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
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technology-driven platform that provides working capital to small and medium
sized businesses across theU.S.
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 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
?
only 14 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,Federal Housing Administration ("FHA"),U.S. Department of Agriculture ("USDA") andU.S. 61 Table of Contents
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" in the Company's Annual Report on Form 10-K.
ANH Merger
OnMarch 19, 2021 , we completed the acquisition ofAnworth Mortgage Asset Corporation ("ANH"), through a merger of ANH with and into a wholly-owned subsidiary of ours, in exchange for approximately 16.8 million shares of our common stock ("ANH Merger"). In accordance with the Agreement and Plan of Merger, dated as ofDecember 6, 2020 ("the Merger Agreement"), by and among us,RC Merger Subsidiary, LLC and ANH, the number of shares of our common stock issued was based on an exchange ratio of 0.1688 per share plus$0.61 in cash. The total purchase price for the merger of$417.9 million consists of our common stock issued in exchange for shares of ANH common stock and cash paid in lieu of fractional shares of our common stock, which was based on a price of$14.28 of our common stock on the acquisition date and$0.61 in cash per share. In addition, we issued 1,919,378 shares of newly designated 8.625% Series B Cumulative Preferred Stock, par value$0.0001 per share (the "Series B Preferred Stock"), 779,743 shares of newly designated 6.25% Series C Cumulative Convertible Preferred Stock, par value$0.0001 per share (the "Series C Preferred Stock") and 2,010,278 shares of newly designated 7.625% Series D Cumulative Redeemable Preferred Stock, par value$0.0001 per share (the "Series D Preferred Stock"), in exchange for all shares of ANH's 8.625% Series A Cumulative Preferred Stock, 6.25% Series B Cumulative Convertible Preferred Stock and 7.625% Series C Cumulative Redeemable preferred stock outstanding prior to the effective time of the ANH Merger. Upon the closing of the transaction and after giving effect to the issuance of shares of common stock as consideration in the merger, our historical stockholders owned approximately 77% of our outstanding common stock, while historical ANH stockholders owned approximately 23% of our outstanding common stock. The acquisition of ANH increased our equity capitalization, supported continued growth of our platform and execution of our strategy, and provided us with improved scale, liquidity and capital alternatives, including additional borrowing capacity. Also, the stockholder base resulting from the acquisition of ANH enhanced the trading volume and liquidity for our stockholders. In addition, part of our strategy in acquiring ANH was to manage the liquidation and runoff of certain assets within the ANH portfolio and repay certain indebtedness on the ANH portfolio following the completion of the ANH Merger, and to redeploy the capital into opportunities in our core SBC strategies and other assets we expect will generate attractive risk-adjusted returns and long-term earnings accretion. Consistent with this strategy, atMarch 31, 2021 , we have liquidated approximately$1.4 billion of assets within the ANH portfolio, primarily consisting of Agency RMBS, and repaid approximately$1.3 billion of indebtedness on the portfolio.
In addition, concurrently with entering into the Merger Agreement, we, theOperating Partnership and the Manager entered into the First Amendment to the Amended and Restated Management Agreement (the "Amendment"), pursuant to which, upon the closing of the ANH Merger, the Manager's base management fee will be reduced by$1,000,000 per quarter for each of the first full four quarters following the effective time of the ANH Merger (the "Temporary Fee Reduction"). Other than the Temporary Fee Reduction set forth in the Amendment, the terms of the Management Agreement remain the same. 62 Table of Contents
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 adjustable rate mortgages ("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 March 31, 2021 , approximately 41% of the loans
in our portfolio were ARMs, and 59% 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.
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. A rising rate environment often means an improving economy, which might have a positive impact on commercial property values, resulting in increased gains on the disposition of these assets. While rising rates could make it more costly to refinance these assets, we expect that the impact of this would be mitigated by higher property values. Moreover, small business owners are generally less interest rate sensitive than large commercial property owners, and interest cost is a relatively small component of their operating expenses. An improving economy will likely spur increased property values and sales, thereby increasing the need for loan financing. 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
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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 rate U.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.
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 of the 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 COVID-19 pandemic around the globe continues to
adversely impact global commercial activity and has contributed to significant
volatility in financial markets. The COVID-19 pandemic and preventative measures
taken by local, state and federal authorities to alleviate the public health
crisis significantly reduced economic activity in most of the United States
resulting in a significant increase in unemployment claims. COVID-19 has had a
continued and prolonged adverse impact on economic and market conditions and has
caused a global economic slowdown which has had and could further have a
material adverse effect on the Company's results and financial condition. The
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pandemic continues to evolve, and 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 of the United States public
health response, including the administration of vaccines throughout the United
States , (iii) the pandemic's impact on the U.S. and global economies, (iv) the
timing, 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.
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, distributable earnings, and net book value per share. As further
described below, distributable earnings is a measure that is not prepared in
accordance with GAAP. We use distributable earnings to evaluate our performance
and determine dividends, excluding the effects of certain transactions and GAAP
adjustments that we believe are not necessarily indicated of our current loan
activity and operations. See "-Non-GAAP Financial Measures" below for
reconciliation to distributable earnings.
The following table sets forth certain information on our operating results:
Three Months Ended
2021 2020
Net Income $ 28,947 $ (51,516)
Earnings per common share - basic $ 0.49 $ (0.98)
Earnings per common share - diluted $ 0.49 $ (0.98)
Distributable Earnings $ 24,708 $ 1,225
Distributable Earnings per common share - basic and diluted $ 0.41 $ 0.01
Dividends declared per common share $ 0.40 $ 0.40
Dividend yield(1) 11.7 % 22.2 %
Book value per common share $ 14.90 $ 14.55
Adjusted net book value per common share(2) $ 14.89 $ 14.52
(1) Based on the closing share price on
The following table presents information on our investment portfolio activity (based on fully committed amounts):
Three Months Ended Three Months Ended
(in thousands) March 31, 2021 March 31, 2020
Loan originations
SBC loan originations $ 823,193 $ 469,732
SBA loan originations 50,223 45,547Residential agency mortgage loan originations 1,240,083
691,309
Total loan originations $ 2,113,499 $ 1,206,588
Total loan acquisitions $ - $ 51,494Total loan investment activity $ 2,113,499 $
1,258,082
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.
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Return Information
The following tables present certain information related to our SBC and SBA loan portfolios as ofMarch 31, 2021 , and per share information for the three months endedMarch 31, 2021 , which includes distributable earnings per share or return information. Distributable earnings is not a measure calculated in accordance with GAAP and is defined further within Item 7 - Non-GAAP Financial Measures in our Annual report on Form 10-K. [[Image Removed: Graphic]] 66 Table of Contents The following table provides a detailed breakdown of our calculation of return on equity and distributable return on equity for the three months endedMarch 31, 2021 . Distributable 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 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:
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SBA Originations, Acquisitions, and Servicing. The following table includes certain portfolio metrics related to our SBA originations, acquisitions and servicing segment:
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Acquired Portfolio. The following table includes certain portfolio metrics related to our acquisitions segment:
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Residential Mortgage Banking. The following table includes certain portfolio metrics related to our residential mortgage banking segment:
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