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~ by Snehasish Chaudhuri, MBA (Finance)
Ready Capital Corporation (NYSE:RC) is a mortgage-based real estate investment trust (mREIT) that acquires, manages, originates, and finances small business commercial (SBC) loans to purchase small multi-family residential, office, retail, mixed-use, or warehouse properties. Its SBC loans typically range up to $40 million. RC’s objective is to provide attractive risk-adjusted returns primarily through dividends. The company generated an average yield in excess of 10 percent over the past 9 years. Moreover, Ready Capital completed a strategic merger with Mosaic Real Estate Credit TE, which is expected to be beneficial for the company in the coming years.
Merger With Mosaic Real Estate Credit TE
Ready Capital Corporation operates through 3 business segments – SBC Lending and Acquisitions, Small Business Lending, and Residential Mortgage Banking. The SBC Lending and Acquisitions segment, through its subsidiary, ReadyCap Commercial, LLC, originates SBC loans secured by stabilized or transitional investor properties using various loan origination channels. The company operates its Small Business Lending through its subsidiary, ReadyCap Lending, LLC. This subsidiary originates, acquires, and services owner-occupied loans. The Residential Mortgage Banking segment operates through its subsidiary, GMFS, LLC, that issues Residential Mortgage-Backed Security (RMBS).
Ready Capital Corporation was founded in 2007 as Sutherland Asset Management Corporation and changed its name to Ready Capital Corporation in September 2018. In 2022, the company acquired Mosaic Real Estate Credit TE, a market-leading commercial real estate investment platform focused on construction lending. This merger was aimed to expand RC’s construction assets portfolio. Post-merger, Ready Capital’s pro forma equity capital base increased to $1.9 billion, and the acquisition is also expected to reduce the company’s leverage profile. Mosaic portfolio accounts for close to 25 percent of stockholders’ equity into construction lending. The company expects this relevering and repositioning of lower-yielding assets into its higher-yielding core products will enhance its earnings.
The Chairman and Chief Executive Officer, Thomas Capasse expressed optimism about this merger. According to him,
“We believe that this transaction is a compelling opportunity for Ready Capital to acquire a market leading commercial real estate investment platform focused on providing differentiated capital solutions across the middle market sector with an emphasis on construction lending………We are excited to integrate the Mosaic team and origination platform and we believe the diverse portfolio of construction assets with attractive portfolio yields will further differentiate Ready Capital’s financing solutions for borrowers and investors.”
Consistent High Yield and Lower Risk Makes RC Attractive
Ready Capital Corporation pays quarterly dividends, and barring the covid-19 pandemic period, the pay-out has ranged between $0.37 and $0.42. This steady pay-out has been matched by an equally stable price. Besides during the pandemic period, the price has been quite flat. As a result, the company has been able to generate consistent strong yield, which averaged more than 10 percent during the past 9 years. However, this year, the yield has averaged almost 12 percent, and the estimated forward yield comes to around 13.5 percent. This is higher than usual, and some investors may doubt the sustainability of such high yields.
One of the major reasons behind such high yield is a 23.5 percent price drop during 2022, which I expect to recover by the end of this year. In the long term, the price will probably remain flat as before. Going forward, the pay-out is expected to remain stable due to the company’s steady earnings growth. The major vulnerability during the current macroeconomic scenario can be adequately managed through interest rate swaps. Interest rate swap is an agreement between two parties to exchange different modes of interest payments, say exchanging a fixed rate of interest with the floating rate of the other party. These agreements are made over a pre-decided duration that effectively fixes interest expense for the anticipated average life of the asset.
This way, the company protects itself from rising interest rates up to a certain extent. The rising interest rate scenario also may act as a favorable thing as it may increase the profit margin for the company, in case the borrowing rate remains the same. This may happen as the company has entered into long-term borrowing contracts. However, worldwide speculation over a possible recession may cause trouble. Unemployment is currently at its peak and a recession would result in job losses and will result in loan defaults. Though the company is hedging itself in terms of interest expenses, the problem of liquidity and default is hard to manage, and thus, the investors should be cautiously optimistic about Ready Capital Corporation.
In my opinion, the impact of inflation and an economic recession will be felt most in the area of liquidity. Since most lending agreements of this mREIT are long-term and the company has adopted effective hedging strategies, I expect Ready Capital Corporation to continue to have steady earnings. Steady price and steady earnings will ensure a double-digit yield. The only hindrance remains over default. If the company is able to recover all the interest income and principal repayments, I don’t foresee any major challenges.
Will the economy go into recession? That’s something which I can’t comment upon. But, given the state of the current economic situation, I don’t foresee any chances of mass default, something that happened during the global financial crisis in 2007-08. If the price remains stable, the company will be able to generate a yield close to 10 percent. But, sustaining a 13 percent or more yield will be an uphill task. Nonetheless, the close to double-digit yield will be good enough to attract income-seeking investors.
Financial Performance During Q2, 2022
Ready Capital delivered one of the most attractive earnings profiles within its peer group. At the end of Q2, 2022, Ready Capital Corporation’s quarterly distributable earnings per common share were $0.48, while quarterly dividend was $0.42. This quarterly earnings were supported by continued growth in net interest income from its loan portfolio. Net interest income increased by 14 percent in the quarter to reach $58.4 million. The major driver behind the growth was a $700 million growth in the loan portfolio. Net interest income, servicing revenue, and earnings from its joint venture investments accounted for 76 percent of Ready Capital’s revenue.
In addition to that, the company earns significant revenue through various public-private partnerships (PPPs). During that quarter, net contributions from PPP businesses increased to $19.5 million. This increase in PPP earnings is likely to remain a significant contributor to earnings over the remainder of the year. Returns from Mosaic portfolio totaled $10 million. The lower return was due to the 29 percent allocation in lower-yielding assets, which are expected to be liquidated expeditiously. Net earnings from the residential mortgage banking business remained almost the same at $7.5 million.
Investment Thesis
Ready Capital Corporation provides attractive risk-adjusted returns through strong yields. As the market price remains flat for a long period of time, and its earnings are expected to grow at a steady rate, the company is expected to generate a double-digit yield. Its strategic merger with Mosaic Real Estate has started paying dividends, and will be exceptionally beneficial for the company in the coming years. It probably will reduce its leverage too. The company also plans to pursue initiatives, which may include strategic transactions, additional leverage, mortgage servicing rights, and additional product offerings to counteract market pressures.
In addition to all these, Ready Capital is well-positioned to mitigate the risks of rising inflation and interest rates by employing effective hedging strategies. The company has successfully taken care of the most pertinent issues in the current macroeconomic scenario, i.e. rising interest rates. In fact, the company has scope of gaining from this situation. In the absence of any economic recession resulting in loan defaults on a mass scale, I don’t foresee any major challenge for this company in the path of generating strong and steady yield. In my opinion, income-seeking investors should continue to hold this stock.
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