Greetings, and welcome to the Ready Capital Corporation Third Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Andrew Ahlborn, Chief Financial Officer. Please go ahead, sir.

Thank you, operator, and good morning to those of you on the call. 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 in 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 third quarter 2022 earnings release and our supplemental information, which can be found in the Investors section of the Ready Capital website. In addition to Tom and myself on today's call, we are also joined by Adam Zausmer, Ready Capital's, Chief Credit Officer. I will now turn it over to Chief Executive Officer, Tom Capasse.

Thanks, Andrew. Good morning, everyone, and thank you for joining the call today. Before we dive into the numbers, a few observations on the macro backdrop, since late first quarter 2022, the historic velocity of the Fed's rate increases has led Ready Capital to pivot to a defensive posture in the event recession. However, we believe Ready Capital's multifamily sector focused and diversified business model affords strength in our liquidity, credit, book value and earnings in a stressed economic environment. First, in terms of liquidity, as of 9/30, ReadyCap had $1 billion in unencumbered assets, including $200 million in cash and an additional $2.4 billion in available warehouse capacity. Further, recourse leverage of 1.6x is within our 2:1 target and critically short-term repo at $392 million is only 4% of total debt and is primarily secured by floating rate, short duration assets subject to low price volatility. Additionally, only 16% of our debt is subject to mark-to-market and the average maturity of our warehouse lines is two years. Finally, near-term maturities and corporate debt are modest with 10% of the outstanding $1.1 billion due in August 2023 and the balance laddered after April 2025. Second is credit. Our historical sector focus on lower middle market multifamily, which comprise 72% of our current CRE portfolio will benefit from the shock and housing affordability, which is tilted to buy versus rent calculus to rent. The doubling in mortgage rates to 7% has increased the US mortgage to rent ratio from the 103% prior 10-year average to a 159% today. This will support lower vacancy rates and positive rent growth even in a recession, particularly in our affordable multifamily niche. In terms of our small business segment, our credit team forecast an increase in delinquencies from 1.5% currently to approximately 3.5%, for which…

Thanks Tom. Quarterly GAAP earnings and distributable earnings per common share were $0.53 and $0.46, respectively. Distributable earnings of $58.2 million equates to a 12.7% return on average stockholders' equity. Absent the effects of PPP, quarterly interest income increased 28% to $172 million, with net interest income increased 5% to $57 million. As of quarter end, 85% of the portfolio is floating rate with an average spread of 320 basis points. The continued climb in short-term rates increases profitability on our existing loan book with each 50 basis point movement in rates, equating to an $0.08 increase in annual EPS. The rise in interest expense was due to both an increase in average debt throughout the quarter and a seven basis point increase to warehouse financing spreads. The provision for loan losses totaled $3.4 million, with the majority of the increase due to a deterioration of macro assumptions used in modeling reserves on our performing loan book. Included in the $3.4 million were specific reserves of $900,000 related to two non-performing office assets, which we expect to liquidate in the fourth quarter. Realized gains from gain on sale production were up $3.5 million quarter-over-quarter to $12.1 million. The change is due to both an $18.6 million reduction in Freddie Mac SBL production as well as a 100 basis point reduction in SBA 7(a) premiums, which averaged 8.6% in the quarter. Net contribution from residential mortgage banking activities declined 60% to $3 million. Other income items of note include the continued contribution from PPP, which totaled $11.8 million, $7 million of fees related to the processing of employee retention credits for our small business customers and mark-to-market reductions of assets held within unconsolidated joint ventures. On the balance sheet, we continue to prioritize increasing liquidity levels, limiting mark-to-market debt and managing…

Thank you. At this time, we will be conducting a question-and-answer session. [Operator Instructions] We have a first question from the line of Stephen Laws with Raymond James. Please go ahead.

Yes. Hi. Good morning. First, maybe on the resi side, I guess a lot of attention in the media. But with where rates are, we saw a shift, 80% purchase, I believe now, how is your outlook for volumes kind of where do you think we trough and get to a level there in that process?

Yes, it's a good question. And obviously, the big topic of conversation. But the bottom line is the -- if you look at the refinanceable universe, that is borrowers that have mortgages that are in the money for an equity -- sorry, a rate refinance, it was north -- upper 80s the total mortgage universe in the summer of last year. Today, it's under 1%. And even if rates rallied 150, it wouldn't -- that number would get up to around 8% to 10%. So the bottom line is we're probably at the trial, but we're going to be in this kind of desert for quite some time unless there's a major reversal in the 10-year, more to that kind of like below 3% level.

Along the lines of realigning the dividend, how much PPP income is remaining? When we think about that, great opportunity and generated great returns. As we look forward and you think about realigning that dividend, how do you think about new investment returns available in this market, repurchasing something in your common stock or something in your own capital stack versus setting that new payout ratio?

Andrew, do you want to touch on that?

Yes. So as of quarter end, There was $20 million of remaining income to flow through the income statement. The expectation is that, the majority of that rolls off in the fourth quarter. I think, as we and the Board, think about the go-forward dividend, certainly setting it in line with our historical targeted return of right around 10%. And so, when you look at the dividend level, pre-COVID for the company, it was right in line with those return goals. So, I think that what we'll see is that, the dividend starts to triangulate to levels similar to pre-COVID, certainly with some thought around establishing a level that is covered with consistency.

That's helpful. Thanks for framing that. And then I guess, on the trade-off, I think, increased the authorization, you've been quite active, more active quarter-to-date than I guess, late last quarter. But on the share repurchases, how do you think about returns there versus new deployment returns or no investment returns.

Yes. As you know, the Board did increase the repurchase program to $50 million. The entirety of that was built in the fourth quarter. When we think about repurchases, it's triangulating not only on the return difference between where we can invest new money today. And obviously, the returns produced by the share repurchase, but also the liquidity levels in the company. And given where the shares were trading at the early part of the quarter and the liquidity levels in the company, certainly thought the repurchase of those shares made a lot of sense. I think, as we look forward, maintaining significant liquidity levels is important. We're starting to see in half or the last couple of months investment opportunities with ROEs, significantly higher than where those opportunities existed at the beginning part of the year. So, it will be a balance between those three items.

Great. Appreciate the comments this morning.

Thank you. We have next question from the line of Steven DeLaney with JMP Securities. Please go ahead.

Good morning, Tom and Andrew. Congrats on a very solid quarter in these challenging times. Excited to see that you were able to get FL-10 off. I mean, it's not seeing much in the CLO world. Your average spread on those loans was 414 basis points. Well, let's just say that's per the commercial mortgage alert table. That's my data source. I was curious, and you said low teens on that. Your pipeline of loans appears to be so far plus about 550, 559 basis points. How should we look at that? I guess, the question is, what you learned from FL10 has probably led to some re-pricing of your new originations, I guess, my comment is, would it be possible with your pipeline in this market, do you think in FL11 can be executed – and with 550-ish basis points of average spread, could you possibly be low-teens? Thanks.

Well, I'll defer to Adam to maybe comment on pricing in the – in the bridge transitional – the lower middle market transitional loan market. But I think one of the hallmarks of Ready Cap is we're very – with the support of the external manager Waterfall, we're very attuned to the capital markets. So we re-priced daily our retained yield based on the spread at which we can execute the AAA tranches for the CRE, CLOs. Those were pre-COVID – I'm sorry, pre-rate cycle, they were – Adam, what was it probably around 175. Today, they're more in the 250 to 300 over for the industry. We've been printing at about 270. So with that in mind, we've re-priced our spread on the production side to achieve an IRR that's probably in the – for the bridge product, probably in the 15-plus zone as opposed to where we were in the first quarter before the impact on the credit spreads for securitized products, we were more in that 13% area. So it's widened on our core product, 200 to 300 basis points in terms of ROE.

That's encouraging. And just one follow-up, quick one. 92% of that collateral in FL10 was multifamily. We've been reading about Freddie trying to reactivate or crank up its Q-series shelf, given your product mix and that program, is there any fit there for you? Thank you. That's my last question.

Adam, you want to take that?

Yeah. Sure. We're certainly talking to the Freddie folks regarding contributing some of our product to the Q shelf. And what's interesting about that shelf is that we can contribute new originations across all of our multifamily products and then also through our acquisition strategy. So we think that, that could be a nice alternative to the CLO space, but we're certainly exploring both avenues in this market.

Great. Thank you all for your comments.

Thank, Steven.

Thank you. We have next question from the line of Christopher Nolan with Ladenburg Thalmann. Please go ahead.

Hey, guys. Andrew, what was the PPP revenues in the quarter?

On a net basis, it was $11 million.

Right. And also on the dividend realignment, is it going to be – I understand, Tom's comments, you're targeting a lower ROE given the absence of PPP and resi. Is that a fair assessment of it?

I would say that, the target return is certainly lower than where we are running just due to the magnitude of PPP, but is in line with where the historical targets were pre all the COVID stimulus programs, so right in that 10% range.

Okay. And then for fourth quarter and so forth, should we expect cash on balance sheet to continue to rise?

Yes. Certainly, one of the priorities here is to increase liquidity levels to make sure we're in a position to take advantage of, what we believe will be, numerous opportunities in the secondary markets. So the timing of those opportunities is a little bit in flux. But in general, the expectation is, liquidity is at 5% or greater of stockholders' equity at any given time.

Okay. Final question. I think in the comments was a reduction in the mark-to-market borrowings. What area of the balance sheet should we expect borrowings to go down with that -- with respect to that?

Yes. Well, certainly, the majority -- the mark-to-market liabilities on the balance sheet, say, are limited. The majority of our warehouse lines are, either non-marked by -- or credit mark only. I'd say, as we move into our next CRE, CLO, certainly that all help to transfer some of our warehouse balances into securitized debt. And so, it will be those activities that really drive the reduction.

Okay. Thank you.

Thank you. We have the next question from the line of Crispin Love with Piper Sandler. Please, go ahead.

Thanks. Good morning, Tom and Andrew. So, I actually have a follow-up on the realigning the dividend as well. So just curious if you could give just a little more detail there. Looking forward or, I guess, in the fourth quarter, does that mean you expect a decrease in the dividend here, or are you confident in core earnings covering that $0.42 level, just considering some potential tailwinds from loan acquisitions and rate increases flowing through interest income?

Yes. I mean, if you look at book value today post share repurchase right around $15.50 and a 10% target, a 10% target, setting a dividend around that level is the most likely scenario. $0.42 on that $15.50 certainly applies a dividend yield in excess of that target. So the expectation is that 10% targeted return is the driving factor of setting the dividend going forward?

Okay. Thanks, Andrew. That makes sense. And then, just a little bit more broadly. What are you seeing in the multifamily market currently? It's been a popular asset class over the last several quarters. But do you expect that to continue given home affordability issues for single-family home ownership, or has demand or could demand pull back meaningfully, just given the cap rates compared to debt costs in the market here for borrowers?

Well, I'll just make one observation and then Adam comment on it. But what we're seeing in the broader multifamily space is a definitive reduction in transaction volume, widening a bit at spreads, which is leading to the trades that do occur with price reductions in the 5% to 15% zone. Now, the -- and a lot of that has to do with the so-called negative leverage, i.e., the cap rates are lower than the debt cost and that will reprice. It has to -- prices have to go down. But the key thing here is a lot of that pain is going to be on the larger balance of urban locations and that have much higher rent price points. Our market is more of the lower -- is workforce, affordable, middle income, just given our small balance focus and that also benefits suburban and better -- more desirable locations post pandemic. So -- and then in those markets that they've been brutalize by the increase in affordability. The affordability in residential housing, which we track at the external manager has gapped out in terms of the time of it took, i.e., three months, four months is the biggest gap adding out in 50 years. So anyway with that, it's going to make the rent versus buy decision as we quoted it was running at about 103%, the mortgage to rent ratio. Today, it's at 159%. Anyway, long-winded way answer to your question, but we think that the if there's a recession, the impact on rent and therefore, cap rates and returns will be a lot more muted in our sector versus the broader multifamily space.

Thanks Tom. All helpful. Just one last question from me. Just on loan acquisitions, how are the opportunities that you're seeing there whether is it banks selling CRE assets or non-core assets or other opportunities in loan acquisitions. Just looking at your investment detail, doesn't look like you've picked up activity in loan acquisitions yet, but just curious how you're looking at the opportunity set as we -- or in a recession or moving towards it?

Yeah. It's a big question for our investment committee just was posted on that a few days ago. But what we're definitely seeing is two funnels for potential distressed assets going into the -- to some extent at the end of this year, but we're definitely into the first quarter of next year. One, is not surprisingly, banks that have, in particular, very large where the ratio of CRE to Tier 1 capital exceeds 250, the regulators are starting to press them on that as we -- as they typically do entering a recession. So we're seeing banks approach us for actual portfolio sales or they're getting more creative with credit risk transfers and seller financing. So we actually bid on a few of those. And so that's the bank channel that will increase. But the other interesting one is the boom in private credit funds in the transitional loan market. We track over 250 funds, and a lot of them aren't going to make it. They were trying to do CRE CLOs, they're start-ups in a way in the capital markets and there's going to be opportunity to buy those bridge assets at a discount. So those are the two things our trading desk attracting that we think will provide ample investment capacity going into the first half of next year.

Thank you, Tom. I appreciate taking my questions.

You bet.

Thanks Crispin.

Thank you. We have next question from the line of Jade Rahmani with KBW. Just go ahead.

Thanks very much. Follow-up on that last comment about transitional lending. Are you seeing M&A opportunities in the mortgage REIT space? There's a number of commercial mortgage REITs trading at pretty low price-to-book values, and could be in that category of needing, I don't know, rescue capital or some financing to get loans off credit lines, help with margin calls, help with the distress that seems to be beginning to play out?

Yeah, Jade, that's a good question. It's interesting. This time, it's more of a -- like a slow moving train wreck on credit in particular office and other potholes in the market like, for example, high – hard money lending on single-family homes. But there's -- we aren't seeing a liquidity crunch. There's a few of them we've seen there. But this time, I think the -- the REIT sector, mREIT sector learned its lesson, but yes, there's -- all that being said, it's really more of a credit bleed and we're seeing a lot of I don't know if capitulation is the right word, but preliminary conversations around accretive M&A transactions for their shareholders and for Ready Cap. And as you know, we look at things first strategically, like Mosaic. And then secondarily, in terms of capital raising. But yes, there's definitely going to be, I would say, material M&A increase in the first half of next year.

And would you venture outside of the small loan space or the foothold that Ready Capital already has?

I think we're more of the turtle than the hair. So we stick to our automatic [ph], so we'll stick-- we might go upstream a little bit to middle market on the bridge side and consider, for example, small commercial lending in Europe, which we've been doing and obviously, the whole -- there's a whole revitalization of application of fintech into the SBA space that we're ahead of the curve on. So I think to answer your question, we're more likely than not would stick to our core commercial real estate lending business.

What do you expect for home prices? I know there's a lot of media reports about home price declines, especially in the high-growth markets, the most high velocity markets -- but there's also a lack of inventory on the existing home side, not necessarily on the new home side and had a 7.5% mortgage rate, that could be a big limiting factor on the volume of transactions. So in that kind of framework, what would you expect for home prices?

Jade, the external manager has spent a lot of time in this. We have our own models, and we buy a lot of distressed residential. And the bottom line is that I think you kind of hit and it on the head, affordability typically with this -- if you look historically at Case-Shiller, going back to the 70s, at increased gapping out affordability like this normally would knock home prices down 10% to 15% from the peak -- where -- but because of the -- what you pointed out, the fact that supply in relation to demand inventory is so low -- and also the tail risk in the mortgage finance system is gone, because of the post-GFC non-QM and other rules, there is no subprime tail. And really, what drives prices is distressed sales. And finally, the over – roughly half of all US homeowners have an LTV less than 50 on and 85% of them are locked into a fixed rate mortgage three points below the – below the current rate. So it was a long winded way of saying our projection for home prices is down 4% to 5% in 2023, and then up 2% to 3% for the three years thereafter. So given all those factors, that won't have a material impact on mortgage credit default, that one caveat being the pandemic baby boom markets – sorry, the ones that benefited from the pandemic boom of migration like Boise, Idaho, those could experience price declines of upwards of 20%. So it's – there can be a lot of SKU news. You got to look at local markets, but that's our more broader macro forecast.

Thank you very much. And overall, in terms of volumes, are you expecting – I think Stephen Laws asked the question, but pretty light fourth quarter and then perhaps a pickup maybe in the first or second quarter, or what would you expect overall CRE lending volumes?

Yeah, Adam, do you want to comment on your views there?

Yeah. Sure. So we're certainly being more selective in this environment and maintaining credit discipline to focus on less volatile asset types. We're certainly taking advantage of the environment and deploying capital only into higher-yielding opportunities. We expect to close roughly $700 million to $900 million of commercial real estate in Q4, which is just under what we executed in Q3.

Thank you very much.

Sure. Thanks Jade.

Thank you. The final question comes from the line of Eric Hagen from BTIG. Please go ahead.

Hey thanks. Good morning and thanks for taking my question. Maybe just a couple of follow-ups. On conditions for CLOs, maybe you can comment on the stability you have for funding loans on balance sheet? And whether you're anticipating any costs on the warehouse lines that you have changing in any meaningful way? And then what are the target assets in Europe? And how much capital do you think you can eventually see yourselves operating with there? And like what is a snapshot of the targeted investment that you're making in Europe look like relative to something that you'd target domestically in terms of cap rate in LTV and borrower quality and such? Thank you very much.

Love your question. Yes, Adam, maybe -- I'm sorry, Andrew, maybe touch on the funding and then Adam, maybe touch on the kind of the credit profile of our -- the bridge product we're originating in the UK versus here?

Yes. So, as Tom said in his remarks, still roughly $2 billion in available capacity of warehouse lines today. In the third quarter, you did see average spreads increase roughly 10 basis points. I think what we're finding is as lines are rolling, advance rates are staying fairly in line with previous levels and pricing is moving anywhere from 25 to 50 basis points. So, we think you're going to see a slight increase in cost as those lines roll. But certainly, I think given where we're pricing loans today, still very attractive returns and ample capacities of fund our pipeline.

And then -- hey, this is Adam. So on the European question, so we're certainly focusing on deals in geographic areas with the legal framework is easier to navigate and when we can rely on the jurisdictional expertise of our local partners in Europe, definitely interested in opportunities located in gateway cities like Dublin, where there's really a material housing shortage similar to what we see in the US. So I'd say, we're certainly focused similarly on how we're lending in the US. We're focused on less volatile asset classes that have shorter duration leases, which really serve as a hedge against inflation, specifically in the multi-family sector, where there also tends to be a shortage of good quality, affordable housing, again, similar to United States. And with that said, there are other property types we focus on and are looking at opportunistically such as industrial and self-storage assets.

Got it. That's helpful. Thank you guys very much.

Thanks.

Thank you. Ladies and gentlemen, we have reached the end of the question-and-answer session. And I'd like to turn the call back over to Tom Capasse, CEO for closing remarks. Over to you, sir.

We thank everybody for their continued support and look forward to the fourth quarter earnings call next year.

Thank you. Ladies and gentlemen, this concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.