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. 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 of a 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 in 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 we are adequately reserved. This segment represents 4.5% of equity, and as such, net credit loss exposure would be modest. In the event of a recession, a big differentiator versus the peer group is portfolio diversification. The 10 largest loans equate to only 9% of the total loan portfolio, and we notably have no exposure to CBD office. Our office allocation is only 5% of our portfolio with a $2.4 million average balance. Third is book value. Given the first two factors, the hallmark of ReadyCap since COVID has been stable book value. Post the first quarter 2020 application of CECL, book value has actually increased 7% to $15.40 per share. This contrasts with the 15% to 30% year-to-date book value declines in the residential REIT sector as well as write-downs of C-REITs with significant CBD office exposure. We view book value preservation and growth as a key metric in evaluating ReadyCap's return. To that end, given the strength of our liquidity, we repurchased 3.6 million shares since September 30, resulting in approximately $0.16 per share accretion. Finally, dividend yield. As we've been communicating for a few quarters, we expect earnings to normalize over the coming quarters due to the runoff of the COVID stimulus revenue from PPP and the decline in mortgage banking. These declines will be moderated by lending and acquisition activity with a 300 to 500 basis point increase in ROE in the current distressed environment for core commercial real estate. Over the last two years, ReadyCap has paid and covered a dividend yield of 11.6% on average book value, which is in excess of the peer group average. As we look forward, we expect our business model to be capable of continuing to deliver a peer group premium, albeit at levels more similar to pre-COVID quarters. Our Board of Directors plans to realign the dividend in the fourth quarter to ensure our go-forward dividend is covered by normalized distributable earnings. Now reflecting industry trends, CRE lending volume was down 34% quarter-over-quarter at $831 million. However, this vintage features a significant yield premium with a more conservative underwriting compared to 2021. In terms of pricing, spreads on new production increased 80 basis points to SOFR+ 480, which even with the wider CRE CLO spreads equates to a 15% levered ROE. These higher yields are despite a defensive pivot in credit. 83% of volume was in cash flow in multifamily and 70% in Tier 1 and Tier 2 markets migrating to our strongest sponsors. Additionally, under stabilized yields our new production increased 8%, while loan-to-value decreased to 65%. Quarterly production in Europe increased with $75 million closed across five deals in the UK sourced via the three strategic European partnerships executed over the last year. The loans have a similar credit profile as our US bridge lending products that feature a 200 basis point yield premium. Our near-term defense strategy positions CRE lending volumes to stabilize near third quarter levels, as we harvest excess liquidity for higher ROE opportunities in the distressed secondary markets. Investment in distressed small balance commercial real estate loans is a differentiating factor in our business model. We were a top three buyer of distressed small balance loans from banks post the GFC, acquiring $3.4 billion, and we note a new supply in the recession from the post-GFC surface of 250-plus private credit funds. In the quarter, the CRE portfolio increased 2% to $9.6 billion across 2,300 loans. A number of credit metrics position the portfolio to outperform in a recession. Weighted average LTVs of 66%, with 84% of the portfolio concentrated in lower risk sectors, cash flow in multifamily mixed-use and industrial versus office. Current 60-day delinquencies remain low at 2.8%. Lastly, from an earnings perspective, 84% of the portfolio is floating rate. In our Small Business Lending segment, 7(a) production increased to $134 million, split 85% between our large loan and 15% in our emerging small loan segments. Pricing averaged prime plus 190 basis points. On the volume side, we expect a cyclical decline in 7(a) volume from $26 billion at FY 9/30, but are projecting continued growth in our volume due to market share gains, especially in our small loan segment. This is evident in our money up pipeline of $225 million as of quarter end. As discussed in prior quarters, we have leveraged our Fintech rebranded as iBusiness to drive efficiencies in volume in the small business lending segment, particularly the SBA 7(a) small and micro loan sectors, which are major policy acts for the Biden administration in terms of reaching minority and women-owned businesses. Beyond the application to our own production, we began marketing the technology as a separate lending-as-a-service profit center. Teeding these technologies within our lending ecosystem and creating scale with a longer term potential spin-off provides another avenue for creating shareholder value. Our residential mortgage banking business, GMFS, continues to be impacted by rising rates and lower refinancing volume with originations of $534 million for the quarter. Despite compressed margins averaging 74 basis points in volume declines of 28%, GMFS remains profitable due to its servicing-retained strategy. As discussed in prior quarters, we continue to pursue and evaluate initiatives, which may include strategic transactions.

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 increasing 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 to prudent leverage ratios. In the quarter, we closed a $100 million 7.375% senior unsecured note and subsequent to quarter end completed our 10th CRE CLO, an $860 million deal with an expected retained yield in the low teens. Total and recourse leverage ratios equaled 4.9 times and 1.6 times, respectively, and mark-to-market debt totaled 16% of total debt. In addition to normal items flowing through the balance sheet, we also completed an update to the business combination accounting related to the Mosaic merger. Fee changes included a $63 million reduction in the value of the asset portfolio, offset by a corresponding reduction in the contingent equity right valuation. These updates were primarily related to assets that were either liquidated or where new information has provided clarity on the expected value of an asset. Since the merger, we have reduced the Mosaic portfolio by 19%. Despite the reduction, 24% of that portfolio remains underperforming the broader business. We estimate the reinvestment of capital at current levels to equate to earnings of $0.14 per share upon liquidation of those assets. The challenging markets notwithstanding, we continue to make good progress on these efforts and expect to have made considerable progress as we work through the first half of 2023. With that, we will open up the line for questions.

Thank you. At this time, we will be conducting a question-and-answer session. 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 if you look at the refinanceable universe, that is borrowers that have mortgages that are in the money for 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, 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 the 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.

Thanks, Steven.

Thank you. We have the 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 noticed a reduction in the mark-to-market borrowings. Which part of the balance sheet should we anticipate seeing a decrease in borrowings related to that?

Yes. The mark-to-market liabilities on the balance sheet are limited. Most of our warehouse lines are either not marked or marked only by credit. As we transition into our next CRE and CLO, this will help transfer some of our warehouse balances into securitized debt. These activities will 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, 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 then let 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, 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 brutalized 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, 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. I have one last question. Regarding loan acquisitions, what opportunities are you seeing? Are banks selling CRE assets or non-core assets, or are there other avenues for loan acquisitions? From your investment details, it appears there hasn't been much activity in loan acquisitions yet. I'm just curious about your perspective on the opportunities as we move towards a recession.

It's a significant topic for our investment committee. We are currently observing two main sources for potential distressed assets as we approach the end of this year and into the first quarter of next year. First, banks with a high ratio of commercial real estate to Tier 1 capital are being pressed by regulators, which is typical as we enter a recession. Consequently, banks are reaching out to us for portfolio sales or are exploring more creative solutions like credit risk transfers and seller financing. We have placed bids on some of these opportunities, and this bank channel is expected to grow. The second notable trend is the rise of private credit funds in the transitional loan market. We've been monitoring over 250 funds, and many of them are likely to struggle. Those attempting to engage in commercial real estate collateralized loan obligations are relatively new in the capital markets, and we foresee opportunities to purchase distressed bridge assets at lower prices. These two areas are what our trading desk is focusing on, and we believe they will create substantial investment capacity in the first half of next year.

Thank you, Tom. I appreciate taking my questions.

You bet.

Thanks Crispin.

Thank you. We have the 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?

Yes, Jade, that's a good question. This time, it feels like a slow-moving disaster particularly with credit in the office sector and other issues in the market, such as high-interest lending for single-family homes. However, we aren't experiencing a liquidity crunch, although there are a few instances of it. I believe the REIT and mREIT sectors have learned from past experiences. Overall, it appears to be more of a gradual decline in credit, and we're witnessing preliminary discussions about beneficial mergers and acquisitions for their shareholders and for us. We approach things strategically, like with Mosaic, and then consider capital raising. There will likely be a significant increase in M&A activity 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 believe we are more like the turtle than the hare. Therefore, we will adhere to our established practices and may consider moving up slightly into the middle market for bridge financing, and explore areas such as small commercial lending in Europe, which we are currently engaged in. Additionally, there is significant potential for applying fintech innovations in the SBA space, where we are leading the way. To answer your question, we are more inclined to continue focusing on our core commercial real estate lending business.

What do you expect for home prices? There have been many media reports about declines in home prices, particularly in the high-growth areas. However, there is also a shortage of inventory in the existing home market, although not necessarily in the new home market. With a mortgage rate at 7.5%, that could significantly restrict the volume of transactions. In this context, what are your expectations for home prices?

Jade, the external manager has dedicated significant effort to this area. We utilize our own models and invest heavily in distressed residential properties. The main point is that you are correct; historically, if you examine Case-Shiller data since the 1970s, a significant gap in affordability typically results in home prices decreasing by 10% to 15% from their peak. However, due to the low supply relative to demand and the absence of tail risk in the mortgage finance system—thanks to post-GFC non-QM and other regulations—there is no subprime risk. The key factor influencing prices is distressed sales. Moreover, approximately half of all US homeowners have a loan-to-value ratio under 50%, and 85% of them are locked into fixed-rate mortgages that are three percentage points below the current rates. To summarize, we project home prices to decline by 4% to 5% in 2023, followed by an increase of 2% to 3% over the next three years. Given these considerations, we believe this will not materially affect mortgage credit defaults, with one exception being the markets that thrived during the pandemic, such as Boise, Idaho, which might see price drops of around 20%. It's important to examine local markets for specific nuances, but that encompasses our broader macro outlook.

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.

Thank you for your question. Yes, Andrew, could you discuss the funding? Then Adam, please address the credit profile of the bridge product we're originating in the UK compared to 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, this is Adam. Regarding the European question, we are definitely concentrating on deals in regions where the legal framework is easier to navigate, and where we can depend on the local expertise of our partners in Europe. We are particularly interested in opportunities in gateway cities like Dublin, which is experiencing a significant housing shortage, similar to what we observe in the US. I would say we are focused on lending in the US as well, concentrating on less volatile asset classes that have shorter duration leases, which provide a hedge against inflation, particularly in the multi-family sector where there is often a lack of good quality, affordable housing, again similar to the United States. Additionally, we are also looking opportunistically at other property types 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.