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Ready Capital Corporation (NYSE:RC)
Q1 2021 Earnings Call
May 7, 2021, 8:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Greetings and welcome to Ready Capital Corp.'s First Quarter 2021 Earnings Conference Call. [Operator Instructions] [Operator Instructions]

I would now like to turn the conference over to your host, Mr. Andrew Ahlborn, Chief Financial Officer. Thank you. You may begin.

Andrew Ahlborn, CPA -- Chief Financial Officer

Thank you, operator, and good morning, 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 first quarter 2021 earnings release and our supplemental information. By now, everyone should have access to our first quarter 2021 earnings release and the supplemental information. Both can be found in the Investors section of the Ready Capital website. In addition to Tom and myself, we are also joined by Adam Zausmer, our Head of Credit.

I will now turn it over to Chief Executive Officer, Tom Capasse.

Thomas Capasse -- Chief Executive Officer

Good morning and thank you for joining our first quarter earnings call. Ready Capital is off to a strong start in 2021. We have accomplished much in the first quarter of the year with our small balance commercial or SBC, CRE lending operations and Small Business Administration or SBA 7(a) lending businesses, posting record originations, including high volume in round two of the Paycheck Protection Program or PPP.

Liquidity in the quarter was bolstered significantly by closing of Anworth merger and accretive capital markets transactions. Additionally, post-COVID credit metrics in our SBC portfolio continue to outperform our large balance spread. To start, we originated a record $823 million of SBC loans. First quarter volume focused on high conviction sectors such as multi-family and industrial, which make up 90% of 2021 volume. For loans originated to hold on balance sheet, average spreads were 431 basis points and average duration is three years. These efforts increased our net portfolio 13% quarter-over-quarter.

Additionally, originations in April totaled $202 million and our current money up pipeline is in excess of $420 million. Our multi-strategy FPC theory platform has enabled us to capitalize on post-pandemic loan demand, particularly in transitional and agency multi-family. Transitional loan demand increased due to pandemic-related rental volatility whereby sponsors have elected to take shorter term bridge loans with prepayment flexibility to allow them to stabilize the real estate and optimize exit financing at a later time. This strategy elevated bridge loan volumes since the fourth quarter last year into the first four months of this year. We expect continuation of this trend, along with demand from strong sponsors pivoting to opportunistic acquisitions in sectors hard hit by COVID, such as hospitality and office to sustain demand into 2022.

In multi-family the Federal Housing Finance Agency reduce the lending cap with the GSEs and increased their affordability mandate, driving more product into the private market, boosting our transitional and fixed programs. Meanwhile, our Freddie small balance loan agency multi-family business has benefited as a large portion of the program meet affordability criteria leading Freddie Mac to price more competitive rates and leverage versus banks. Again, this is reflected in record SBA quarterly volume and pipeline, a trend we project will continue through 2021.

Beyond our Freddie SBA program, correspondent agency agreement executed in the third quarter of 2020 will not only allow us to refinance our bridge loans which we control with an exit fee, but also allow us to access a broader set with GSE products. Our SBA operations are also off to a strong start for the year due to pent up post-COVID demand from small businesses. As discussed in the prior earnings call, the first quarter decline in 7(a) volume was expected due to the updated FDA guidance released in February. Although first quarter volume was down quarter-over-quarter to $50 million, originations through April equaled $41 million and the money up pipeline is over $235 million. Increased production is complemented by an attractive market for SBA guaranteed net sale premiums, which have averaged 13% in 2021. And in terms of our secondary market strategy, we may sell 7(a) loans at lower premiums keeping a higher servicing strip.

This would increase future servicing revenue versus current loan sale gains, particularly in markets where the strip is undervalued. Similar to our outlook on commercial real estate, we believe we are at the beginning of increased growth in our SBA franchise by gaining market share in the projected $25 billion to $30 billion 7(a) market with a 3-pronged strategy. First is loan officer hires. The SBA business has actively recruited talent in the SBA lending space and added 19 new members to the production team in the first quarter to manage the increase in demand for SBA loans. Second is affinity programs.

We've made senior level hires and are investing in technology to build out affinity programs, providing other financial services companies with access to the 7(a) program. And finally program expansion. As we've discussed on prior calls, we continue to rollout our SBA small loan program with our fintech Knight Capital, featuring loans under $350,000 approved via a credit score system. Our goal is to continue to grow market share, the leading non-bank SBA lender and expect our second quarter volumes will likely exceed $100 million. Knight Capital combined with our SBA license has enabled us to be active participants in round two of PPP over the last four months. Through April 30, we have originated over $1.8 billion of PPP loans in round two. Our focus has been on helping smaller businesses with 55,000 loans originated at an average loan size of $33,000. As of May 3, PPP authority had reached its approved limit with Ready Capital achieving its target goals.

Our business will benefit on a go-forward basis from the front end origination technology we have built for PPP, accelerating SBA production efficiency and capabilities going forward. Now turning to our residential mortgage business, originations remain elevated in the first quarter at $1.2 billion. As expected, cyclical margin compression resulted in the quarter, declining 100 basis points to 150 basis points due to rising rates and additional competition. Over the next few quarters, we expect origination volumes to decline approximately 25% from our quarterly run rate over the last few quarters, with margins holding near pre-COVID levels.

Notably, we expect our volume and margin metrics to compare favorably to the industry due to a higher focus on purchase channels, which are benefiting from ramp in housing demand. In the current cyclical rates environment, our strategy of retaining mortgage servicing rights as a production had boosted results, as we recovered $15 million in MSR value and expect continued appreciation, which will result in book value per share increases going forward. Beyond the day-to-day operations, we successfully closed the Anworth merger and welcome the Anworth shareholders. The transaction added 338 million in common and preferred equity, bringing the market cap of the company to over $1 billion and was completed at dilution level 25% lower than previously communicated.

We've also successfully executed some of our post close objectives including liquidating $1.8 billion of agency RMBS securities, generating $200 million of current liquidity. The remaining $200 million of non-agency MBS assets will be liquidated in conjunction with our go-forward acquisition and origination pipeline. We want to thank the Anworth management team for helping to close the transaction and transition the operations seamlessly. Our small balance commercial portfolio continues to be differentiated and stable source of revenue for the company. The portfolio currently consists of 4,500 loan totaling $4.7 billion. Credit performance remained stable with 60-day plus delinquencies in our portfolio holding at 2.3%.

I would like to highlight that we have yet to experience a realized loss in our new originations book since the inception of the company. In terms of stability and outlook for our dividend, we continue to grow core earnings with a combination of net interest margin from capital redeployment in our core SBC, CRE segment and gain on sale revenue from our government sponsored businesses.

Be clear, our dividend for the first quarter was $0.40 and the separate distributions of $0.30 and $0.10, a function of the merger mechanic in the Anworth acquisition. Over the last 12 months, our core earnings have covered 140% of our annualized quarterly dividend of $0.40. Future dividend tailwinds from the deployment of Anworth Capital in SBC, CRE investment along with increases in SBA production and deferred PPP revenue will be included in determining the company's normalized forward dividend rate.

With that, I'll turn it over to Andrew to discuss financial results.

Andrew Ahlborn, CPA -- Chief Financial Officer

Thank you, Tom, and good morning, everyone. GAAP earnings and distributable earnings per share were $0.49 and $0.41 respectively. With distributable earnings of $24.7 million and a 10.9% distributable return on equity, we have surpassed our 10% target for the fourth consecutive quarter. Our earnings profile is reflective of efforts to grow our loan and servicing portfolio from COVID lows, continued performance from our gain on sale operations and the trend toward normalization in our residential mortgage banking operations. Interest income in the quarter grew $8.6 million due to a 13% increase in our loan portfolio as well as the accretion of fees related to recent PPP originations.

Interest expense rose in the quarter as a result of short-term borrowings to fund our PPP originations, increased warehouse balances due to our securitization cycle and slightly higher leverage due to the Anworth acquisition. $5.4 million of the increase in interest expense in the quarter should be considered non-recurring and is related to short-term borrowings incurred to fund PPP production. Adding to our stable earnings profile was $4.2 million growth in servicing revenue, which is reflective of the quarter-over-quarter growth in our servicing asset. Net realized gains from our SBA and Freddie Mac gain on sale operations were all $500,000 due to lower volumes in the SBA 7(a) operations.

As Tom mentioned, these declines were anticipated due to updated SBA guidance received in February, which slowed the first quarter pipeline. We expect the quarterly run rate in our SBA business to be higher and a 90% guarantee through the end of Q3 is expected to increase gain on sale revenue. A reduction in our SBA business was partially offset by increased Freddie Mac production where gain on sale revenue increased 76%. As indicated in our last earnings call, mortgage banking income was down $7 million due to the normalization of margins in the back half of the first quarter. Margin declines were offset by elevated volume which remained at record levels, as well as the recovery in the value of the servicing asset, which increased by $21.7 million. Although not included in distributable earnings, we expect go-forward valuation increases in the MSR to be a significant source of book value appreciation in the upcoming quarters.

While being pleased with our distributable earnings, there were several one-time items included in the quarter that should be highlighting. The largest is how income related to our PPP originations was recognized. In the quarter, we earned $73.3 million of net fees related round two of PPP originations of which, $67.8 million was deferred and will be recognized in future periods. Total net income related to PPP for the quarter equaled $3.6 million. The first quarter recognition of both deferred fee income from prior quarters of $6.7 million and the recognition of $6.9 million of interest income from round two production was offset by $10 million of expenses incurred due to around two production.

Additionally, since the end of the first quarter, we have originated $700 million of PPP loans and expect total PPP efforts in 2021 to produce pre-tax net income in excess of $100 million. This income in addition to the 65 basis points carry on the portfolio will be accretive through interest income. The quarterly change in our balance sheet was driven by a few key items including the completion of the Anworth merger, growth in the portfolio due to the increased origination activities, and improvements to our capitalization. Our loan portfolio grew 13% to its highest historical level due to $823 million in originations, net of $276 million in principal payments and maturities.

The weighted average coupon in the portfolio remained at 5.4% and with rising rates, we expect margins to increase in our floating rate portfolio, which represents 66% of the total. In addition to asset growth, we had several key transactions on the liability side, which reduced our overall cost of funds 14% to 300 basis point. The first was the completion of our fifth CRE CLO, the $768 million deal lower the debt costs of 138 basis points and increased advance rates from 70% to 80%. Next we executed a $200 million baby bond at five 3/4 to both redeem our existing 6.5% baby bonds and invest in our core strategies. And last, we closed $113 million non-mark-to-market warehouse facility to support our loan acquisition operations. These efforts to both increase the scale of the balance sheet to support growth in our operations and to pursue lower cost and more conservative financing will be accretive to earnings going forward.

I will now turn it over to Tom for closing remarks.

Thomas Capasse -- Chief Executive Officer

Thank you, Andrew. We continue to believe that our differentiated platform diversified across markets and across investments provides stability of earnings and output from our embedded operating companies.

With that, we'll now open up the line for questions.

Questions and Answers:

Operator

[Operator Instructions] Our first question comes from the line of Tim Hayes with BTIG. Please proceed with your question.

Tim Hayes -- BTIG -- Analyst

Hey, good morning guys. Congrats on another very strong quarter. Sounds like things are all trending in the right direction for you. Just as it relates to the PPP earnings, Andrew, it might be helpful, if you can just give us a little context of the scheduled recognizing those fees. Should we need -- is it kind of like a straight line recognition over a certain time period, is it going to be lumpy? And then as it relates to the carry on the loans on balance sheet, I think that was about like a 65 basis point gross spread. Is that how, I guess we'll have to net out some costs, maybe if you can just talk through the economics of that, how long do you think those level stay on balance sheet, that would be helpful.

Andrew Ahlborn, CPA -- Chief Financial Officer

Tim, yes, I think the majority of it is going to be accreted over four to six quarters. If you look at sort of the velocity of forgiveness from round one production, that should correlate into that sort of four to six quarter timeline. And in the recognition of the carry, which is the 65 basis points will be highly dependent upon how the portfolio moves. So, the earnings profile won't be straight lined, I think it will be a little choppy over the next four to six quarters, but that's the expectation of round one through the overwhelming majority of this income will be recognized.

Tim Hayes -- BTIG -- Analyst

Okay, got it. And then, last quarter you guys talked about that you've been targeting a 10% ROE for, I think ever since becoming a public company, maybe even before that, but last quarter you mentioned that your ROE target was a little bit higher than that. I don't think you put an exact number around it, but can you just give us an idea of the ROE you think you're able to achieve and whether the target is inclusive of the PPP economics that you'll be recognizing over the next 1.5 years or if -- do you have something in mind once you kind of get on the other end of that and no longer have that tailwind earnings?

Thomas Capasse -- Chief Executive Officer

Yes, I think, and Andrew, please step in, but when we're looking at a kind of a core ROE from our CRE, the more capital-intensive business, our SBC acquisition and origination business, high-singles. And then another 200-ish basis points of gain on sale income from the government sponsored operating secondary market companies we have there, the residential mortgage banking, the SBA and the Freddie Mac. So and Andrew, obviously you would add to that.

Andrew Ahlborn, CPA -- Chief Financial Officer

Yes, no, that's right. When I -- when we look at our outlook, our goal is to really grow our SBA 7(a) capabilities. That business requires very, very little equity. And so as we increase production there those returns are highly accretive on an ROE basis. So we're focused on putting -- investing in that platform. As Tom mentioned, we hired a several front end people this year and I think we'll continue to invest in the technology and front-end customer experience to make that a success.

Tim Hayes -- BTIG -- Analyst

Okay.So it sounds like still that maybe 10% to 11% range is what you should -- we should be targeting in a post PPP world.

Andrew Ahlborn, CPA -- Chief Financial Officer

Correct.

Tim Hayes -- BTIG -- Analyst

Okay. And then very strong SBC originations this quarter, record for you guys. How much of that was attributable to expanding the products that versus just your normal run out of -- run in the mill SBC loans that you've been originating since inception?

Thomas Capasse -- Chief Executive Officer

Well, a lot of it is that is kind of this bidding, been a number of secular shifts in the commercial real estate market relate -- obviously related to COVID. So what we did was we pivoted to target in particular multi-family and industrial sponsors, strong sponsors that otherwise would have opted for a stabilized loan. And instead, we were able to successfully sell them on the benefits of a bridge, such that it gives them time to increase occupancy rates that declined during COVID and then exit in 2022 with a much better stabilized loan and higher LTV and lower costs.

So that was part of -- that was -- and we designed a product around that, kind of a stabilizer bridge light. I'm sorry, yeah bridge light, if you will. So it was kind of a combination of our team targeting the demand from COVID and tweaking existing product lines to capture that business.

Tim Hayes -- BTIG -- Analyst

Okay, got it. I mean, did that weigh on -- I know that's -- maybe I don't know, how many of your originations this quarter were that origination like product, but was that -- is that collateralized by the CRE CLO? Are you still able to get the same ROE on that type of product? I imagine it's a little bit of a tighter spread there versus some of the other stuff you're doing, so just wondering how the ROEs there compared to the other SBC loans?

Thomas Capasse -- Chief Executive Officer

Yes, multi-family generally is a little bit tighter, may be 100, 50 to 100 on an ROE-adjusted basis, but with lower loss volatility. But I would say on a blended basis, and Andrew, correct me if I'm wrong, but the secondary market execution that we've been looking at and have executed this quarter, we're still pricing loans about 150 basis points higher ROE in that program than where we were pre-COVID.

Andrew Ahlborn, CPA -- Chief Financial Officer

And I would say, it compares favorably to the larger balance REITs where there's definitely been much more margin compression versus what we've seen in our lower-middle market space.

Tim Hayes -- BTIG -- Analyst

That's helpful. Thanks for taking my question this morning. I appreciate the color.

Andrew Ahlborn, CPA -- Chief Financial Officer

Thanks Tim.

Thomas Capasse -- Chief Executive Officer

Thanks Tim.

Operator

Our next question comes from the line of Steve Delaney with JMP Securities. Please proceed with your question.

Steve Delaney -- JMP Securities -- Analyst

Thanks. Hey good morning Tom and Andrew, congrats on the quarter, but also the Anworth deal, not a large -- not a huge transaction, but it really was in my mind, it was a brilliant capital play on your part. So thank you for helping to roll up the industry and strengthen your company in the process. So the thing about your company that I find interesting is that, we've been watching the large originators just get wiped out this week on higher rates competition, as soon as rocket loan depots everybody.

And you've got the same issues at GMFS despite the purchase focus, but the beauty is the diversification of your platform. You are not a pure play, if you will, on resi mortgage by any means. So, yesterday, we saw a mortgage REIT, a resi credit mortgage REIT by a specialty originator. I mean, I'm just curious if there any products out there, credit products lend themselves to securitization, which is your forte, and anything that you're not in today, that you might find of interest in whether adding another bolt-on platform is something that we might see over the next year or two to broaden your product line even further? Thank you.

Thomas Capasse -- Chief Executive Officer

Yeah, I mean, as you know Steve, we're always looking given our track record in acquisitions, we're always looking for accretive add bolt-ons. I think just look at the impact that Knight Capital, the small and secured business lockdown down in Florida backfired in third quarter, they get crushed it with a overlay of technology on our SBA business for PPP and now that's going to -- that investment will then be levered into more technology affinity based expansion of the SBA business.

So -- and it's similar in the commercial side, we're looking, I'd say two silos. One is, bolt-ons for the residential business run by Anuj Gupta who -- that would round out the agency component of it. So obviously I am looking at things like syndicated tax credits, but there is less competitive niches, that's one thing we're looking at. And then the other -- and we're also looking at the other aspect of our business, where true SBC small balance commercial which is $0.5 million to $5 million, we're looking at potentially going downstream to micro, which has a heavy weighting toward single-family commercial, providing credit SFR for example. And so that's within the commercial space.

And then on the more broaden that I would say the other two things we're looking at is continued expansion in Europe as the market recovers, because I remember we had a flow arrangement with the bridge lender in Ireland, which we're going to -- which we're reinstating. And other products, we're looking at manufactured housing as well, which is what we call the broad swath of resi-mercial, build a lot loans is another example. So yes, we are definitely looking with the strong liquidity position we have with Anworth, not just the capital that we have currently, but the additional ability to lever the -- from an unsecured standpoint, recourse debt on the incremental equity. We are definitely looking to redeploy into those two silos.

Steve Delaney -- JMP Securities -- Analyst

Great. Well, it sounds like, you've got a full widescreen out there of where the opportunities are. Thanks for that color Tom. I'm good.

Operator

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

Jade Rahmani -- KBW -- Analyst

Thank you very much. I was wondering on the dividend. If it's reasonable to expect a full quarter of $0.40 dividend to be declared?

Andrew Ahlborn, CPA -- Chief Financial Officer

Jade, I think the Board, as Tom mentioned earlier, is looking at the income from PPP to be distributed as part of our sort of normalized dividend run rate over the time that income is accreted. So I do -- based on that and the outlook in the rest of the business, I would say $0.40 is most likely the floor for the sort of go-forward dividend over the next few quarters. And then depending on how much of that PPP revenue is to reinvested back into the business to position ourselves in a good place for the future, that will drive moving off that $0.40. I think $0.40 is the floor, at least for now.

Jade Rahmani -- KBW -- Analyst

Thanks. And one commercial mortgage REIT that is also managed by company that manages BDCs declared a regular dividend and a supplemental dividend as their distributable earnings are running ahead of the current dividend, but given potential spread compression, I don't think they want to change the run rate dividends, so they introduce that distinguishing characteristic. Is that something you might consider?

Thomas Capasse -- Chief Executive Officer

I think...

Andrew Ahlborn, CPA -- Chief Financial Officer

Yeah I mean sort of -- yeah go ahead, Tom, I am sorry.

Thomas Capasse -- Chief Executive Officer

I was going to say in that case that's really more -- that's a single strategy CREIT and again, we're seeing definite margin compression in the larger up -- more upscale from us, kind of like $25 million plus bridge loans, and that's too an influx of private debt funds that had gotten wiped out during first quarter of last year that are coming back. So I think that's more tactical to keep the dividend to not have a situation where you have increase in a dividend, that you have to distribute and then reduce it because of margin, a more normalized core earnings that's lower due to the margin compression.

So we're not in that situation. As Andrew said, we're in a situation where we have sort of the earnings over four to eight quarters from PPP and we see a normalization and an increase in our other businesses, in particular the SBA and the continued deployment of the Anworth capital in the SBC business. So that's my view of that situation and how it does not apply to us.

Jade Rahmani -- KBW -- Analyst

Thanks. Just on credit, I know I noticed you said that the 60-day delinquency bucket or 60-day plus delinquencies were constant at 2.3%. Could you give us the percentage of loans in the CRE book on non-accrual and how that compared with last quarter? And any color on the percentage of loans that are in forbearance?

Thomas Capasse -- Chief Executive Officer

Andrew and Adam, can you?

Adam Zausmer -- Head of Credit Risk Management

Yes, this is Adam. So loans on forbearance, it's only 1.5% of our total CRE portfolio, I think just from a performance perspective, the loans that had been in forbearance about 85% plus remains current. And then the loans on accrual, it's less than 0.5%, loan accrual.

Jade Rahmani -- KBW -- Analyst

Thanks very much.

Thomas Capasse -- Chief Executive Officer

Thanks Jade.

Adam Zausmer -- Head of Credit Risk Management

Thanks Jade.

Operator

Our next question comes from the line of Stephen Laws with Raymond James. Please proceed with your question.

Stephen Laws -- Raymond James -- Analyst

Hi, good morning. Very nice quarter. I wanted to -- you covered a number of things. On the Anworth side, certainly quickly able to liquidate a lot of the agency securities. I do think they had a -- say SFR type portfolio down in South Florida, maybe some other assets. Can you talk about the non-agency things that came with Anworth, sorry, the non-MBS that came with Anworth and as well as your intention there on whether those assets are going to be sold or something you're looking to opportunistically grow?

Thomas Capasse -- Chief Executive Officer

Andrew, you can comment on the disposition measures. I would say that that portfolio is targeted for broader liquidation because of the excess demand we have in our core SBC and the ROE is available there. But the liquidity for those resi credit assets, given the strength of the housing market is very strong in terms of the potential bids. But Andrew, what's the current target for liquidation and the strategy there?

Andrew Ahlborn, CPA -- Chief Financial Officer

Yes, I mean, since quarter-end, we brought down the balance sheet quite a bit and what remains is roughly $200 million of the non-agency RMBS is the $100 million loan portfolio that you alluded to, as well as some OREO, that we're in the process of liquidating, that's around $25 million. So I think the plan is on the OREO to move out of that in short order, and then, on the rest of the RMBS and the loan book, to liquidate those in conjunction with redeployment.

And so, we'd suspect that happen sometime over the next two, three quarters, as we sort of reinvest not only to liquidity, we already generated on top of just our natural liquidity but the liquidity that will come off of those remaining assets. So I think it's quarterly liquidation through the end of the year.

Thomas Capasse -- Chief Executive Officer

But that's -- so that is liquidation and not something that we looked at.

Stephen Laws -- Raymond James -- Analyst

Okay. Steve touched on this a little bit around GMFS, but can you talk to April volumes there, how those have trended given the increase in mortgage rates and what you're seeing on the mortgage margin front, just given the news in that sector yesterday?

Andrew Ahlborn, CPA -- Chief Financial Officer

So originations in April remained above $300 million, so we haven't seen a drastic change in our monthly run rates. But, as Tom mentioned earlier, margins really are hanging in around pre-COVID levels.

Stephen Laws -- Raymond James -- Analyst

Great. Lastly, looking at page eight in your presentation, looks like the 60-plus day delinquency has declined quite a bit on the SBA segment, and I think the Q1 number probably doesn't have a lot of clue, but I'm not sure, how impact of that was and that was my question. Can you give us an idea of where that's trending, what's driving that improvement in the performance of those loans and that segment?

Adam Zausmer -- Head of Credit Risk Management

This is Adam Zausmer. So the second one is CARES Act payments started in February 2021, so SBA loans originated prior to the pandemic qualified with three months of payments and then, hotels and restaurants qualified brought the eight months of automatic payments up to a $9,000 a month. That's the majority of it. The SBA's really just keeping those loans current and then in addition, there is also some deferments in there as well.

Stephen Laws -- Raymond James -- Analyst

Great. Appreciate the comments there. Thanks for taking my questions this morning.

Operator

Our next question comes from the line of Christopher Nolan with Ladenburg Thalmann. Please proceed with your question.

Christopher Nolan -- Ladenburg Thalmann -- Analyst

Hey Tom, on your -- to follow-up on earlier question on the affinity program, is this sort of a strategic direction in terms of you trying to become more like one of the lending club or something, where let's say you're going down market to smaller loans and using technology like for apps and so forth for your advantage?

Thomas Capasse -- Chief Executive Officer

Yes, but in the context of the SBA. Yes, we continue to in a measured way do the smaller unsecured lending, but it's really not a material percentage of our total gross portfolio. Really what that's being applied to is the what we call the SBA small loan program, where the SBA allows you to use a credit score and accept more accelerated underwriting versus the larger loans. And that's, kind of the 150,000 to 500,000 targeted loan where it's typically not used for real estate its use more for equipment.

And so, based on that loan, so that -- that's how we're going to take our front-end technology and apply that to that program. So there is actually a private company called Smartbiz that does that. They do actually the micro loans below 150,000 but it's a little bit of applying that same lower customer acquisition cost and quicker underwriting decisioning to what you're referring to on the unsecured side.

Christopher Nolan -- Ladenburg Thalmann -- Analyst

Great. The new package to the loans and then just securitize like you would others, is that correct?

Thomas Capasse -- Chief Executive Officer

Yes, they go right into the SBA 7(a) pools. So our pools as opposed to being more less diversified because their real estate I think, Andrew, our average balance sales has been running what, 850,000, 900,000 in the SBA 7(a) space? This would have let's say, a third of the pool being smaller with loans with better diversification and more stable prepays, which might justify incremental premium increase in the secondary market.

Christopher Nolan -- Ladenburg Thalmann -- Analyst

And not to put too fine of a point on it, but is this sort of a pilot, I understand it's small. Is this sort of a pilot program to rollout for other sectors let's say, real estate and things like that or it's just really just a niche type of application?

Thomas Capasse -- Chief Executive Officer

It is obviously a niche within the context of the SBA program or the regulatory program, but that being said, we are looking, our Chief Operating Officer, Gary Taylor, his team are looking at -- with Adam, actually runs credit to roll this out to the commercial space as well.

Christopher Nolan -- Ladenburg Thalmann -- Analyst

And is this going to affect operating expenses much in terms of the rest of the 2021?

Andrew Ahlborn, CPA -- Chief Financial Officer

No, because there is not -- BSI from a hiring, may be a handful of specialists underwriters for maybe $0.5 million to $1 million, total incremental expense it -- the revenue would far outweigh the incremental expenses given the profit margins in the SBA business.

Christopher Nolan -- Ladenburg Thalmann -- Analyst

Great. Okay, that's it for me. Thank you.

Andrew Ahlborn, CPA -- Chief Financial Officer

Thanks Chris.

Operator

Our next question comes from the line of Matthew Howlett with B. Riley. Please proceed with your question.

Matthew Howlett -- B. Riley -- Analyst

Hey guys. Thanks for taking my questions. Just can you give a little more color on decision to retain more of the servicing strip on the SBA premium, what to expect going forward and what you're seeing in the market?

Thomas Capasse -- Chief Executive Officer

I'll let Andrew comment, but again from my perspective, it's -- we always said at some point that we're going to undertake as the SBA business achieves greater volumes and we have strong coverage of core ratings from our capital intensive SBC business, that we would look to extend the duration of our cash flow stream in the SBA business by -- so instead of selling let's say, the 13 point premium per 100 bp strip maybe sell at par for a 200 basis points strip.

And the other thing strategy though we also look at is in certain markets, the IO strip is valued at in terms of recapture, years to recapture at its mispriced, if there is excess concerns on prepayments that we don't agree with. And that's another way to capture from a overall valuation perspective to capture value in the business. I don't know, Andrew, if you would add to that but...

Andrew Ahlborn, CPA -- Chief Financial Officer

No.

Matthew Howlett -- B. Riley -- Analyst

Great. I appreciate that. And then just on the Freddie small balance outlook, I mean they're obviously doing affordability mission-driven stuff. Could you give some production guidance on that or outlook on how to think about that in terms of the rest of the year?

Thomas Capasse -- Chief Executive Officer

Yes, Adam, maybe -- because Adam manages that from a credit perspective. Adam, what are your views in terms of the Freddie outlook?

Adam Zausmer -- Head of Credit Risk Management

Yes, sure. Obviously demand for affordable housing United States remains extremely strong. There is certainly a lot of rate movement on the Freddie side. These are mission-driven targets to hit on their front, I mean we're continuing to ramp up and expectation is going to far exceed the 2020 production numbers, I think something north of $600 million in total SBO excuse me SBO origination is the target.

Matthew Howlett -- B. Riley -- Analyst

Do you have a target in terms of the league tables where are you, we could go, I mean just, so we're just taking a really -- to get going on in this business.

Adam Zausmer -- Head of Credit Risk Management

Yes, sure. From the seller servicer standpoint, we're certainly top five, between, I think we're probably closer to four today.

Thomas Capasse -- Chief Executive Officer

And over time, our goal would be top three, that's kind of the integrated term.

Matthew Howlett -- B. Riley -- Analyst

Great. That's all I have. Thanks a lot.

Operator

And our final question comes from the line of Christian Crispin Love with Piper Sandler. Please proceed with your question.

Christian Crispin Love -- Piper Sandler -- Analyst

Thanks. Good morning.We saw the preferred tender during the quarter, which was of course related to the Anworth merger. Do you have any interest to tender the other preferred that you assumed with the merger?

Thomas Capasse -- Chief Executive Officer

Yes, so the Series B and D are both redeemable now. I think when I look at the dividend there, they seem expensive compared to the rest of the capital stack and certainly compared to what -- where we're seeing other deals execute in the market recently. So, I do expect us to to look into refinance out sometime in the upcoming recent months.

Christian Crispin Love -- Piper Sandler -- Analyst

Okay. Thanks. That's helpful. And then, Andrew, I just want to clarify something that I thought I heard in the prepared remarks. Will future PPP fees all be in interest income rather than non-interest income as you've mentioned in past quarters or is it just that 65 bps spread that should be an interest income?

Andrew Ahlborn, CPA -- Chief Financial Officer

So given that we are accounting for these as low and the entire revenue stream will flow through interest income.

Christian Crispin Love -- Piper Sandler -- Analyst

Okay. Thank you. And that's different than how it was in the first round, correct?

Andrew Ahlborn, CPA -- Chief Financial Officer

Yes, the first round production or the income generated in the first half was treated as a sort of a service contract, so the fees were down in other income.

Christian Crispin Love -- Piper Sandler -- Analyst

Great. Thank you.

Operator

And with that, we reached the end of our question-and-answer session, and I would like to turn the call back over to Mr. Capasse for any closing remarks.

Thomas Capasse -- Chief Executive Officer

We are pleased with the strong quarter and the tailwinds we face going forward and look forward to next quarter's earnings call, and please reach out to management with any additional questions.

Operator

[Operator Closing Remarks]

Duration: 43 minutes

Call participants:

Andrew Ahlborn, CPA -- Chief Financial Officer

Thomas Capasse -- Chief Executive Officer

Adam Zausmer -- Head of Credit Risk Management

Tim Hayes -- BTIG -- Analyst

Steve Delaney -- JMP Securities -- Analyst

Jade Rahmani -- KBW -- Analyst

Stephen Laws -- Raymond James -- Analyst

Christopher Nolan -- Ladenburg Thalmann -- Analyst

Matthew Howlett -- B. Riley -- Analyst

Christian Crispin Love -- Piper Sandler -- Analyst

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