Ready Capital Corporation (NYSE: RC) is a multi-strategy real estate finance company that originates, acquires, finances, and services lower-to-middle-market (LMM) loans, Small Business Administration (SBA) loans, construction loans, and mortgage-backed securities (MBS) collateralized primarily by LMM loans. The company's diverse portfolio and strategic initiatives position it to weather the current market volatility and emerge stronger.
Founded in 2011, Ready Capital has grown to become a leading player in the real estate finance industry. The company's annual revenue reached $1,135,110,000 in 2023, with a net income of $339,451,000. Its strong financial performance is underpinned by a robust business model and a disciplined approach to risk management.
Business Overview
Ready Capital's operations are organized into two main segments: LMM Commercial Real Estate and Small Business Lending. The LMM Commercial Real Estate segment originates and services loans across the full life-cycle of LMM properties, including construction, bridge, stabilized, and agency channels. This segment also includes the company's Freddie Mac SBL program and its affordable housing financing activities through Red Stone. The Small Business Lending segment acquires, originates, and services loans guaranteed by the SBA under the SBA Section 7(a) Program, as well as purchased future receivables through the company's Knight Capital platform.
Ready Capital's diversified business model has been a key strength, allowing the company to navigate the challenges posed by the current market environment. While the commercial real estate sector has faced headwinds, the company's focus on LMM loans and its exposure to the resilient multifamily market have helped mitigate some of the risks.
Financials
In the first quarter of 2024, Ready Capital reported a net loss of $74,167,000, primarily due to a $146,180,000 valuation allowance related to the transfer of loans to the held-for-sale portfolio. This strategic move, which the company believes will enhance its long-term profitability, resulted in a 4.5% decline in book value per share to $13.43.
Despite the short-term impact, Ready Capital remains well-positioned financially. The company's quarterly operating cash flow was $23,450,000, and its free cash flow reached $304,824,000. As of March 31, 2024, Ready Capital had total assets of $12,043,532,000 and total liabilities of $9,535,289,000, resulting in a debt-to-equity ratio of 3.69.
To further strengthen its liquidity, the company recently closed a $150 million, 5-year private term loan at SOFR plus 5.50%, which will be tax-affected to an effective cost in the 7% range. Additionally, Ready Capital has been actively managing its capital structure, renewing $1 billion in warehouse facilities and exploring opportunities in the corporate debt markets.
Risks and Challenges
The current market environment has presented several challenges for Ready Capital, particularly in the commercial real estate sector. The company has identified three key factors impacting its near-term performance:
1. Reduced profitability from credit impairment in the originated portfolio due to late-cycle stress in the multifamily sector, driven by higher interest rates, declining rent growth, and inflationary increases in operating expenses.
2. Increased profitability from the ongoing liquidation of the company's M&A portfolio, which includes assets from the 2022 Mosaic and 2023 Broadmark acquisitions, as well as reduced operating expenses and growth in the Small Business Lending segment.
3. More aggressive liquidation of targeted non-performing loans, including all office loans without a short-term resolution, to reposition capital into market-yielding and cash-flowing investments.
To address these challenges, Ready Capital has implemented a five-pronged strategy:
1. Reallocation of low-yield assets from the M&A portfolio into higher-yielding investments, such as the 18% refinancing of a $68 million multifamily loan in Austin, Texas.
2. Leveraging the balance sheet to achieve the company's target leverage ratio of 4x, including accessing the corporate debt markets and leveraging new investments at better terms.
3. Exiting the residential mortgage banking business, which has lagged in distributable return on equity (ROE).
4. Accelerating growth in the Small Business Lending segment, with a long-term target of $1 billion in annual originations.
5. Reducing operating expenses, including an 11% reduction in staffing in April 2024, resulting in annual savings of $8 million.
These initiatives are expected to provide a 200 to 300 basis point ROE accretion, offsetting the near-term ROE drag from the increased non-accrual percentage in the multifamily portfolio.
Multifamily Exposure and Credit Quality
Ready Capital's portfolio is heavily weighted towards the multifamily sector, which accounts for approximately 78% of its total exposure. While the company has seen an increase in delinquencies and non-accrual loans in this segment, it remains confident in the long-term fundamentals of the multifamily market.
The company's multifamily portfolio has a weighted average loan-to-value (LTV) ratio of 62%, providing a cushion against the 16% decline in multifamily prices seen since the 2022 peak, with an additional 5% forecast for the 2024 bottom. Furthermore, the company's proprietary GEO tier model, which ranks markets from 1 to 5 based on factors such as projected negative absorption, has helped it avoid the most severely impacted submarkets.
As of March 31, 2024, 91% of Ready Capital's originated portfolio was in markets ranked 3 or better, mitigating the impact of the current market stress. The company believes the financial effect will be short-term earnings pressure, as the multifamily loans reach maturity and work through modification, forbearance, or refinancing processes, with the government-sponsored enterprises (GSEs) providing a pathway for takeout of bridge loans.
Diversification and Risk Mitigation
In addition to its multifamily focus, Ready Capital's portfolio is further diversified by loan type and geographic distribution. The company's LMM loans have an average balance of $4.4 million, avoiding single-asset concentration risk. This diversification is evident in the company's credit performance, where loans under $25 million have experienced significantly lower delinquency rates compared to larger loans.
Ready Capital's limited exposure to the office sector, which accounts for only 4.4% of its total portfolio as of March 31, 2024, has also helped mitigate risk. The company believes the recovery in the office sector will be long-dated and has therefore opted to reposition capital from this segment into more attractive investment opportunities.
Outlook
Despite the near-term challenges, Ready Capital remains optimistic about its long-term prospects. The company's strategic initiatives, including the growth of its Small Business Lending segment and the optimization of its capital structure, are expected to drive improved financial performance in the coming quarters.
In the Small Business Lending segment, Ready Capital has appointed Gary Taylor as CEO to continue the dual strategy of large and small loan 7(a) originations, leveraging the company's fintech platform, iBusiness, to drive cost efficiencies. Additionally, the company recently signed a definitive agreement to acquire the Madison One Company, the nation's second-largest USDA originator, which is expected to generate over $300 million in annual USDA volume and expand the company's government-guaranteed small business offerings.
Ready Capital's diversified business model, prudent risk management, and strategic initiatives position the company to navigate the current market challenges and emerge as a stronger, more resilient real estate finance provider. As the company continues to execute on its growth plans and optimize its portfolio, investors can look forward to a more stable and profitable future.
Conclusion
Ready Capital Corporation is a well-diversified real estate finance company that has demonstrated its ability to adapt to changing market conditions. While the company faces near-term headwinds in the commercial real estate sector, its strategic initiatives, including the growth of its Small Business Lending segment and the optimization of its capital structure, are expected to drive improved financial performance in the coming quarters. With a strong balance sheet, a diversified portfolio, and a focus on risk management, Ready Capital is well-positioned to weather the current market volatility and capitalize on future opportunities in the real estate finance industry.