Ready Capital - Earnings Call - Q4 2020

Transcript

Speaker 0

Greetings. Welcome to Ready Capital Corporation Fourth Quarter and Full Year twenty twenty Earnings Conference Call. At this time, all participants are in a listen only mode. A question and answer session will follow the formal presentation. Please note this conference is being recorded.

At this time, I'll now turn the conference over to Andrew Alborn, Chief Financial Officer. Mr. Alborn, you may now begin.

Speaker 1

Thank you, operator, and good morning, and thanks to those of you on the call for joining us this morning. Some of our comments today will be forward looking statements within the meaning of the federal securities laws. Such statements are subject to numerous risks and uncertainties that could cause actual results to differ materially from what we expect. Therefore, you should exercise caution in interpreting and relying on them. We refer you to our SEC filings for a more detailed discussion of the risks that could impact our future operating results and financial condition.

During the call, we will discuss our non GAAP measures, which we believe can be useful in evaluating the company's operating performance. These measures should not be considered in isolation or as a substitute for our financial results prepared in accordance with GAAP. A reconciliation of these measures to the most directly comparable GAAP measure is available in our fourth quarter twenty twenty earnings release and our supplemental information. By now, everyone should have access to our fourth quarter twenty twenty earnings release and the supplemental information. Both can be found in the Investors section of the Ready Capital website.

In addition to Tom and myself, we are also joined by Adam Zausmer, our Head of Credit on today's call. Before turning it over to Tom, I would like to point out that beginning this quarter, we have changed our non GAAP earnings measure from core earnings to distributable earnings. This change aligns us with our mortgage REIT peers and with recent SEC guidance. There has been no change in the methodology for calculating our non GAAP earnings measure. I will now turn it over to Chief Executive Officer, Tom Capasse.

Speaker 2

Thanks, Andrew. Good morning, and thank you for joining our fourth quarter earnings call. 2020 marked the great COVID recession which shocked our commercial real estate debt market. Yet Ready Capital delivered record results in a recession due to our diversified business model featuring four key aspects. First, earnings.

Our resilient distributable earnings comprising stable net interest margin from our $4,200,000,000 portfolio of small balance commercial or SBC loans and our $11,700,000,000 servicing portfolio supplemented with income from highly profitable government sponsored gain on sale operations, which have all weather access to the capital markets. Second, investment strategy. Our dual strategy of direct lending and acquisitions enables us to allocate capital efficiently across the economic cycle. Third, credit. The relative credit strength of our SBC niche versus our large balance peers overlaid with a deep asset management infrastructure is evident in our superior credit metrics at year end versus our peer group.

Fourth, a conservative approach to leverage. Compared to peers who suffered COVID book value write downs of 25% to 50% due to forest asset sales, our modest book value decline was limited to CECL reserves and MSR mark to market declines. At the height of the pandemic, margin calls on our modest exposure to mark to market liabilities were met with available liquidity. Let me highlight significant 2020 accomplishments. For the year, distributable earnings and ROE were $1.82 per share and 12.3%, surpassing our 10% target with a robust 1.4x dividend coverage.

Despite the pandemic shutdown for over half the year, we originated and acquired $910,000,000 of SBC loans to be held on balance sheet. In our government sponsored Small Business Administration or SBA, residential and Freddie Mac gain on sale businesses, we originated $4,900,000,000 up 83% year over year with additional originations of $2,700,000,000 of payment protection plan loans or PPP. We ranked number two among nonbank SBA lenders and climbed to number five in the Freddie Mac small balance loan league table. Despite difficult capital markets, we securitized over 609,000,000 of loans, renewed six credit facilities, and managed average recourse leverage to 2.1 x. Finally, we continue to find accretive ways to expand and scale our business with the signing of the $350,000,000 Amworth merger.

The foundation of our business is our $4,200,000,000 portfolio of first lien SBC loans. Unlike our peers with average loan balances over $100,000,000 our portfolio is de risked with over 5,400 loans averaging only $800,000 This granularity provides numerous benefits. First, low single asset risk, with our largest loan only 1% of gross exposure. Second, our SBC focus avoids high beta COVID sectors such as big box retail, large central business district office, and hospitality. Third, the portfolio is more correlated to residential housing than large balance commercial real estate, which benefits from the current strong housing fundamentals.

Additionally, our strong credit culture, which emphasizes experienced sponsors, superior markets, and low risk collateral types, has held sixty day plus delinquencies at 2.7 versus 6% in the large balance CMBS market. With a portfolio weighted average coupon of 5.4% and a duration of seven years, this is the core of our stable dividend. The net interest margin from our loan portfolio is supplemented by a growing servicing fee revenue. At year end, we serviced over $11,700,000,000 of loans across our residential SBA and Freddie Mac platform with a weighted average servicing fee of 34 basis points across these three products. Now as compared to model on commercial REITs, Ready Capital is truly unique in that it also owns three government sponsored lending platforms providing a supplemental gain on sale revenue stream.

Each of these businesses owned by the REIT in a taxable REIT subsidiary have unique barriers to entry, command current market values significantly in excess of carrying value, and have access to liquidity in stressed capital markets. This was evident in 2020 with record earnings across each business. Our most significant and differentiated platform is our SBA seven lending subsidiary, one of only 14 nonbank small business lending companies licensed by the SBA. Acquired in 2014 from CIT, this business has originated $820,000,000 since inception, including $83,000,000 and $65,000,000 in the 2020, respectively. We continue to grow market share in 2020 rising from fourteenth to ninth largest seven lender and second non bank lender.

Throughout the pandemic, bilateral support in DC for the SBA is evident in three stimulus programs. Two rounds of the Paycheck Protection Program or PPP, principal and interest support on seven loans, and the increase in government guarantee from 75% to 90%. Integration of our Miami based fintech unsecured lender with the SBA business provided PPP leadership and rollout of seven a small loan program. PPP originations totaled 2,700,000,000.0 in 2020 and totaled in excess of 1,000,000,000 in 2021 as of last Friday. The increase to a 90% guarantee through September 30 will add to twenty twenty one seven a volume with current secondary market premiums averaging 12%.

Further, over the last six months, we have added seven business development officers, expanded our capabilities in small loan lending, and formed new affinity relationships. We also continue to expand our Freddie Mac SBL and broader GSE lending operations originating $545,000,000 in 2020. Demand for this product continues to grow due to low rates relative to banks and stable fundamentals in the SBC property market as rent growth and collections have held up through the pandemic. Additionally, we entered into two agency correspondent agreements in 2020, which allows us to offer a full suite of GSE products. We expect volume to these new programs to experience modest growth as we build out the necessary infrastructure to achieve scale.

It was a historic year in residential mortgage originations and GMFS experienced record volume and profitability. In 2020, GMFS originated $4,200,000,000 at margins averaging two eighty five basis points, up 100% and 2x versus 2019 respectively. Additionally, we increased the mortgage servicing portfolio balance 17% to $9,500,000,000 while lowering the weighted average coupon 9% to three sixty eight basis points. The trend in elevated performance has continued in the new year with over $750,000,000 originated year to date. In 2021, we look to target distributable earnings at or above pre COVID levels through a number of means.

First, the restart of our SBC lending and acquisition activities, which began at the end of the third quarter and reached normalized levels in the first quarter. Through the February, we have originated and acquired $600,000,000 which is 1.5 times the volume over the comparable period in 2020. Importantly, as typically occurs on the recessionary up cycle, we have tightened credit metrics focusing on stronger sponsors and lower risk sectors, including multifamily and industrial. Second, we will continue to expand the earnings contribution of our SBA seven subsidiary from a combination of increased seven volume in conjunction with capitalization on the six month window for the benefit from this ninety percent seven guarantee and higher profits in the second round of the PPP program. Through the February, we originated 26,000,000 of seven loans.

The modest start to the year is primarily driven by our decision to wait an updated seven guidance on the 90% guarantee from the SBA, which became effective February 1. We believe the plan of expanding our BDO and affinity network targeting industry verticals and developing a robust small loan infrastructure will result in increased volume going forward. Meanwhile, we funded over 1,000,000,000 of PPP loans through last Friday with prospects for growth enhanced by the House Small Business Committee yesterday passing a resolution extending PPP through May 31. Lastly, we expect to continue to scale our business to benefit from operating leverage created over the previous years. This begins with the closing of the Enworth merger.

The merger is expected to grow stockholders' equity to $1,100,000,000 providing incremental liquidity of $380,000,000 increased float in our shares by 30% and reduced day one operating expense ratio by approximately 200 basis points. Unlike past mergers, the liquid nature of the Enworth balance sheet provides more flexibility in turning over the portfolio into our core strategies. We expect to do this in a prudent manner best suited for creating value for our shareholders. I'll now turn it over to Andrew to discuss financial results.

Speaker 1

Thank you, Tom, and good morning, everyone. We closed out a record 2020 with our third consecutive quarter significantly above target returns, with GAAP earnings per share of zero four nine dollars and distributable earnings per share of $0.51 Our distributable earnings for the quarter equate to a 13.3% return on average equity. Distributable earnings for the year were $101,400,000 or a 12.3% return on average equity. As Tom mentioned earlier, our business is structured to provide stable earnings from our loan and servicing portfolios with upside from our gain on sale operating segments. The current quarter's earnings profile continues to highlight these benefits.

Net interest income before loss provisions increased 36 quarter over quarter to $23,500,000 This increase was driven by the redeployment of $160,000,000 of net capital on $367,000,000 of originations and acquisitions into the loan portfolio as well as the realization of discounts on payoffs. Our total CECL reserve remained at Q3 levels, although there were shifts in the composition of that balance. In the quarter, we released $2,300,000 of reserves on loans with clean pay history over the last twelve months. This release was offset by additional reserves of $400,000 on delinquent loans and $1,900,000 of reserves on newly originated loans. Reserves on delinquent loans have been included in our calculation of distributable earnings.

Net mortgage banking revenue continued to provide strong earnings despite a $11,700,000 decline in quarter over quarter revenue. In the quarter, residential volume remained relatively flat at $1,200,000,000 but average margins declined 25 basis points to two seventy five basis points. Net realized gains from our SBA and Freddie Mac SBL businesses increased 41% to 11,300,000 This increase was driven by a 84% quarter over quarter increase in SBA guarantee sales and a 25% increase in Freddie Mac production. SBA CL premiums continue to be high and averaged 12% in the quarter. Given the recent update to a 90% guarantee, we expect the return profile of the SBA business to improve considerably.

Earnings contributions from our servicing portfolio increased $1,300,000 to $11,400,000 The increase is due to the addition of $557,000,000 into the servicing asset during the quarter. Our balance sheet is reflective of both the reemergence of our core lending strategies and the continued focus on maintaining adequate liquidity and leverage levels. In the quarter, our core loan portfolio increased to 4,200,000,000.0 marking a return to portfolio growth after two consecutive quarters of portfolio declines. Performance in the portfolio remained stable with sixty plus day delinquencies remaining below 2.7%. Forbearance remains low at 2% in the CRE portfolio and deferments in the SBA portfolio remain low at 6.8%.

We believe the diversity of this portfolio will continue to deliver superior performance to large balance CRE assets. We remain focused on liquidity and mark to market debt. We currently have $172,000,000 in cash and liquidity and average recourse leverage in the fourth quarter was 2.1x. Included in our total recourse debt of $1,800,000,000 at year end was $370,000,000 to support our agency lending activities and $450,000,000 of corporate debt. Recently, we priced a $200,000,000 senior unsecured note offering.

The five year note has a coupon of 5.5%, 45 basis points inside of our previous best execution. Additionally, we plan to come to market with the $625,000,000 CLO at the end of the first quarter and are in the final stages of negotiating two new warehouse facilities to fund our investment pipeline. Our future efforts will focus on lowering cost of funds and reducing reliance on mark to market leverage. As we have previously done, we have provided a supplemental earnings deck, which includes summary information on the company's earnings profile, various operating segments and key financial metrics. Of note is our company update on Slide three, the strength of the earnings profile on Slide six and the investment activities on Slide seven.

We have also included a summary of the annual transaction on Slide 20. I will now turn it over to Tom for closing remarks.

Speaker 2

Thanks, Andrew. In the four years since we went public via our merger with Zeiss Financial, much has been accomplished. With the pending close of the Anworth merger, we will have doubled the equity base of the company, originated or acquired over $20,000,000,000 of assets, completed 17 seconduritizations, and developed a leading platform in the small balance commercial market. Over this period, our model has delivered 45% total return for our shareholders, which compares favorably to the 26% return from iShares Mortgage Real Estate Capped ETF. We are committed to providing superior returns and looking ahead to 2021 and beyond, and we'll continue to benefit from steady revenue stream from the loan and servicing portfolios and Alpha from the opportunities embedded in our government sponsored lending segments.

So with that, operator, I'll now open it up for questions.

Speaker 0

Thank you. We'll now be conducting a question and answer session. You may press star two if you would like to remove your question from the queue. For participants that are using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment please while we poll for questions.

Thank you. And our first question is coming from the line of Christian Love with Piper Sandler. Please proceed with your questions.

Speaker 3

Thanks. Good morning. Tom and Andrew, gain on sale margins were under some pressure in the quarter. I think in the presentation, you commented around $2.75 bps. I was wondering, can you speak to how margins are trending in the first quarter and what you would expect in the near to medium term with respect to margins?

And that's the on the revenue side.

Speaker 2

You're talking about the residential mortgage banking segment. Correct?

Speaker 4

Exactly. Yeah.

Speaker 2

Yeah. So I think and, Andrew, maybe you could comment on the actual year quarter to date. But generally speaking, with the the fifty, sixty basis point upward move in the in the ten year, we expect, you know, stating the obvious, re refi to decline, you know, up to 75% this year in in the industry. That'll be more that'll be partly offset though versus prior cycles by, you know, a significant purchase demand. So I think, you know, we expect origination volume to decline, you know, up to 30 to 40% versus the elevated 2020 levels.

As far as margins, given that decline, you're continuing to see the typical cycle with refi burnout and and more availability of of staff. So you'll see a lot more competition on rates. And as a result of that, we expect margins to normalize to more of that, you know, 75 to a 150 basis point level you've seen historically by the third quarter of this year. But that said, our our our our GMFS, it tends to be in its own ecosystem, and it it tends to lag both in terms of prepays and some of them the the more competitive price elastic market. So, Andrew, I don't know what what with that kind of macro backdrop, what are you seeing in the trends in the quarter?

Speaker 1

Yes. I mean, far margins have come down probably 25 basis points where they were at year end. So certainly, some compression there. I think, you know, when we look at the effects of rates on GMFS, you know, it's important to note that, you know, the MSR has lost, you know, close to 40,000,000 in value over the last, call it, eight quarters. And during that time, we've added close to 2,000,000,000 into that that portfolio.

So I certainly think there's gonna be, you as rates move, some recovery in the value of that asset as well.

Speaker 2

Yeah. And that that that's an important differentiating factor, Christian. Some mortgage bankers sell MSRs, don't retain it. We, we retain MSRs as a hedge against production. And when you have a whipsaw like this in the ten year, you would expect that to be reflected, as Andrew's saying, in in this quarter and subsequent quarters in an improved valuation for the MSR book.

Speaker 3

Okay. Great. Thank you. That's all all helpful. One more from me.

So how should we be thinking about, PPP fees? I guess, first, what's remaining from round one that needs to be recognized? And then what would you expect for round two for net fees? Does kind of in the ballpark around 15,000,000 makes sense? And then kind of what and and over what time frame time frame would you expect those to be, realized?

Speaker 2

Yeah. I'll let Andrew comment on So net income. Just just to add to one backdrop, the, couple days ago, the the House Small Business Committee extended or voted to extend sixty days. So that could give us a a longer the senate has to approve it, that that would give us a longer another two months of of potential revenues associated with the program in the round two.

I'm sorry, Andrew. Go ahead.

Speaker 1

Yeah. So, Chris, in terms of round one production, there's 10,000,000 left to be recognized. I expect all that to be recognized in the current year. You know, profitability on round two is gonna be, at least on a percentage basis, significantly higher than where we were in round one. And so, you know, my expectation is that round two revenue is gonna be either at or one and a half x where we were in round one.

There'll be some differences in how we treat that income, because we are carrying those loans on balance sheet through the through financing with the PPPLF. So the the fees earned there will be a yield adjustment on the loan, you know, recognized over the average life, which is probably under two years. In addition to that, you're gonna get the the spread from carrying that portfolio. So I do think PPP round two could have a a fairly significant impact on the earnings of the company over the next, call it, six to eight quarters.

Speaker 3

Okay. And just to clarify, so you were talking about the 1.5 times. You mean 1.5 times on a kind of a like to like in originations, right, not as because I think you did some or, like, you're expecting to do something like 40,000,000 in round one in fees, but you you don't

Speaker 1

necessarily on a dollar level. Not on a dollar basis. So if we did 40 in round one, I certainly think round two profitability is going to exceed that.

Speaker 3

Perfect. Thank you. Very helpful.

Speaker 0

Our next question is from the line of Tim Hayes with BTIG. Please proceed with your question.

Speaker 4

Hey. Good morning, guys. Congrats on a nice wrap to a challenging year. First question for me, I know you kind of touched on the impact of higher rates on GMFS there. And, you know, in your disclosures, you talk about, obviously, the impact from higher short term rates on NIM, and it seems like that would actually a higher one month LIBOR would benefit you there.

But just thinking about the higher long term rate impact, like I said, you mentioned GMFS, but maybe if you could talk about the impact on the broader SBC ecosystem and what that could mean for kind of transaction activity and for your pipeline. And I know the magnitude and linearity of a move makes a big difference, but any comments around that would be helpful.

Speaker 2

Yeah. It's a good question. Yeah. The the largest segment of our origination where most of the capital is dedicated is the small balance bridge. And and we are, kind of pivoting a little bit more to multifamily industrial, you know, for obvious reasons.

But the what's interesting about as compared to the residential credit space, obviously, the the the there's that correlation between NOI and and rates, you know, in a rising rate environment. It's it's a bull market and and you'll see a in this case, a recovery in in the sectors of of CRE that we're focused. So as a result, purchase demand in commercial real estate will can will come off the bottom. And as a result of that, we are seeing a big regardless of the increase in the ten year, let's say, it's a 100 let's say let's say, we're at two and a half at year end, which is a lot of street forecast. We don't we we see a purchase volume in the CRE space that we focus on kind of that mid market level where that which drives the need for bridge financing.

So that we think that actually will be be a neutral impact in terms of of rates. The only one one area it may have an incremental is the Freddie Mac small balance, the GSE space. That could impact refi volume there, but nowhere nowhere near the the the delta that you have in the residential space. So I'd say on balance, it's rising rates for us are net positive because of the fact that our, you know, our bridge book is floating rate based off of LIBOR.

Speaker 4

Mhmm. Okay. That that's helpful in in framing that. Appreciate it. This this might be a dumb question here, but I I think the wording you guys used in your earnings release about, I guess, 4Q I forget if it was 4Q or 1Q origination activity, but was that you acquired or originated a certain amount of small and medium sized commercial loans.

Is that language different than what you've used in the past in terms of the medium sized loans? Are you doing some bigger loans here, or was it still kind of business as usual for you guys?

Speaker 2

Well, the Yeah. So Go ahead, Andrew. Sorry.

Speaker 1

Yeah. So, you know, the majority of our lending activity in the first quarter has been in the bridge business bridge segment, and we have seen some uptick in loan sizes there. You know, historically, those loans have averaged below $10,000,000, but we are doing some, you know, larger loans in excess of $10,000,000. So that's really the reasoning for putting in that language.

Speaker 2

Yeah. I and actually, just to be more specific, we're doing some, the same size loans, you know, kind of in that, 3 to $25,000,000, but we're doing it, across a number of properties with one sponsor where we cross collateralize. So it's still, you know, squarely in the, that kind of that mid market mid mid market property property value. You know, again, it's compared to the the the much the larger series which are focused on, you know, 100,000,000 plus single property deals.

Speaker 4

Right. I guess I guess my question around that though is, are you butting up against more of the middle traditional middle market players as you get a little bit bigger? And does that impact the kind of yield you're able to or coupon you're able to achieve there? Or, you know, is there just increased competition, as you kinda go higher in size?

Speaker 2

Actually, Adam, do you wanna take a, you know, from your vantage point on the credit side, you're obviously, driving the the the approval of these loans. What what how would you, view the current trends?

Speaker 5

Yeah. I think in terms of the larger loans, you know, certainly sticking with kind of, you know, the highest performing asset classes through through COVID, so specifically on the multifamily, industrial, and self storage side. And, you know, those tend to be slightly lower rates than we have gotten historically, and and that's certainly a competitive sector. But I think, you know, the the the the type of transactions that that we are doing, you know, really enables us to, you know, improve our our our cash flowing bridge bridge portfolio, which really enhances, you know, the overall portfolio and and and keeps us at a good risk profile.

Speaker 2

Yeah. I I'd just add to that. If you look at so we're moving to COVID less COVID affected sectors with tighter spreads. However, the comeback in the CRE CLO market has more than offset any tightening on the the lending margin such that the ROEs, the incremental ROEs, Andrew, are running what, kind of in the 15 zone?

Speaker 1

Yeah. Closer to 20.

Speaker 2

Okay. So yeah. So they're they're they're about three to 400 basis points higher than they were pre COVID due to the the the up going up in credit quality from the standpoint of the, again, the the sectors least affected by by COVID.

Speaker 4

Got it. No. That's a that that's helpful because I that's what I was trying to get at is if, you know, we should be anticipating some type of yield degradation as you yeah. As competition picks up for the the types of assets you're going after in the bridge business, but it sounds like that's more than offset by,

Speaker 3

the financing side of things.

Speaker 4

And just right. But just on your sorry, sorry, Tom. But just on the on your warehouse lines, credit facilities, are you seeing kind of better leverage and, you know, lower costs there as well? Is the bank have to compete with that market? Just wondering if there's some tailwind there as well.

Speaker 2

Andrew, what are seeing in terms of the facilities?

Speaker 6

Yeah. I don't I don't

Speaker 1

think we're seeing, significantly lower cost than what we've experienced historically. Although, as we mentioned in remarks, we are seeing opportunities to bring in other lending partners. Know, right now, we're in the midst of negotiating, you know, two new warehouse lines. We think we'll be, accretive going forward. One's a $500,000,000 facility to, you know, fund our our core origination activities.

And the terms of that are are fairly consistent with our existing warehouse lines. And then we are, in the midst of finalizing a non mark to market facility to fund our acquisitions business. So we are seeing opportunities to expand the partners who lend to us.

Speaker 5

Yeah. And, Andrew, just to add, you know, I'd say that, you know, these the larger the larger loans, you know, kind of the middle market larger loans that we're doing, the warehouse partners that we have are certainly, you know, very interested in these type of asset classes that we're lending in now given, you know, kind of the credit strengths of these assets. So, you know, certainly seeing some better advance rates from them and and and then lower lower financing costs.

Speaker 2

Yeah. And that and that that in turn drives the ROE on the incremental ROE and therefore the NIM attribution, to again about three, four hundred basis points higher than where we were pre COVID. Both lower lower debt cost and higher advance rate due to the shift in property mix to more lower risk sectors and in cash flowing properties.

Speaker 4

Got it. That's really helpful, guys. Appreciate it. I'm gonna hop back in the queue for now, but thanks again for, taking my questions this morning, Rob.

Speaker 2

Sure thing.

Speaker 0

Thank you. Our next question is from the line of Steve Delaney with JMP Securities. Please proceed with your question.

Speaker 7

Good morning, Tom and Andrew, and congratulations on a truly great year under the circumstances. You mentioned in your Freddie Mac small balance that you had added some correspondent programs. Could you comment on that a little bit? I'm just curious if you're developing, you know, partnerships with community banks or independent mortgage brokers to to source loans that are broader than your own network. Thanks.

Speaker 2

Yeah. Actually, Adam, why don't you why don't you take that one?

Speaker 5

Yeah. Sure. For you know, we're the the the agency product that we have is the Freddie Mac SPL license. So that's the, you know, the smaller balance agency loans. Sure.

To the extent that our production folks have opportunities that are larger in size, you know, kind of fit the profile of, you know, either a Freddie, Fannie type type financing. We're we're partnering with with various lenders that have those licenses where, you know, we send them opportunities, and then, you know, the license that they don't have is is particularly, you know, on the smaller balance side where where our specialty is, and they send us opportunities. So that's it's kind of a back and forth partnership, and, you know, we kind of, you know, kind of feed each other Got it.

Speaker 1

From Okay.

Speaker 7

So you're you're you're accessing the DUS program or the K program simply by working with with those licensees to show them loans, hopefully, there's some reciprocity there, maybe on the small balance side. Is that is that what I'm That's exactly right. Yeah. Exactly. Okay.

Great.

Speaker 0

Exactly. I think you

Speaker 5

Yeah. No. I'm sorry. I was I was just gonna add. Then and then on our bridge side, it also works well where, you know, we bounce opportunities off of our agency partners on the larger balance side that just kinda check out, you know, just make sure that the takeout sizes to an agency financing.

So then when our loans, you know, kind of stabilize, come to maturity, we we then, again, partner with those agencies. Sorry. We we partner with the lenders that have those products and they really become a takeout for our bridge lending.

Speaker 7

Yes. Okay. No, that's very helpful. And we'll keep an eye on that. Obviously, great business and limited number of licenses out there, so definitely an important part of what you have.

Look, we all know 2020 was the best year ever for resi mortgage. I think what some people are missing, and a lot of lot of IPOs and a lot of volatility in the stocks. You know, our view is while while 2021 is is gonna come down from 2020, it's probably still gonna be the second best year ever, you know, for the resi mortgage business. And just to to make sure I was clear on your guidance, I think I heard you say look for volume to be down 30 to 40% year to day and a normalization down from the high 2 hundreds to, you know, maybe the low 100 plus or whatever by the fourth quarter of next year. Did I did I get that reasonably accurate?

Speaker 1

Yes.

Speaker 7

Okay, good. I will take all that into account. Okay, thanks. And to pick up on where Tim was, Tim Hayes a little bit earlier, I think you answered this. And my question about the pending, I think Andrew mentioned, you've got a CLO financing targeted coming up and you've got over $600,000,000 of recently originated.

It sounds like the return profile between the combination of pricing on the loans and we've seen CLO pricing in terms of executions be as tight as ever. It sounds like your expectation for the next CLO that the net return on equity could exceed the median or the average within your existing portfolio. Is that an accurate takeaway?

Speaker 1

Yes, I think that's right, Steve.

Speaker 7

All right. Well, thanks. Thank you all for the comments.

Speaker 0

Next question is from the line of Steven Laws with Raymond James. Please proceed with your questions.

Speaker 2

Hi, good morning.

Speaker 6

Tom, first on the ANH acquisition, when that closes, how do we think about capital reallocation? Will you actively or how quickly sell down the MBS portfolio as

Speaker 7

you

Speaker 6

think about investment opportunities in other business segments? And as we think about kind of when that's fully done, how does that change the current business mix of, you know, given the the opportunities you like today?

Speaker 2

Yeah. I think it's it's a it's a very and Andrew chime in, but based on our current, acquisition and origination forecast in the core SBC business, it looks to be a linear one to two quarter reduction in the MBS portfolio in in lockstep with, you know, funding the origination investment net net investment in the SBC loans. So this yeah. That the the Anworth merger plus the ability to relever that roughly 300,000,000 plus of capital provides us with funding for our all of our base case originations and acquisition forecast for 2021. You know, that that said, there are a number of potential kind of bolt on acquisitions we're looking at across the you know, across our our our platform more broadly.

You know, pick recall the the Knight Financial acquisition back in twenty fourth quarter twenty nineteen. So, you know, between the the should the regular way acquisitions and originations, in particular, the bridge space where we're seeing a lot of post COVID demand, and the these potential smaller bolt on acquisitions, we, we we think we'll be able to very quickly redeploy that capital in a in a one to two quarter time period. I don't know, Andrew, if you you'd comment on that. Right.

Speaker 1

You know, think that's right. I think you will see some, you know, movement post close to get out of some more volatile items and to bring, you know, their existing leverage more in line with where we have. But outside of that, I think we'll manage the runoff to meet the investment pipeline.

Speaker 6

Great. Appreciate the color on that. Andrew, to touch on the other operating expenses, down quite a bit in the last four quarters. Can you give us, Anatia, a little bit more detail what's in that line item? But also, this kind of $50,000,000 a year annualized number the right target?

Or how do we think about this expense going forward?

Speaker 1

Yes. So the fourth quarter, the movement, a lot of that was due to adjustments in bonus compensation, in the residential mortgage banking business. So although a lot of that adjustment occurred in the fourth quarter, I think the as a percentage of profitability, it's more in line with what on an annualized basis with what you can expect going forward. So that those that reduction was offset by some increases in year end accruals. But to answer your second question, yes, I think the annual run rate here is more in line with what you can expect in the New Year.

Speaker 0

Thank you. Our next question is from the line of Randy Binner with B. Riley FBR. Please proceed with your questions.

Speaker 8

Hey, thanks. Good morning. I just have a few follow-up questions across the what we've covered so far. So first on the resi origination figure, which you think I think you said down 75% on refi versus last year and then overall down 3040%. So the number kinda continues to jump out at me, and and I just wanna understand if that's a comment more towards your book or that the, you know, resi origination market overall.

Speaker 2

I'm sorry. It's the overall. That that was just I was just quoting an MBA data Okay. A

Speaker 3

poll

Speaker 2

I did recently that said that and just to be clear, that's not declined in the origination volume. The the shift in this quarter, they expect to be go from 70 ish, 75 ish last same quarter last year down to only, 25 or so this this this quarter. Just just to that's a that's so that's percentage of industry, originations. I mean, I think, again, we we view the the overall decline, you know, obviously, the purchase volume going down very significantly and offset by, sorry, the refi volume going down significantly offset by a secular shortage of of homes and and increase therefore, increase in purchase demand. But that net net will be 30 to 40% in the industry.

I would argue that GMFS is in a market where there's still it's again, it's a lot more it's a if if you look at the CPRs, they're usually about one to two points slower in the MSR book. And the the the delta on refi is is is is is a frac is probably 20%, 30% less than hot competitive markets like California. So yeah. Anyway, so to so that that we do expect that sort of decline in overall volume tied to a again, that's that's more tied to a a view of the ten year being above two year end. But, you know, so that that's I don't if that's helpful, but that's how we're thinking about it in context of the broader market and but a a lower percentage decline in for GMFS.

Speaker 8

Okay. Understood. That is helpful. And then on, you mentioned the CLO coming up. Just kinda curious if you have a sense of how that might price versus, you know, where's if it's possible to, you know, compare it to where a similar book would have priced pre COVID.

Yeah. I guess the the high level question is, you know, where where where do you think a CLO can price for your high quality book now versus pre COVID, higher or lower?

Speaker 2

Yeah. Andrew or Adam can can, you know, maybe touch on what what you guys are hearing on in the current market. But, you know, pre COVID, I think we were at what, Andrew, maybe on the triple a seniors, double a seniors were at l plus 110, 125. Is that right?

Speaker 1

Yeah. That's right.

Speaker 2

Then it gapped out, you know, in the dark days of first quarter of last year, the the the seniors gapped out to, like, 600 over for the the worst trades. Today, I I Adam and Andrew or Adam, I think we're we're we're we're basically at or near pre COVID tights. Is that correct?

Speaker 1

Yes. I think that's right.

Speaker 2

Yeah. Okay.

Speaker 8

That that's helpful. Yeah. No. That's good. Just just curious.

I mean, the the market's gotten quite a bit tighter, and and so that's just one data point. The last thing I had was you mentioned, I think, you know, kind of some origination affinity relationships, but and I think those were well described. But then in the opening script, I I thought I heard that you had kind of fintech activity there. And so I'd you know, if if we

Speaker 0

could just spend a second on that, if

Speaker 8

I heard that right, what is the I guess, what's the what is that technology play that that you use? Because to me, it sounded like the affinity relationships were pretty traditional, but it but would would like to hear if there's, you know, a technology enabler there.

Speaker 2

Yeah. The the the the the fintech reference, it relates to the unsecured Knight Financial, the unsecured small business lender that we that we acquired late late last year. And, you know, they they're part of us an ecosystem of these small lenders that utilize scoring methodologies. But importantly, they develop portals which enable a a a a small business borrower to go online and, you know, download documents and and go through a scoring program and and and use a it use a much less manually intensive origination front end loan origination system. And we're able to utilize that product first, you know, with respect to these small loans, which the SBA allows you to use a scorecard on, the scoring methodologies that obviously is custom fit to a company a technology front end platform like what Knight has.

So we've adopted that to roll out a small loan program, which we'll use it for affinity. And then we're gonna do the same program with the, large loans, the a seven a loans, which are, you know, more, labor intensive, but we have delegated underwriting authority from as a preferred lender from the SBA. So that and that that can be white labeled to, let's say, a bank, a credit union, or or what have you. So those are that's that's how the the that sort of front end system, both in terms of the online portal and the ability to score and download documents is what we're talking about as opposed to the more traditional method, is having, you know, a BDO that said that that business development officers that will then take the referrals and then go through the more traditional loan underwriting process.

Speaker 8

Understood. Thanks so much.

Speaker 0

Our next question comes from the line of Christopher Nolan with Ladenburg Thalmann. Please proceed with your questions.

Speaker 9

Hey, guys. For the ANH acquisition, because of the changes in the interest rate environment since the deal was announced, any changes in terms of the expectations for accretion to book value or earnings for Freddie Capital?

Speaker 1

Yes. So ANH's book value from September 30 through December 31 increased slightly. We saw some appreciation in January that was given up in February, but we expect the accretion or dilution to be right around, if not slightly improved from where we modeled it at September 30.

Speaker 9

Great. And as a follow-up question, Tom, given your comments in terms of or excuse me, Andrew's comments in terms of lower expense run rate, what is the expectations in terms of core ROE target for 02/2021? Thanks.

Speaker 2

Yeah. I think our our view is that, you know, pre COVID, we were targeting a 10% return on book. I would say that, you know, post COVID given, you know, the the incremental, increase in the ROE on the core bridge lending business coupled with the, some of the the the gain on sale businesses continuing to contribute. You know, the the residential mortgage banking is not gonna repeat at 2021, but it'll be strong. And clearly, the the SBA with the PPP round two and the, you know, they've also increased the guarantee amount from 75 to 90 through, October 1.

That, along with continued strength in the Freddie business, those gain on sale, those two will offset any sort of decline incrementally in the, in the mortgage banking segment so that we we expect, I I to have, you know, ROE target in excess of that that 10% that we were targeting pre COVID.

Speaker 1

Great. Thank you.

Speaker 0

Thank you. Our next question is from the line of Tim Hayes, BTIG. Please proceed with your question.

Speaker 4

Hey, guys. Just one more follow-up for me, and I just wanna put your last comments in kind of the context of the dividend, which I know is a board decision. But, you know, if you're gonna be bigger following the acquisition of Anworth and you're having a higher ROE target than you did before COVID where your dividend was $0.40 and you're expecting, you know, all these tailwinds to the gain on sale businesses ex GMFS and, you know, and and the core bridge business, you know, to to more than offset what's going on with GMFS. I'm just trying to understand at what point we might be, you know, there there seems to be very good dividend coverage here. So, you know, at what point or what would it take for you guys to recommend an increase in the dividend at the the current level?

Speaker 2

Aaron, do want to touch on that?

Speaker 1

Yes. So as we said on previous earnings calls, the goal is to first get back to that $0.40 dividend level. I think we're well on our way to that. Again, can't speak. It's a Board decision.

But in terms of when we get to that level, I think the Board is probably going to look at how the Inworth integration goes in combination with, certainly, the expected revenue from PPP round two, which, as I said before, could be quite substantial. So given those fact patterns, you know, a return to normal, I believe, could happen, you know, quicker than might otherwise have been expected as in PPP.

Speaker 0

Thank you. We've reached the end of the question and answer session. Now I'll turn the call over to mister Thomas Capacity for closing remarks.

Speaker 2

Yeah. And we appreciate everybody's time and after after, you know, a tough 2020, and, you know, we feel we're strongly positioned for 2021, and I look forward to the next earnings call.

Speaker 0

Thank you. This does conclude today's conference. You may disconnect your lines at this time, and we thank you for your participation.