READY CAPITAL CORPORATION INTRODUCTION
Management's Discussion and Analysis of Financial Condition and Results of
Operations ("MD&A") is intended to provide a reader of our financial statements
with a narrative from the perspective of our management on our financial
condition, results of operations, liquidity and certain other factors that may
affect our future results. Our MD&A is presented in five main sections:
? Overview
? Results of Operations
? Liquidity and Capital Resources
? Off Balance Sheet Arrangements and Contractual Obligations
? Critical Accounting Policies and Estimates
The following discussion should be read in conjunction with our unaudited interim consolidated financial statements and accompanying Notes included in Item 1, "Financial Statements," of this quarterly report on Form 10-Q and with Items 6, 7, 8, and 9A of our annual report on Form 10-K. See "Forward-Looking Statements" in this quarterly report on Form 10-Q and in our annual report on Form 10-K and "Critical Accounting Policies and Use of Estimates" in our annual report on Form 10-K for certain other factors that could cause actual results or future events to differ, perhaps materially, from historical performance and from those anticipated in the forward-looking statements included in this quarterly report on Form 10-Q. OVERVIEW Our Business We are a multi-strategy real estate finance company that originates, acquires, finances, and services SBC loans, SBA loans, residential mortgage loans, and to a lesser extent, MBS collateralized primarily by SBC loans, or other real estate-related investments. Our loans generally range in original principal amounts up to$35 million and are used by businesses to purchase real estate used in their operations or by investors seeking to acquire small multi-family, office, retail, mixed use or warehouse properties. Our originations and acquisition platforms consist of the following four operating segments:
Acquisitions. We acquire performing and non-performing SBC loans as part of our
business strategy. We hold performing SBC loans to term, and we seek to
maximize the value of the non-performing SBC loans acquired by us through
? borrower based resolution strategies. We typically acquire non-performing loans
at a discount to their unpaid principal balance ("UPB") when we believe that
resolution of the loans will provide attractive risk-adjusted returns. We also
acquire purchased future receivables through our
SBC Originations. We originate SBC loans secured by stabilized or transitional
investor properties using multiple loan origination channels through our
? wholly-owned subsidiary,
These originated loans are generally held-for-investment or placed into
securitization structures. Additionally, as part of this segment, we originate
and service multi-family loan
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products under the Federal Home Loan Mortgage Corporation's Small Balance Loan
Program ("Freddie Mac" and the "Freddie Mac program"). These originated loans
are held for sale, then sold to Freddie Mac.
SBA Originations, Acquisitions and Servicing. We acquire, originate and service
owner-occupied loans guaranteed by the SBA under its Section 7(a) loan program
(the "SBA Section 7(a) Program") through our wholly-owned subsidiary, ReadyCap
?
non-bank Small Business Lending Companies ("SBLCs") and have been granted
preferred lender status by the SBA. These originated loans are either held-for-investment, placed into securitization structures, or sold. Residential Mortgage Banking. We operate our residential mortgage loan
origination segment through our wholly-owned subsidiary,
GMFS originates residential mortgage loans eligible to be purchased, guaranteed
? or insured by the Federal National Mortgage Association ("Fannie Mae"), Freddie
Mac,
("USDA") and
correspondent and broker channels. These originated loans are then sold to
third parties, primarily agency lending programs.
Our objective is to provide attractive risk-adjusted returns to our stockholders, primarily through dividends and secondarily through capital appreciation. In order to achieve this objective, we intend to continue to grow our investment portfolio and we believe that the breadth of our full service real estate finance platform will allow us to adapt to market conditions and deploy capital in our asset classes and segments with the most attractive risk-adjusted returns. We are organized and conduct our operations to qualify as a REIT under the Code. So long as we qualify as a REIT, we are generally not subject toU.S. federal income tax on our net taxable income to the extent that we annually distribute all of our net taxable income to stockholders. We are organized in a traditional UpREIT format pursuant to which we serve as the general partner of and conduct substantially all of our business throughSutherland Partners, LP , or our operating partnership, which serves as our operating partnership subsidiary. We also intend to operate our business in a manner that will permit us to be excluded from registration as an investment company under the 1940 Act.
For additional information on our business, refer to Part I, Item 1, Business of our 2019 Annual Report on Form 10-K.
Factors Impacting Operating Results
We expect that our results of operations will be affected by a number of factors and will primarily depend on, among other things, the level of the interest income from our assets, the market value of our assets and the supply of, and demand for, SBC and SBA loans, residential loans, MBS and other assets we may acquire in the future and the financing and other costs associated with our business. Our net investment income, which includes the amortization of purchase premiums and accretion of purchase discounts, varies primarily as a result of changes in market interest rates, the rate at which our distressed assets are liquidated and the prepayment speed of our performing assets. Interest rates and prepayment speeds vary according to the type of investment, conditions in the financial markets, competition and other factors, none of which can be predicted with any certainty. Our operating results may also be impacted by conditions in the financial markets, credit losses in excess of initial estimates or unanticipated credit events experienced by borrowers whose loans are held directly by us or are included in our MBS. Our operating results may also be impacted by difficult market conditions as well as inflation, energy costs, geopolitical issues, health epidemics and outbreaks of contagious diseases, such as the recent outbreak of COVID-19, unemployment and the availability and cost of credit. Our operating results will also be impacted by our available borrowing capacity.
Changes in Market Interest Rates
We own and expect to acquire or originate fixed rate mortgages ("FRMs"), and
ARMs, with maturities ranging from five to 30 years. Our loans typically have
amortization periods of 15 to 30 years or balloon payments due in five to ten
years. ARM loans generally have a fixed interest rate for a period of five,
seven or ten years and then an adjustable interest rate equal to the sum of an
index rate, such as the LIBOR, plus a margin, while FRM loans bear interest that
is fixed for the term of the loan. As of June 30, 2020 , approximately 57% of the
loans in our portfolio were ARMs, and 43% were FRMs, based on UPB. We utilize
derivative financial and hedging instruments in an effort to hedge the interest
rate risk associated with our ARMs.
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With respect to our business operations, increases in interest rates, in general, may over time cause:
? the interest expense associated with our variable-rate borrowings to increase;
? the value of fixed-rate loans, MBS and other real estate-related assets to
decline;
? coupons on variable-rate loans and MBS to reset to higher interest rates; and
? prepayments on loans and MBS to slow.
Conversely, decreases in interest rates, in general, may over time cause:
? the interest expense associated with variable-rate borrowings to decrease;
? the value of fixed-rate loans, MBS and other real estate-related assets to
increase;
? coupons on variable-rate loans and MBS to reset to lower interest rates; and
? prepayments on loans and MBS to increase.
Additionally, non-performing loans are not as interest rate sensitive as performing loans, as earnings on non-performing loans are often generated from restructuring the assets through loss mitigation strategies and opportunistically disposing of them. Because non-performing loans are short-term assets, the discount rates used for valuation are based on short-term market interest rates, which may not move in tandem with long-term market interest rates.
Changes in Fair Value of Our Assets
Certain originated loans, mortgage backed securities, and servicing rights are carried at fair value and future assets may also be carried at fair value. Accordingly, changes in the fair value of our assets may impact the results of our operations for the period in which such change in value occurs. The expectation of changes in real estate prices is a major determinant of the value of loans and ABS. This factor is beyond our control. Prepayment Speeds Prepayment speeds on loans vary according to interest rates, the type of investment, conditions in the financial markets, competition, foreclosures and other factors that cannot be predicted with any certainty. In general, when interest rates rise, it is relatively less attractive for borrowers to refinance their mortgage loans and, as a result, prepayment speeds tend to decrease. This can extend the period over which we earn interest income. When interest rates fall, prepayment speeds on loans, and therefore, ABS and servicing rights tend to increase, thereby decreasing the period over which we earn interest income or servicing fee income. Additionally, other factors such as the credit rating of the borrower, the rate of property value appreciation or depreciation, financial market conditions, foreclosures and lender competition, none of which can be predicted with any certainty, may affect prepayment speeds on loans. Credit Spreads Our investment portfolio may be subject to changes in credit spreads. Credit spreads measure the yield demanded on loans and securities by the market based on their credit relative to a specific benchmark and is a measure of the perceived risk of the investment. Fixed rate loans and securities are valued based on a market credit spread over the rate payable on fixed rate swaps or fixed rateU.S. Treasuries of similar maturity. Floating rate securities are typically valued based on a market credit spread over LIBOR (or another floating rate index) and are affected similarly by changes in LIBOR spreads. Excessive supply of these loans and securities or reduced demand may cause the market to require a higher yield on these securities, resulting in the use of a higher, or "wider," spread over the benchmark rate to value such assets. Under such conditions, the value of our portfolios would tend to decline. Conversely, if the spread used to value such assets were to decrease, or "tighten," the value of our loans and securities would tend to increase. Such changes in the market value of these assets may affect our net equity, net income or cash flow directly through their impact on unrealized gains or losses. 70 Table of Contents The spread between the yield on our assets and our funding costs is an important factor in the performance of this aspect of our business. Wider spreads imply greater income on new asset purchases but may have a negative impact on our stated book value. Wider spreads generally negatively impact asset prices. In an environment where spreads are widening, counterparties may require additional collateral to secure borrowings which may require us to reduce leverage by selling assets. Conversely, tighter spreads imply lower income on new asset purchases but may have a positive impact on our stated book value. Tighter spreads generally have a positive impact on asset prices. In this case, we may be able to reduce the amount of collateral required to secure borrowings. Loan and ABS Extension Risk
Waterfall estimates the projected weighted-average life of our investments based on assumptions regarding the rate at which the borrowers will prepay the underlying mortgages and/or the speed at which we are able to liquidate an asset. If the timeline to resolve non-performing assets extends, this could have a negative impact on our results of operations, as carrying costs may therefore be higher than initially anticipated. This situation may also cause the fair market value of our investment to decline if real estate values decline over the extended period. In extreme situations, we may be forced to sell assets to maintain adequate liquidity, which could cause us to incur losses. Credit Risk We are subject to credit risk in connection with our investments in loans and ABS and other target assets we may acquire in the future. Increases in defaults and delinquencies will adversely impact our operating results, while declines in rates of default and delinquencies will improve our operating results from this aspect of our business. Default rates are influenced by a wide variety of factors, including, property performance, property management, supply and demand factors, construction trends, consumer behavior, regional economics, interest rates, the strength ofthe United States economy and other factors beyond our control. All loans are subject to the possibility of default. We seek to mitigate this risk by seeking to acquire assets at appropriate prices given anticipated and unanticipated losses and by deploying a value-driven approach to underwriting and diligence, consistent with our historical investment strategy, with a focus on projected cash flows and potential risks to cash flow. We further mitigate our risk of potential losses while managing and servicing our loans by performing various workout and loss mitigation strategies with delinquent borrowers. Nevertheless, unanticipated credit losses could occur which could adversely impact operating results. Size of Investment Portfolio The size of our investment portfolio, as measured by the aggregate principal balance of our loans and ABS and the other assets we own, is also a key revenue driver. Generally, as the size of our investment portfolio grows, the amount of interest income and realized gains we receive increases. A larger investment portfolio, however, drives increased expenses, as we may incur additional interest expense to finance the purchase of our assets. Current market conditions
The recent outbreak of the COVID-19 pandemic around the globe continues to adversely impact global commercial activity and has contributed to significant volatility in financial markets. The impact of the outbreak has been rapidly evolving, with several countries taking drastic measures to limit the spread of the virus by instituting quarantines or lockdowns and imposing travel restrictions. Such actions are creating significant disruptions to global supply chains and adversely impacting several industries, including but not limited to airlines, hospitality, retail, and the broader real estate industry. The major disruption caused by COVID-19 halted most economic activity in most ofthe United States resulting in a significant increase in unemployment claims and a significant continued decline in theU.S. GDP. COVID-19 could have a continued and prolonged adverse impact on economic and market conditions and trigger a period of global economic slowdown which could have a material adverse effect on the Company's results and financial condition. The full impact of COVID-19 on the real estate industry, the commercial real estate market, the small business lending market and the credit markets generally, and consequently on the Company's financial condition and results of operations is uncertain and cannot be predicted at the current time as it depends on several factors beyond the control of the Company including, but not limited to, (i) the uncertainty around the severity and duration of the outbreak, (ii) the effectiveness ofthe United States public health response, (iii) the pandemic's impact on theU.S. and global economies, (iv) the timing, 71 Table of Contents scope and effectiveness of governmental responses to the pandemic, including the PPP and other programs under the CARES Act, (v) the timing and speed of economic recovery, (vi) the availability of a treatment or vaccination for COVID-19, and (vii) the negative impact on our borrowers, real estate values and cost of capital.
Critical Accounting Policies and Use of Estimates
See Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies and Use of Estimates" included within the Company's Annual Report on Form 10-K for the year endedDecember 31, 2019 . There have been no material changes to our Critical Accounting Policies described in our annual report on Form 10-K filed with theSEC onMarch 12, 2020 , other than a supplement to the accounting policy for our current expected credit loss reserve that was adopted by the Company in the first quarter of 2020. Refer to Note 3 and 4 of our consolidated financial statements for further description of the accounting policy for our current expected credit loss reserve and our other significant accounting policies.
RESULTS OF OPERATIONS
Key Financial Measures and Indicators
As a real estate finance company, we believe the key financial measures and
indicators for our business are earnings per share, dividends declared per
share, core earnings, and net book value per share. As further described below,
core earnings is a measure that is not prepared in accordance with GAAP. We use
core earnings to evaluate our performance excluding the effects of certain
transactions and GAAP adjustments that we believe are not necessarily indicative
of our current loan activity and operations. See "-Non-GAAP Financial Measures"
below for reconciliation to core earnings.
The following table sets forth certain information on our operating results:
Three Months Ended Three Months Ended Six Months Ended Six Months Ended
June 30, June 30, June 30, June 30,(in thousands, except share data)
2020 2019 2020 2019
Net Income $ 34,663 $ 11,245 $ (16,853) $ 41,693 Earnings per common share - basic $ 0.62 $ 0.25$ (0.33) $
1.05
Earnings per common share - diluted
$ 0.62 $ 0.25 $ (0.33) $ 1.05
Core Earnings $ 39,223 $ 16,775 $ 40,448 $ 28,050 Core Earnings per common share - basic and diluted $ 0.70 $ 0.37 $ 0.73 $
0.70
Dividends declared per common share
$ 0.25 $ 0.40 $ 0.65 $ 0.80
Dividend yield(1) 11.5 % 10.7 % 11.5 % 10.7 %Book value per common share
$ 14.48 $ 17.01 $ 14.48 $
17.01
Adjusted net book value per common share(2)
$ 14.46 $ 16.65 $ 14.46 $
16.65
(1) Based on the closing share price on
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The following table sets forth certain information on our investment portfolio activity (based on fully committed amounts):
Three Months Ended Three Months Ended Six Months Ended Six Months Ended
(in thousands) June 30, 2020 June 30, 2019 June 30, 2020 June 30, 2019
Loan originations
SBC loan originations $ 157,945 $ 419,603 $ 627,677 $ 711,568
SBA loan originations 20,824 53,664 66,371 97,777
Residential agency mortgage
loan originations 1,191,165 518,186 1,882,474 862,586
Total loan originations $ 1,369,934 $ 991,453 $ 2,576,522 $ 1,671,931
Total loan acquisitions $ - $ 362,184 $ 51,494 $ 490,884
Total loan investment
activity $ 1,369,934 $ 1,353,637 $ 2,628,016 $ 2,162,815
We operate in a competitive market for investment opportunities and competition
may limit our ability to originate or acquire the potential investments in the
pipeline. The consummation of any of the potential loans in the pipeline depends
upon, among other things, one or more of the following: available capital and
liquidity, our Manager's allocation policy, satisfactory completion of our due
diligence investigation and investment process, approval of our Manager's
Investment Committee, market conditions, our agreement with the seller on the
terms and structure of such potential loan, and the execution and delivery of
satisfactory transaction documentation. Historically, we have acquired less than
a majority of the assets in our Manager's pipeline at any one time and there can
be no assurance the assets currently in its pipeline will be acquired or
originated by our Manager in the future.
Return Information
The following tables present certain information related to our SBC and SBA loan portfolio as ofJune 30, 2020 and per share information for the three months endedJune 30, 2020 , which includes core earnings per share or return information. Core earnings is not a measure calculated in accordance with GAAP and is defined further within Item 7 - Non-GAAP Financial Measures in our 2019 Annual report on Form 10-K. [[Image Removed: Graphic]] 73 Table of Contents The following table provides a detailed breakdown of our calculation of return on equity and core return on equity for the three months endedJune 30, 2020 . Core return on equity is not a measure calculated in accordance with GAAP and is defined further within Item 7 - Non-GAAP Financial Measures in our 2019 Annual report on Form 10-K. [[Image Removed: Graphic]] Portfolio Metrics SBC Originations The following table includes certain portfolio metrics related to our SBC originations segment: [[Image Removed: Graphic]] 74 Table of Contents
SBA Originations, Acquisitions, and Servicing
The following table includes certain portfolio metrics related to our SBA originations, acquisitions and servicing segment:
[[Image Removed: Graphic]]
Acquired Portfolio
The following table includes certain portfolio metrics related to our
acquisitions segment:
[[Image Removed: Graphic]]
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Residential Mortgage Banking
The following table includes certain portfolio metrics related to our residential mortgage banking segment:
[[Image Removed: Graphic]]
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Changes in Financial Condition
The following table compares our consolidated balance sheets as of
June 30, March 31, $ Change % Change
(In Thousands) 2020 2020 Q2'20 vs. Q1'20 Q2'20 vs. Q1'20
AssetsCash and cash equivalents$ 257,017 $ 122,265 $ 134,752 110.2 % Restricted cash 91,539 93,164 (1,625) (1.7) Loans, net (including$124,298 and$19,813 held at fair value) 1,432,807 1,969,052 (536,245) (27.2) Loans, held for sale, at fair value 297,669 306,328 (8,659) (2.8) Mortgage backed securities, at fair value 75,411 78,540 (3,129) (4.0) Loans eligible for repurchase from Ginnie Mae 186,197 77,605 108,592 139.9 Investment in unconsolidated joint ventures 53,939 53,379 560 1.0 Purchased future receivables, net 27,190 49,150 (21,960) (44.7) Derivative instruments 19,037 17,756 1,281 7.2 Servicing rights (including$73,645 and$78,631 held at fair value) 107,761 110,111 (2,350) (2.1) Real estate, held for sale 47,009 48,292 (1,283) (2.7) Other assets 103,701 114,891 (11,190) (9.7) Assets of consolidated VIEs 2,761,655 2,229,517
532,138 23.9
Total Assets $ 5,460,932 $ 5,270,050 $ 190,882 3.6 %
Liabilities
Secured borrowings $ 1,253,895 $ 1,698,937 $ (445,042) (26.2) %
Securitized debt obligations of
consolidated VIEs, net 2,140,009 1,692,074 447,935 26.5
Convertible notes, net 111,581 111,310 271 0.2
Senior secured notes, net 179,481 179,387 94 0.1
Corporate debt, net 150,387 150,074 313 0.2
Guaranteed loan financing 436,532 457,032 (20,500) (4.5)
Liabilities for loans eligible for
repurchase from Ginnie Mae 186,197 77,605 108,592 139.9
Derivative instruments 9,106 16,585 (7,479) (45.1)
Dividends payable 14,524 21,747 (7,223) (33.2)
Accounts payable and other accrued
liabilities 166,174 89,740 76,434 85.2
Total Liabilities $ 4,647,886 $ 4,494,491 $ 153,395 3.4 %
Stockholders' Equity
Common stock $ 5 $ 5 $ - 0.0 %Additional paid-in capital 854,222 837,064 17,158 2.0 Retained earnings (deficit) (49,755) (69,605) 19,850 (28.5) Accumulated other comprehensive (loss) (9,876) (9,536) (340) 3.6Total Ready Capital Corporation equity 794,596 757,928 36,668 4.8 % Non-controlling interests 18,450 17,631 819 4.6 Total Stockholders' Equity$ 813,046 $ 775,559 $ 37,487 4.8 % Total Liabilities and Stockholders' Equity$ 5,460,932 $ 5,270,050 $ 190,882 3.6 %
Comparison of balances at
Assets
Cash and cash equivalents increased
Loans, net decreased by$536.2 million as a result of loans transferred to VIEs as part of the Ready Capital Mortgage Financing 2020-FL4 ("FL4") securitization that was completed inJune 2020 and theSutherland Commercial Mortgage Trust 2020-SBC9 ("SBC9") securitization that was completed inJune 2020 . Purchased future receivables, net decreased by$22.0 million , primarily due to a suspension in the origination of purchased future receivables during the quarter and pay-downs on the existing portfolio.
Assets of consolidated VIEs increased by
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Liabilities
Secured borrowings associated with our repurchase agreements and credit
facilities decreased by
Securitized debt obligations of consolidated VIEs, net increased by
Dividends payable decreased by
Accounts payable and other accrued liabilities increased by
Equity Total equity attributable to our company increased by$36.7 million , primarily the result of net income, attributable to income from origination of PPP loans, unrealized gains on MBS and MSRs, and the recovery of loan reserves.
Selected Balance Sheet Information by Business Segment and Corporate - Other
The following table presents certain selected balance sheet information by each of our four business segments, with the remaining amounts reflected in Corporate -Other, as ofJune 30, 2020 :
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