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Home›Fixed Rate Loans›READY CAPITAL CORP Discussion and analysis of the financial and earnings position by management (Form 10-Q)

READY CAPITAL CORP Discussion and analysis of the financial and earnings position by management (Form 10-Q)

By Mary M. Cox
November 5, 2021
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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 regulations 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 as part of our

Business strategy. We hold SBC term loans and aim to

? maximize the value of the SBC distressed loans we purchase through

borrower-based settlement strategies. We typically acquire bad loans

at a discount to their principal unpaid balance (“UPB”), if we believe that

   resolution of the loans will provide attractive risk-adjusted returns.



SBC originations. We issue SBC loans backed by stabilized or transitional loans

Investor properties that have multiple lending channels through our

wholly owned subsidiary, ReadyCap Commercial, LLC (“ReadyCap Advertising”).

These extended loans are generally held for investment or in

Securitization structures. In addition, as part of this segment, we come from

? and service multi-family loan products under the Federal Home Loan Mortgage

The Corporation’s Small Balance Loan Program (“Freddie Mac” and the “Freddie Mac.”)

Program “). These granted loans are held for sale and then sold to Freddie Mac.

In addition, the SBC originations include construction and permanent funding for

   the preservation and construction of affordable housing primarily utilizing
   tax-exempt bonds.






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Small Business Loans. We acquire, grant and manage self-used loans

from the SBA under its Section 7 (a) Loan Program (the “SBA Section”

7 (a) program “) through our wholly owned subsidiary, ReadyCap Lending, LLC

(“ReadyCap Lending” or “RCL”). We have an SBA license as one of only 14

Non-Bank Small Business Lending Companies (“SBLCs”) and have been granted

preferred lender status by the SBA. These granted loans are either

held for investment, placed in securitization structures or sold. We also

? Acquire purchased future claims through ours Knight capital platform

(“Knight capital“). Knight capitalthat we acquired in 2019 is a

technology-driven platform that provides working capital to small and medium-sized companies

large companies all over US In the second quarter of 2021 our Chief

Executive Officer as our Chief Operating Decision Maker (“CODM”), realigned

include our business areas Knight capital in small business lending

Segment from the acquisitions segment more closely to the

Activities and forecasts for Knight capital. We have recruited all of the previous ones

   period amounts and segment information to conform to this presentation.




   Residential Mortgage Banking. We operate our residential mortgage loan

Origination segment through our wholly-owned subsidiary, GMFS, LLC (“GMFS”).

GMFS issues buyable mortgage loans for residential properties with a guarantee

? or insured by the Federal National Mortgage Association (“Fannie Mae”), Freddie

Mac, Federal Housing Administration (“FHA”), U.S. Department of Agriculture

(“USDA”) and US Department of Veterans Affairs (“VA”) by retail,

Correspondent and broker channels. These issued 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 to U.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 through Sutherland Partners, L.P., 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 more information about our business, see Part I, Item 1, “Business” in the company’s Annual Report on Form 10-K.

Acquisitions

Anworth Mortgage Asset Corporation. On March 19, 2021, we completed the
acquisition of Anworth 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 of December 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. 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 $25.00 per share, plus accrued and unpaid
dividends up to, but excluding, the redemption date.



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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, as of September 30, 2021, we have liquidated
approximately $2.0 billion of assets within the ANH portfolio, primarily
consisting of Agency RMBS, and repaid approximately $1.7 billion of indebtedness
on the portfolio.


In addition, concurrently with entering into the Merger Agreement, we, the
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 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.



Red Stone. On July 31, 2021, the Company acquired Red Stone and its affiliates
("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 million
paid in cash, retention payments to key executives aggregating $7 million in
cash and 128,533 shares of common stock of the Company issued to Red Stone
executives under the 2012 Plan. Additional purchase price payments may be made
over the next three years if the Red Stone business achieves certain hurdles.



Factors Affecting Operating Results

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 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 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 September 30, 2021, approximately 68% of the
loans in our portfolio were ARMs, and 32% 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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In general, in relation to our business, over time, interest rate hikes can cause:

? the interest expense associated with our floating rate loans increases;

? the value of fixed rate loans, MBS, and other real estate-related assets

Reject;

? Coupons on floating rate loans and MBS to move to higher interest rates; and

? Slow down prepayments on loans and MBS.

Conversely, in general, over time, rate cuts can:

? the interest expense associated with floating-rate loans decreases;

? the value of fixed rate loans, MBS, and other real estate-related assets

Increase;

? Coupons on floating rate loans and MBS to reduce interest rates; and

? Increase prepayments on loans and MBS.




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 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.





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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 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. Although more normalized activities have
resumed, the full impact of COVID-19 on 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 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 pandemic, including the emergence and severity of COVID-19
variants (ii) the effectiveness of the United States public health response,
including the administration and effectiveness of COVID-19 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, and (v) the timing and speed of economic recovery.





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Results of Operations


Financial metrics 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 provides certain information about our operating results.



                                             Three Months Ended September 30,           Nine Months Ended September 30,
($ in thousands, except share data)              2021                 2020                   2021               2020
Net Income                                 $        46,535       $        

35,363 $ 106,386 $ 18,510
Earnings per common share – basic $ 0.61 $ 0.63

           1.47     $         0.32

Earnings per common share – diluted $ 0.60 $ 0.63

           1.46     $         0.31
Distributable Earnings                     $        49,365       $        32,126      $        115,501     $       72,574
Distributable Earnings per common share
- basic and diluted                        $          0.64       $          0.57      $           1.60     $         1.30

Declared Dividends Per Common Share $ 0.42 $ 0.30

           1.24     $         0.95
Dividend yield                                        11.6 %                10.7 %                17.0 %             10.7 %
Book value per common share                $         15.07       $        

$ 14.86 15.07 $ 14.86
Adjusted Net Book Value Per Common Share $ 15.06 $ 14.84 $ 15.06 $ 14.84

In the table above,

? The dividend yield is based on the respective closing price of the share.

? The adjusted net book value per common share excludes the equity component of our

   2017 convertible note issuance.



The table below contains information on our investment portfolio start-ups and acquisitions (based on the fully committed amounts).




                            Three Months Ended September 30,           Nine Months Ended September 30,
(in thousands)                  2021                  2020                2021                 2020
Loan originations
SBC loan originations     $       1,002,267     $         122,487    $      2,926,786     $        750,164
SBA loan originations               138,261                82,912             334,229              149,283
Residential agency mortgage
loan originations                 1,020,445             1,184,237           3,332,273            3,066,711
Total loan
originations              $       2,160,973     $       1,389,636    $      6,593,288     $      3,966,158
Total loan
acquisitions              $         167,980     $          20,989    $        167,980     $         72,483
Total loan investment
activity                  $       2,328,953     $       1,410,625    $      6,761,268     $      4,038,641




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 Small
Business Lending loan portfolios as of September 30, 2021, and per share
information for the three months ended September 30, 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]]



The following table provides a detailed breakdown of our calculation of return
on equity and distributable return on equity for the three months ended
September 30, 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]]



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Portfolio Metrics


SBC originations. The following table contains specific portfolio metrics related to our SBC origination segment:


                           [[Image Removed: Graphic]]


Small Business Loans. The following table provides specific portfolio metrics related to our Small Business Lending segment:


                           [[Image Removed: Graphic]]



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Acquired portfolio. The following table contains specific portfolio metrics related to our acquisition segment:


                           [[Image Removed: Graphic]]


Mortgage banking for residential real estate. The following table provides specific portfolio metrics related to our residential mortgage lending segment:


                           [[Image Removed: Graphic]]







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