10-K/A: Ready Capital Amends 2024 Annual Report, Details Financial Shifts

Ready Capital Corporation filed an amendment to its 2024 Annual Report, primarily correcting certification errors, while detailing a strategic shift to LMM commercial real estate and small business lending, alongside significant financial performance changes including a net loss.

Summary

• Ready Capital Corporation (RC) is a multi-strategy real estate finance company focusing on lower-to-middle-market (LMM) loans, Small Business Administration (SBA) loans, construction loans, and USDA loans.
• A strategic shift was approved in Q4 2023 to focus on LMM commercial real estate lending and government-backed small business loans, with residential mortgage banking activities being divested.
• The company reported a consolidated net loss of $430.4 million for the year ended December 31, 2024, a significant decrease from a net income of $348.4 million in 2023.
• Distributable earnings for 2024 were $28.4 million, down from $190.1 million in 2023.
• Total assets decreased by $2.3 billion to $10.1 billion as of December 31, 2024, primarily due to paydowns on securitized loans and increased Current Expected Credit Loss (CECL) reserves.
• Total stockholders' equity decreased by $702.7 million to $1.9 billion, mainly due to net losses, dividends paid, and common stock repurchases.
• Completed acquisitions in 2024 include Funding Circle USA, Inc. for approximately $41.2 million in cash and Madison One Capital for an initial purchase price of approximately $32.9 million in cash.
• The company entered into a definitive merger agreement with United Development Funding IV (UDF IV), expected to close in the first half of 2025, which is anticipated to result in a pro forma equity capital base exceeding $2.2 billion.
• The loan portfolio was $8.5 billion (excluding PPP loans) as of December 31, 2024, diversified across 50 states and Europe, with 97% secured by senior liens.
• The LMM Commercial Real Estate segment experienced an $80.9 million decrease in interest income and a $324.9 million increase in non-interest loss in 2024.
• The Small Business Lending segment saw interest income increase by $32.1 million and non-interest income increase by $6.5 million in 2024.
• Total loan originations for 2024 were $2.4 billion, up from $2.18 billion in 2023, with a current loan investment pipeline of $2.51 billion.

Sentiment

Score: 3

Explanation: The company reported a substantial net loss and a significant decline in distributable earnings and equity for 2024. Its stock performance lagged both the broader market and its peer group. While strategic shifts and acquisitions are noted, the financial results indicate considerable challenges and increased credit risk.

Positives

• The company is undergoing a strategic shift to focus on LMM commercial real estate lending and government-backed small business loans, aiming for attractive risk-adjusted returns.
• Book value grew from $536 million in 2017 to approximately $1.9 billion in 2024, representing a 22% compound annual growth rate (CAGR).
• LMM loan originations have shown a 24.2% CAGR since inception in 2013.
• The Small Business Lending segment demonstrated growth in 2024, with interest income increasing by $32.1 million and non-interest income increasing by $6.5 million.
• Total loan investment activity increased to $2.4 billion in 2024 from $2.18 billion in 2023, indicating continued origination and acquisition efforts.
• Successful acquisitions of Funding Circle and Madison One in 2024 are expected to integrate new platforms and expand loan product offerings.
• The anticipated merger with UDF IV is expected to create a pro forma equity capital base in excess of $2.2 billion, enhancing scale.
• The company maintained compliance with all debt and financial covenants as of December 31, 2024.
• A full valuation allowance on deferred tax assets was reversed as of December 31, 2024, indicating management's expectation of future realization of these assets.

Negatives

• Reported a consolidated net loss of $430.4 million for the year ended December 31, 2024, a significant decline from a net income of $348.4 million in 2023.
• Distributable earnings decreased substantially to $28.4 million in 2024 from $190.1 million in 2023.
• Total assets decreased by $2.3 billion (18.5%) and total stockholders' equity decreased by $702.7 million (26.6%) from December 31, 2023, to December 31, 2024.
• The provision for loan losses increased significantly by $285.5 million to $292.8 million in 2024, indicating deteriorating credit quality.
• The LMM Commercial Real Estate segment experienced an $80.9 million decrease in interest income and a $324.9 million increase in non-interest loss in 2024.
• Overall non-interest income decreased by $510.2 million in 2024, partly due to a non-recurring bargain purchase gain from the Broadmark Merger in the prior year.
• Non-interest expense increased by $50.3 million in 2024, driven by charge-offs of real estate acquired in settlement of loans and increased loan servicing expenses.
• A significant portion of the loan portfolio, 4.7%, was 60+ days past due as of December 31, 2024.
• Loans with loan-to-value (LTV) ratios greater than 80% represent 27.8% of the loan portfolio, increasing potential credit risk.
• Dividends declared per common share decreased to $1.10 in 2024 from $1.46 in 2023.
• The company's common stock total return performance (RC: 130.5) significantly underperformed both the S&P 500 (279.5) and its Competitor Composite Average (194.8) from October 31, 2016, to December 31, 2024.

Risks

• Difficult conditions in the mortgage, residential, and commercial real estate markets, including market volatility, inflation, and geopolitical tensions, may cause market losses.
• Inability to obtain cost-effective financing due to disruptions in financial and banking sectors.
• Lack of liquidity of assets may adversely affect business, including the ability to value and sell assets.
• A significant portion of investments in LMM loans are subject to credit risk, with higher LTV ratios potentially leading to greater credit losses.
• Due diligence of potential LMM loans and ABS assets may not reveal all liabilities or weaknesses.
• Use of underwriting guideline exceptions in LMM loan origination may result in increased delinquencies and defaults.
• Deficiencies in appraisal quality may result in increased principal loss severity.
• Costs or delays in foreclosure or liquidation of underlying property may reduce proceeds and increase losses.
• Real estate properties acquired through foreclosure expose the company to additional risks such as integration difficulties, carrying costs, inability to sell, vacancies, impairment charges, and tenant defaults/bankruptcies.
• Mezzanine loan assets involve greater risks of loss than senior loans.
• Exposure to environmental liabilities with respect to properties to which the company takes title.
• Investments outside the U.S. denominated in foreign currencies subject the company to foreign currency risks and uncertainty of foreign laws and markets.
• Loans are dependent on the commercial property owner's ability to generate net income, risking default and foreclosure.
• Current or future pandemics and epidemics may adversely affect borrowers, the real estate industry, global markets, and the company's business and operations.
• Portfolio concentration in certain property types or geographic areas increases exposure to economic downturns.
• Increasing federal, state, and local laws may affect mortgage-related assets and materially increase the cost of doing business.
• Failure to obtain or maintain required approvals and/or state licenses necessary to operate mortgage-related activities.
• Loans to small businesses involve a high degree of business and financial risk, which can result in substantial losses.
• Some mortgage loans originated or acquired are made to self-employed borrowers who have a higher risk of delinquency and default.
• Some mortgage loans originated or acquired are secured by non-owner/user properties that may experience increased frequency of default.
• Failure to maintain status as an approved Freddie Mac seller/servicer could harm the business.
• Acquisitions and the integration of acquired businesses subject the company to various risks and may not result in all anticipated cost savings and benefits.
• Unique risks related to integrating a construction lending platform and the origination and ownership of construction loans.
• Underestimation of credit analysis and the expected risk-adjusted return by Waterfall may result in losses.
• Reliance on analytical models and data, including third-party data, which may be incorrect, misleading, or incomplete.
• The failure of a third-party servicer or the company's own internal servicing system to effectively service the mortgage loan portfolio would materially and adversely affect the company.
• The bankruptcy of a third-party servicer would adversely affect the business.
• New entrants in the market for LMM loan acquisitions and originations could adversely impact the company's ability to acquire LMM loans at attractive prices and originate LMM loans at attractive risk-adjusted returns.
• Unintended consequences and market distortions may stem from far-ranging interventions in the financial system and oversight of financial markets.
• Joint venture investments could be adversely affected by lack of sole decision-making authority, reliance on joint venture partners' financial condition and liquidity, and disputes.
• Inability to manage future growth could have an adverse impact on financial condition and results of operations.
• Declines in the fair market values of assets may adversely affect periodic reported results and credit availability.
• Investments may include subordinated tranches of ABS which are subordinate in right of payment to more senior securities.
• In certain cases, the company may not control the special servicing of mortgage loans included in the securities in which it may invest.
• Any credit ratings assigned to LMM loans and ABS assets will be subject to ongoing evaluations and revisions and may be downgraded.
• Receivables underlying ABS may be subject to credit risks, liquidity risks, interest rate risks, market risks, operations risks, structural risks, and legal risks.
• Downgrades of the U.S. government's sovereign credit rating and uncertain political and financial market conditions may affect the terms or stability of securities issued or guaranteed by the U.S. federal government.
• If the company cannot acquire, make, or sell government-guaranteed or other loans, it may generate less interest income and fewer origination fees.
• Increases in interest rates could adversely affect the demand for new LMM loans, the value of LMM loans and ABS assets, and the availability of target assets, and could cause interest expense to increase.
• Some LMM loans will have interest rate features that adjust over time, and any interest rate caps on these loans may reduce income or cause losses during periods of rising interest rates.
• Because the assets held and expected to acquire may experience periods of illiquidity, the company may lose profits or be prevented from earning capital gains if it cannot sell LMM loans and ABS assets at an opportune time.
• Maintenance of the 1940 Act exception imposes limits on operations.
• Rapid changes in the values of target assets may make it more difficult to maintain REIT qualification or exclusion from the 1940 Act.
• Working capital advances provided to small businesses may become uncollectible.
• Any disruption in the availability and/or functionality of technology infrastructure and systems could adversely impact the business.
• Cybersecurity risk and cyber incidents may adversely affect the business by causing a disruption to operations, a compromise or corruption of information, and/or damage to reputation or business relationships.
• Highly dependent on information systems and communication systems; systems failures and other operational disruptions could significantly affect the business.
• Accounting rules for certain transactions are highly complex and involve significant judgment and assumptions; changes could adversely impact the ability to timely and accurately prepare consolidated financial statements.
• Provisions for credit losses under the Current Expected Credit Loss (CECL) model are difficult to estimate.
• Inability to integrate prior or future acquisitions successfully and realize the anticipated synergies and other expected benefits.
• Seeking to sell one of the business segments in an effort to maximize shareholder value may adversely affect the company, its reputation, results of operations, financial position, or stock price.
• Dependence on Waterfall and its key personnel for success; may not find a suitable replacement if the management agreement is terminated or key personnel leave.
• Various conflicts of interest exist in the relationship with Waterfall, which could result in decisions not in the best interests of stockholders.
• Termination of the management agreement may be difficult and require payment of a substantial termination fee or other amounts, including in the case of termination for unsatisfactory performance.
• If management functions are internalized or Waterfall is internalized by another sponsored program, the company may be unable to obtain key personnel, and the consideration paid could exceed the termination fee.
• The Class A special unit entitling Waterfall to an incentive distribution may induce Waterfall to make certain investments that may not be favorable, including speculative investments.
• The Board will not approve each investment and financing decision made by Waterfall unless required by investment guidelines.
• Interest rate mismatches between floating rate mortgages and borrowings used to fund purchases of these assets may cause losses.
• The company may be subject to liability in connection with residential mortgage loans for potential violations of consumer protection laws and regulations.
• Failure to maintain GMFS's status as a seller/servicer approved by Freddie Mac, Fannie Mae, HUD/FHA, USDA, and VA could harm the business.
• GMFS operates within a highly regulated industry, and changes in laws and regulations could adversely affect business results.
• Mortgage loan modification and refinance programs, as well as future legislative action, may adversely affect the value of, and returns on, target assets.
• The company may be affected by alleged or actual deficiencies in servicing and foreclosure practices of third parties, as well as related delays in the foreclosure process.
• Mortgage Servicing Rights (MSRs) will expose the company to significant risks.
• GMFS originates residential mortgage loans which have risks of losses due to mortgage loan defaults or fraud.
• The company will hold and may originate or acquire additional residential mortgage loans collateralized by subprime mortgage loans, which are subject to increased risks.
• Deficiencies in the underwriting of newly originated residential mortgage loans may result in an increase in the severity of losses.
• Losses could occur due to a counterparty that sold loans to GMFS or other subsidiaries refusing to or being unable to repurchase that loan or pay damages related to breaches of representations.
• The diminished level of Freddie Mac participation in, and other changes in the role of Freddie Mac in, the mortgage market may adversely affect the business.
• Risks associated with originating or acquiring SBA and other government-guaranteed loans.
• A government shutdown or curtailment of the government-guaranteed loan programs could cut off an important segment of the business.
• The use of leverage as part of the investment strategy, without a formal policy limiting the amount of debt, and the Board's ability to change leverage policy without stockholder consent.
• Inability to successfully complete additional securitization transactions could limit potential future sources of financing.
• The transition away from LIBOR to alternative reference rates may adversely impact borrowings and assets.
• Securitization transactions may expose the company to potentially material risks, including litigation.
• The company may be required to repurchase mortgage loans or indemnify investors if it breaches representations and warranties.
• Certain financing arrangements restrict operations and expose the company to additional risk.
• Securitizations may reduce and/or restrict available cash needed to pay dividends to stockholders to satisfy REIT requirements.
• Repurchase agreements used to finance assets will restrict leveraging and may require additional collateral.
• If a counterparty to repurchase transactions defaults, or if the value of the underlying asset declines, or if the company defaults, losses will be incurred.
• Rights under repurchase agreements may be subject to the effects of bankruptcy laws.
• Change of control provisions in senior secured notes and corporate debt could deter, delay, or prevent an otherwise beneficial merger, acquisition, tender offer, or other takeover attempt.
• Hedging transactions could expose the company to contingent liabilities in the future and adversely impact financial condition.
• Hedging against interest rate exposure may adversely affect earnings.
• Use of derivatives may expose the company to counterparty and other risks.
• Regulation as a commodity pool operator could subject the company to additional regulation and compliance requirements.
• If the company attempts to qualify for hedge accounting treatment for derivative instruments but fails, it may suffer losses.
• Failure to qualify as a REIT, or the failure of its predecessor to qualify as a REIT, would subject the company to U.S. federal income tax and applicable state and local taxes.
• The percentage of assets represented by TRSs and the amount of income received in the form of TRS dividends and interest are subject to statutory limitations.
• Complying with REIT requirements may force the company to liquidate or forego otherwise attractive investments.
• Distributions or gain on the sale of common stock may be treated as unrelated business taxable income (UBTI) to U.S. tax-exempt holders.
• REIT distribution requirements could adversely affect the ability to execute the business plan and may require incurring debt, selling assets, or taking other actions.
• The company may be required to report taxable income with respect to certain investments in excess of the economic income ultimately realized.
• Interest apportionment rules may affect the ability to comply with the REIT asset and gross income tests.
• Ownership limits that apply to REITs, as prescribed by the Code and by the charter, may inhibit market activity and restrict business combination opportunities.
• Certain financing activities may subject the company to U.S. federal income tax and increase the tax liability of stockholders.
• The tax on prohibited transactions will limit the ability to engage in transactions, including certain methods of securitizing mortgage loans.
• Characterization of repurchase agreements entered into to finance investments as sales for tax purposes rather than as secured lending transactions would adversely affect REIT qualification.
• The failure of excess MSRs held by the company to qualify as real estate assets, or the failure of the income from excess MSRs to qualify as interest from mortgages, could adversely affect REIT qualification.
• If the company were to make a taxable distribution of shares of its stock, stockholders may be required to sell such shares or other assets to pay any tax imposed.
• Complying with REIT requirements may limit the ability to hedge effectively.
• Even if the company qualifies as a REIT, it may face tax liabilities that reduce cash flow.
• REIT qualification and exemption from U.S. federal income tax may be dependent on the accuracy of legal opinions or advice, statements by issuers, or information provided by shareholders or other third parties.
• Potential changes to U.S. tax laws could adversely impact the company.
• There may be tax consequences to any modifications to hedging transactions and other contracts to replace references to LIBOR.
• Conflicts of interest could arise as a result of the REIT structure.
• Certain provisions of Maryland law could inhibit changes in control and prevent stockholders from realizing a premium.
• The ability to issue additional shares of common and preferred stock may prevent a change in control.
• Rights to take action against directors and officers are limited, which could limit recourse in the event of actions not in the best interests of stockholders.
• Bylaws designate the Circuit Court for Baltimore City, Maryland, as the sole and exclusive forum for some litigation, which could limit stockholders' ability to obtain a favorable judicial forum.
• Future offerings of debt or equity securities, which may rank senior to common stock, may adversely affect the market price of common stock.
• Inability to assure ability to pay distributions in the future.
• Changes in accounting rules could occur at any time and could impact the company in significantly negative ways.
• Failure to maintain effective internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act.
• Inability to access funding could have a material adverse effect on results of operations, financial condition, and business.
• An increase in borrowing costs relative to the interest received on leveraged assets may adversely affect profitability and cash available for distribution.

Future Outlook

The company expects to continue growing its investment portfolio and adapting to market conditions, with a focus on LMM commercial real estate and government-backed small business loans. The merger with UDF IV is anticipated to close in the first half of 2025, which is projected to significantly increase the equity capital base. Management will continue to monitor the impact of interest rates, credit spreads, and inflation on its operations and financing. The company intends to maintain its current distribution practices to satisfy REIT requirements and will utilize various financing strategies, including securitizations and debt/equity issuances, to fund future growth. Federal and state net operating loss carryforwards, totaling over $576 million, are available to offset future taxable income, with some beginning to expire in 2025.

Management Comments

• Our objective is to provide attractive risk-adjusted returns to our stockholders primarily through dividends.
• We believe that the breadth of our full-service real estate finance platform will allow us to adapt to market conditions and deploy capital to asset classes and segments with the most attractive risk-adjusted returns.
• We believe that we have significant opportunity to originate LMM loans at attractive risk-adjusted returns compared to many banks that have restrictive credit guidelines for target assets.
• We believe this fragmented market, combined with the portfolio expertise required to manage these loans, provides attractive origination and acquisition opportunities and limits competition.
• We believe that Waterfall's experience, reputation and ability to underwrite LMM loans make it an attractive buyer for this asset class, and that its network of relationships will continue to produce opportunities for it to acquire LMM loans on attractive terms.
• We currently target a total debt-to-equity leverage ratio between 4:1 to 4.5:1 and a recourse debt-to-equity leverage ratio between 1.5:1 to 2:1. We believe that these target leverage ratios are conservative for these asset classes and exemplify the conservative levels of borrowings we intend to use over time.
• We intend to use leverage for the primary purpose of financing our portfolio and not for the purpose of speculating on changes in interest rates.
• We aim to hedge our originated loan inventory pending securitization with respect to changes in securitization liability cost resulting from both changes in benchmark treasuries and credit spreads.
• We expect Waterfall's professionals and their industry expertise to provide us a competitive advantage in sourcing transactions and help us assess acquisition and origination risks and determine appropriate pricing for potential assets.
• We believe that we are currently one of only a handful of active market participants in the secondary LMM loan market.
• We are not aware of any risks from cybersecurity threats that have materially affected or are reasonably likely to materially affect us, including our financial position, results of operations and/or business strategy.

Industry Context

The commercial mortgage market is characterized by a bifurcation between large balance loans (typically over $40 million, financed by insurance companies and CMBS conduits) and LMM loans (typically $500,000 to $40 million, financed by community/regional banks, specialty finance companies, and SBA programs). The LMM market is fragmented, offering opportunities for specialized lenders like Ready Capital. The U.S. mortgage market has faced severe disruptions, including defaults and liquidity concerns, while investor demand for government-guaranteed SBA Section 7(a) Program loans remains strong. The industry also faces competition from various financial institutions and is navigating the transition away from LIBOR to alternative reference rates like SOFR. Broader economic conditions, including U.S. government credit rating downgrades by Fitch and Moody's, indicate increased instability and potential impacts on borrowing costs and market liquidity.

Comparison to Industry Standards

• The company's common stock total return performance (RC: 130.5) significantly underperformed the S&P 500 Index (279.5) and a Competitor Composite Average (194.8) from October 31, 2016, to December 31, 2024. The Competitor Composite Average includes Blackstone Mortgage Trust Inc. (BXMT), Starwood Property Trust, Inc. (STWD), Ares Commercial Real Estate Corporation (ACRE), Apollo Commercial Real Estate Finance Inc. (ARI), Arbor Realty Trust, Inc. (ABR), and Ladder Capital Corporation (LADR).
• Management believes it has a competitive advantage in the fragmented LMM market compared to many banks with restrictive credit guidelines and large banks not focused on this market.
• The company asserts it is 'one of only a handful of active market participants in the secondary LMM loan market,' suggesting a niche competitive position.

Management Changes

Corporate Governance

Legal Proceedings

• On June 6, 2024, a class action lawsuit, Eibling v. Pyatt, et al., was filed in the Circuit Court for Baltimore City, Maryland, against Broadmark's former board of directors.
• The lawsuit alleges breaches of fiduciary duties in connection with the Broadmark Merger, including failure to properly consider superior acquisition proposals, reliance on false/misleading valuation analyses, and authorizing a false/misleading proxy statement.
• Claims also assert aiding and abetting against Broadmark's financial advisor.
• The action seeks compensatory, quasi-appraisal, rescissory damages, disgorgement of merger-related benefits, and litigation expenses/fees.
• The company is not a defendant but is subject to contractual indemnification obligations related to the defendants' service to Broadmark.
• The defendants intend to vigorously defend against the action.

Related Party Transactions

• The company is externally managed and advised by Waterfall Asset Management, LLC (the Manager).
• A management fee is paid to Waterfall, calculated quarterly in arrears, equal to 1.5% per annum of stockholders' equity up to $500 million and 1.00% per annum of stockholders' equity in excess of $500 million. Total management fee for 2024 was $24.9 million.
• Waterfall is entitled to an incentive distribution based on incentive fee core earnings (IFCE) exceeding an 8.00% hurdle; no incentive fee distribution was paid for 2024.
• The management agreement's current term expires on October 31, 2025, with automatic one-year renewals, and termination without cause is difficult and costly, requiring substantial termination fees.
• The company reimburses Waterfall for certain expenses, totaling $12.3 million for 2024.
• The company has a $125.0 million commitment to Waterfall Atlas Anchor Feeder, LLC, a fund managed by Waterfall, with $92.0 million contributed as of December 31, 2024.
• Conflicts of interest may arise due to Waterfall managing other clients and its personnel not being exclusively dedicated to Ready Capital, though a side letter agreement restricts certain LMM mortgage loan activities.

Stakeholder Impact

• Shareholders face negative impacts from the significant net loss, reduced distributable earnings, and decreased dividend per share, as well as potential dilution from future equity offerings and the possibility of UBTI for tax-exempt holders.
• Employees are affected by management changes resulting from the Broadmark merger and participate in stock-based compensation plans.
• Borrowers may experience challenges, as indicated by the increased provision for loan losses and the offering of loan modifications to those in financial difficulty.
• Lenders and counterparties are impacted by the company's compliance with debt covenants and are exposed to counterparty risk in derivative and repurchase agreements.
• Regulatory bodies continue to oversee the company's operations, particularly regarding SEC, CFPB, SBA, and USDA regulations, and REIT compliance.

Next Steps

• The merger with United Development Funding IV (UDF IV) is expected to close in the first half of 2025.
• Continue to grow the investment portfolio and adapt to market conditions, focusing on LMM commercial real estate and government-backed small business loans.
• Complete the disposition of its residential mortgage banking segment in the first quarter of 2025.
• Repay indebtedness and utilize proceeds from the $220.0 million private placement for general corporate purposes.
• Continue to source LMM loan originations through direct and indirect lending relationships.
• Continue to finance assets through the securitization market on a long-term, non-recourse basis.
• Monitor the impact of shifts in interest rates, credit spreads, and inflation on the company's operations and liquidity.

Key Dates

Recommendation

The company's 2024 financial results show a substantial net loss, a significant decline in distributable earnings, and a notable reduction in total equity. Its stock performance has considerably lagged both the broader market and its peer group. The significant increase in the provision for loan losses points to deteriorating credit quality within its portfolio, and a high percentage of past-due loans, coupled with high LTV ratios, exacerbates credit risk. While strategic shifts and acquisitions are in progress, the current financial health and market underperformance suggest a negative outlook for investors, warranting a 'sell' recommendation.

Keywords

Real Estate Finance, LMM Loans, SBA Loans, Commercial Real Estate, Mortgage-Backed Securities, REIT, Financial Reporting, Corporate Governance, Risk Management, Acquisitions, Securitization, Small Business Lending, USDA Loans, Construction Loans, Interest Rates, Credit Risk, Liquidity, Capital Markets, Cybersecurity, Financial Performance, Stock Repurchase, UDF IV Merger