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
? Cash and capital resources
? Contractual obligations and off-balance sheet arrangements
? Critical accounting estimates
The following discussion should be read in conjunction with our unaudited interim consolidated financial statements and accompanying Notes included in Part I, 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 Estimates" in our annual report on Form 10-K for certain other factors that may cause actual results to differ, materially, from those anticipated in the forward-looking statements included in this quarterly report on Form 10-Q.
We are a multi-strategy real estate finance company that originates, acquires, finances, and services SBC loans, SBA loans, residential mortgage loans, construction 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
$40 millionand are used by businesses to purchase real estate used in their operations or by investors seeking to acquire multi-family, office, retail, mixed use or warehouse properties. Our objective is to provide attractive risk-adjusted returns to our stockholders, primarily through dividends as well as through capital appreciation. In order to achieve this objective, we continue to grow our investment portfolio and 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 report our activities in the following three operating segments:
SBC loans and acquisitions. We issue SBC loans throughout the lifecycle
of an SBC property including construction, transition, stabilization and agency
loan origination channels through our wholly owned subsidiary, ReadyCap
held for investment purposes or placed in securitization structures. As part of this
segment, we create and manage multi-family loan products under the Freddie
Mac SBL program. These insider loans are held for sale and then sold to Freddie
? Mac. We provide construction and permanent funding for the preservation and
construction of affordable housing, mainly using tax-exempt bonds
through Red Stone, a wholly owned subsidiary. In addition, we acquire small
balance commercial lending as part of our commercial strategy. We would like to perform
Term SBC loans and seek to maximize the value of non-performing SBCs
loans we acquired through borrower-based resolution strategies. We usually have
acquire non-performing loans at a discount to their outstanding principal balance
when we believe that resolution of the loans will provide attractive risk-adjusted returns.
Small business loan. We acquire, issue and service homeowner loans
guaranteed by the SBA under the SBA Section 7(a) program through our
wholly-owned subsidiary, ReadyCap Lending. We hold an SBA license as one of
? only 14 non-bank SBLCs and have been granted preferred lender status by the
SBA. These issued loans are either held for investment purposes or placed in
securitization structures, or sold. We also acquire purchased futures contracts
provides working capital to small and medium-sized businesses across the
71 Table of Contents Residential Mortgage Banking. We operate our residential mortgage loan
origination segment through our wholly owned subsidiary, GMFS. GMFS originated
? residential mortgage loans that may be purchased, guaranteed or insured by
Fannie Mae, Freddie Mac, FHA,
brokerage channels. These originated loans are then transferred to third parties,
primarily agency loan programs.
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 to
U.S.federal income tax on our net taxable income to the extent that we annually distribute substantially 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 through our operating partnership. 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 more information about our business, see Part I, Item 1, “Business” of the Company’s Annual Report on Form 10-K.
March 16, 2022, pursuant to the terms of that certain Merger Agreement, dated as of November 3, 2021, as amended on February 7, 2022, the Company acquired, in a series of mergers (collectively, the "Mosaic Mergers"), a group of privately held, real estate structured finance opportunities funds, with a focus on construction lending (collectively, the "Mosaic Funds"), managed by MREC Management, LLC("the "Mosaic Manager"). As consideration for the Mosaic Mergers, each former investor was entitled to receive an equal number of shares of each of Class B-1 Common Stock, $0.0001par value per share (the "Class B-1 Common Stock"), Class B-2 Common Stock, $0.0001par value per share (the "Class B-2 Common Stock") Class B-3 Common Stock, $0.0001par value per share (the "Class B-3 Common Stock"), and Class B-4 Common Stock, $0.0001par value per share (the "Class B-4 Common Stock" and, together with the Class B-1 Common Stock, the Class B-2 Common Stock and the Class B-3 Common Stock, the "Class B Common Stock"), of Ready Capital, contingent equity rights ("CERs") representing the potential right to receive shares of Common Stock as of the end of the three-year period following the closing date of the Mosaic Mergers based upon the performance of the assets acquired by Ready Capitalpursuant to the Mosaic Mergers, and cash consideration in lieu of any fractional shares of Class B Common Stock. The Class B Common Stock ranked equally with the common stock, except that the shares of Class B Common Stock were not listed on the New York Stock Exchange. On May 11, 2022, each issued and outstanding share of Class B Common Stock automatically converted, on a one-for-one basis, into an equal number of shares of Common Stock, and as such, no shares of Class B Common Stock remain outstanding. The CERs are contractual rights and do not represent any equity or ownership interest in Ready Capitalor any of its affiliates. If any shares of common stock are issued in settlement of the CERs, each former investor will also be entitled to receive a number of additional shares of common stock equal to (i) the amount of any dividends or other distributions paid with respect to the number of whole shares of common stock received in respect of CERs and having a record date on or after the closing date of the Mosaic Mergers and a payment date prior to the issuance date of such shares of common stock, divided by (ii) the greater of (a) the average of the volume weighted average prices of one share of common stock over the ten trading days preceding the determination date and (b) the most recently reported book value per share of common stock as of the determination date.
The acquisition further broadened the company’s investment portfolio and origination platform to include a diversified portfolio of construction assets with attractive portfolio yields. See Note 5, included in Part I, Item 1, “Financial Statements,” of this Quarterly Report on Form 10-Q, for assets acquired and liabilities assumed in connection with the merger.
Red Stone. On
July 31, 2021, the Company acquired Red Stone, a privately owned real estate finance and investment company that provides innovative financial products and services to multifamily affordable housing, in exchange for an initial purchase price of approximately $63 millionpaid in cash, retention payments to key executives aggregating $7 millionin cash and 128,533 shares of common stock of the Company issued to Red Stone executives under the Company's 2013 equity incentive plan (the "Equity Incentive Plan"). Additional purchase price payments may be made over the three years following the acquisition date if the Red Stone business achieves certain hurdles. The acquisition of Red Stone supported a significant growth opportunity for the Company by expanding presence in a sector with otherwise low correlation to our assets. In acquiring Red Stone, we considered the value of the anticipated synergies arising from the acquisition and the value of the acquired assembled workforce, neither of which qualify for recognition as an intangible asset. Anworth Mortgage Asset Corporation. On March 19, 2021, we completed the acquisition of Anworth, through a merger of Anworth with and into a wholly-owned subsidiary of ours, in exchange for approximately 16.8 million shares of our common stock ("Anworth Merger"). In accordance with the Agreement and Plan of Merger, dated as of December 6, 2020(the "Anworth Merger Agreement"), by and among us, RC Merger Subsidiary, LLCand Anworth, the number of shares of our common stock issued was based on an exchange ratio of 0.1688 per share plus $0.61in cash per share. The total purchase price for the merger of $417.9 millionconsists of our common stock issued in exchange for shares of Anworth common stock and cash paid in lieu of fractional shares of our common stock, which was based on a price of $14.28per share of our common stock on the acquisition date and $0.61in cash per share. In addition, we issued 1,919,378 shares of newly designated 8.625% Series B Cumulative Preferred Stock, par value $0.0001per share (the "Series B Preferred Stock"), 779,743 shares of newly designated 6.25% Series C Cumulative Convertible Preferred Stock, par value $0.0001per share (the "Series C Preferred Stock") and 2,010,278 shares of newly designated 7.625% Series D Cumulative Redeemable Preferred Stock, par value $0.0001per share (the "Series D Preferred Stock"), in exchange for all shares of Anworth'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 Anworth Merger. On July 15, 2021, the Company redeemed all of the outstanding Series B and Series D Preferred Stock, in each case at a redemption price equal to $25.00per share, plus accrued and unpaid dividends up to, but excluding, the redemption date.
Upon closing of the transaction and after giving effect to the issuance of ordinary shares in consideration for the merger, our historical shareholders held approximately 77% of our outstanding ordinary shares, while historical Anworth shareholders held approximately 23 % of our common shares outstanding. .
The acquisition of Anworth 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 Anworth enhanced the trading volume and liquidity for our stockholders. In addition, part of our strategy in acquiring Anworth was to manage the liquidation and runoff of certain assets within the Anworth portfolio and repay certain indebtedness on the Anworth portfolio following the completion of the Anworth 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. In addition, concurrently with entering into the Anworth Merger Agreement, we, our operating 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 Anworth Merger, the Manager's base management fee was reduced by
$1,000,000per quarter for each of the first full four quarters following the effective time of the Anworth 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. 73
Factors Affecting Results of Operations
We expect that our results of operations will be affected by a number of factors and will primarily depend on the level of interest income from our assets, the market value of our assets and the supply of, and demand for, SBC loans, SBA loans, residential loans, construction loans, MBS and other assets we may acquire in the future, demand for housing, population trends, construction costs, the availability of alternative real estate financing from other lenders and the financing and other costs associated with our business. These factors may have an impact on our ability to originate new loans or the performance of our existing loan portfolio. 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 our available borrowing capacity, 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. Difficult market conditions as well as inflation, energy costs, geopolitical issues, health epidemics and outbreaks of contagious diseases, such as the outbreak of COVID-19 and the emergence and severity of variants, unemployment and the availability and cost of credit are factors which could also impact our operating results. 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 two to 30 years. Our loans typically have amortization periods of 15 to 30 years or balloon payments due in two to 10 years. FRM loans bear interest that is fixed for the term of the loan and we typically utilize derivative financial and hedging instruments in an effort to hedge the interest rate risk associated with such FRMs. As of
September 30, 2022, 75% of fixed rate loans are match funded in securitization. ARM loans generally have a fixed interest rate for a period of five, seven or 10 years and then an adjustable interest rate equal to the sum of a fixed spread plus an index rate, such as the Secured Overnight Financing Rate ("SOFR"), which typically resets monthly. As of September 30, 2022, approximately 85% of the loans in our portfolio were ARMs, and 15% were FRMs, based on UPB. With respect to our business operations, increases in interest rates may generally 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 slowdown. Conversely, decreases in interest rates generally tend to have the opposite effect. 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, MBS, and servicing rights are carried at fair value, while 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 in the period such changes occur. The expectation of changes in real estate prices is a key determinant for 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 and servicing fee income. When interest rates fall, prepayment speeds increase on loans, and therefore, ABS, 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. 74 Table of Contents 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 SOFR (or another floating rate index) and are affected similarly by changes in SOFR 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. The Company 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 Stateseconomy and other factors beyond our control. All loans are subject to the possibility of default. We seek to mitigate this inherent 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. Current market conditions. The third quarter occurred in an environment of market uncertainty amid significant inflationary pressures, macroeconomic concerns and geopolitical shifts which continue to contribute to overall market volatility. In an effort to combat inflation and restore price stability, the U.S. Federal Reservehas raised interest rates and, although the full impact of recent changes remains uncertain and difficult to predict, it is likely the U.S. Federal Reservewill continue to raise interest rates into 2023. The persistence of COVID-19 and its impact on the Company and our borrowers will largely depend on future developments beyond the control of the Company including, but not limited to the emergence and severity of variants, the efficacy of vaccinations and booster programs, the impact and reactions on the U.S.and global economies, the effectiveness of governmental responses thereto and the timing and speed of economic recovery. Concerns and uncertainties about the economic outlook may lead to an adverse impact on our financial condition, results of operations
and cash flows. 75 Table of Contents Results of Operations
Main 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 indicative of our current loan activity and operations. See "-Non-GAAP Financial Measures" below for a reconciliation of net income to distributable earnings.
The table below sets forth certain information about our results of operations.
Three Months Ended September 30, Nine Months Ended September 30, ($ in thousands, except share data) 2022 2021 2022 2021 Net Income
$ 66,253 $ 46,535 $ 189,481 $ 106,386Earnings per common share - basic $ 0.53 $ 0.61 $ 1.66 $ 1.47 Earnings per common share - diluted $ 0.50 $ 0.60 $ 1.56 $ 1.46 Distributable earnings $ 58,186 $ 49,365 $ 167,151 $ 115,501Distributable earnings per common share - basic $ 0.46 $ 0.64 $ 1.46 $ 1.60 Distributable earnings per common share - diluted $ 0.44 $ 0.64 $ 1.38 $ 1.60 Dividends declared per common share $ 0.42 $
0.42 $ 1.26 $ 1.24 Dividend yield 16.6 % 11.6 % 16.6 % 11.5 % Return on equity 14.5 % 16.3 % 15.1 % 13.2 %
Distributable return on equity 12.7 % 17.3 % 13.3 % 14.7 % Book value per common share $ 15.40 $
$15.07 $15.40 $15.07 Adjusted net book value per common share $15.40 $15.06 $15.40 $15.06
In the table above,
? The dividend yield is based on the closing share price at the end of the respective period.
? Adjusted net book value per common share excludes the equity component of our
Issuance of convertible notes 2017.
Our loan portfolio
We have a large and active pipeline of potential acquisition and origination opportunities that are in various stages of our investment process. We refer to assets as being part of our acquisition or origination pipeline if (i) an asset or portfolio opportunity has been presented to us and we have determined, after a preliminary analysis, that the assets fit within our investment strategy and exhibit the appropriate risk/reward characteristics (ii) in the case of acquired loans, we have executed a non-disclosure agreement ("NDA") or an exclusivity agreement and commenced the due diligence process or we have executed more definitive documentation, such as a letter of intent ("LOI"); and (iii) in the case of originated loans, we have issued an LOI, and the borrower has paid a deposit. 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 pipeline at any one time and there can be no assurance the assets currently in our pipeline will be acquired or originated by us in the future.
The table below presents information on creations and acquisitions in our investment portfolio (based on fully committed amounts).
Three Months Ended September 30, Nine Months Ended September 30, (in thousands) 2022 2021 2022 2021 Loan originations: SBC loans $ 831,104
$ 1,106,957 $ 3,629,775 $ 3,031,476SBA loans 133,571 144,253 362,698 345,045 Residential agency mortgage loans 534,339 1,020,445 2,050,568 3,332,273 Total loan originations $ 1,499,014 $ 2,271,655 $ 6,043,041 $ 6,708,794Total loan acquisitions $ - $ 167,980$ 659,636 $ 167,980Total loan investment activity $ 1,499,014 $ 2,439,635 $ 6,702,677 $ 6,876,77476 Table of Contents
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