Item 2. Management’s Discussion and Analysis
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Introduction
Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to provide a reader of our financial statements with a narrative from the perspective of our management on our financial condition, results of operations, liquidity and certain other factors that may affect our future results. Our MD&A is presented in five main sections:
● Overview
● Results of Operations
● Liquidity and Capital Resources
● Contractual Obligations and Off-Balance Sheet Arrangements
● Critical Accounting Estimates
The following discussion should be read in conjunction with our unaudited interim consolidated financial statements and accompanying Notes included in Part I, Item 1, “Financial Statements,” of this quarterly report on Form 10-Q and with Items 6, 7, 8, and 9A of our annual report on Form 10-K. See “Forward-Looking Statements” in this quarterly report on Form 10-Q and in our annual report on Form 10-K and “Critical Accounting Estimates” in our annual report on Form 10-K for certain other factors that may cause actual results to differ, materially, from those anticipated in the forward-looking statements included in this quarterly report on Form 10-Q.
Overview
Our Business
We are a multi-strategy real estate finance company that originates, acquires, finances, and services SBC loans, SBA loans, residential mortgage loans, construction loans, and to a lesser extent, MBS collateralized primarily by SBC loans, or other real estate-related investments. Our loans generally range in original principal amounts up to $40 million and are used by businesses to purchase real estate used in their operations or by investors seeking to acquire multi-family, office, retail, mixed use or warehouse properties. Our objective is to provide attractive risk-adjusted returns to our stockholders, primarily through dividends as well as through capital appreciation. In order to achieve this objective, we continue to grow our investment portfolio and believe that the breadth of our full service real estate finance platform will allow us to adapt to market conditions and deploy capital in our asset classes and segments with the most attractive risk-adjusted returns. We report our activities in the following three operating segments:
● SBC Lending and Acquisitions . We originate SBC loans across the full life-cycle of an SBC property including construction, bridge, stabilized and agency loan origination channels through our wholly-owned subsidiary, ReadyCap Commercial. These originated loans are generally held-for-investment or placed into securitization structures. As part of this segment, we originate and service multi-family loan products under the Freddie Mac SBL program. These originated loans are held for sale, then sold to Freddie Mac. We provide construction and permanent financing for the preservation and construction of affordable housing, primarily utilizing tax-exempt bonds through Red Stone, a wholly owned subsidiary. In addition, we acquire small balance commercial loans as part of our business strategy. We hold performing SBC loans to term and seek to maximize the value of the non-performing SBC loans acquired by us through borrower-based resolution strategies. We typically acquire non-performing loans at a discount to their unpaid principal balance when we believe that resolution of the loans will provide attractive risk-adjusted returns.
● Small Business Lending . We acquire, originate and service owner-occupied loans guaranteed by the SBA under the SBA Section 7(a) Program through our wholly-owned subsidiary, ReadyCap Lending. We hold an SBA license as one of only 14 non-bank SBLCs and have been granted preferred lender status by the SBA. These originated loans are either held-for-investment, placed into securitization structures, or sold. We also acquire purchased future receivables through Knight Capital, which is a technology-driven platform that provides working capital to small and medium sized businesses across the U.S.
● Residential Mortgage Banking . We operate our residential mortgage loan origination segment through our wholly-owned subsidiary, GMFS. GMFS originates residential mortgage loans eligible to be purchased, guaranteed or insured by Fannie Mae, Freddie Mac, FHA, USDA and VA through retail, correspondent and broker channels. These originated loans are then sold to third parties, primarily agency lending programs.
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We are organized and conduct our operations to qualify as a REIT under the Code. So long as we qualify as a REIT, we are generally not subject to U.S. federal income tax on our net taxable income to the extent that we annually distribute substantially all of our net taxable income to stockholders. We are organized in a traditional UpREIT format pursuant to which we serve as the general partner of, and conduct substantially all of our business through, our operating partnership. We also intend to operate our business in a manner that will permit us to be excluded from registration as an investment company under the 1940 Act.
For additional information on our business, refer to Part I, Item 1, “Business” in the Company’s Annual Report on Form 10-K.
Acquisitions
Broadmark. On February 26, 2023, the Company, Broadmark Realty Capital Inc., a Maryland corporation (“Broadmark”), and RCC Merger Sub, LLC, a Delaware limited liability company and a wholly owned subsidiary of Ready Capital (“RCC Merger Sub”), entered into an Agreement and Plan of Merger (the “Broadmark Merger Agreement”), pursuant to which, subject to the terms and conditions therein, Broadmark will be merged with and into RCC Merger Sub, with RCC Merger Sub remaining as a wholly owned subsidiary of the Company (such transaction, the “Broadmark Merger”).
Under the terms of the Broadmark Merger Agreement, at the effective time of the Broadmark Merger (the “Effective Time”), each share of common stock, par value $0.001 per share, of Broadmark (the “Broadmark Common Stock”) issued and outstanding immediately prior to the Effective Time (excluding any shares held by the Company, RCC Merger Sub or any of their respective subsidiaries) will automatically be converted into the right to receive from the Company 0.47233 shares of its common stock, par value $0.0001 (“common stock”), subject to adjustment as provided in the Broadmark Merger Agreement (the “Exchange Ratio”).
Each award of performance restricted stock units (each a “Broadmark Performance RSU Award”) granted by Broadmark under its 2019 Stock Incentive Plan (the “Broadmark Equity Plan”) will, as of the Effective Time, automatically be cancelled in exchange for the right to receive a number of shares of common stock equal to the product of (i) the number of shares of Broadmark Common Stock subject to such Broadmark Performance RSU Award based on the achievement of the applicable performance metric measured as of immediately prior to the Effective Time and (ii) the Exchange Ratio.
Each award of restricted stock units that is not a Broadmark Performance RSU Award granted pursuant to the Broadmark Equity Plan (each a “Broadmark RSU Award”) will be assumed by the Company and converted into an award of restricted stock units with respect to a number of shares of common stock, equal to the product of (i) the total number of shares of Broadmark Common Stock subject to such Broadmark RSU Award as of immediately prior to the Effective Time and (ii) the Exchange Ratio (rounded to the nearest whole share), on the same terms and conditions as were applicable to such Broadmark RSU Award as of immediately prior to the Effective Time.
Each holder of a warrant (whether designated as public warrants, private warrants or otherwise) representing the right to purchase shares of Broadmark Common Stock (each a “Broadmark Warrant”) may exercise such Broadmark Warrant at any time prior to the Effective Time in exchange for Broadmark Common Stock, in accordance with, and subject to, the terms and conditions of the agreement governing such Broadmark Warrant. Following the Effective Time, each Broadmark Warrant that is outstanding as of the Effective Time shall remain outstanding and entitle each holder thereof to receive, upon exercise of such Broadmark Warrant, a number of shares of common stock equal to the product of (i) the total number of shares of Broadmark Common Stock that such holder would have been entitled to receive had such holder exercised such Broadmark Warrant immediately prior to the Effective Time and (ii) the Exchange Ratio.
Following the consummation of the Broadmark Merger, the number of directors on the Company's Board will be increased by three members, from nine to twelve, and will include all of the current directors of the Company's Board and three additional directors, each of whom currently serves on the board of directors of Broadmark.
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The Company currently expects that the Broadmark Merger will close as soon as the second quarter of 2023, subject to the respective approvals of the Company’s stockholders and Broadmark’s stockholders and other customary closing conditions.
Mosaic. On March 16, 2022, pursuant to the terms of that certain Merger Agreement, dated as of November 3, 2021, as amended on February 7, 2022, the Company acquired, in a series of mergers (collectively, the “Mosaic Mergers”), a group of privately held, real estate structured finance opportunities funds, with a focus on construction lending (collectively, the “Mosaic Funds”), managed by MREC Management, LLC (“the “Mosaic Manager”).
As consideration for the Mosaic Mergers, each former investor was entitled to receive an equal number of shares of each of Class B-1 Common Stock, $0.0001 par value per share (the “Class B-1 Common Stock”), Class B-2 Common Stock, $0.0001 par value per share (the “Class B-2 Common Stock”) Class B-3 Common Stock, $0.0001 par value per share (the “Class B-3 Common Stock”), and Class B-4 Common Stock, $0.0001 par value per share (the “Class B-4 Common Stock” and, together with the Class B-1 Common Stock, the Class B-2 Common Stock and the Class B-3 Common Stock, the “Class B Common Stock”), of Ready Capital, contingent equity rights (“CERs”) representing the potential right to receive shares of common stock as of the end of the three-year period following the closing date of the Mosaic Mergers based upon the performance of the assets acquired by Ready Capital pursuant to the Mosaic Mergers, and cash consideration in lieu of any fractional shares of Class B Common Stock.
The Class B Common Stock ranked equally with the common stock, except that the shares of Class B Common Stock were not listed on the New York Stock Exchange. On May 11, 2022, each issued and outstanding share of Class B Common Stock, pursuant to a Board resolution, automatically converted, on a one-for-one basis, into an equal number of shares of common stock, and as such, no shares of Class B Common Stock remain outstanding.
The CERs are contractual rights and do not represent any equity or ownership interest in Ready Capital or any of its affiliates. If any shares of common stock are issued in settlement of the CERs, each former investor will also be entitled to receive a number of additional shares of common stock equal to (i) the amount of any dividends or other distributions paid with respect to the number of whole shares of common stock received in respect of CERs and having a record date on or after the closing date of the Mosaic Mergers and a payment date prior to the issuance date of such shares of common stock, divided by (ii) the greater of (a) the average of the volume weighted average prices of one share of common stock over the ten trading days preceding the determination date and (b) the most recently reported book value per share of common stock as of the determination date.
The acquisition further expanded the Company’s investment portfolio and origination platform to include a diverse portfolio of construction assets with attractive portfolio yields. Refer to Note 5, included in Part I, Item 1, “Financial Statements,” of this quarterly report on Form 10-Q, for assets acquired and liabilities assumed in the Mosaic Mergers.
Factors Impacting Operating Results
We expect that our results of operations will be affected by a number of factors and will primarily depend on the level of interest income from our assets, the market value of our assets and the supply of, and demand for, SBC loans, SBA loans, residential loans, construction loans, MBS and other assets we may acquire in the future, demand for housing, population trends, construction costs, the availability of alternative real estate financing from other lenders and the financing and other costs associated with our business. These factors may have an impact on our ability to originate new loans or the performance of our existing loan portfolio. Our net investment income, which includes the amortization of purchase premiums and accretion of purchase discounts, varies primarily as a result of changes in market interest rates, the rate at which our distressed assets are liquidated and the prepayment speed of our performing assets. Interest rates and prepayment speeds vary according to the type of investment, conditions in the financial markets, competition and other factors, none of which can be predicted with any certainty. Our operating results may also be impacted by our available borrowing capacity, conditions in the financial markets, credit losses in excess of initial estimates or unanticipated credit events experienced by borrowers whose loans are held directly by us or are included in our MBS. Difficult market conditions as well as inflation, energy costs, geopolitical issues, health epidemics and outbreaks of contagious diseases, such as the outbreak of COVID-19 and the emergence and severity of variants, unemployment and the availability and cost of credit are factors which could also impact our operating results.
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Changes in Market Interest Rates. We own and expect to acquire or originate fixed rate mortgages (“FRMs”) and adjustable rate mortgages (“ARMs”) with maturities ranging from two to 30 years. Our loans typically have amortization periods of 15 to 30 years or balloon payments due in two to 10 years. FRM loans bear interest that is fixed for the term of the loan and we typically utilize derivative financial and hedging instruments in an effort to hedge the interest rate risk associated with such FRMs. As of March 31, 2023, 72% of fixed rate loans are match funded in securitization. ARM loans generally have an adjustable interest rate equal to the sum of a fixed spread plus an index rate, such as the Secured Overnight Financing Rate (“SOFR”), which typically resets monthly. As of March 31, 2023, approximately 86% of the loans in our portfolio were ARMs, and 14% were FRMs, based on UPB.
With respect to our business operations, increases in interest rates may generally over time cause the interest expense associated with our variable-rate borrowings to increase, the value of fixed-rate loans, MBS and other real estate-related assets to decline, coupons on variable-rate loans and MBS to reset to higher interest rates, and prepayments on loans and MBS to slowdown. Conversely, decreases in interest rates generally tend to have the opposite effect.
Non-performing loans are not as interest rate sensitive as performing loans, as earnings on non-performing loans are often generated from restructuring the assets through loss mitigation strategies and opportunistically disposing of them. Because non-performing loans are short-term assets, the discount rates used for valuation are based on short-term market interest rates, which may not move in tandem with long-term market interest rates.
Changes in Fair Value of Our Assets . Certain originated loans, MBS, and servicing rights are carried at fair value, while future assets may also be carried at fair value. Accordingly, changes in the fair value of our assets may impact the results of our operations in the period such changes occur. The expectation of changes in real estate prices is a key determinant for the value of loans and ABS. This factor is beyond our control.
Prepayment Speeds. Prepayment speeds on loans vary according to interest rates, the type of investment, conditions in the financial markets, competition, foreclosures and other factors that cannot be predicted with any certainty. In general, when interest rates rise, it is relatively less attractive for borrowers to refinance their mortgage loans and, as a result, prepayment speeds tend to decrease. This can extend the period over which we earn interest income and servicing fee income. When interest rates fall, prepayment speeds increase on loans, thereby decreasing the period over which we earn interest income or servicing fee income. Additionally, other factors such as the credit rating of the borrower, the rate of property value appreciation or depreciation, financial market conditions, foreclosures and lender competition, none of which can be predicted with any certainty, may affect prepayment speeds on loans.
Credit Spreads. Our investment portfolio may be subject to changes in credit spreads. Credit spreads measure the yield demanded on loans and securities by the market based on their credit relative to a specific benchmark and is a measure of the perceived risk of the investment. Fixed rate loans and securities are valued based on a market credit spread over the rate payable on fixed rate swaps or fixed rate U.S. Treasuries of similar maturity. Floating rate securities are typically valued based on a market credit spread over SOFR (or another floating rate index) and are affected similarly by changes in SOFR spreads. Excessive supply of these loans and securities, or reduced demand, may cause the market to require a higher yield on these securities, resulting in the use of a higher, or “wider,” spread over the benchmark rate to value such assets. Under such conditions, the value of our portfolios would tend to decline. Conversely, if the spread used to value such assets were to decrease, or “tighten,” the value of our loans and securities would tend to increase. Such changes in the market value of these assets may affect our net equity, net income or cash flow directly through their impact on unrealized gains or losses.
The spread between the yield on our assets and our funding costs is an important factor in the performance of this aspect of our business. Wider spreads imply greater income on new asset purchases but may have a negative impact on our stated book value. Wider spreads generally negatively impact asset prices. In an environment where spreads are widening, counterparties may require additional collateral to secure borrowings which may require us to reduce leverage by selling assets. Conversely, tighter spreads imply lower income on new asset purchases but may have a positive impact on our stated book value. Tighter spreads generally have a positive impact on asset prices. In this case, we may be able to reduce the amount of collateral required to secure borrowings.
Loan and ABS Extension Risk. The Company estimates the projected weighted-average life of our investments based on assumptions regarding the rate at which the borrowers will prepay the underlying mortgages and/or the speed at which we are able to liquidate an asset. If the timeline to resolve non-performing assets extends, this could have a negative impact
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on our results of operations, as carrying costs may therefore be higher than initially anticipated. This situation may also cause the fair market value of our investment to decline if real estate values decline over the extended period. In extreme situations, we may be forced to sell assets to maintain adequate liquidity, which could cause us to incur losses.
Credit Risk. We are subject to credit risk in connection with our investments in loans and ABS and other target assets we may acquire in the future. Increases in defaults and delinquencies will adversely impact our operating results, while declines in rates of default and delinquencies will improve our operating results from this aspect of our business. Default rates are influenced by a wide variety of factors, including, property performance, property management, supply and demand factors, construction trends, consumer behavior, regional economics, interest rates, the strength of the United States economy and other factors beyond our control. All loans are subject to the possibility of default. We seek to mitigate this inherent risk by seeking to acquire assets at appropriate prices given anticipated and unanticipated losses and by deploying a value-driven approach to underwriting and diligence, consistent with our historical investment strategy, with a focus on projected cash flows and potential risks to cash flow. We further mitigate our risk of potential losses while managing and servicing our loans by performing various workout and loss mitigation strategies with delinquent borrowers. Nevertheless, unanticipated credit losses could occur which could adversely impact operating results.
Current market conditions. The first quarter occurred in an environment of continued market volatility caused by significant, yet subsiding, inflationary pressures, macroeconomic concerns, and geopolitical shifts. In an effort to combat inflation and restore price stability, the U.S. Federal Reserve has continued to raise interest rates. However, there has been a recent shift towards a less aggressive monetary policy amid easing inflation, with interest rate increases decelerating. In addition, the persistence of COVID-19 and its impact on us and our borrowers will largely depend on future developments beyond our control including, but not limited to the emergence and severity of variants, the efficacy of vaccinations and booster programs, the impact and reactions on the U.S. and global economies, the effectiveness of governmental responses thereto and the timing and speed of economic recovery. Concerns and uncertainties about the economic outlook may adversely impact our financial condition, results of operations and cash flows.
Results of Operations
Key Financial Measures and Indicators
As a real estate finance company, we believe the key financial measures and indicators for our business are earnings per share, dividends declared per share, distributable earnings, and net book value per share. As further described below, distributable earnings is a measure that is not prepared in accordance with GAAP. We use distributable earnings to evaluate our performance and determine dividends, excluding the effects of certain transactions and GAAP adjustments that we believe are not necessarily indicative of our current loan activity and operations. See “—Non-GAAP Financial Measures” below for a reconciliation of net income to distributable earnings.
The table below sets forth certain information on our operating results.
Three Months Ended March 31,
($ in thousands, except share data)
2023
2022
Net Income
$
36,978
$
64,263
Earnings per common share - basic
$
0.30
$
0.70
Earnings per common share - diluted
$
0.29
$
0.66
Distributable earnings
$
38,149
$
48,863
Distributable earnings per common share - basic
$
0.31
$
0.52
Distributable earnings per common share - diluted
$
0.30
$
0.48
Dividends declared per common share
$
0.40
$
0.42
Dividend yield
15.7
%
11.2
%
Return on equity
8.2
%
18.0
%
Distributable return on equity
8.5
%
13.6
%
Book value per common share
$
15.07
$
15.22
Adjusted net book value per common share
$
15.07
$
15.21
In the table above,
● Dividend yield is based on the respective period end closing share price.
● Adjusted net book value per common share excludes the equity component of our 2017 convertible note issuance.
Our Loan Pipeline
We have a large and active pipeline of potential acquisition and origination opportunities that are in various stages of our investment process. We refer to assets as being part of our acquisition or origination pipeline if (i) an asset or portfolio opportunity has been presented to us and we have determined, after a preliminary analysis, that the assets fit within our
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investment strategy and exhibit the appropriate risk/reward characteristics (ii) in the case of acquired loans, we have executed a non-disclosure agreement (“NDA”) or an exclusivity agreement and commenced the due diligence process or we have executed more definitive documentation, such as a letter of intent (“LOI”); and (iii) in the case of originated loans, we have issued an LOI, and the borrower has paid a deposit.
We operate in a competitive market for investment opportunities and competition may limit our ability to originate or acquire the potential investments in the pipeline. The consummation of any of the potential loans in the pipeline depends upon, among other things, one or more of the following: available capital and liquidity, our Manager’s allocation policy, satisfactory completion of our due diligence investigation and investment process, approval of our Manager’s Investment Committee, market conditions, our agreement with the seller on the terms and structure of such potential loan, and the execution and delivery of satisfactory transaction documentation. Historically, we have acquired less than a majority of the assets in our pipeline at any one time and there can be no assurance the assets currently in our pipeline will be acquired or originated by us in the future.
The table below presents information on our investment portfolio originations and acquisitions (based on fully committed amounts).
Three Months Ended March 31,
(in thousands)
2023
2022
Loan originations:
SBC loans
$
410,516
$
2,194,885
SBA loans
92,296
100,956
Residential agency mortgage loans
325,982
769,133
Total loan originations
$
828,794
$
3,064,974
Total loan acquisitions
$
—
$
5,253
Total loan investment activity
$
828,794
$
3,070,227
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Balance Sheet Analysis and Metrics
(in thousands)
March 31, 2023
December 31, 2022
$ Change
% Change
Assets
Cash and cash equivalents
$
111,192
$
163,041
$
(51,849)
(31.8)
%
Restricted cash
49,632
55,927
(6,295)
(11.3)
Loans, net (including $9,859 and $9,786 held at fair value)
3,128,197
3,576,310
(448,113)
(12.5)
Loans, held for sale, at fair value
236,578
258,377
(21,799)
(8.4)
Paycheck Protection Program loans (including $346 and $576 held at fair value)
146,557
186,985
(40,428)
(21.6)
Mortgage-backed securities, at fair value
32,607
32,041
566
1.8
Loans eligible for repurchase from Ginnie Mae
64,293
66,193
(1,900)
(2.9)
Investment in unconsolidated joint ventures (including $7,913 and $8,094 held at fair value)
114,169
118,641
(4,472)
(3.8)
Investments held to maturity
3,306
3,306
—
—
Purchased future receivables, net
10,568
8,246
2,322
28.2
Derivative instruments
13,773
12,963
810
6.2
Servicing rights (including $188,985 and $192,203 held at fair value)
278,936
279,320
(384)
(0.1)
Real estate owned, held for sale
90,104
117,098
(26,994)
(23.1)
Other assets
202,690
189,769
12,921
6.8
Assets of consolidated VIEs
7,054,861
6,552,760
502,101
7.7
Total Assets
$
11,537,463
$
11,620,977
$
(83,514)
(0.7)
%
Liabilities
Secured borrowings
2,484,902
2,846,293
(361,391)
(12.7)
Paycheck Protection Program Liquidity Facility (PPPLF) borrowings
169,596
201,011
(31,415)
(15.6)
Securitized debt obligations of consolidated VIEs, net
5,300,967
4,903,350
397,617
8.1
Convertible notes, net
114,689
114,397
292
0.3
Senior secured notes, net
343,798
343,355
443
0.1
Corporate debt, net
663,623
662,665
958
0.1
Guaranteed loan financing
238,948
264,889
(25,941)
(9.8)
Contingent consideration
16,636
28,500
(11,864)
(41.6)
Liabilities for loans eligible for repurchase from Ginnie Mae
64,293
66,193
(1,900)
(2.9)
Derivative instruments
2,639
1,586
1,053
66.4
Dividends payable
47,308
47,177
131
0.3
Loan participations sold
55,967
54,641
1,326
2.4
Due to third parties
12,881
11,805
1,076
9.1
Accounts payable and other accrued liabilities
132,523
176,520
(43,997)
(24.9)
Total Liabilities
$
9,648,770
$
9,722,382
$
(73,612)
(0.8)
%
Preferred stock Series C, liquidation preference $25.00 per share
8,361
8,361
—
—
Commitments & contingencies
Stockholders’ Equity
Preferred stock Series E liquidation preference $25.00 per share
111,378
111,378
—
—
Common stock, $0.0001 par value, 500,000,000 shares authorized, 110,745,658 and 110,523,641 shares issued and outstanding, respectively
11
11
—
—
Additional paid-in capital
1,687,631
1,684,074
3,557
0.2
Retained earnings (deficit)
(6,532)
4,994
(11,526)
(230.8)
Accumulated other comprehensive loss
(12,353)
(9,369)
(2,984)
31.8
Total Ready Capital Corporation equity
1,780,135
1,791,088
(10,953)
(0.6)
Non-controlling interests
100,197
99,146
1,051
1.1
Total Stockholders’ Equity
$
1,880,332
$
1,890,234
$
(9,902)
(0.5)
%
Total Liabilities, Redeemable Preferred Stock, and Stockholders’ Equity
$
11,537,463
$
11,620,977
$
(83,514)
(0.7)
%
As of March 31, 2023, total assets in our consolidated balance sheet were $11.5 billion, a decrease of $84 million from December 31, 2022, primarily reflecting decreases in Cash and cash equivalents, Loans net, and PPP loans, partially offset by increases in Assets of consolidated VIEs. Cash and cash equivalents decreased $52 million due to dividend payments and loan originations exceeding loan payoffs. Loans, net decreased $448 million due to the closing of RCMF 2023-FL11. PPP loans decreased $40 million due to principal forgiveness. Assets on consolidated VIEs increased $502 million due to the closing of RCMF 2023-FL11.
As of March 31, 2023, total liabilities in our consolidated balance sheet were $9.6 billion, a decrease of $74 million from December 31, 2022, primarily reflecting decreases in Secured borrowings, Accounts payable and other accrued liabilities and PPPLF borrowings, partially offset by increase in Securitized debt obligations of consolidated VIEs. Secured borrowings decreased $361 million due to the payoffs related to closing RCMF 2023-FL11. Accounts payable and other accrued liabilities decreased $44 million due to payment of accrued liabilities. PPPLF borrowings decreased $31 million due to PPP principal forgiveness. Securitized debt obligations of consolidated VIEs increased $398 million due to the closing of RCMF 2023-FL11.
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As of March 31, 2023, total stockholders’ equity was $1.9 billion, a decrease of $10 million from December 31, 2022, primarily reflecting dividends declared of $45 million, partially offset by net income of $37 million.
Selected Balance Sheet Information by Business Segment. The table below presents certain selected balance sheet data by each of our three business segments, with the remaining amounts reflected in Corporate –Other .
(in thousands)
SBC Lending and Acquisitions
Small Business Lending
Residential Mortgage Banking
Total
March 31, 2023
Assets
Loans, net
$
9,432,960
$
540,042
$
5,146
$
9,978,148
Loans, held for sale, at fair value
73,452
43,427
119,699
236,578
Paycheck Protection Program loans
—
146,557
—
146,557
MBS, at fair value
32,607
—
—
32,607
Servicing rights
67,911
22,040
188,985
278,936
Investment in unconsolidated joint ventures
114,169
—
—
114,169
Investments held to maturity
3,306
—
—
3,306
Purchased future receivables, net
—
10,568
—
10,568
Real estate owned, held for sale
105,029
—
—
105,029
Liabilities
Secured borrowings
$
2,105,541
$
162,839
$
216,522
$
2,484,902
Paycheck Protection Program Liquidity Facility (PPPLF) borrowings
—
169,596
—
169,596
Securitized debt obligations of consolidated VIEs
5,258,163
42,804
—
5,300,967
Guaranteed loan financing
—
238,948
—
238,948
Senior secured notes, net
330,317
13,481
—
343,798
Corporate debt, net
663,623
—
—
663,623
Convertible notes, net
108,963
5,726
—
114,689
Loan participations sold
55,967
—
—
55,967
In the table above, Loans, net includes assets of consolidated VIEs and excludes allowance for loan losses, and Investments held to maturity and Real estate owned, held for sale include assets of consolidated VIEs.
Income Statement Analysis and Metrics
Three Months Ended March 31,
(in thousands)
2023
2022
$ Change
Interest income
SBC lending and acquisitions
$
198,039
$
96,343
$
101,696
Small business lending
17,929
26,237
(8,308)
Residential mortgage banking
1,605
1,825
(220)
Total interest income
$
217,573
$
124,405
$
93,168
Interest expense
SBC lending and acquisitions
(149,494)
(53,093)
(96,401)
Small business lending
(9,374)
(5,690)
(3,684)
Residential mortgage banking
(1,526)
(1,958)
432
Corporate - other
—
(276)
276
Total interest expense
$
(160,394)
$
(61,017)
$
(99,377)
Net interest income before recovery of (provision for) loan losses
$
57,179
$
63,388
$
(6,209)
Recovery of (provision for) loan losses
SBC lending and acquisitions
8,129
(270)
8,399
Small business lending
(1,395)
(1,272)
(123)
Total recovery of (provision for) loan losses
$
6,734
$
(1,542)
$
8,276
Net interest income after recovery of (provision for) loan losses
$
63,913
$
61,846
$
2,067
Non-interest income
SBC lending and acquisitions
9,556
23,808
(14,252)
Small business lending
21,743
14,246
7,497
Residential mortgage banking
12,468
49,161
(36,693)
Corporate - other
331
592
(261)
Total non-interest income
$
44,098
$
87,807
$
(43,709)
Non-interest expense
SBC lending and acquisitions
(22,210)
(24,112)
1,902
Small business lending
(17,091)
(15,275)
(1,816)
Residential mortgage banking
(14,588)
(13,344)
(1,244)
Corporate - other
(16,753)
(14,810)
(1,943)
Total non-interest expense
$
(70,642)
$
(67,541)
$
(3,101)
Net income (loss) before provision for income taxes
SBC lending and acquisitions
44,020
42,676
1,344
Small business lending
11,812
18,246
(6,434)
Residential mortgage banking
(2,041)
35,684
(37,725)
Corporate - other
(16,422)
(14,494)
(1,928)
Total net income before provision for income taxes
$
37,369
$
82,112
$
(44,743)
Results of Operations – Supplemental Information. Realized and unrealized gains (losses) on financial instruments are recorded in the consolidated statements of income and classified based on the nature of the underlying asset or liability.
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The table below presents the components of realized and unrealized gains (losses) on financial instruments.
Three Months Ended March 31,
(in thousands)
2023
2022
$ Change
Realized gain (loss) on financial instruments
Realized gain on loans - Freddie Mac and CMBS
$
252
$
1,178
$
(926)
Creation of MSRs - Freddie Mac
224
1,268
(1,044)
Realized gain on loans - SBA
5,239
5,362
(123)
Creation of MSRs - SBA
1,511
1,734
(223)
Creation of MSRs - Red Stone
2,858
195
2,663
Realized gain (loss) on derivatives, at fair value
3,686
(1,125)
4,811
Realized gain on MBS, at fair value
—
1,373
(1,373)
Net realized gain (loss) - all other
(2,195)
(1,978)
(217)
Net realized gain (loss) on financial instruments
$
11,575
$
8,007
$
3,568
Unrealized gain (loss) on financial instruments
Unrealized loss on loans - Freddie Mac and CMBS
$
(2,668)
$
(10,775)
$
8,107
Unrealized gain on loans - SBA
474
288
186
Unrealized gain (loss) on residential MSRs, at fair value
(6,093)
32,598
(38,691)
Unrealized gain (loss) on derivatives, at fair value
(3,537)
26,933
(30,470)
Unrealized gain (loss) on MBS, at fair value
210
(2,612)
2,822
Net unrealized gain (loss) - all other
(114)
(1,117)
1,003
Net unrealized gain (loss) on financial instruments
$
(11,728)
$
45,315
$
(57,043)
SBC Lending and Acquisitions Segment Results.
Q1 2023 versus Q1 2022. Interest income of $198.0 million represented an increase of $101.7 million, primarily due to increases in interest rates. Interest expense of $149.5 million represented an increase of $96.4 million, driven by increases in interest rates. Recovery of loan losses of $8.1 million represented an increase of $8.4 million, primarily due to more positive economic assumptions partially offset by reserves on assets within the office sector. Non-interest income of $9.6 million represented a decrease of $14.3 million, primarily due to decreases in net unrealized gains on financial instruments and decreases in income from unconsolidated joint ventures, partially offset by increases in other income and increases in realized gains on financial instruments. Non-interest expense of $22.2 million represented a decrease of $1.9 million, primarily due to decreased professional fees and compensation.
Small Business Lending Segment Results.
Q1 2023 versus Q1 2022. Interest income of $17.9 million represented a decrease of $8.3 million, primarily due to decreased loan balances. Interest expense of $9.4 million represented an increase of $3.7 million, driven by increases in interest rates. Provision for loan losses of $1.4 million represented an increase of $0.1 million, due to loan originations. Non-interest income of $21.7 million represented an increase of $7.5 million, primarily due to fees earned related to employee tax credit consulting. Non-interest expense of $17.1 million represented an increase of $1.8 million, primarily due to an increase in compensation related to employee tax credit consulting.
Residential Mortgage Banking Segment Results.
Q1 2023 versus Q1 2022. Interest income of $1.6 million was essentially unchanged from the respective prior year period. Interest expense of $1.5 million was essentially unchanged from the respective prior year period. Non-interest income of $12.5 million represented a decrease of $36.7 million, due to unrealized losses on MSRs, partially offset by increases in servicing income. Non-interest expense of $14.6 million represented an increase of $1.2 million, primarily due to increased variable expenses on residential mortgage banking activities.
Corporate – Other.
Q1 2023 versus Q1 2022. Non-interest expense of $16.8 million represented an increase of $1.9 million, primarily due to increased compensation expense, professional fees and management fees.
Non-GAAP financial measures
We believe that providing investors with distributable earnings, formerly referred to as core earnings, gives investors greater transparency into the information used by management in our financial and operational decision-making, including the determination of dividends. Distributable earnings is a non-U.S. GAAP financial measure and because distributable earnings is an incomplete measure of our financial performance and involves differences from net income computed in accordance with U.S. GAAP, it should be considered along with, but not as an alternative to, our net income as a measure
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of our financial performance. In addition, because not all companies use identical calculations, our presentation of distributable earnings may not be comparable to other similarly-titled measures of other companies.
We calculate distributable earnings as GAAP net income (loss) excluding the following:
i) any unrealized gains or losses on certain MBS not retained by us as part of our loan origination businesses
ii) any realized gains or losses on sales of certain MBS
iii) any unrealized gains or losses on Residential MSRs
iv) any unrealized current non-cash provision for credit losses on accrual loans
v) any unrealized gains or losses on de-designated cash flow hedges
vi) any non-cash compensation expense related to stock-based incentive plan
vii) one-time non-recurring gains or losses, such as gains or losses on discontinued operations, bargain purchase gains, or merger related expenses
In calculating distributable earnings, net income (in accordance with GAAP) is adjusted to exclude unrealized gains and losses on MBS acquired by us in the secondary market but is not adjusted to exclude unrealized gains and losses on MBS retained by us as part of our loan origination businesses, where we transfer originated loans into an MBS securitization and retain an interest in the securitization. In calculating distributable earnings, we do not adjust net income (in accordance with GAAP) to take into account unrealized gains and losses on MBS retained by us as part of our loan origination businesses because we consider the unrealized gains and losses that are generated in the loan origination and securitization process to be a fundamental part of this business and an indicator of the ongoing performance and credit quality of our historical loan originations. In calculating distributable earnings, net income (in accordance with GAAP) is adjusted to exclude realized gains and losses on certain MBS securities due to a variety of reasons which may include collateral type, duration, and size. In 2016, we liquidated the majority of our MBS portfolio excluded from distributable earnings to fund our recurring operating segments.
In addition, in calculating distributable earnings, net income (in accordance with GAAP) is adjusted to exclude unrealized gains or losses on residential MSRs, held at fair value. We treat our commercial MSRs and residential MSRs as two separate classes based on the nature of the underlying mortgages and our treatment of these assets as two separate pools for risk management purposes. Servicing rights relating to our small business commercial business are accounted for under ASC 860 while our residential MSRs are accounted for under the fair value option under ASC 825. In calculating distributable earnings, we do not exclude realized gains or losses on either commercial MSRs or residential MSRs, held at fair value, as servicing income is a fundamental part of our business and an indicator of the ongoing performance.
To qualify as a REIT, we must distribute to our stockholders each calendar year dividends equal to at least 90% of our REIT taxable income (including certain items of non-cash income), determined without regard to the deduction for dividends paid and excluding net capital gain. There are certain items, including net income generated from the creation of MSRs, that are included in distributable earnings but are not included in the calculation of the current year’s taxable income. These differences may result in certain items that are recognized in the current period’s calculation of distributable earnings not being included in taxable income, and thus not subject to the REIT dividend distribution requirement, until future years.
The table below presents a reconciliation of net income to distributable earnings.
Three Months Ended March 31,
(in thousands)
2023
2022
Change
Net Income
$
36,978
$
64,263
$
(27,285)
Reconciling items:
Unrealized (gain) loss on MSR
6,093
(32,599)
38,692
Impact of CECL on accrual loans
(7,321)
1,968
(9,289)
Non-recurring REO impairment
—
1,567
(1,567)
Non-cash compensation
1,853
956
897
Merger transaction costs and other non-recurring expenses
1,733
5,699
(3,966)
Total reconciling items
$
2,358
$
(22,409)
$
24,767
Income tax adjustments
(1,187)
7,009
(8,196)
Distributable earnings
$
38,149
$
48,863
$
(10,714)
Less: Distributable earnings attributable to non-controlling interests
1,869
589
1,280
Less: Income attributable to participating shares
2,371
2,412
(41)
Distributable earnings attributable to common stockholders
$
33,909
$
45,862
$
(11,953)
Distributable earnings per common share - basic
$
0.31
$
0.52
$
(0.21)
Distributable earnings per common share - diluted
$
0.30
$
0.48
$
(0.18)
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Q1 2023 versus Q1 2022. Consolidated net income of $37.0 million for the first quarter of 2023 represented a decrease of $27.3 million from the first quarter of 2022, primarily due a decrease in net interest income driven by payoffs of PPP loans and increased unrealized losses on financial instruments, partially offset by other income. Consolidated distributable earnings of $38.1 million for the first quarter of 2023 represented a decrease of $10.7 million from the first quarter of 2022. The increase in the distributable earnings reconciling items is primarily due to increased unrealized losses on MSRs and increased loss reserve recoveries when compared to the respective prior period.
COVID-19 Impact on Operating Results
There has been a wide-ranging response of international, federal, state and local public health and governmental authorities to the COVID-19 pandemic in regions across the United States and the world. The full magnitude and duration of the COVID-19 pandemic and the extent to which it impacts our financial condition, results of operations and cash flows will depend on future developments, which continue to be uncertain. We will continue to monitor for any material or adverse effects on our business resulting from the COVID-19 pandemic. Further discussion of the potential impacts on our business from the COVID-19 pandemic is provided in the section entitled “Risk Factors” in Part I, Item 1A of the Company’s Annual Report on Form 10-K.
Incentive distribution payable to our Manager
Under the partnership agreement of our operating partnership, our Manager, the holder of the Class A special unit in our operating partnership, is entitled to receive an incentive distribution, distributed quarterly in arrears in an amount, not less than zero, equal to the difference between (i) the product of (A) 15% and (B) the difference between (x) distributable earnings (as described below) of our operating partnership, on a rolling four-quarter basis and before the incentive distribution for the current quarter, and (y) the product of (1) the weighted average of the issue price per share of common stock or operating partnership unit (“OP unit”) (without double counting) in all of our offerings multiplied by the weighted average number of shares of common stock outstanding (including any restricted shares of common stock and any other shares of common stock underlying awards granted under the Equity Incentive Plan) and OP units (without double counting) in such quarter and (2) 8%, and (ii) the sum of any incentive distribution paid to our Manager with respect to the first three quarters of such previous four quarters; provided, however, that no incentive distribution is payable with respect to any calendar quarter unless cumulative distributable earnings is greater than zero for the most recently completed 12 calendar quarters.
The incentive distribution shall be calculated within 30 days after the end of each quarter and such calculation shall promptly be delivered to our Company. We are obligated to pay the incentive distribution 50% in cash and 50% in either common stock or OP units, as determined in our discretion, within five business days after delivery to our Company of the written statement from the holder of the Class A special unit setting forth the computation of the incentive distribution for such quarter. Subject to certain exceptions, our Manager may not sell or otherwise dispose of any portion of the incentive distribution issued to it in common stock or OP units until after the three year anniversary of the date that such shares of common stock or OP units were issued to our Manager. The price of shares of our common stock for purposes of determining the number of shares payable as part of the incentive distribution is the closing price of such shares on the last trading day prior to the approval by our board of the incentive distribution.
For purposes of determining the incentive distribution payable to our Manager, distributable earnings (which is referred to as core earnings in the partnership agreement of our operating partnership) is defined under the partnership agreement of our operating partnership in a manner that is similar to the definition of distributable earnings described above under "Non-GAAP Financial Measures" but with the following additional adjustments which (i) further exclude: (a) the incentive distribution, (b) non-cash equity compensation expense, if any, (c) unrealized gains or losses on SBC loans (not just MBS and MSRs), (d) depreciation and amortization (to the extent we foreclose on any property), and (e) one-time events pursuant to changes in U.S. GAAP and certain other non-cash charges after discussions between our Manager and our independent directors and after approval by a majority of the independent directors and (ii) add back any realized gains or losses on the sales of MBS and on discontinued operations which were excluded from the definition of distributable earnings described above under "Non-GAAP Financial Measures".
Liquidity and Capital Resources
Liquidity is a measure of our ability to turn non-cash assets into cash and to meet potential cash requirements. We use significant cash to purchase SBC loans and other target assets, originate new SBC loans, pay dividends, repay principal and interest on our borrowings, fund our operations and meet other general business needs. Our primary sources of liquidity will include our existing cash balances, borrowings, including securitizations, re-securitizations, repurchase agreements,
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warehouse facilities, bank credit facilities and other financing agreements (including term loans and revolving facilities), the net proceeds of offerings of equity and debt securities, including our senior secured notes, corporate debt, and convertible notes, and net cash provided by operating activities.
We are continuing to monitor the impact of rising interest rates, credit spreads and inflation on the Company, the borrowers underlying our real estate-related assets, the tenants in the properties we own, our financing sources, and the economy as a whole. Because the severity, magnitude and duration of these economic events remain uncertain, rapidly changing and difficult to predict, the impact on our operations and liquidity also remains uncertain and difficult to predict.
Cash flow
Three Months Ended March 31, 2023. Cash and cash equivalents as of March 31, 2023, decreased by $50.3 million to $246.7 million from December 31, 2022, primarily due to cash used for financing and operating activities, partially offset by cash provided by investing activities. The net cash used for financing activities primarily reflected net payments on secured borrowings, partially offset by net proceeds from issuances of securitized debt. The net cash used for operating activities primarily reflected a decrease in operating liabilities and increase in operating assets, partially offset by net proceeds on disposition and principal payments of loans, held for sale, at fair value. The net cash provided by investing activities primarily reflected proceeds from disposition and principal payments of loans and proceeds from the sale of real estate held for sale, partially offset by net cash used for loan originations.
Three Months Ended March 31, 2022. Cash and cash equivalents as of March 31, 2022, decreased by $23.2 million to $300.1 million from December 31, 2021, primarily due to net cash used for investing activities, partially offset by net cash provided from financing and operating activities. The net cash used for investing activities primarily reflected loan originations and purchases, partially offset by paydowns and principal forgiveness. The net cash provided from financing activities primarily reflected net proceeds from secured borrowings as a result of an increase in our origination activities, proceeds from issuances of securitized debt and proceeds from equity issuances primarily in connection with the Mosaic Merger, partially offset by repayment of PPPLF borrowings. The net cash provided by operating activities primarily reflected net proceeds on disposition and principal payments of loans, held for sale, at fair value and an increase in operating assets, partially offset by an increase in operating liabilities and realized and unrealized gains on financial instruments.
Financing Strategy and Leverage
In addition to raising capital through offerings of our public equity and debt securities, we finance our investment portfolio through securitization and secured borrowings. We generally seek to match-fund our investments to minimize the differences in the terms of our investments and our liabilities. Our secured borrowings have various recourse levels including full recourse, partial recourse and non-recourse, as well as varied mark-to-market provisions including full mark-to-market, credit mark only and non-mark-to-market. Securitizations allow us to match fund loans pledged as collateral on a long-term, non-recourse basis. Securitization structures typically consist of trusts with principal and interest collections allocated to senior debt and losses on liquidated loans to equity and subordinate tranches, and provide debt equal to 50% to 90% of the cost basis of the assets.
We also finance originated Freddie Mac SBL and residential loans with secured borrowings until the loans are sold, generally within 30 days.
As of March 31, 2023, we had a total leverage ratio of 5.1x and recourse leverage ratio of 1.4x. Our operating segments have different levels of recourse debt according to the differentiated nature of each segment. Our SBC Lending and Acquisitions, Small Business Lending and Residential Mortgage Banking segments have recourse leverage ratios of 0.4x, 1.3x and 1.9x, respectively. The remaining recourse leverage ratio is from our corporate debt offerings.
Secured Borrowings
Credit Facilities and Other Financing Agreements. We utilize credit facilities and other financing arrangements to finance our business. The financings are collateralized by the underlying mortgages, assets, related documents, and instruments, and typically contain index-based financing rate and terms, haircut and collateral posting provisions which depend on the types of collateral and the counterparties involved. These agreements often contain customary negative covenants and financial covenants, including maintenance of minimum liquidity, minimum tangible net worth, maximum
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debt to net worth ratio and current ratio and limitations on capital expenditures, indebtedness, distributions, transactions with affiliates and maintenance of positive net income.
The table below presents certain characteristics of our credit facilities and other financing arrangements.
Pledged Assets
Carrying Value at
Lenders (1)
Asset Class
Current Maturity (2)
Pricing (3)
Facility Size
Carrying Value
March 31, 2023
December 31, 2022
3
SBA loans
October 2023 – March 2025
SOFR + 2.875%
Prime - 0.55%
$
250,000
$
235,036
$
162,839
$
160,903
2
SBC loans - USD
June 2023 – February 2024
1 ML + 7.00%
SOFR + 1.35%
360,000
360,009
109,336
111,966
1
SBC loans - Non-USD (4)
June 2026
SONIA + 3.25%
123,370
50,716
36,317
61,596
5
Residential loans
May 2023 – November 2023
Variable Pricing
440,000
122,850
118,641
132,658
1
Residential MSRs
February 2026
SOFR + 3.00%
120,000
131,185
97,881
49,900
1
Purchased future receivables
October 2023
1 ML + 4.50%
50,000
—
—
—
Total borrowings under credit facilities and other financing agreements
$
1,343,370
$
899,796
$
525,014
$
517,023
(1) Represents the total number of facility lenders.
(2) Current maturity does not reflect extension options available beyond original commitment terms.
(3) Asset class pricing is determined using an index rate plus a weighted average spread.
(4) Non-USD denominated credit facilities have been converted into USD for purposes of this disclosure.
Repurchase Agreements. Under the loan repurchase facilities and securities repurchase agreements, we may be required to pledge additional assets to our counterparties in the event that the estimated fair value of the existing pledged collateral under such agreements declines and such lenders demand additional collateral, which may take the form of additional assets or cash. Generally, the loan repurchase facilities and securities repurchase agreements contain a SOFR-based financing rate, term and haircuts depending on the types of collateral and the counterparties involved. The loan repurchase facilities also include financial maintenance covenants.
If the estimated fair values of the assets increase due to changes in market interest rates or other market factors, lenders may release collateral back to us. Margin calls may result from a decline in the value of the investments securing the loan repurchase facilities and securities repurchase agreements, prepayments on the loans securing such investments and from changes in the estimated fair value of such investments generally due to principal reduction of such investments from scheduled amortization and resulting from changes in market interest rates and other market factors. Counterparties also may choose to increase haircuts based on credit evaluations of our Company and/or the performance of the assets in question. Historically, disruptions in the financial and credit markets have resulted in increased volatility in these levels, and this volatility could persist as market conditions continue to change. Should prepayment speeds on the mortgages underlying our investments or market interest rates suddenly increase, margin calls on the loan repurchase facilities and securities repurchase agreements could result, causing an adverse change in our liquidity position. To date, we have satisfied all of our margin calls and have never sold assets in response to any margin call under these borrowings.
Our borrowings under repurchase agreements are renewable at the discretion of our lenders and, as such, our ability to roll-over such borrowings are not guaranteed. The terms of the repurchase transaction borrowings under our repurchase agreements generally conform to the terms in the standard master repurchase agreement as published by the Securities Industry and Financial Markets Association, as to repayment, margin requirements and the segregation of all assets we have initially sold under the repurchase transaction. In addition, each lender typically requires that we include supplemental terms and conditions to the standard master repurchase agreement. Typical supplemental terms and conditions, which differ by lender, may include changes to the margin maintenance requirements, required haircuts and purchase price maintenance requirements, requirements that all controversies related to the repurchase agreement be litigated in a particular jurisdiction, and cross default and setoff provisions.
We maintain certain assets, which, from time to time, may include cash, unpledged SBC loans, SBC ABS and short-term investments (which may be subject to various haircuts if pledged as collateral to meet margin requirements) and collateral in excess of margin requirements held by our counterparties, or collectively, the “Cushion”, to meet routine margin calls and protect against unforeseen reductions in our borrowing capabilities. Our ability to meet future margin calls will be impacted by the Cushion, which varies based on the fair value of our investments, our cash position and margin requirements. Our cash position fluctuates based on the timing of our operating, investing and financing activities and is managed based on our anticipated cash needs.
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The table below presents certain characteristics of our repurchase agreements.
Pledged Assets
Carrying Value at
Lenders (1)
Asset Class
Current Maturity
Pricing (2)
Facility Size
Carrying Value
March 31, 2023
December 31, 2022
7
SBC loans
November 2023 – March 2026
1 MT + 2.00%
SOFR + 2.46%
$
3,870,500
$
1,920,195
$
1,527,847
$
1,905,358
1
SBC loans - Non-USD (3)
January 2024
EURIBOR + 3.00%
216,780
46,724
39,174
—
6
MBS
April 2023 – August 2023
6.93%
392,867
773,823
392,867
423,912
Total borrowings under repurchase agreements
$
4,480,147
$
2,740,742
$
1,959,888
$
2,329,270
(1) Represents the total number of facility lenders
(2) Asset class pricing is determined using an index rate plus a weighted average spread.
(3) Non-USD denominated repurchase agreements have been converted into USD for purposes of this disclosure.
Collateralized borrowings under repurchase agreements
The table below presents collateralized borrowings outstanding under repurchase agreements as of the end of each quarter, the average amount of collateralized borrowings outstanding under repurchase agreements during the quarter and the highest balance of any month end during the quarter.
(in thousands)
Quarter End Balance
Average Balance in Quarter
Highest Month End Balance in Quarter
Q2 2020
714,162
936,760
1,057,522
Q3 2020
624,549
669,356
831,200
Q4 2020
827,569
726,059
827,569
Q1 2021
1,320,644
1,785,656
2,481,436
Q2 2021
1,223,527
1,145,354
1,223,527
Q3 2021
1,552,135
1,497,324
1,552,135
Q4 2021
2,045,717
1,824,260
2,045,717
Q1 2022
2,771,038
2,835,212
3,065,412
Q2 2022
2,701,180
2,805,935
3,009,961
Q3 2022
2,870,807
2,887,318
2,940,474
Q4 2022
2,329,270
2,295,348
2,329,270
Q1 2023
1,959,888
2,094,621
2,371,413
The net decrease in the outstanding balances during the first quarter of 2023 was primarily due to the closing of RCMF 2023-FL11.
Paycheck Protection Program Facility borrowings. The Company uses the Paycheck Protection Program Liquidity Facility (“PPPLF”) from the Federal Reserve to finance PPP loans. The program charges an interest rate of 0.35%. As of March 31, 2023, we had approximately $169.6 million outstanding under this credit facility .
Senior Secured Notes, Convertible Notes and Corporate Debt, Net
The table below presents information about senior secured notes, convertible notes and corporate debt issued through public and private transactions.
(in thousands)
Coupon Rate
Maturity Date
March 31, 2023
Senior secured notes principal amount (1)
4.50
%
10/20/2026
$
350,000
Unamortized deferred financing costs - Senior secured notes
(6,202)
Total Senior secured notes, net
$
343,798
Convertible notes principal amount (2)
7.00
%
8/15/2023
115,000
Unamortized discount - Convertible notes (3)
(77)
Unamortized deferred financing costs - Convertible notes
(234)
Total Convertible notes, net
$
114,689
Corporate debt principal amount (4)
5.50
%
12/30/2028
110,000
Corporate debt principal amount (5)
6.20
%
7/30/2026
104,613
Corporate debt principal amount (5)
5.75
%
2/15/2026
206,270
Corporate debt principal amount (6)
6.125
%
4/30/2025
120,000
Corporate debt principal amount (7)
7.375
%
7/31/2027
100,000
Unamortized discount - corporate debt
(9,141)
Unamortized deferred financing costs - corporate debt
(4,369)
Junior subordinated notes principal amount (8)
3ML + 3.10
%
3/30/2035
15,000
Junior subordinated notes principal amount (9)
3ML + 3.10
%
4/30/2035
21,250
Total corporate debt, net
$
663,623
Total carrying amount of debt
$
1,122,110
Total carrying amount of conversion option of equity components recorded in equity
$
77
(1) Interest on the senior secured notes is payable semiannually on April 20 and October 20 of each year.
(2) Interest on the convertible notes is payable quarterly on February 15, May 15, August 15, and November 15 of each year.
(3) Represents the discount created by separating the conversion option from the debt host instrument.
(4) Interest on the corporate debt is payable semiannually on June 30 and December 30 of each year.
(5) Interest on the corporate debt is payable quarterly on January 30, April 30, July 30, and October 30 of each year.
(6) Interest on the corporate debt is payable semiannually on April 30 and October 30 of each year.
(7) Interest on the corporate debt is payable semiannually on January 31 and July 31 of each year.
(8) Interest on the Junior subordinated notes I-A is payable quarterly on March 30, June 30, September 30, and December 30 of each year.
(9) Interest on the Junior subordinated notes I-B is payable quarterly on January 30, April 30, July 30, and October 30 of each year.
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The table below presents the contractual maturities for senior secured notes, convertible notes, and corporate debt.
(in thousands)
March 31, 2023
2023
$
115,000
2024
—
2025
120,000
2026
660,883
2027
100,000
Thereafter
146,250
Total contractual amounts
$
1,142,133
Unamortized deferred financing costs, discounts, and premiums, net
(20,023)
Total carrying amount of debt
$
1,122,110
ReadyCap Holdings 4.50% senior secured notes due 2026. On October 20, 2021, ReadyCap Holdings, an indirect subsidiary of the Company, completed the offer and sale of $350.0 million of its 4.50% Senior Secured Notes due 2026 (the “Senior Secured Notes”). The Senior Secured Notes are fully and unconditionally guaranteed by the Company, each direct parent entity of ReadyCap Holdings, and other direct or indirect subsidiaries of the Company from time to time that is a direct parent entity of Sutherland Asset III, LLC or otherwise pledges collateral to secure the Senior Secured Notes (collectively, the “Guarantors”).
ReadyCap Holdings’ and the Guarantors’ respective obligations under the Senior Secured Notes are secured by a perfected first-priority lien on certain capital stock and assets (collectively, the “SSN Collateral”) owned by certain subsidiaries of the Company.
The Senior Secured Notes are redeemable by ReadyCap Holdings’ following a non-call period, through the payment of the outstanding principal balance of the Senior Secured Notes plus a “make-whole” or other premium that decreases the closer the Senior Secured Notes are to maturity. ReadyCap Holdings is required to offer to repurchase the Senior Secured Notes at 101% of the principal balance of the Senior Secured Notes in the event of a change in control and a downgrade of the rating on the Senior Secured Notes in connection therewith, as set forth more fully in the note purchase agreement.
The Senior Secured Notes were issued pursuant to a note purchase agreement, which contains certain customary negative covenants and requirements relating to the collateral and our company, including maintenance of minimum liquidity, minimum tangible net worth, maximum debt to net worth ratio and limitations on transactions with affiliates.
Convertible notes . On August 9, 2017, we closed an underwritten public sale of $115.0 million aggregate principal amount of our 7.00% convertible senior notes due 2023 (the “Convertible Notes”). As of March 31, 2023, the conversion rate was 1.6548 shares of common stock per $25 principal amount of the Convertible Notes, which is equivalent to a conversion price of approximately $15.11 per share of our common stock. Upon conversion, holders will receive, at our discretion, cash, shares of our common stock or a combination thereof.
We may redeem all or any portion of the Convertible Notes on or after August 15, 2021, if the last reported sale price of our common stock has been at least 120% of the conversion price in effect for at least 20 trading days (whether or not consecutive) during any 30 consecutive trading day period ending on, and including, the trading day immediately preceding the date on which we provide notice of redemption, at a redemption price payable in cash equal to 100% of the principal amount of the Convertible Notes to be redeemed, plus accrued and unpaid interest. Additionally, upon the occurrence of certain corporate transactions, holders may require us to purchase the Convertible Notes for cash at a purchase price equal to 100% of the principal amount of the Convertible Notes to be purchased, plus accrued and unpaid interest.
The Convertible Notes will be convertible only upon satisfaction of one or more of the following conditions: (1) the closing market price of our common stock is greater than or equal to 120% of the conversion price of the respective Convertible Notes for at least 20 out of 30 days prior to the end of the preceding fiscal quarter, (2) the trading price of the Convertible Notes is less than 98% of the product of (i) the conversion rate and (ii) the closing price of our common stock during any five consecutive trading day period, (3) we issue certain equity instruments at less than the 10 day average closing market price of our common stock or the per-share value of certain distributions exceeds the market price of our common stock by more than 10%, or (4) certain other specified corporate events (significant consolidation, sale, merger share exchange, etc.) occur.
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Corporate debt
We issue senior unsecured notes in public and private transactions. The notes are governed by a base indenture and supplemental indentures. Often, the notes are redeemable by us following a non-call period, through the payment of the outstanding principal balance plus a “make-whole” or other premium that typically decreases the closer the notes are to maturity. We are often required to offer to repurchase the notes in some cases at 101% of the principal balance of the notes in the event of a change in control or fundamental change pertaining to our company, as defined in the applicable supplemental indentures. The notes rank equal in right of payment to any of our existing and future unsecured and unsubordinated indebtedness; effectively junior in right of payment to any of our existing and future secured indebtedness to the extent of the value of the assets securing such indebtedness; and structurally junior to all existing and future indebtedness, other liabilities (including trade payables) and (to the extent not held by us) preferred stock, if any, of our subsidiaries. The supplemental indentures governing the notes often contain customary negative covenants and financial covenants relating to maintenance of minimum liquidity, minimum tangible net worth, maximum debt to net worth ratio and limitations on transactions with affiliates.
The Debt ATM Agreement
On May 20, 2021, the Company entered into an At Market Issuance Sales Agreement (the “Sales Agreement”) with B. Riley Securities, Inc. (the “Agent”), pursuant to which it may offer and sell, from time to time, up to $100.0 million of the 6.20% 2026 Notes and the 5.75% 2026 Notes. Sales of the 6.20% 2026 Notes and the 5.75% 2026 Notes pursuant to the Sales Agreement, if any, may be made in transactions that are deemed to be “at the market offerings” as defined in Rule 415 under the Securities Act (the “Debt ATM Program”). The Agent is not required to sell any specific number of the notes, but the Agent will make all sales using commercially reasonable efforts consistent with its normal trading and sales practices on mutually agreed terms between the Agent and the Company. No such sales through the Debt ATM Program were made during the three months ended March 31, 2023.
Securitization transactions
Our Manager’s extensive experience in loan acquisition, origination, servicing and securitization strategies has enabled us to complete several securitizations of SBC and SBA loan assets since January 2011. These securitizations allow us to match fund the SBC and SBA loans on a long-term, non-recourse basis. The assets pledged as collateral for these securitizations were contributed from our portfolio of assets. By contributing these SBC and SBA assets to the various securitizations, these transactions created capacity for us to fund other investments.
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The table below presents information on the securitization structures and related issued tranches of notes to investors.
(in millions)
Collateral Asset Class
Issuance
Active / Collapsed
Bonds Issued
Trusts (Firm sponsored)
Waterfall Victoria Mortgage Trust 2011-1 (SBC1)
SBC Acquired loans
February 2011
Collapsed
$
40.5
Waterfall Victoria Mortgage Trust 2011-3 (SBC3)
SBC Acquired loans
October 2011
Collapsed
143.4
Sutherland Commercial Mortgage Trust 2015-4 (SBC4)
SBC Acquired loans
August 2015
Collapsed
125.4
Sutherland Commercial Mortgage Trust 2018 (SBC7)
SBC Acquired loans
November 2018
Collapsed
217.0
ReadyCap Lending Small Business Trust 2015-1 (RCLT 2015-1)
Acquired SBA 7(a) loans
June 2015
Collapsed
189.5
ReadyCap Lending Small Business Loan Trust 2019-2 (RCLT 2019-2)
Originated SBA 7(a) loans,
Acquired SBA 7(a) loans
December 2019
Active
131.0
Real Estate Mortgage Investment Conduits (REMICs)
ReadyCap Commercial Mortgage Trust 2014-1 (RCMT 2014-1)
SBC Originated conventional
September 2014
Collapsed
$
181.7
ReadyCap Commercial Mortgage Trust 2015-2 (RCMT 2015-2)
SBC Originated conventional
November 2015
Active
218.8
ReadyCap Commercial Mortgage Trust 2016-3 (RCMT 2016-3)
SBC Originated conventional
November 2016
Active
162.1
ReadyCap Commercial Mortgage Trust 2018-4 (RCMT 2018-4)
SBC Originated conventional
March 2018
Active
165.0
Ready Capital Mortgage Trust 2019-5 (RCMT 2019-5)
SBC Originated conventional
January 2019
Active
355.8
Ready Capital Mortgage Trust 2019-6 (RCMT 2019-6)
SBC Originated conventional
November 2019
Active
430.7
Ready Capital Mortgage Trust 2022-7 (RCMT 2022-7)
SBC Originated conventional
April 2022
Active
276.8
Waterfall Victoria Mortgage Trust 2011-2 (SBC2)
SBC Acquired loans
March 2011
Collapsed
97.6
Sutherland Commercial Mortgage Trust 2018 (SBC6)
SBC Acquired loans
August 2017
Active
154.9
Sutherland Commercial Mortgage Trust 2019 (SBC8)
SBC Acquired loans
June 2019
Active
306.5
Sutherland Commercial Mortgage Trust 2020 (SBC9)
SBC Acquired loans
June 2020
Collapsed
203.6
Sutherland Commercial Mortgage Trust 2021 (SBC10)
SBC Acquired loans
May 2021
Active
232.6
Collateralized Loan Obligations (CLOs)
Ready Capital Mortgage Financing 2017 – FL1
SBC Originated bridge
August 2017
Collapsed
$
198.8
Ready Capital Mortgage Financing 2018 – FL2
SBC Originated bridge
June 2018
Collapsed
217.1
Ready Capital Mortgage Financing 2019 – FL3
SBC Originated bridge
April 2019
Active
320.2
Ready Capital Mortgage Financing 2020 – FL4
SBC Originated bridge
June 2020
Active
405.3
Ready Capital Mortgage Financing 2021 – FL5
SBC Originated bridge
March 2021
Active
628.9
Ready Capital Mortgage Financing 2021 – FL6
SBC Originated bridge
August 2021
Active
652.5
Ready Capital Mortgage Financing 2021 – FL7
SBC Originated bridge
November 2021
Active
927.2
Ready Capital Mortgage Financing 2022 – FL8
SBC Originated bridge
March 2022
Active
1,135.0
Ready Capital Mortgage Financing 2022 – FL9
SBC Originated bridge
June 2022
Active
754 .2
Ready Capital Mortgage Financing 2022 – FL10
SBC Originated bridge
October 2022
Active
860.1
Ready Capital Mortgage Financing 2022 – FL11
SBC Originated bridge
February 2023
Active
586.0
Trusts (Non-firm sponsored)
Freddie Mac Small Balance Mortgage Trust 2016-SB11
Originated agency multi-family
January 2016
Active
$
110.0
Freddie Mac Small Balance Mortgage Trust 2016-SB18
Originated agency multi-family
July 2016
Active
118.0
Freddie Mac Small Balance Mortgage Trust 2017-SB33
Originated agency multi-family
June 2017
Active
197.9
Freddie Mac Small Balance Mortgage Trust 2018-SB45
Originated agency multi-family
January 2018
Active
362.0
Freddie Mac Small Balance Mortgage Trust 2018-SB52
Originated agency multi-family
September 2018
Active
505.0
Freddie Mac Small Balance Mortgage Trust 2018-SB56
Originated agency multi-family
December 2018
Active
507.3
Key Commercial Mortgage Trust 2020-S3 (1)
SBC Originated conventional
September 2020
Active
263.2
(1) Contributed portion of assets into trust
We used the proceeds from the sale of the tranches issued to purchase and originate SBC and SBA loans. We are the primary beneficiary of all firm sponsored securitizations; therefore they are consolidated in our financial statements.
Contractual Obligations and Off-Balance Sheet Arrangements
Other than the items referenced above, there have been no material changes to our contractual obligations for the three months ended March 31, 2023. See Item 7 "Management’s Discussion and Analysis of Financial Condition and Results of Operations – Contractual Obligations" in the Company's annual report on Form 10-K for further details. As of the date of this quarterly report on Form 10-Q, we had no off-balance sheet arrangements, other than as disclosed.
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Critical Accounting Estimates
Our financial statements are prepared in accordance with GAAP, which requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. We believe that all of the decisions and assessments upon which our financial statements are based were reasonable at the time made, based upon information available to us at that time. The following discussion describes the critical accounting estimates that apply to our operations and require complex management judgment. This summary should be read in conjunction with our accounting policies and use of estimates included in “Notes to Consolidated Financial Statements, Note 3 – Summary of Significant Accounting Policies” included in Item 8, “Financial Statements and Supplementary Data,” in the Company’s annual report on Form 10-K.
Allowance for credit losses
The allowance for credit losses consists of the allowance for losses on loans and lending commitments accounted for at amortized cost. Such loans and lending commitments are reviewed quarterly considering credit quality indicators, including probable and historical losses, collateral values, LTV ratio and economic conditions. The allowance for credit losses increases through provisions charged to earnings and reduced by charge-offs, net of recoveries.
ASC 326, Financial Instruments-Credit Losses (“ASC 326”) , became effective for us on January 1, 2020 and replaced the “incurred loss” methodology previously required by GAAP with an expected loss model known as the Current Expected Credit Loss (“CECL”) model. CECL amends the previous credit loss model to reflect a reporting entity's current estimate of all expected credit losses, not only based on historical experience and current conditions, but also by including reasonable and supportable forecasts incorporating forward-looking information. The measurement of expected credit losses under CECL is applicable to financial assets measured at amortized cost. The allowance for credit losses required under ASC 326 is deducted from the respective loans’ amortized cost basis on our consolidated balance sheets. The related Accounting Standards Update No. 2016-13 (“ASU 2016-13”) also requires a cumulative-effect adjustment to retained earnings as of the beginning of the reporting period of adoption.
In connection with ASU 2016-13, we implemented new processes including the utilization of loan loss forecasting models, updates to our reserve policy documentation, changes to internal reporting processes and related internal controls. We implemented loan loss forecasting models for estimating expected life-time credit losses, at the individual loan level, for its loan portfolio. The CECL forecasting methods used by the Company include (i) a probability of default and loss given default method using underlying third-party CMBS/CRE loan database with historical loan losses and (ii) probability weighted expected cash flow method, depending on the type of loan and the availability of relevant historical market loan loss data. We might use other acceptable alternative approaches in the future depending on, among other factors, the type of loan, underlying collateral, and availability of relevant historical market loan loss data.
We estimate the CECL expected credit losses for our loan portfolio at the individual loan level. Significant inputs to our forecasting methods include (i) key loan-specific inputs such as LTV, vintage year, loan-term, underlying property type, occupancy, geographic location, and others, and (ii) a macro-economic forecast. These estimates may change in future periods based on available future macro-economic data and might result in a material change in our future estimates of expected credit losses for its loan portfolio.
In certain instances, we consider relevant loan-specific qualitative factors to certain loans to estimate its CECL expected credit losses. We consider loan investments that are both (i) expected to be substantially repaid through the operation or sale of the underlying collateral, and (ii) for which the borrower is experiencing financial difficulty, to be “collateral-dependent” loans. For such loans that we determine that foreclosure of the collateral is probable, we measure the expected losses based on the difference between the fair value of the collateral (less costs to sell the asset if repayment is expected through the sale of the collateral) and the amortized cost basis of the loan as of the measurement date. For collateral-dependent loans that we determine foreclosure is not probable, we apply a practical expedient to estimate expected losses using the difference between the collateral’s fair value (less costs to sell the asset if repayment is expected through the sale of the collateral) and the amortized cost basis of the loan.
While we have a formal methodology to determine the adequate and appropriate level of the allowance for credit losses, estimates of inherent loan losses involve judgment and assumptions as to various factors, including current economic conditions. Our determination of adequacy of the allowance for credit losses is based on quarterly evaluations of the above factors. Accordingly, the provision for loan losses will vary from period to period based on management's ongoing assessment of the adequacy of the allowance for credit losses.
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Significant judgment is required when evaluating loans for impairment; therefore, actual results over time could be materially different. Refer to “Notes to Consolidated Financial Statements, Note 6 – Loans and Allowance for Credit Losses” included in this Form 10-Q for results of our loan impairment evaluation.
Accretion of discounts associated with PPP loans, held for investment
The Company’s loan originations in the second round of the program are accounted for as loans, held-for-investment under ASC 310, Receivables . Loan origination fees and related direct loan origination costs are capitalized into the initial recorded investment in the loan and are deferred over the loan term. The net amount between the loan origination fees and direct loan origination costs is recognized as a discount in the carrying value of the loans, and the discount is required to be recognized in income at a constant effective yield over the life of the instrument.
The effective yield is determined based on the payment terms required by the loan contract as well as with actual and expected prepayments from loan forgiveness by the federal government. Because prepayments from loan forgiveness often deviate from the estimates, the Company periodically recalculates the effective yield to reflect actual prepayments to date and anticipated future prepayments. Anticipated future prepayments are estimated based on past prepayment patterns, historical, current, and projected interest rate environments, among other factors, to predict future cash flows.
Adjustments to anticipated future prepayments are recorded on a retrospective basis, meaning that the net investment or liability is adjusted to the amount that would have existed had the new effective yield been applied since the initial recognition of the instrument. As prepayment speeds change, these accounting requirements can be a source of income volatility. Accelerations of prepayments accelerate the accretion and increase current earnings. Conversely, when prepayments decline, thus lengthening the effective maturity of the instruments and shifting some of the discount accretion to future periods.
Significant judgment is required when evaluating the effective yield on PPP loans; therefore, actual results over time could be materially different. Refer to “Notes to Consolidated Financial Statements, Note 20 – Other Income and Operating Expenses” included in Item 8, “Financial Statements and Supplementary Data,” in the annual report on Form 10-K for a more complete discussion of PPP loans, held for investment.
Valuation of financial assets and liabilities carried at fair value
We measure our MBS, derivative assets and liabilities, residential MSRs, and any assets or liabilities where we have elected the fair value option at fair value, including certain loans we have originated that are expected to be sold to third parties or securitized in the near term.
We have established valuation processes and procedures designed so that fair value measurements are appropriate and reliable, that they are based on observable inputs where possible, that the valuation approaches are consistently applied, and the assumptions and inputs are reasonable. We also have established processes to provide that the valuation methodologies, techniques and approaches for investments that are categorized within Level 3 of the ASC 820 Fair Value Measurement fair value hierarchy (the “fair value hierarchy”) are fair, consistent and verifiable. Our processes provide a framework that ensures the oversight of our fair value methodologies, techniques, validation procedures, and results.
When actively quoted observable prices are not available, we either use implied pricing from similar assets and liabilities or valuation models based on net present values of estimated future cash flows, adjusted as appropriate for liquidity, credit, market and/or other risk factors. Refer to “Notes to Consolidated Financial Statements, Note 7 – Fair Value Measurements” included in Item 8, “Financial Statements and Supplementary Data,” in the annual report on Form 10-K for a more complete discussion of our critical accounting estimates as they pertain to fair value measurements.
Servicing rights impairment
Servicing rights, at amortized cost, are initially recorded at fair value and subsequently carried at amortized cost. We have elected the fair value option on our residential MSRs, which are not subject to impairment.
For purposes of testing our servicing rights, carried at amortized cost, for impairment, we first determine whether facts and circumstances exist that would suggest the carrying value of the servicing asset is not recoverable. If so, we then compare the net present value of servicing cash flow with its carrying value. The estimated net present value of servicing cash flows of the intangibles is determined using discounted cash flow modeling techniques which require management to make estimates regarding future net servicing cash flows, taking into consideration historical and forecasted loan prepayment rates, delinquency rates and anticipated maturity defaults. If the carrying value of the servicing rights exceeds
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the net present value of servicing cash flows, the servicing rights are considered impaired and an impairment loss is recognized in earnings for the amount by which carrying value exceeds the net present value of servicing cash flows. We monitor the actual performance of our servicing rights by regularly comparing actual cash flow, credit, and prepayment experience to modeled estimates.
Significant judgment is required when evaluating servicing rights for impairment; therefore, actual results over time could be materially different. Refer to “Notes to Consolidated Financial Statements, Note 9 – Servicing Rights” included in this Form 10-Q for a more complete discussion of our critical accounting estimates as they pertain to servicing rights impairment.
Refer to “Notes to Consolidated Financial Statements, Note 4– Recently Issued Accounting Pronouncements” included in Item 8, “Financial Statements and Supplementary Data,” in the Company’s annual report on Form 10-K for a discussion of recent accounting developments and the expected impact to the Company.
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.