, and good morning, and thanks to those of you on the call for joining us this morning. Some of our comments today will be forward-looking statements within the meaning of the federal securities laws. Such statements are subject to numerous risks and uncertainties that could cause actual results to differ materially from what we expect. Therefore, you should exercise caution interpreting and relying on them. We refer you to our SEC filings for a more detailed discussion of the risks that could impact our future operating results and financial condition. During the call, we will discuss our non-GAAP measures, which we believe can be useful in evaluating the company's operating performance. These measures should not be considered in isolation or as a substitute for our financial results prepared in accordance with GAAP. A reconciliation of these measures to the most directly comparable GAAP measure is available in our second quarter 2020 earnings release and our supplemental information. Yesterday evening, we issued a press release with the presentation of our results along with our supplemental financial information presentation. These materials can be found in the Investor Relations section of the Ready Capital website and have been filed with the SEC. We plan to file our second quarter 2020 10-Q this evening. In addition to Tom and myself, we are also joined by Adam Zausmer, Head of Credit, on today's call. I will now turn it over to Tom Capasse, our CEO.

Thanks, Andrew, and good morning. We appreciate you joining the call, in what continue to be unprecedented and challenging times. Our thoughts remain with you and your loved ones and hope that you are help -- safe and healthy. As the lending business had historically adept at remote operations, we have readily adapted to the COVID environment, managing greater work demands with equal or greater productivity. In response to the pandemic, our management team undertook a 3 phase process. Phase 1 was defense. We harvested liquidity and preserved book value via holistic asset management with aggressive loss mitigation during the second quarter, we preserved much of our book value from the first quarter as the decline was only 10% with a current 60-day delinquency rate of 2.2% versus over 7% for our large balance commercial peers. Phase 2 is offense. Armed with over $260 million of liquidity today, we've completed a strategic review of our diverse businesses to chart the path forward. We will continue to expand our government-sponsored lending segments and plan relaunch of our CRE acquisition and lending businesses, including the introduction of new products. Operating expenses were also reduced in line with reduced CRE loan volume and a planned greater reliance on technology. Phase 3 is implementation from the early third quarter to year-end. We will seek to restore our normalized core earnings, comprising a combination of net interest margin from redeployment of excess liquidity into the robust post-COVID CRE acquisition and lending opportunities and cash gain on sale income from our government lending businesses. In the current quarter, we achieved our Phase 2 objectives and record results by leveraging our gain on sale businesses, including allocating substantial resources to the Paycheck Protection Program, or PPP. Additionally, we focused on the asset management of our existing small…

Thank you, Tom. We are pleased to report GAAP earnings of $0.62 per share and core earnings of $0.70 per share, both quarterly records when normalizing for business combination effects. This quarter highlights the company's ability to allocate capital and resources to their best use in varying economic climate. The company's strong financial results were due to elevated production in our gain on sale businesses, our participation into PPP and the continued performance of our core small balance commercial loan portfolio. Revenue sources were diverse in the quarter with 39% coming from elevated net mortgage banking activities, 31% coming from stable net interest margin and servicing, 24% coming from our PPP efforts and 6% coming from gain on sale activities. Key adjustments to core earnings included a $9 million net markdown of our residential MSR portfolio, offset by a $5.1 million recovery of CECL reserves on performing loans. Included in core earnings is a $4.5 million increase in CECL reserves on nonperforming loans. Our residential mortgage banking business, GMFS, posted excellent numbers in the quarter. Record production of $1.2 billion in combination with margins exceeding 300 basis points, resulted in a 180% quarterly increase in net mortgage banking revenue to $44.1 million. The $12 million decline in the residential MSR valuation due to a 130 basis point increase in CPR assumptions was partially mitigated by a 42% retention rate. At quarter end, commitments to originate reached $582 million, and we believe elevated performance will continue into Q3. Our efforts in the PPP program helped tens of thousands of small businesses to maintain jobs at a time when they needed it most. Since the beginning of the PPP program, we've facilitated the funding of 40,000 loans totaling $2.7 billion. Total net revenue, meaning gross fees paid by the SBA, less payments…

Thanks, Andrew. We had a productive quarter managing through this pandemic recession. Our personal business model featuring government-sponsored businesses provided earnings and liquidity to bridge the period of capital markets volatility. Further expansion of these businesses, including CARES Act programs, together with pending redeployment of excess liquidity harvested during the crisis into relaunch of our net interest margin based, small balanced commercial direct lending segments will provide a ramp to normalized core earnings in subsequent quarters. Our management team sees in the crisis as an opportunity to refocus our lending businesses by applying technology to design strategies to cut loan acquisition costs while increasing volume. We believe successful execution of these plans alongside pandemic bonds, lending and acquisition opportunities will over time provide core earnings growth for the benefit of shareholders. With that, operator, we can open the line for questions.

[Operator Instructions]. Our first question comes from Stephen Laws with Raymond James.

Tom, I guess to start off maybe with the PPP gains, Page 3 talks about $18 million of earnings to be recognized in future periods. Was that all hitting 3Q? Or is this going to be more water-filled out than that?

Andrew, do you want to address that?

Sure. It's going to be dependent on two things. So a portion of the deferred revenue will be allocated to the forgiveness process, which we expect to be completed within the year, so sometime over the third and fourth quarter. The remaining amount will be allocated to any ongoing servicing costs, and that may extend into 2021, but we expect the entirety of that amount to be recognized over the next 4 quarters.

Great. I guess staying on kind of the income and margins. Resi banking margins, you talked a good bit about the strength there in prepared remarks. I mean, are those margin levels holding through July? Are we -- do you expect that to gradually pullback? Or will we get even stronger margins here before they normalize? What are your outlook kind of second half, your outlook for residential mortgage loan margins?

Yes. Margins remained elevated in July. Certainly, not quite at the levels we saw in April and May, but much higher than where they were in the first quarter. I think we expect throughout the third quarter margins to continue to be elevated. Tom, do you want to give more color on our forward-looking statements and that.

Yes, sure. I think just more broadly, I think GMFS, those -- they are very efficient purchase-oriented mortgage banker with a dominant market share in the Louisiana, Mississippi, Alabama area where you have a lot less convexity in terms of prepayments and what have you. But just more broadly, we expect -- the elevated margins today, as evidenced by the rocket mortgage IPO are really a function of a historic imbalance of demand for refinancing, given the historic decline in the 10-year versus refinancing versus production capacity in the industry. A number of companies have had to reposition staff and what have you, but it's just -- at this point, the pricing elasticity, which is very atypical for the industry, is a function of that supply-demand imbalance. So given that, we expect a gradual normalization of the margins over the next, let's say, probably by the first quarter of next year when that the production capacity equals the -- obviously, the refinancing volume will decline as you work through the inventory of higher FICO borrowers that will be the low-hanging fruit. And so yes, so we expect a gradual normalization over going into the first quarter of next year.

Great. And Tom, I guess, to ask one more question kind of outlook and apologies if I missed this. I know you talked about CRE lending a good bit in the prepared remarks. But you resumed lending activity. Kind of how -- what kind of volumes do you think you'll put up in the second half? Is it just kind of putting the toe back in the water, how quickly will you ramp back up the CRE lending activity?

There's definitely -- it's interesting. It's basically there's a demand -- supply demand factor at work. Right now, our bridge team, our transitional lending team estimates that about 65 -- almost 2/3 of the lenders have pulled -- are still not back in London. We hear that in terms of color from our larger capital providers as well as doing our own research. So we expect -- and then on the flip side, demand is somewhat subdued, particularly of areas that are most affected by the pandemic retail and hospitality, where we don't really have as much of a focus, we're more multifamily oriented. So there's reduced demand, but reduced supply. So long-winded way in saying, I think it's going to be until the first quarter of next year before you see our volume back to the levels it was in the first quarter of this year, let's say, last quarter of 2019.

Our next question comes from Steve Delaney with JMP Securities.

And congratulations on your Phase 1 success, and it looks to me that you're well positioned for 2 and 3. And Tom, given that you've survived the tempest to the storm fairly well in terms of liquidity and lowering leverage. It seems to me your big decision, not that you don't have challenges in this market, but your big decision really is where to deploy your capital and liquidity. And I guess, looking first to the buyback plan, the authorization, about 5% of your market cap today. We're seeing the shares at 60% of book. And I'm curious if that level the current valuation, would you say that, that meets with your return requirement on the accretion from repurchasing shares at this level?

Yes, it does.

No, I would just say, I realize you have to balance. You have to balance that. But I think what you're saying is at this level or lower. I think from a modeling standpoint, we might want to assume some level of buybacks here over the next quarter or 2?

Yes. So I think or -- yes. Go ahead, Andrew, sorry.

Yes, Steve, I think that's right. Over the next quarter or 2, I think you will see repurchase activity.

Very good. Okay. Then -- okay. And Tom, you guys were able to get through between your securitizations and just not being over-levered in the first place, but we have seen now 8 transactions. I'm just going to go ahead and call it rescue capital. That's not intended to be demeaning of the companies or the transactions. I think they're both sides, one on -- or winners on most of those transactions. It doesn't appear to me that you guys need any defensive capital. But the other question is, there's money out there looking to partner with people that have opportunities. And would you consider certainly not talking about common equity, but would you consider partnering or taking on some opportunistic capital rather than defensive capital just to take advantage with your market opportunities, even if you have to share the returns with another entity?

Yes. I think that's a good point. We -- the -- there's 2 answers to that question. One is we actually are working on a number of straight-up corporate debt transactions, given the fact that we do have some capacity in that regard, probably $100 million-ish. So we are moving forward on that front, given the effect that we've stabilized, and we have a cash position equal to almost 1/3 of our GAAP book value -- equity book value. And then on the number of REITs, as you pointed out, that our capital -- that have more investment opportunities in relation to the deployable capital. We have undertaken JVs with private funds, I think we -- our external manager has around $8 billion of opportunity capital, which we could deploy in the JV with the external mantra. A number -- a few other companies have done that over the last 3 to 5 years. So I think that would be the -- yes, that we would -- that door is and has always been open. And we've actually historically done that, for example, that. Andrew, when was the -- was that fourth -- the Louisiana purchase of the nonperforming loans, for example, that was a 50-50 split with the external manager. So I think right now between the corporate debt capacity that we're working on and the external manager, we have ample capital to leverage the ReadyCap platform and then allocate where we have concentration limits or limitations in terms of overall capital, but yet capitalized on the fee income and the -- any sort of promotion we would get on that investment.

Great. That's very helpful. And just one housekeeping. Andrew, when we look at the $14 million remaining PPP fees, what would be an approximate tax rate which you put on that?

25%.

Our next question comes from Timothy Hayes with B. Riley.

And my first question, just kind of staying in line with talking about being opportunistic here. Tom, you made some constructive comments on the resi lending and housing environment. And just wondering if you've considered expanding into some more resi credit focused strategies and you anticipate maybe seeing some good acquisition opportunities in the back half of the year like you expect on the small balance commercial real estate side?

Yes. On the -- we definitely have been looking to expand -- broaden our investment activities and lending activities on the residential front. We've looked at some of -- opportunistically, the fix and flip market, the SFR financing market, single-family rental market, not the property investment, but financing those strategies, builder lot loans has been on our radar screen. So yes, there's definitely ways to expand around the opportunity set. We have avoided the non-QM space because we view it as a high, very -- having significant liquidity risk as what occurred. With a number of the residentially focused REITs. So yes. So I think we will look to expand opportunistically, leveraging off the GMFS platform. And then there are definitely some distressed M&A opportunities that we think, both in the private and public space on the C-REIT side -- I'm sorry, the commercial and residential REIT side that we will continue to pursue along the lines of what we did, for example, with the Owens merger last year.

Okay. And I guess, just on the acquisition front, it sounds like you expect -- you've seen some -- you haven't really seen a lot of portfolios trade here. And I'm just curious, are you seeing bid-ask spreads starting to tighten a little bit? And what do you think will be the main drivers of seeing a lot more acquisition opportunities in the back half of the year? And where do you expect they might come from?

A lot of them are community banks that have -- and regional banks that have taken much larger CECL reserves due to the -- what do you call it, the pandemic, which turn -- which was on top of the implementation. And granted, they have regulatory forbearance. But so I think what we're seeing is a lot sales of either scratch and dent or performing small balance portfolios, which they view as noncore. And so that -- we're currently -- we're as of last week, we had about $3 billion that we had tracked about 1/5 traded. And we're currently engaged on about $250 million. But I think the -- right now, there's a significant bid-ask that is due to the forbearance. And the SBC portfolio is running at about -- quite running its peak at around 15%, 20%. But you're seeing roll rates, for example, our two credit officers on right now, but I think our roll rates were out of delinquency -- sorry, out of forbearance where back to paying, was around 85%. So when that volume comes down, I think you're going to see a lot more volume in the third and fourth quarter.

Got it. Got it. That's good color. And then just small balance commercial real estate prices, as you pointed out in the past, have historically tracked closer at the resi market than the large balance CRE market. But that relationship be a little bit broken in a situation like this. And I know it's going to differ by market, mass and type. But just wondering how you think broadly SEC real estate prices will trend and whether we see bear case scenarios where we're really eating into your LTVs?

Yes. I think the correlation has been 0.8% over the last 30 -- 25 years using the Boston mean data versus the Case-Shiller. And I'm not sure that, that decoupling significantly in this recession. Housing is extremely strong due to supply shortages. Our house forecast is now for a decline this year of 2.5% in Case-Shiller. For large balance, the Moody's increase index we're expecting a 20-ish percent decline versus 40% in the last recession, and a lot of that is 80% of that is hospitality and retail sectors. Given that 2.5% for housing and down 20% for commercial large balance. We're expecting maybe a down 10% for see a -- small balance. So now if you compare that, Andrew, our current LTV in our portfolio is, what, 6 -- upper -- late 60s?

Yes.

Yes. So to answer your question. So, yes. So if you look at that stress layer on default rates and liquidation expenses, yes, I think we're in a very strong place in terms of principal impairment, in particular, in relation to our reserves -- our CECL reserves.

Our next question comes from Jade Rahmani with KBW.

One of the major commercial real estate brokers is anticipating a sizable uptick in loan portfolio sales after Labor Day. Their pipeline totals around $3.5 billion including strategic advisory assignments. I was wondering if those loans -- if the average balance was more in line with overall commercial real estate loans, say, around $20 million. Is that something that ReadyCap would look to participate in?

I would say we stick to our knitting. We have the trading levels of these SBC loans on a levered basis, be it securitization exit or term financing from banks is probably a 300 to 500 basis point yield premium. And we have -- we have ample opportunities there. So I would say we wouldn't get out of our fairway and strategy drift into large balance. We have ample acquisition opportunities in our core SBC market.

Okay. And when we think about earnings in the quarter of $0.7 core earnings, that included an estimated roughly $0.43 from the PPP program. And you've said that there's a $18.2 million of remaining PPP fees. So I assume the $14 million that you mentioned is the after-tax amount. If we assume 2/3 of that took place in the third quarter, you would end up with earnings of around $0.40. Are there any adjustments for that that we should be thinking about as we project out the next 1 to 2 quarters.

Jade, the one thing I'd point out is when you look at the PPP economics in the current quarter, there are certain other items that were heavily influenced by the PPP, such as the booking of incentive fees, obviously, the calculation of taxes was much higher. And so when you whittle down the true impact of the PPP, it becomes a little smaller in the current quarter. On a go-forward basis, obviously, the $14 million, which is a pretax number, Jade. We'll obviously elevate earnings depending on the timing of the recognition, which will be dependent upon how quickly these loans are forgiven or paid-off. With increased residential mortgage banking activity in the third quarter, I suspect that revenue will be high once again. And then absence, and then depending how large of a participation we undertake in whatever new PPP programs are rolled out, it could lead to some volatile results over the next 2 quarters. So I think the combination of those 3 things could add some volatility on the upside to earnings.

Okay. And when you said current quarter, where you're referring to the second quarter, when you say that $0.43 estimate that I provided for the PPP impact in the second quarter. It sounds like that's too [indiscernible] an estimate.

Yes. I think the effects of PPP on the EPS are a little lower than the $0.43. When you take the totality of the cumulative effects across taxes, incentive fees and things like that.

Okay. And if the PPP earnings were to completely -- the impact would dissipate, and there weren't other new programs to replace that. Are you still targeting -- I mean the past dividend pre-COVID was that $0.40 annualized, that represents double-digit ROE. Is that still kind of the target range or based on the G&A alignments, you mentioned the technology execution that we could be seeing higher ROEs than that.

Yes. I think the goal in the short-term is to get the company back up to stabilized earnings at that $0.40 level and then to grow from there.

Okay. In terms of how you're thinking about the credit seasoning of the book, elevated levels of unemployment. If we were to see a second wave in the fall. Is that something that [indiscernible] is prepared for in terms of the balancing offense and defense. And also a follow-up, a related question is, did you see any in recent weeks, pull back some deterioration in economic performance in any of the markets you're operating in?

Jade, this is Adam Zausmer.

Yes. Go ahead, Adam.

Jade, it's Adam Zausmer. Yes. So I mean, still significant uncertainty in the market. We do remain optimistic that the credit profile of our diverse and granular portfolio. Tom mentioned 60% LTV. Additionally, we have 11% weighted average debt yield. So significant cash flow cushion on these loans. Strong liquid geographies that we're lending in. Tom also mentioned limited hospitality in large retail properties as collateral. And then also just generally solid loan structure tailed to sponsored business plans. We think that's going to help keep our portfolio on solid ground. There is -- July was the first month where forbearances expired. We mentioned that 87% have remained current. Additionally, only 4.5% of our portfolio is under forbearance today. We expected that number to be much higher. So again, that just kind of speaks to the strength of our sponsors and the commitment to these properties. Additionally, just in terms of added protection here, the securitization structures that we have, very unique and designed to give us full control of the loans so that we can reach optimal [indiscernible]. We're authorized to work directly with sponsors and wave strategies and prepayment penalties as needed to get complete control of the loans. And then also just the servicing agreements that we have, provide really good servicing experience for customers. We have staff that liaises with these borrowers and the servicers. So we can reach optimal resolution and identify red flags as usual.

Our next question comes from Crispin Love with Piper Sandler.

First, how much of the PPP volume did you sell during the quarter? And how much was on the balance sheet as of June 30 that is on it now?

Yes. So we sold the overwhelming majority of production. Only around $105 million remains on the balance sheet.

And is it the -- are the buyers there? Is that mostly banks?

Yes.

Okay. And then just one on the repurchase program. Why do you think you needed to increase the programs here even though you haven't repurchased any shares with the current authorization? And I guess, is there anything that was keeping you from repurchasing any shares on the prior authorization which I think was first initiated about a couple of years ago.

Yes. The Board of Directors, given the current share price, decided that more flexibility in terms of an increase allocation was appropriate in this environment. I'd say going to the original program, which is about 2 years old, we weren't quite trading at the discount level we are today. And then the reasoning behind why that wasn't utilized over the last couple of months was purely that the company's focus really was on getting to a financial position that was significantly more conservative than we were at the first quarter, just in terms of cash and exposure to mark-to-market liabilities. So we feel we're now in a position where we have sufficient cash to not only weather any uncertain downside but also to start deploying that cash in means that provide the best returns for our shareholders, which includes share repurchasing.

That makes sense. And then just one last one. Tom, I think you said that the percent of lands in the 4 and 5 risk bucket is currently around 8%. What did you say it was pre-COVID?

I don't have a number, Adam, do you have that.

Yes. Jade, yes, it was 4%.

Our next question comes from Christopher Nolan with Ladenburg Thalmann.

I'm excluding the effects of PPP on earnings, is it fair to say that core ROE was closer to around 10% annualized?

Yes, that's correct.

Okay. Great. And then on the CECL reserves, given Tom's comments that with the expiration of the forbearance, we could see higher losses. Are those already reserved for or do you have to reserve for those in the quarter the forbearance expires?

Yes. No, our CECL reserve is reflective of current expectations of losses. It actually, in terms of how CECL breaks down, our specific reserves on loans that we've identified, significantly lower than the total CECL reserve we have booked. So we do believe it's all captured in the current reserve number.

Great. And then the direction of leverage, I mean, you're in the range of historically where you are, given all the risks in the world, where are you thinking about leverage going forward?

Yes. I think we'll continue to try and maintain leverage ratios around where they're at today. When we look at our recourse leverage ratio. It sort of breaks down into 3 buckets. The first bucket, as we mentioned, is really to support our government-sponsored businesses. So that accounts for about half a turn. The other parts in that recourse leverage are corporate debt offerings, which we will most likely keep around the same size. It may increase a little bit to take advantage of go-forward opportunities. And the remaining amount is supporting our core commercial real estate lending and acquisition segment, we'll try to maintain at these levels, at least for the short term.

Great. Finally, Tom mentioned in his comments, you might be rolling out new commercial real estate type of strategies. Can you guys give an indication what this might be.

Yes. A couple of things. One is we're looking at expanding our correspondent relationships with other, let's say, smaller lenders that have unutilized agency licenses, for example, Fannie Mae, small balance, or HUD, multifamily, senior housing and what have you. That's one area that the President of the -- our commercial business is looking into. We're looking at other areas, for example, like commercial PACE program to assessed clean energy, which is taking on a new life in the post pandemic world. For example, New York state just passed legislation. So that couples very well with our small balance transitional lending business as a form of quasi equity. So that's another area -- another example of -- those are 2 examples where we're looking to expand In the commercial space.

This concludes the question-and-answer session. I would like to turn the conference back over to management for any closing remarks.

I'd just like to thank everybody for the time today, and we'll be looking forward to our next quarterly earnings call next quarter. Thank you.

This concludes today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.