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Disclosures
Related to the stocks in this article:
CWMF is long: RITM-D, GPMT-A, DX-C, EFC-A, RITM-C, EFC-B, PMT-C, AGNCP, CIM-D, RITM-B, RITM, SLRC, GPMT, RC.
Scott Kennedy is long: RITM, RC, SLRC, GBDC, MITT, GPMT, ARCC, RITM-D, MITT-B, MITT-C, GAINL, MFAN, ECCC.
The rest of this post is from Scott Kennedy.
Summary
This 21st earnings assessment article reviews RC’s and SLRC’s BV/NAV and core earnings/NII performance during Q4 2023.
RC’s BV matched my/our expectations while its core earnings was a modest underperformance. RC's quarterly originations volume disappointed while expenses remained high.
SLRC’s NAV matched my/our expectations while its NII was a minor outperformance. Overall, a good quarter for SLRC.
RC received a 2.5% recommendation range “downgrade”. No change in RC’s risk/performance rating (remains a 4). While RC remains notably undervalued, subscribers must have patience for cycles to play out.
No change in SLRC’s percentage recommendation ranges or risk/performance rating. SLRC is currently deemed undervalued (BUY).
Introduction:
Hi subscribers. For new members, my name is Scott Kennedy and currently I fully cover 20 mortgage real estate investment trust (mREIT) and 15 business development company (“BDC”) common stocks within this Investing Group regarding research/data, subscriber questions, weekly projected book values/net asset values (BV/NAV), and common stock recommendation ranges. Colorado (“CO”) Wealth Management handles the mREIT preferred stocks and he and his team handles all other applicable REIT sectors outside the mREIT sector. CO also provides some mREIT common stock and BDC articles from time-to-time which are more of an “overview/introduction” discussion; typically based either on my or our combined research/data. This also includes some macroeconomic trends and data. My name is always attached to all Investing Group articles I personally wrote so there is no confusion for subscribers.
This REIT Forum article is part of a series of articles over a span of 6-7 weeks which will analyze my previously projected BV/NAV and core earnings (or core earnings equivalent)/net investment income (“NII”) figures and compare these metrics to each mREIT’s and BDC’s actual reported results, respectively. For readers who are familiar with my public mREIT and/or BDC articles, these types of articles are beneficial to readers who desire to pursue a more active investing strategy and/or want more “real time” thoughts/analysis.
I hope my services/contributions ultimately help enhance a subscriber’s total investment returns or minimize their total investment losses within the mREIT and BDC sectors. At the very least, I hope subscribers will gain more insight into the mREIT and BDC sectors by reading my/our exclusive REIT Forum articles.
1) RC’s BV and Core Earnings Q4 2023 Performance (Projected Versus Actual Results):
On 2/27/2024, Ready Capital Corp. RC 0.00%↑ reported the company’s earnings results for the fourth quarter of 2023. Table 1 below provides RC’s BV and earnings summary.
Table 1 – RC Q4 2023 BV and Earnings Summary
Source: Taken Directly from the REIT Forum’s © Analytical Spreadsheets/Data
I provided the following commentary in regards to RC’s results for the fourth quarter of 2023:
“Hi subscribers. I was able to review RC's Q4 2023 earnings results. RC reported a BV as of 12/31/2023 of $14.10 per common share (2.2% decrease) versus my projection of $14.10 per common share (2.2% decrease). I consider this an exact match and was well within my $13.55 - $14.65 per common share range. Still, let us reconcile RC’s underlying valuation fluctuations when compared to my expectations for comparative purposes.
First, let us discuss RC’s provision for potential future credit losses account. I projected a modest proportional increase in quarterly reserves (considering the recently acquired BRMK portfolio of commercial loans). In comparison, RC recorded a minor proportional increase in reserves during the fourth quarter of 2023. As I reviewed the quarterly changes to RC’s internal risk ratings (some continued deterioration in investment portfolio health; especially within BRMK investments and even some stress in bridge loans), I continue to believe the company’s reserves were a bit low (to remain non-bias). RC recorded a ($7) million provision during the fourth quarter of 2023. Some will believe this is a bullish/good sign. Some will believe this was an overly aggressive judgement. In comparison, understanding the general rise in recessionary/credit risk across broader financial markets (especially in commercial real estate), I projected a provision for loan losses of ($30) million. When calculated, this $23 million variance directly led to a BV outperformance of $0.14 per common share when compared to my expectations.
Second, outside this credit loss/reserve account, RC’s total net valuation gain within the company’s entire investment portfolio during the fourth quarter of 2023 slightly underperformed my expectations. RC reported a residential mortgage net valuation loss (which was actually classified as discontinued operations [more on this in a bit]) of ($18) million, net realized gains on investments and real estate owned (“REO”) of $15 million (again, consider the discounted purchase price of BRMK assets), net unrealized gains on financial instruments of $2 million, and servicing income (net of amortization and impairment) of $4 million. When combined, along with several other small valuation/non-interest income accounts, this was a total net valuation gain/income of $42 million during the fourth quarter of 2023. In comparison, I projected a total net valuation gain/income of $60 million. Remember, RC’s total investment portfolio size was $12.0 billion as of 12/31/2023. So, a pretty accurate projection. When calculated, this ($18) million variance directly led to a BV underperformance of ($0.11) per common share when compared to my expectations.
When the 2 variances noted above are combined, along with RC’s core earnings/earnings available for distribution (“EAD”) underperformance of ($0.034) per common share (which will be discussed next), this fully reconciles to the company’s quarterly BV matching my expectations. I correctly anticipated RC would not repurchase any outstanding shares of common or preferred stock during the fourth quarter of 2023.
Moving on, RC’s core earnings/EAD of $0.261 per common share for the fourth quarter of 2023 was a modest underperformance versus my prior projection of $0.295 per common share. RC’s core earnings/EAD was $0.281 per common share for the third quarter of 2023. As such, I projected a core earnings/EAD increase of $0.014 per common share. In actuality, RC reported a core earnings/EAD decrease of ($0.020) per common share. The institutional analysts’ consensus average was core earnings/EAD of $0.291 per common share. Let us reconcile RC’s quarterly core earnings/EAD underperformance when compared to my expectations.
RC’s investment portfolio, when based on fair market value (“FMV”) fluctuations, decreased (2.5%) during the fourth quarter of 2023. In comparison, I projected a quarterly increase of 1% - 5% (mean increase of 3%). I incorrectly assumed RC would be a bit more aggressive putting some merger-related cash/capital to use. For the 2nd straight quarter, along with a slight weighted average yield underperformance, this negatively impacted RC’s net spread metrics (hence core earnings/EAD) when compared to my expectations. This was directly the result of RC having another decrease in quarterly loan originations/purchases when compared to the prior quarter. RC originated/purchased a total of $1.1 billion of investments during the second quarter of 2023 (outside the BRMK merger). RC originated/purchased a total of $1.0 billion of investments during the third quarter of 2023 (when including the now “shuttered” residential mortgage loans/banking sub-portfolio). RC originated/purchased a total of only $449 million of investments during the fourth quarter of 2023. When broken out, this included originations/purchases of $297 million of small-to-medium balance commercial (“SBC”) loans (which is now classified as “lower middle market” [LMM] loans) and $152 million of U.S. Small Business Administration (“SBA”) Section 7(a) government loans. To finance these originations, RC has recently continued to utilize securitizing commercial and residential whole loans (generally attractive yields and underlying characteristics). This has continued to mitigate valuation gains/(losses) within RC’s investment portfolio with its debt securitizations (liabilities). This has been specifically discussed within prior/recent EFC, MFA, CIM, and MITT earnings notes so I would just refer back to those mREITs for a further discussion of this specific topic. Again, RC has now classified the company’s previous residential mortgage loans/banking sub-portfolio as being a “discontinued operation” and all applicable assets held for sale. This was a surprise and a bit odd in my professional opinion. I hope management discusses this decision/strategy in tomorrow’s conference call.
First, RC reported net interest income of $53 million during the fourth quarter of 2023. This was a ($6) million decrease when compared to the third quarter of 2023. In comparison, I projected RC would report net interest income of $55 million. When calculated, this ($2) million variance directly led to a core earnings/EAD underperformance of ($0.013) per common share when compared to my expectations. Simply put, a bit of a disappointment which, again, was mainly due to RC’s smaller investment portfolio size via lower quarterly loan originations.
Second, even with the recently completed BRMK merger, the company’s operational expenses (including all non-interest-related expenses) slightly increased during the fourth quarter of 2023 when compared to the prior quarter. Again, a bit of a disappointment there. RC reported total operational/non-interest expenses of ($80) million during the fourth quarter of 2023. This was a ($7) million increase when compared to the third quarter of 2023. In comparison, even when I thought I was being cautious, I projected total operational/non-interest expenses of ($76) million. When calculated, this ($4) million variance directly led to a core earnings/EAD underperformance of ($0.021) per common share when compared to my expectations. This directly related to another extremely large increase in professional fees and other operational expenses (which were only partially reversed out of core earnings/EAD) partially offset by a large decrease in loan servicing expenses (due to the “shedding” of mortgage servicing rights [MSR] assets in relation to the broader wind down of the residential mortgage loan/banking sub-portfolio).
When these 2 factors are combined, this fully reconciles to RC’s core earnings/EAD underperformance of ($0.034) per common share during the fourth quarter of 2023 when compared to my expectations.
So, all-in-all, an exact match on RC’s quarterly BV (variance of 0.0%) and a modest underperformance on the company’s core earnings/EAD (variance of $0.034 per common share). While RC’s BV matched my expectations, I still believe the company’s reserves are too low in the current/projected future environment. RC has multifamily exposure which is technically classified as commercial real estate. I have discussed recent multifamily trends in other broader sector earnings notes (simply refer back to ACRE, BXMT, FBRT, GPMT, and NYMT earnings notes). As such, I am projecting RC’s reserve will be increasing as 2024 progresses. This is already “embedded” to my/our CURRENT BV projection. In addition, after a severe decrease in core earnings/EAD during the third quarter of 2023, I wanted to see at least a minor “bounce back” during the fourth quarter of 2023. Simply put, this did not occur. RC’s strategy of monetizing BRMK assets (always knew there would be a high level of non-performance within this specific portfolio) is simply taking longer than management (and myself) first envisioned. This has directly “hampered” core earnings/EAD (including future earnings projections). I believe RC will EVENTUALLY be able to grow core earnings/EAD above the company’s current $0.30 per common share dividend level. However, I am becoming less confident this can occur by mid-2024.
My/Our projected RC dividend per share rate remains $0.30 per common share for the first quarter of 2024. However, my/our initial projected RC dividend per share range for the second quarter of 2024 will be $0.275 - $0.30 per common share. This implies the chance of another dividend reduction (albeit a less severe cut versus what occurred during the fourth quarter of 2023). In order for RC to once again generate core earnings/EAD above $0.30 per common share, management needs to resolve existing, troubled loans (where no yield is currently being generated) and deploy these proceeds, along with unused capital, into attractively-priced, producing assets. This will take some time (not going to “sugar coat” it). Simply put, this allows RC to “leverage back up” (of course while performing due diligence) which will allow the company to enhance/lever returns if/when management sees attractive risk-adjusted investment opportunities over the foreseeable future. The key question is how fast will RC take to lever the company back up? I believe that will ultimately decide whether another minor dividend reduction is implemented by the Board of Directors (“BoD”) over the next several quarters. This needs to be reflected in the per share recommendation ranges.
When taking RC’s recent and projected performance into consideration, along with macroeconomic trends/events (mainly Fed monetary policy, the general projected movement of rates/yields, and projected economic performance over the foreseeable future), I/we are “downgrading” our RC percentage recommendation ranges (relative to CURRENT BV) by (2.5%). This change is already reflected in the subscriber spreadsheets (resulted in a price target decrease of approximately ($0.35) per share). However, this does not result in a downgrade to RC’s risk/performance rating (remains a 4 but does move it closer to a 4.5 to remain non-bias).
Even with this minor recommendation range downgrade, at a closing price as of 2/27/2024 of $8.93 per share, RC is deemed to be NOTABLY UNDERVALUED/a STRONG BUY recommendation (price target of $12.90 per share). Simply put, RC is still priced at a deep discount to estimated CURRENT BV. That said, and I cannot stress this enough, this is a longer-term play where subscribers need to be patient for cycles/trends/catalysts to play out. Over the long-term (at least 1 year out), there is a high likelihood subscribers will see an attractive total return from their RC position…”
2) SLRC’s NAV and NII Q4 2023 Performance (Projected Versus Actual Results):
On 2/27/2024, SLRC Investment Corp. SLRC 0.00%↑ reported the company’s earnings results for the fourth quarter of 2023. Table 2 below provides SLRC’s NAV and earnings summary.
Table 2 – SLRC Q4 2023 NAV and Earnings Summary
Source: Taken Directly from the REIT Forum’s © Analytical Spreadsheets/Data
I provided the following commentary in regards to SLRC’s results for the fourth quarter of 2023: