NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed Ladder Capital Finance Holdings LLLP and Ladder Capital Finance Corp's (collectively, Ladder) long-term Issuer Default Ratings and senior unsecured debt at 'BB'. The Rating Outlook for both entities is Stable.
KEY RATING DRIVERS - IDRs and Senior Debt
The affirmations reflect Ladder's conservative leverage and operating profile, strong credit and performance trends, good liquidity and experienced management team. Rating constraints include limited financial flexibility due to a high proportion of secured funding, exposure to cyclical commercial real estate (CRE) markets, an operating history which is limited to post-crisis, and key man risk.
On Feb. 11, 2014, Ladder completed an initial public offering (IPO) of $259 million of class A common stock at an issue price of $17 per share, reflecting a 19% premium to the then book value. Proceeds were primarily used to invest and grow the business. Fitch views the IPO as neutral to ratings. The public ownership addresses the relatively shorter-term investment horizon of some of Ladder's private equity firm owners, which could have otherwise potentially introduced strategic uncertainty or shareholder friendly activities. However, public ownership could potentially put pressure on the company to generate short-term earnings growth or challenge the company's current balanced operating strategy.
Operating Performance Normalizing
Ladder continues to post solid operating performance reflecting the attractive opportunities in the CRE lending sector post-crisis. The company reported core earnings of $202.3 million in 2013, up 14% from $177.5 million in 2012. However, gain on sale margins on securitizations, which comprise a material portion of earnings, have begun to normalize due to increased competition in the CRE lending and securitization space. Core earnings declined to $119.1 million in 1H'14, down 12% from $135.5 million in 1H'13. Still, return on average equity was 17.7% annualized for 1H'14, up slightly compared to 17.5% for full-year 2013, which is viewed as solid, particularly considering the relatively low leverage used during the periods. Fitch believes profitability metrics will continue to normalize as competition increases in the origination space and liquidity increases in the CMBS markets.
Increased Balance Sheet Loan Origination
Ladder has been very active in taking advantage of market dislocations and proceeds from its 1Q'14 IPO to increase originations of first mortgage balance sheet loans at attractive spreads. In 1H'14, Ladder originated $575.3 million of balance sheet loans, up significantly from $179 million in 1H'13. As of June 30, 2014, Ladder held 35 balance sheet first mortgage loans with a book value of $912.2 million, or 24% of total assets and a weighted average LTV ratio of 69.9%. Balance sheet loans are conservatively underwritten and carry relatively shorter terms than conduit loans. However, these bridge loans are also considered less liquid as they are backed by transitional or less stabilized properties. Through 2Q'14, Ladder had not suffered any credit losses on these loans, which can be attributed not only to the company's conservative underwriting standards, but also to the fact that these loans have been originated in the benign post-crisis credit environment. Nevertheless, this portfolio does provide a more stable source of net interest income and origination fees compared to the gain on sale of loans into securitization.
RE Equity Investment Stabilizing
Real estate equity investments measured $561.2 million at June 30, 2014, down slightly from $624.2 million at YE13, as real estate purchase activity was quiet in 1H'14 with no new investments, while the company sold two assets and continued to sell residential condos in Miami, FL and Las Vegas, NV. Still, gross real estate equity exposure as a percentage of total assets has substantially increased to 14.7% at June 30, 2014, from just 1.1% at YE'11. While such real estate equity investments are in control positions and may have sound credit fundamentals, they typically have less liquidity, which warrants active management of the positions while limiting their size relative to Ladder's overall balance sheet.
Ladder's conservative capitalization and leverage profile is one of its key ratings strength. Leverage, measured as debt to tangible equity, was 1.5x at the end of 2Q'14, well below the company's internal target of 2.0x to 3.0x, and down from 1.9x at year-end 2013, as proceeds from the IPO were used in part to repay debt. Tangible equity to tangible assets was a solid 38.4% at June 30, 2014, up slightly from 34% at year-end 2013, and compares favorably to similarly rated financial institutions. Fitch expects management to conservatively manage its leverage in the 2.0x-3.0x range over the longer term, particularly in light of increased real estate equity investments.
Improving Funding Profile, Although FHLB Risks Loom
Ladder has continued to diversify and extend its funding profile through its 3Q'14 issuance of seven-year $300 million senior unsecured notes (in addition to its $325 million senior unsecured notes issued in 2012) and replacing repurchase facilities funding with Federal Home Loan Bank (FHLB) borrowings. However, Ladder's funding profile is still dominated by secured debt (85% as of June 30, 2014 before the $300 million unsecured notes issuance) and is relatively short-term in nature (48% of total debt is due within next 18 months), which reduces the company's financial flexibility.
Ladder's access to FHLB borrowings through its captive insurer increased to $903 million at the end of 2Q'14, accounting for 41% of total debt funding, up from 18% in FY12. Fitch views FHLB financing favorably, as it provides a stable and economical source of relatively longer-term funding compared to shorter-term repurchase facilities. However, the Federal Housing Finance Agency (FHFA), the regulator of the FHLBs has been scrutinizing the access to FHLB funding from non-bank members through captive insurance companies. On Sept. 2, 2014, the FHFA proposed a rule which would effectively ban captive insurers from gaining FHLB membership while giving existing captives five years to exit the system, which, if enacted, would effectively grandfather Ladder as a member for five years. Interested parties have 60 days to submit any comments on the proposed rule.
Fitch believes that Ladder's potential ultimate loss of access to FHLB funding in five years would be manageable, considering Ladder finances high quality conduit loans and CMBS securities with FHLB, which can be replaced with other sources of funding including term debt and repurchase facilities. However, this shift in funding would increase Ladder's cost of borrowing impacting its earnings and profitability metrics, and if replaced with shorter-term repurchase facilities, further reduce Ladder's liquidity profile and financial flexibility. Fitch will monitor the regulatory developments and Ladder's response to the FHFA proposal. Access to more unsecured and longer-term funding sources would be viewed positively.
Improved Contingent Liquidity
In February 2014, Ladder entered into a $75 million syndicated unsecured revolving credit facility with a three-year maturity and pricing of one month LIBOR plus 3.5%. Fitch views this facility favorably as it is unsecured in nature and improves the company's contingent liquidity. At June 30, 2014, Ladder had $1.25 billion of excess committed capacity under its committed secured repurchase funding facilities, $358.9 million of undrawn committed term financing from FHLB, $50 million under its secured credit agreement, and $75 million in the above mentioned facility for a combined $1.7 billion available to fund future growth in its business. Furthermore, unencumbered assets and unrestricted cash measured $728 million at 2Q'14, providing ample coverage for unsecured debt holders and offering a good source of contingent liquidity. However, high liquidity levels are viewed as appropriate relative to the short-term nature of some of Ladder's funding sources, particularly repurchase facilities.
RATING SENSITIVITIES - IDRs and Senior Debt
The Stable Outlook assigned to Ladder reflects Fitch's expectation that the company will continue to prudently grow its business, maintain underwriting standards, manage leverage conservatively, monetize some of or otherwise lower its direct real estate equity exposure, and continue to access diversified longer-term funding sources, while maintaining adequate liquidity levels.
The following factors may have a positive impact on Ladder's ratings and/or Outlook:
--Greater revenue diversity with reduced reliance on gain on sale income;
--Sustained profitability and asset quality performance through multiple market environments, while maintaining conservative leverage and strong liquidity levels;
--Increased economic access to long-term unsecured debt funding.
The following factors may have a negative impact on Ladder's ratings and/or Outlook:
--Regulatory or political risks that immediately impede access to FHLB borrowings without an offsetting increase in long-term economic sources of funding;
--Change in management or organizational structure that adversely impacts the current balanced and conservative approach of operating the company;
--Material increase in exposure to more aggressively underwritten balance sheet loans or real estate equity investments without adequate reserves and commensurate decrease in leverage;
--An increase in leverage beyond the company's articulated target;
--Reduction in liquidity levels and/or unencumbered assets relative to outstanding unsecured debt;
--Sustained operating losses or material weakening of asset quality.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Global Financial Institutions Rating Criteria' (Jan. 31, 2014);
--'Finance and Leasing Companies Criteria' (Dec. 11, 2012);
--'Criteria for Rating U.S. Mortgage REITs and Similar Finance Companies' (Feb. 25, 2014);
--'Ladder Capital's IPO Neutral to 'BB' Issuer Default Rating' (Feb. 7, 2014).
Applicable Criteria and Related Research:
Global Financial Institutions Rating Criteria
Finance and Leasing Companies Criteria
Criteria for Rating U.S. Mortgage REITs and Similar Finance Companies