Ready Capital Corp

NYSE:RC

Earnings Call Transcript 2018-Q3

[Operator]

Greetings, and welcome to the Ready Capital Corporation Third Quarter 2018 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Rick Herbst, Chief Financial Officer. Please go ahead.

[Frederick Herbst, executive]

Thank you, operator, and good morning, and thanks to those of you on the call for joining us this morning. Some of our comments today will be forward-looking statements within the meaning of the federal securities laws. Such statements are subject to numerous risks and uncertainties that could cause actual results to differ materially from what we expect. Therefore, you should exercise caution in interpreting and relying on them. We refer you to our SEC filings for a more detailed discussion of the risks that could impact our future operating results and financial condition. During the call, we will discuss our non-GAAP measures, which we believe can be useful in evaluating the company's operating performance. These measures should not be considered in isolation or as a substitute for our financial results prepared in accordance with GAAP. A reconciliation of these measures to the most directly comparable GAAP measure is available in our third quarter 2018 earnings release and our supplemental information. By now, everyone should have access to our third quarter 2018 earnings release and the supplemental information. Both can be found in the Investors section of the Ready Capital website. I will now turn it over to Tom Capasse, our Chief Executive Officer.

[Thomas Capasse, executive]

Thanks, Rick, and good morning. Before discussing the quarterly financial results, I'd like to take a few minutes to discuss in greater detail the transaction we announced last evening. Specifically, we are extremely excited to have signed a definitive merger agreement with commercial mortgage REIT, Owens Realty Mortgage, Inc. Owens is a publicly listed and established specialty finance REIT that focuses on originating small-balance and middle-market commercial real estate loans, very similar to our own transitional loan business. We have also posted a summary transaction presentation on the Investors section of the Ready Capital website. This will be a stock-for-stock merger. We are acquiring the assets of Owens at a discount to what we believe to be their fair value, fair market value. As a result, we expect the transaction to be accretive to our 2019 results. We anticipate this transaction will close by the end of the first quarter of 2019, and we will manage the combined company. Additionally, Owens owns hard assets that we expect to dispose of through sale. We anticipate we will redeploy the proceeds from the sale of those real estate assets and their principal proceeds from their loans into Ready Capital's existing investment strategies. We believe this transaction will benefit our shareholders in many ways. First, it is an extremely cost-efficient way to raise capital, particularly when compared to a stock offering, which would need to be executed at a significant discount to book value. In this case, we believe the initial book value dilution, if any, will be nominal. Second, this will be accretive to 2019 earnings per share and recapture the book value dilution within 1 year. Third, we have underwritten Owens' real estate assets and estimate their fair value based on current market conditions, well in excess of the book value of these assets, as of September 30, 2018. Based on the range of values of these assets, we believe this transaction will result in initial adjusted tangible book value dilution of 0 to 1%. Our estimated range of value is based on our underwriting efforts; our assessment of the fair value of these assets under current market conditions, including a review of third-party valuations and appraisals; assessment of original loans filed; physical inspection of real estate; and review of transactions with key employees. Fourth, the shares issued will increase our float nearly 50%, which we expect will improve the liquidity of the shares and reduce the impact of technical dynamics given our relatively low current trading volume. Fifth, commercial mortgage REITs with larger market caps tend to be valued higher on a price-to-book basis. Sixth, the transaction will provide growth capital to expand our platform and execute our business plan. In addition, it will allow us to raise incremental debt capital to further increase our scale. Finally, we expect the increased scale will be cost-effective, resulting in reduced OpEx ratios from their current levels. We look forward to working with the Owens team during this transition, and we believe this is a classic win-win situation where shareholders of both companies will benefit. Now before I comment on the quarterly financial results, I'd like to touch on the name change. As you all know, we rebranded at the corporate level to Ready Capital Corporation last month as part of our strategy to further enhance shareholder value. The makeover brings greater exposure to our Ready Capital lending businesses, enabling us to unify and simplify our marketing to enhance growth across all of our platforms. We are well positioned to continue to develop the Ready Capital franchise as a leader in mortgage finance. Now I'll turn to the third quarter financial results. For the third consecutive quarter, we exceeded an 11% return on equity, ahead of our targeted 10% given the steady earnings contribution from our small-balance commercial origination franchise, with returns enhanced with output from our acquisitions business. The results this quarter further support our operating thesis that having a multipronged platform provides greater earnings diversity and, thus, consistency compared to single-strategy lenders. Strong returns in one segment can offset a softening in another. For example, increases in our conventional loan origination volume and gains on sales of acquired assets positively impacted results this quarter. These were partially offset by reduced gains of Small Business Administration and Freddie Mac loan sales. We continue to believe the small-balance commercial space is an underserved market niche, a dynamic that continues to be reflected in our results, including some of the following highlights from the third quarter. First, GAAP earnings were $17.6 million or $0.53 per share, representing a GAAP ROE of 12.4%. On a core basis, we earned $0.48 per share or an ROE of 11.3%. Through the first 3 quarters of this year, our cumulative GAAP ROE is 12.3% and core ROE is 11.2%. Secondly, our ability to originate and acquire new SBC assets continues to be a strength of our company. New asset additions were $429 million, the second-highest quarter since we became a public company, although off a bit from last quarter. We originated $342 million of new loans in the quarter and acquired another $86 million of loans. In addition, we originated $125 million of new loans in October. Now included in the acquired loans was an inaugural purchase of a $10 million subordinate interest in a securitization of conduit small-balance loans, those between $5 million and $30 million, originated on a forward-flow basis with a leading regional bank. This represents an additional liquidity channel for Ready Capital and underscores a key differentiating factor in our platform: investment capacity that exceeds our liquidity. This is in stark contrast with other commercial mortgage REIT spaces focused exclusively on large-balance, short-term transitional lending, where intense competition has resulted in reinvestment of increased prepayments at compressed margins. Third, pipelines of both segments are strong, totaling nearly $500 million in new SBC and SBA loans. On the acquisitions side, the pipeline is over $216 million as we continue to see numerous accretive opportunities to collapse legacy securitization of seasoned performing loans and other one-off transactions. Of note in our SBA business this quarter, we hired a team in the Pacific Northwest, which sourced approximately $85 million of Small Business Administration loans in the prior 12 months.

Fourth, since the beginning of the year, our adjusted book value increased $0.40 to $17.08. This underscores another differentiating factor for Ready Capital versus the broader mortgage REIT universe: book value stability in a volatile rate environment. This is due to the fact that only 7% of our assets are subject to mark-to-market pricing risks, our taxable REIT subsidiary structure allows earnings retention, and 74% of our portfolio is floating-rate match funded and is therefore not subject to interest rate risk.

Further, the majority of our mark-to-market assets are mortgage servicing rights in our residential mortgage segment, which increased in value again this quarter and we would expect to continue to do so in a rising rate environment. Lastly, Ready Capital's access to the securitized debt markets remains strong. Earlier this week, we priced a legacy commercial mortgage-backed securities transaction. This transaction had an advance rate of 83% for proceeds of $217 million with a current coupon of 4.7%, which is 150 basis points over swaps. Ready Capital now has completed 18 securitizations totaling $3.4 billion since 2011. This transaction highlights a niche in our acquisition business in collapsing legacy securitizations more common in the residential market. Let me now offer a few relevant observations on the small-balance commercial property markets, which continue to show strength. Trends in the SBC market continue to track the housing market, prices of which are highly correlated. As with the housing market, tighter post-crisis regulation reduced bank lending for small-balance construction -- small-balance commercial construction finance, curtailing supply. Meanwhile, demand from SBC apartment dwellers and small business occupants increased as the business cycle turned. This is reflected in 32 consecutive quarters of positive SBC net absorption through the third quarter and a 4.3% historic low vacancy rate. The results are a major credit positive for SBC lending: Record year-to-date annualized rent increases of 4% to 10%, with a big 6% surprise in retail, which bucks the negative large-balance commercial real estate trend and highlights the experiential nature of SBC retail; also a 6.4% year-over-year gain in SBC property prices through July, marking the full recovery since the crisis peak, which is 1 and 4 years behind the housing and large-balance CRE markets, respectively.

As with housing, we expect a departure from the traditional small-balance commercial oversupply driven correction in prices as supply scarcity overtly suppresses demand, slowing the rate of price appreciation but avoiding a material cyclical decline in prices. Against this backdrop, small-balance commercial originations, excluding Small Business Administration loans, increased 13% to $57 billion with full year projections exceeding $200 billion for the fourth consecutive year. The market remains highly fragmented, with the top 15 lenders accounting for just 19% of originations. To put all this in perspective, we have a current market share of under 0.5% with a longer-term goal of 1%. Given the size of the market, we believe we can grow our new loan origination volumes without compromising our strong credit standards. As I mentioned on last quarter's call, the Freddie Mac small-balance multi-family experienced decline in new loan applications starting in the middle of the second quarter, when Freddie increased rates 60 basis points. This resulted in a $90 million or 56% reduction in new Freddie loans this quarter. New loan applications did pick up when Freddie subsequently reduced rates 40 basis points, and our Freddie pipeline has grown to $84 million as of October 31, up from $46 million at the end of July. On the positive side, our conventional fixed-rate product became much more competitive with Freddie, and we had record originations this quarter of $125 million, up $56 million or 80% from the previous quarter. Our Small Business Administration 7(a) loan originations topped $50 million this quarter for the first time in our history. While our pipeline remains strong, it is down a bit from last quarter and the overall SBA numbers have softened slightly as the election got closer. In addition, we did see a slight decline in sales premium starting this summer, but we are now seeing those premiums have bottomed and are starting to rebound.

I'll now hand it off to Rick to discuss our financial results.

[Frederick Herbst, executive]

Thanks, Tom. Before hitting the highlights on some of the slides included in the supplemental information deck, I'd like to discuss a few of the income statement items for the quarter. As Tom mentioned, we continue to benefit from our diverse platform. As you review our quarterly results, there are a few items I'd like to highlight.

On the positive side, we continue to benefit from returns on quality assets. This quarter, we recorded a $3.4 million positive mark on a bond that we sold in October. This was partially offset by reduced gains on sales in our Freddie and Small Business Administration businesses. In the Freddie segment, income generated from gains on sale and creation of mortgage servicing rights were down about $2.4 million from last quarter. As Tom mentioned, new Freddie loan volumes were down 56% this quarter, although our pipeline is now back in a growth mode. In this product, lower volumes had an immediate impact on our bottom line. Offsetting this were the increased conventional originations, which will have a positive impact on our bottom line going forward. Slide 3 depicts some summary highlights for the third quarter 2018. We continue to be pleased with our financial results and the composition of our balance sheet. Our adjusted book value per share is now $17.08, up $0.40 since the beginning of the year. Growing our book value is an important component of our ability to maximize shareholder value. Between originations and acquisitions, we added $429 million of new assets in the quarter, the second highest in our 2 years as a public company. On Slide 4, our levered yields continue to be strong with an 18.6 levered yield all-in. While slightly lower than last quarter, this return continues to average about 300 basis points higher than last year, reflecting the increased earnings capacity as a result of deploying the proceeds of our corporate debt offerings.

Slide 5 summarizes our loan originations over the previous 5 quarters and shows solid volumes in each business line, with the exception of the Freddie business we mentioned earlier. In addition, we acquired $86 million of loans during the quarter. Slide 7 covers the activities of the originations segment. The gross levered yield was down a bit this quarter due to lower leverage in the segment during the quarter. Credit performance remains outstanding with nominal delinquencies. Slide 8 summarizes our Small Business Administration segment. The gross levered yield was again over 30% this quarter. As we mentioned earlier and last quarter, we did see some softening in the premiums, which averaged 9.8% this quarter as compared to 11% last quarter. Our average coupon in SBA loans rose again for the third quarter in a row as these adjustable-rate loans reset, supporting strong levered returns here. Slide 9 shows some summary information for the acquired portfolio. The returns in this segment were helped with the asset sale I mentioned and continued strong returns from the joint venture investment. In the last 3 quarters, we've acquired almost $500 million of assets and they're generating accretive risk-adjusted returns. The pipeline here remains strong, and we will selectively acquire more assets as liquidity permits. Slide 10 summarizes our residential mortgage business. Volumes were down less than 4% from the third quarter of last year, much better than the MBA average. This is due to 80% of the business related to new home purchases rather than refinancing of existing loans, which are more sensitive to interest rate increases. We retained servicing rights on new loans, and the value of the servicing rights portfolio continues to grow. As we've said in the past, the value of servicing rights generally increases in a rising rate environment. Slide 11 is an update to the summary of the securitizations we've done within Ready Capital and does not include the one we repriced earlier this week. The newly originated product continues to perform well from a credit perspective with nominal delinquencies. Slide 12 provides information without the interest rate sensitivity of our portfolio. The positive impact from rising rates was down a bit this quarter because we do have an inventory of fixed-rate loan acquisitions which were funded by variable-rate warehouse debt as of September 30. The majority of these assets were included in the securitization I just mentioned, and they are now match funded and no longer subject to interest rate risk. Slide 14 summarizes our capital stack as of September 30. Our goal is to continue to minimize liquidity risk by converting recourse mark-to-market warehouse debt into match-funded securitized debt. The warehouse debt is a bit higher at quarter-end this time, but a portion of the debt was converted to securitized debt as a result of that securitization we just priced. The next few slides are similar to those presented in previous quarters and reflect the diversity of our loan pool and composition of our capital structure with various liquidity sources.

Now I'll turn it back over to Tom for some final thoughts before we take questions.

[Thomas Capasse, executive]

We've now completed our second year as a public company, and we plan to build on our success as we continue to grow our business under the Ready Capital name. We thank our team for their ongoing efforts, and our shareholders for your continued confidence in our company. Operator, we would now like to open up the line for questions.

[Operator]

[Operator Instructions] Our first question comes from the line of Steve Delaney from JMP Securities.

[Steven Delaney, analyst]

Congratulations on the quarter and also on your merger. tom, we noticed the Freddie Mac volumes right off the bat, so I appreciate the color you provided on that. Seems, though, in both their small balance and their regular programs that they often get crossways in the market in terms of their view towards being aggressive, whether it's in pricing or what have you. And we actually saw -- in the larger market, we saw Freddie being more competitive with Fannie in the third quarter. Given that point, obviously, you've mentioned before that you would consider pursuing a Fannie Mae small-balance license. Can you give us an update on any progress there or whether that is still in the plans?

[Thomas Capasse, executive]

Yes. Thanks, Steve. We're continuing to look at teams and evaluate the various licenses, but nothing specific to report today.

[Steven Delaney, analyst]

Okay. And you mentioned Freddie. Do you feel that Freddie is back with pricing that is competitive, that, that program will be on solid footing going forward for the next couple quarters until you can get a Fannie license, as far as just dealing with the multi-family opportunities?

[Thomas Capasse, executive]

Yes. No, and I've seen this over the years between the 2 of them, even on the Ready side, that there was -- I think some part of what the Freddie hype was in part a catch-up on their -- on where rates are moving and their senior execution on the pass-throughs that are used to finance the sales of the small-balance multi-family pools. And the other part of it was the competition with Fannie reducing their rates. So it's a little bit of both. I think they're -- we're in period, it seems now, where the pricing has been more normalized between the 2, so we would expect the volume to continue to increase over the next quarter or 2.

[Steven Delaney, analyst]

Great. And just a couple quick things on Owens. As you know, we covered that little company. And my first question is, do you envision maintaining any kind of a regional office out there in the Bay Area?

[Thomas Capasse, executive]

We currently don't have a presence there. We are definitely continuing to evaluate working with the team and establishing an office there.

[Steven Delaney, analyst]

So I would assume that anything that you maintain going forward would be production-oriented and things -- all the administrative and servicing, asset management, will that all transition to New York or Dallas as early as possible?

[Thomas Capasse, executive]

Well, we haven't -- just to be clear, we haven't made a determination at this point to take on the team, which we're very impressed with in terms of credit underwriting. But in -- conceptually, if we did, it would be a loan production office.

[Steven Delaney, analyst]

Got it, okay. And the REO was $68 million in June. I see in your deck $20 million, maybe plus in terms of potential gains. I'm curious if realizing those gains is going to require material CapEx or further investment, and I'm specifically thinking about the Lake Tahoe property.

[Thomas Capasse, executive]

No. The -- you're referring to Zalanta. Those are primarily completed projects without much additional CapEx required. It's more sales of units or leasing the retail property, so we don't expect any material additional investment in the REO.

[Steven Delaney, analyst]

Okay. So you're going to be in the real estate sales business, not the real estate development business, it sounds like.

[Thomas Capasse, executive]

That's correct. That being said, recall that Ready Capital and its predecessor private fund, Waterfall, bought $5 billion of distressed small-balance properties just like this. Very complex, very quirky in terms of their exit strategy. So we have a very strong team. Roughly, our asset management team is probably about 25, 30 people with really strong [ wrapped ] technology around it. So we're very -- as part of our diligence, we spent a lot of time looking at the projects and coming up with either confirmation of the existing exit strategy or maybe some enhancements to that. But in short, we're very comfortable with management of the REO book.

[Operator]

Our next question comes from the line of Jade Rahmani with KBW.

[Jade Rahmani, analyst]

Just sticking with the merger, what's the magnitude of transaction costs and friction costs as a function of the asset sales that you expect?

[Frederick Herbst, executive]

It'll be disclosed in the proxy statement. I'm not sure we can talk about it now, but it is -- those transaction costs are factored into our -- the potential dilution, where we said, max, we think it'll be at most 1%, hopefully a little bit less than that, and those transaction costs are factored into that.

[Jade Rahmani, analyst]

Okay. What's the magnitude of assets that you plan to sell? Is it beyond just the REO?

[Frederick Herbst, executive]

We would plan to sell the REO as quickly as possible, recognizing it'll take a little while, particularly with the condo units that Tom mentioned. The loans are fairly short-duration loans, kind of average maybe duration of about 1 year, so we would expect those to pay down. And then depending if we are able to retain the loan origination team there, that would replenish those or that capital would be diverted into our own loan portfolio and our own originations.

[Jade Rahmani, analyst]

In terms of liquidating the REO, is it reasonable to expect like a 1.5-year timeframe?

[Frederick Herbst, executive]

I think, yes, 1.5 to 2 years on the back end, hopefully. Yes, that's the range we're talking about.

[Jade Rahmani, analyst]

What's the magnitude of earnings accretion that's reasonable? And does that factor in carrying cost of the REO?

[Frederick Herbst, executive]

It does. The earnings accretion, we expect to earn back the minimal dilution within 1 year. So you can do the math there. And then going forward, potentially, it goes beyond that as we dispose of the REO and redeploy it into higher-yielding assets.

[Jade Rahmani, analyst]

And the -- when you say accretive, what is that relative to? Is that relative to your internal forecast for 2019?

[Frederick Herbst, executive]

Yes. Correct.

[Jade Rahmani, analyst]

Okay. Just in terms of the overall environment, I'm not sure if you have a strong view about the impact of additional Federal Reserve interest rate increases. But do you think that additional interest rate increases could start to cause increasing credit deterioration in commercial real estate?

[Thomas Capasse, executive]

Well, in terms of the large balance market, we see -- our view is you're going to see probably a pricing contraction of between 5% and 15% once the -- what we think will be a mild recession is triggered by where we are in terms of the rate cycle. But I wanted to just underscore that the small-balance commercial market, which is about 15% of this total $4 trillion of commercial real estate debt, is fundamentally attached to the housing market in terms of correlation of prices and dynamics. And so we're about -- and then [ finding that ] is below [ $5 million ] in appraised value, that market is about 3 years, 4 years behind in the cycle. And it's suffering the same way as housing is suffering from a dramatic undersupply of properties as reflected in record rent increases over the last year of 4% to 10% and property price appreciation of, I think it was around 6%. So again, just to -- that trends very similar to what you're seeing in the housing market with undersupply causing a secular increase in prices. We believe that the small-balance market will be buffered and have a much lower beta to a recession than what you're going to see with the large-balance market.

[Jade Rahmani, analyst]

On the large-balance side, the 5% to 15%, is that referring to declines in commercial real estate prices? And over what time period do you expect that to play out?

[Thomas Capasse, executive]

5%, 15%, when the recession hits, that could happen over a period of 12 to 24 months. You look at some of the large firms that are steeped in credit research, you'll see that that's not out of consensus. But that's our view in terms of the large-balance market. And we would expect a contraction of maybe 0 to 5% in the small-balance market and 2% to 5% in housing.

[Jade Rahmani, analyst]

The decline in CRE prices, does that create acquisition opportunities? And would you confine those primarily through the small-balance space?

[Thomas Capasse, executive]

We look at -- when we look at acquisitions, we do look at somewhat larger, but still in the midcap space, maybe up to $50 million. But yes, that definitely will create a lot of opportunities. In particular, it's kind of like the BDC in the leveraged loan market, which we think is in a bit of a mini bubble in terms of credit. You're going to see a lot of private real estate funds, that we see are doing very aggressive transitional lending that some of our credit underwriters call bridges to nowhere, that we think will present acquisition opportunities when the inevitable correction occurs.

[Jade Rahmani, analyst]

In terms of the correlation to housing, we are seeing a slowdown in home sales and homebuilders potentially having to offer increased selling concessions. Does -- have you seen any spillover effects from a softer housing market into your asset class?

[Thomas Capasse, executive]

You're definitely seeing -- it's similar but different. The regulations that were passed after the crisis really targeted community banks and HVCRE, the high-value commercial real estate loans, and squarely in that was acquisition or construction finance for small-balance commercial properties. As a result of that, and I don't have the numbers in front of me, but the new deliveries have been running at like 25% of the pre-crisis highs. And meanwhile, demand has been increasing from small businesses and apartment dwellers. So you've had 32 consecutive quarters of net positive absorption in the small-balance commercial market. And so while the rise in rates will affect maybe refi and acquisition -- to some extent, acquisition demand, that fundamental factor is such that you'll see prices slow down to let's say from 6% to down to maybe low single digits. We think the same thing is going to happen in housing. And so yes, so there'll be more of a correction in terms of a slowdown in prices rather than an actual decline -- a significant decline in prices at this stage of the cycle.

[Frederick Herbst, executive]

Jade, just one quick follow-up to your earlier question on the accretion, just to help you out a little bit. If you look at their balance sheet, they're very, very under-levered. We would anticipate that we would move those loans to our financing facilities, which have higher advance rates and lower cost of debt, and then the redeployment of those proceeds will contribute to that accretion.

[Operator]

Our next question comes from the line of Tim Hayes from B. Riley FBR.

[Timothy Hayes, analyst]

Just a couple on the earnings accretion. I'm sure the bulk of that comes from, to Rick, your point, redeploying proceeds into higher-yielding assets, getting better advance rates, lower cost of capital, all that. But are there any material cost savings contributing to your earnings accretion forecast?

[Frederick Herbst, executive]

There will be some cost saves depending on how everything is resolved with the team there versus where they're operating currently. Obviously, as a combined company, our expense ratios would be much lower because there will not be a lot of incremental costs going forward on a much larger capital base. So some of those statistical numbers will be much more efficient.

[Timothy Hayes, analyst]

Okay. And do you have an estimate of the potential benefit that this enhanced scale and liquidity will have on your cost of capital going forward, all else equal?

[Frederick Herbst, executive]

On a cost of capital, obviously, it will depend on where our stock price goes and how the market reacts. I would think it would have obviously a slight positive impact on our cost of capital as we scale up. We view somewhere between $750 million, which is where we'll be, and $1 billion as more of an optimal size for our cost of capital. So this is a good big step forward in getting us on that path.

[Timothy Hayes, analyst]

Okay. And do you believe any of the Owens loans could be collateral for a securitization? And can you just clarify what your securitization pipeline looks like today?

[Frederick Herbst, executive]

They're somewhat challenging for a couple of reasons. One, they're short-term duration loans, generally 1 year, maybe with a 1-year extension, and they generally do not have prepayment protection. So those 2 make it challenging, not impossible, but that's not our -- it's not the most likely funding source for these types of loans. In terms of our securitization, we priced 1 yesterday, or Tuesday, I guess, it's going to close today, of some legacy fixed-rate products. And then we have on tap another of our bridge products that we'll hopefully get off in the first quarter.

[Timothy Hayes, analyst]

Okay, appreciate that. And then there's a good amount of retail exposure in the Owens loan book. Just can you give a little bit of color of what type of stores are backing the loans?

[Frederick Herbst, executive]

Somewhat similar to ours. Their average loans size is about $2 million, not too far off from ours. So they're experiential-type retail centers, where if it's something in a small strip center, you have to be there. It's not going to be [ raided ] by Amazon or that type of competition.

[Thomas Capasse, executive]

Yes, the average balance is what, Rick, $1.7 million, yes, about $2 million. So yes, it's like athletic facilities, that sort of thing, strip malls.

[Operator]

Our next question comes from the line of Stephen Laws from Raymond James.

[Stephen Laws, analyst]

I think everything has been covered that I had on the acquisition front. Really just wanted to touch on the SBA 7(a) market and the pricing there. Clearly, those prices have come down. Those premiums have come down quite a bit in the last month. Can you talk about what's driving that and how you look at the opportunity there? And maybe impacts or any thoughts on that business now that it's kind of -- some prices on those products have dipped below that 10% premium threshold, so comments there, Tom or Rick?

[Frederick Herbst, executive]

Yes. Actually, we've seen -- and we have some deals out in the market. We have seen a little bit of recovery on those pricing. For example, the -- and we have -- we do both 10-year term loans and 25-year term loans. About 1/3 are 10 years and 2/3 are 25. So on the 10-year, back in the spring, they were trading around 111. They dipped down to 108 back in September and we just priced the deal at 109.5. So it's not quite back to where it was. And keep in mind that the SBA retains half of anything over 10%. So it goes from 111 to 110, it's a 50 basis point impact to us, not the full 100. So we're seeing some strengthening there. On the 25-year product, which is 2/3 of our product, that has flattened out. It was around 113. Now we're seeing 111.5 or so, and we haven't seen any further decline over the last couple of months. So that's -- we're hopeful about that. There seemed to be a glut of product -- couple things. There was a glut of product after Labor Day, after the summer, so the pricing softened up a little bit. There was some uncertainty around the election and the election results and what might happen. Obviously, remains to be seen, now that the election is behind us, where that ends up. The market never likes uncertainty. And there was some concern about prepayment rates. Obviously, the buyer who's paying a 10% or 11% premium, they're concerned if prepayment rates are accelerating. So there was some of that pressure in the pricing. But again, we've seen it either, at a minimum, bottom out or start to turn around on the upside.

[Stephen Laws, analyst]

Great. And just want to touch base, so the stock's been a little weak. I know back when you announced your year-end results, you authorized the $20 million stock repurchase. Is that still in place? Is that something you would consider? Can you maybe talk about how you view deploying capital to new investments versus repurchasing stock with shares trading at about a, I don't know, roughly 13% discount, I guess to the adjusted book value here?

[Frederick Herbst, executive]

It's something we're constantly looking at. We were kind of out of the market recently given where we were in the merger transaction. So that was -- we were kind of precluded from doing that. In terms of the weakness of the stock price, we've looked at it and I think it relates to our average trading volume. And we've looked at our ETF ownership, as ETFs sold off on some financial stocks, our -- because of our low trading volume, we've looked at an ETF ownership, they own about 28x our average daily trading volume, which is much higher than most of the peer group given our low trading volumes. So if ETFs are lightening up on the financial services, I think we get hit probably a little bit more than some others. Conversely, if they start to reload, then we should recover a little quicker than some of the others. We were a little bit above book value back a month or 6 weeks ago, and obviously the stock performance hasn't been as strong as we would like since. We'll see how the market -- we feel very strongly, very positive about the merger as well as 3 strong quarters of earnings and hopefully, the market will start to reflect that.

[Thomas Capasse, executive]

I would just add to that. One of the benefits -- to underscore that, one of the benefits of the transaction is to increase our float from currently 55% of our Ready Capital market cap to roughly 66% on a pro forma basis, which is on Page 7 of the transaction summary.

[Stephen Laws, analyst]

Great. And I guess I do have one question on the transaction. I may have missed this or I don't see it in the press release. When is it expected to close? And depending on that closing, do you anticipate paying separate dividends for the quarter before and after the close or anything like that? Or how do we think about the distributions around the closing date?

[Frederick Herbst, executive]

We estimate -- it's always hard to tell, but we estimate it'll close sometime towards the end of the first quarter. Both companies are expected to pay their normal quarterly dividends. In the case of Owens, we don't think it's highly likely, but if they need to make a distribution for tax purposes, REIT compliance purposes, they are entitled to do that and it's appropriately adjusted.

[Operator]

Our next question comes from the line of Crispin Love from Sandler O'Neill.

[Crispin Love, analyst]

In the presentation, I believe it said that the floating-rate loans are now about 51% of the total. Can you comment on what's causing the change there? Because I believe it has been kind of closer to around 60% in recent quarters.

[Frederick Herbst, executive]

Yes. The adjustable-rate loans are the -- primarily the transitional loans, the bridge transitional loans and the SBA loans. The SBA volumes, while we did over $50 million, they're a small fraction or a smaller fraction of the total. Our fixed-rate product, between Freddie and the conventional fixed-rate product, is the majority of our loan volume. So depending really on where we are in the cycle of originations, on a spot balance, that can pop up a little bit. And then we've done some acquisitions, which are often fixed-rate acquisitions. And again, a majority of those got flipped into the securitization today when we closed that transaction.

[Crispin Love, analyst]

Okay, great. And then just one on the Owens acquisition. Are you going to be selling all of the Owens real estate assets? And if that is the case, what would you expect the timeframe of selling them and then redeploying them into Ready Capital assets after the deal closes?

[Frederick Herbst, executive]

Yes, we expect to -- we're not an operator of real estate, although we're capable of doing and Waterfall's history has done some of that, but that's not our intent. We would -- our plan is to dispose of the assets over 2 years, and as those proceeds come in, redeploy those into either new Owens-type loans or the loans or acquisitions that we've historically done.

[Thomas Capasse, executive]

But well over half -- if you look at the business plans assigned by our asset management team to each of the assets, REO assets, and sometimes confirmatory with respect to Owens' strategy, who, by the way, has a long history and track record of managing these types of assets as well, you'd see that more than half of the process would be realized in the first year.

[Operator]

Our next question comes from the line of Ben Zucker from BTIG.

[Benjamin Zucker, analyst]

I'm also a little familiar with Owens and its REO book, and I believe that company was taking more of a measured approach to its divestitures because it was limited by some REIT selling restrictions. So I'm just curious, now that you're bringing that capital into ReadyCap, where you can generate a net return of 10%-plus, have you looked at ways or are there ways to accelerate that 1.5- to 2-year disposition time line to get that money redeployed maybe a little bit quicker? Or are your hands kind of tied by those same REIT selling rules that I know were impacting ORM? I'm just kind of curious how you came up with that expected timeline.

[Frederick Herbst, executive]

Well, first of all, you're exactly right. They were -- really due to size limitations, where the REIT rules are, you can only sell what -- some percentage of your assets or number of transactions. Given our much larger size, theoretically, we could dispose of it all tomorrow if we had a buyer. We're not constricted by those size limitations, so that's one advantage of size does matter. And the 2-year timeframe, hopefully we can do it a little quicker. But as you probably know, Ben, a good chunk of those assets are those condo units out in Tahoe. That'll just take a while to dispose of those assets as we go. For the most part, the rest of them should be done, as Tom mentioned, hopefully within 12 months.

[Benjamin Zucker, analyst]

Well, they do look like nice assets on the Zalanta website, for what that's worth. I know that...

[Frederick Herbst, executive]

I recommend you take a -- you should take a site visit, Ben.

[Benjamin Zucker, analyst]

Yes, appreciate it. That's a great idea, Rick. I think it was touched on that Owens has a strong presence in California and the Pacific Northwest. How does their borrower network and relationship mesh with your current footprint and market exposure there? Is this an area and region that you like and felt you were underrepresented in? Or were you really just after ORM's capital?

[Frederick Herbst, executive]

We were hoping for both. Obviously, from a capital perspective, what we just talked about, the increased size, increased float, increased market capital of that, that's the primary objective. We don't have a huge presence in Northern California, so we would like to expand there. I think Tom mentioned, we just hired a team up in Seattle, primarily on the SBA business, but they'll be able to generate other business as well for us. And we do have loan officers more in Southern California. So we would like to expand in that Northern California-type market. We don't see a lot of overlap with the borrowers. Quite frankly, they're just a little bit different type of borrower than what we typically target. However, we'd love to expand our relationships with them.

[Benjamin Zucker, analyst]

That makes a lot of sense. I guess turning to the securitization that you guys recently priced, I think in your deck, you can calculate an advance rate of like 83% or initial leverage of 4.7, 4.8:1. Just curious what the gross levered returns on that pool is looking like once the securitization closes?

[Thomas Capasse, executive]

Yes, if you look at additional incremental repo on the subordinate tranches, it's roughly mid-teens.

[Benjamin Zucker, analyst]

Very nice. And would you say that that's fairly consistent with how your acquisition and securitization strategy plays out historically?

[Thomas Capasse, executive]

Yes, correct. And I would point out, if you look at the duration of our equity, if you think about our equity in a context of a bond investment, we like these investments because they're very -- there's limited structural leverage, these are seasoned loans, the loss curve is very stable and they generate a 3- to 4-year duration net interest margin over -- as opposed to, let's say, 100% of your balance sheet being in transitional loans with a duration of 1 year. So we like those kind of acquisitions and we think they're accretive at the margin. And in fact, I would add that this acquisition does open us up now to more aggressively pursuing other acquisitions because we've been prioritizing capital for growth in our origination platform in order to create the operating leverage that exists in that business.

[Benjamin Zucker, analyst]

That's great. And Tom, can you just quickly remind me while we're on the subject, on the acquired loans, what percentage of the total interest income -- on average, I understand it's different by loan pool acquisition -- what percentage of the net interest income comes from the stated coupon? And what percent comes from the accretion of purchase discounts?

[Frederick Herbst, executive]

It's more on the coupon now. It used to be, a couple years ago, we'd buy loans at a significant discount to the market. Now when we buy loans, it's generally in the 90s-type price range, being 90 and par, so the discount accretion is far less than it used to be.

[Operator]

Our next question comes from Scott Valentin from Compass Point.

[Scott Valentin, analyst]

Just on the acquisition, simplistically, the way I look at it, they have about $200 million of capital if we assume assets are liquidated close to par. Does that imply about $600 million of balance sheet growth for you guys over time? That kind of $200 million equity, 3x to 3.5x leverage, is that a fair way to look at it?

[Frederick Herbst, executive]

Yes, that's a reasonable assumption, yes.

[Scott Valentin, analyst]

Okay. And then on provision expense, I notice it was up this quarter. I think it was the acquisition segment that had a little bit higher provision. Is there anything particular with the provision expense?

[Frederick Herbst, executive]

We had one loan where we always remark or get appraisals and additional values or updated values for the property. We had one loan that dropped in value a bit.

[Scott Valentin, analyst]

Okay. And then Tom, you were making the analogy between residential mortgage or residential housing and SBC. Do you expect a production -- I mean, origination slowdown for the market given what we're seeing in residential housing? You kind of implied the same dynamics are playing out, where not much supply, prices are high, therefore demand is kind of slowing.

[Thomas Capasse, executive]

It's interesting, the answer is somewhat of a slowing in the rate of growth. I think it was 13% -- I'm sorry, it was flat to slightly up the past year-over-year and will hit another $200 billion of -- and this is on the investor loans. But one of the things the projection -- the analysts are protecting in terms of why it might increase 5% or so next year is because a lot of the property owners are looking to -- because of the rent-versus-buy decision, they're looking to purchase buildings that they currently occupy. So we expect to see a lot of increase in acquisition activity due to the relative economic decision related to buy versus rent given that rent, if you look at an index of rent, it's well in excess of the -- where it was pre-crisis for the small-balance commercial properties. So that's one thing that would lead us to believe that you'll see maybe a mid-single-digit in increase percentage terms in originations for small-balance commercial investor properties in the next year. On the SBA side, just the demand exceeds the caps that the government allows. We continue to see probably a $25 billion to $28 billion year this year and the same next year for the SBA 7(a) program.

[Scott Valentin, analyst]

All right, that's helpful. And then you mentioned you hired an SBA team. Are there opportunities out there to do that? Is it easy to find teams? Or is it getting more costly?

[Thomas Capasse, executive]

I wouldn't say we didn't pay, I mean, in terms of these teams. The interesting thing is we're 1 of 14 nonbank lenders and we use a model where we use both loan officer -- we hire loan officers with production goals of $5 million to $15 million per loan officer and they're usually very seasoned. But we haven't had to offer big retention bonuses or acquisition packages because of a lot of what -- the frustration of a lot of these teams have working at banks because of the tight credit box and the compensation structure, such that moving to a nonbank is very attractive to them in terms of compensation and volume. So we actually have had a reverse increase in a lot of these teams. Another example is we hired a team out in Ohio that focuses on certain verticals, in that case, funeral parlors and dental practices. So yes, we're going to continue to see organic growth in our originations, which this year are roughly $200 million to $230 million. We want to continue to ramp that growth through both organically as well as through acquisitions of new teams.

[Scott Valentin, analyst]

Okay. And one final question for me. On the -- you mentioned, Tom, you guys purchased, I guess a conduit or just chunk of a conduit. How does that compare to returns of stuff that you originate internally? Is it a similar return? And then two, is there an opportunity to -- is there a significant opportunity there to do more of that going forward?

[Thomas Capasse, executive]

There's definitely an opportunity to do more of that going forward. This was a large regional bank that's a very large player in the conduit market. They have their own servicing business as well. And this was a, I'll call it, small-balance conduit. If you look at the hierarchy of small-balance commercial, micro is below $1 million. Typically there, you look at the borrower's credit as well. We're squarely in the small and mid-market, which is, let's say, $1 million to $5 million. And in the conduit market, there's -- they define it as $5 million to $25 million or $30 million. So this bank, we worked on underwriting guidelines that are consistent with our credit criteria, and then they rolled out this program based on the forward commitments by the subordinate bond from -- by ReadyCap. So in terms of the answer to your question, it's probably about, I'd call it, 13% to 14%, 15% return versus similar loans that -- for example, like that legacy pool we bought is probably more in the 15% -- 14% to 16% range. So maybe it's about 100 basis points below the manufactured deals that we do, but it clearly meets the criteria on a levered return basis for generating -- again, what we want to do on our balance sheet is to generate very stable longer-duration net interest margin match-funded via the securitization market. So this, we think, is very accretive and we will continue to work with this partner and potentially roll it out to others in the future.

[Operator]

Our next question comes from the line of Christopher Nolan from Ladenburg Thalmann.

[Christopher Nolan, analyst]

Rick, what do you expect the leverage ratios to be for the combined entity at closing?

[Frederick Herbst, executive]

At closing? They will be about -- the overall leverage goes about -- down to about 2.5:1 and recourse drops to about 1.5:1.

[Christopher Nolan, analyst]

Great. And then on the earnings for the SBC, the levered yield came down. Does that reflect just more conventional?

[Frederick Herbst, executive]

No, it really had to do with leverage, a little bit less leverage. We paid down -- we had a little excess liquidity so we paid down the repo lines, which is what we do when we generally have excess cash. So it was really more a function of just the terms of leverage in this quarter versus last. There's also -- it's not an exact science. We use month-end balances to compute the average balances, so it's not an average daily balance. So sometimes there are anomalies in there, but it has nothing to do with average coupon or cost of debt or anything like that.

[Christopher Nolan, analyst]

Great. And then final question, the recourse debt-to-equity ratio ticked up this quarter. Should we expect it to go back down given the securitization you guys have done?

[Frederick Herbst, executive]

Yes, that'll immediately convert recourse to non-recourse debt, that's $200 million.

[Operator]

Our next question is a follow-up question from Jade Rahmani from KBW.

[Jade Rahmani, analyst]

How are you guys thinking about the dividend with core earnings having run in excess of the dividend for the year? Is the plan to maintain the dividend, retain additional capital given the amount of income coming from gains and from the [ TRS ]? Or do you think that in 2019, given potential earnings accretion from the merger, you would likely raise the dividend?

[Frederick Herbst, executive]

Our board is kind of taking a policy of taking it year by year. It'll be something we'll discuss in the December meeting for our fourth quarter dividend. My guess is unless there's a tax need to distribute, as we think we have a very competitive dividend -- if you look at our dividend yield versus the peer group, I think we're at the top, or if not, we're very close to the top. So we would -- again, it's up to the board, but my guess would be at the first quarter meeting when we go through the annual plan and projections and all that, we will potentially reset the dividend based on a number that we're comfortable one, is competitive; two, we'll be able to cover with our core earnings for the year as we did this year; and three, hopefully grow book value a little bit.

[Jade Rahmani, analyst]

In terms of timing, do you anticipate the merger closing in early 1Q?

[Frederick Herbst, executive]

I think it's probably going to be later, Jade. If you go through the process, we have to put together a proxy, which will take, I don't know, 30 days, then it's got to go to the SEC. Depending on whether or not they review it, they likely will, you're probably talking some -- into late January by the time they review it and get back to us. Then we have to circulate it to investors and give them 30 to 45 days to consider it. So you're talking about a vote, according to that schedule, unless the SEC pleasantly surprises us, you're probably talking sometime in March.

[Jade Rahmani, analyst]

Okay. The vote would be in March and the closing would be in March?

[Frederick Herbst, executive]

Yes, the closing would be shortly after the vote. Keep in mind, it's all subject to -- that's what we're currently kind of planning out in our own time line. Things sometimes go quicker or longer, but that's kind of the working model.

[Jade Rahmani, analyst]

And do the asset dispositions continue apace until the merger closes and then you guys take over? Or would they be, like, on pause or something? Because potentially the market -- okay, go ahead.

[Frederick Herbst, executive]

No, they will continue to run their business. We've kind of established with them here are the prices that you've indicated and we've indicated we think these properties are worth. And so as long as they're within that band, they can continue to dispose of and we factor those numbers into our projections.

[Jade Rahmani, analyst]

Okay. In terms of overall credit in the market, just tracking the commercial mortgage REITs, we've detected a modest pickup of sort of one-off credit issues, but they do seem to be happening with a little bit more frequency. Are you seeing any of that either in your own portfolio or in the trends that you track?

[Thomas Capasse, executive]

Not really. We've had some -- a few maturity extensions, but -- and maybe 1 or 2 properties that didn't lease up on time. But what you're seeing, and -- because we see this in our -- in terms of the external manager being a major investor in large-balance commercial real estate, the stressed debt, we are definitively seeing idiosyncratic defaults, if you will, due to the intense competition in the large-balance market and the migration to more specialty-use properties with more difficult business plans to execute. So I think that you're definitely starting to see that as people are stressed for credit in the competitive large-balance market. But we're just -- we're not seeing that as much in the small-balance space, in part due to the limited number of, especially, nonbank private funds that target that market.

[Jade Rahmani, analyst]

Sorry, what was the other type that you mentioned? I didn't hear it clearly. Mixed-use or what was the other category you...

[Thomas Capasse, executive]

Specialty use.

[Jade Rahmani, analyst]

Specialty use, okay.

[Thomas Capasse, executive]

Yes, like repositioning a large block of fitness centers or a project in a -- let's say, a stadium project, a mixed-use development around a stadium project, which is for a $500 million transitional loan. It's -- you're seeing more of that in the large-balance space than you did, let's say, 2 or 3 years ago. And if you drill down and look at the actual projects on each of the large or small balance -- sorry, large-balance REITs, that's a lot of these -- it's the kind of idiosyncratic project risk that's being introduced by taking on more difficult credits from a transitional loan standpoint than you did, let's say, 2 or 3 years ago.

[Operator]

Ladies and gentlemen, we have reached the end of the question-and-answer session. And I'd like to turn the call back to management for any closing remarks.

[Thomas Capasse, executive]

Again, we appreciate everybody's continued support, and we're very pleased with this accretive merger and look forward to continuing to deploy the capital and growing earnings, and we look forward to next quarter's earnings call.

[Operator]

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.