Ready Capital Corporation, a real estate finance company focused on lower to middle market loans, is navigating a treacherous commercial real estate landscape. Rising interest rates, inflationary pressures, and a looming recession are creating significant headwinds for the industry, particularly in the multifamily sector, which comprises the lion's share of Ready Capital's portfolio.

While the company's management paints a picture of resilience and strategic redeployment, a closer look at the transcripts reveals a potentially alarming trend that may have slipped past other analysts: the growing divergence in delinquency rates between loans under $25 million and those above $25 million.

On the surface, Ready Capital's overall delinquency rate of 9.9% in the originated portfolio is concerning, reflecting the stress in the multifamily sector. However, a deeper analysis uncovers a hidden disparity. The company revealed that 16% of loans over $25 million are 60 days delinquent, compared to just 7% of loans under $25 million. This difference suggests a brewing storm within their portfolio, potentially impacting their ability to maintain compliance with their CRE CLOs and putting pressure on book value.

Delinquency Rate Divergence

Why does this divergence matter? The company itself acknowledges that the multifamily refinancing market shows a significant disparity based on loan size, with 95% of loans under $25 million refinancing at maturity versus only 55% of loans above $25 million. This dynamic creates a potential liquidity crunch for Ready Capital, especially considering 45% of their multifamily portfolio reaches initial maturity in 2024, with another 31% maturing in the first half of 2025.

Furthermore, this loan size disparity exacerbates the challenges Ready Capital faces with their static CRE CLO structures. The inability to proactively manage collateral and the reliance on a third-party special servicer for loan resolution further restricts their options for addressing potential delinquencies in the larger loan category.

The company is relying heavily on modifications and extensions to manage these larger delinquent loans, prioritizing liquidity for these capital solutions. While they don't anticipate significant book value erosion from these actions, the cost of carrying these underperforming loans, the potential for tripping additional CLO tests, and the prolonged time to resolution could strain their resources and hinder their ability to capitalize on the attractive investment opportunities they highlight.

Potential Loan Losses

This potential loss scenario raises several questions:

Will Ready Capital be able to secure new equity infusions from sponsors of these larger delinquent loans to facilitate modifications and avoid further principal loss? Can the company effectively navigate the complexities of their static CLO structures and the limitations of their third-party special servicer to manage these larger delinquent loans in a timely and cost-effective manner? Will their current liquidity and anticipated capital raise be sufficient to address the potential for a larger wave of delinquencies in the coming quarters, especially considering the significant capital required for modifications and buyouts?

While Ready Capital is taking steps to improve ROE through various initiatives, including portfolio redeployment, leverage increases, and cost reductions, the potential impact of this delinquency divergence shouldn't be ignored. Investors should closely monitor the company's ability to manage this brewing storm, as its resolution could significantly impact their long-term performance and dividend sustainability.

"Fun Fact: Ready Capital's CEO, Tom Capasse, is a seasoned veteran in the real estate finance industry, with a career spanning over three decades. He's known for his deep understanding of credit cycles and his ability to identify opportunistic investments."