OREANDA-NEWS. Fitch Ratings has affirmed the Long-Term Issuer Default Ratings (IDRs) and senior unsecured note ratings of Ladder Capital Finance Holdings LLLP and Ladder Capital Finance Corporation, subsidiaries of Ladder Capital Corp (collectively Ladder), at 'BB'. The Rating Outlook is Stable. A full list of rating actions is at the end of this rating action commentary.

KEY RATING DRIVERS

IDRS AND SENIOR DEBT

The affirmations reflect Ladder's established platform as a commercial real estate (CRE) lender and investor; conservative underwriting culture; relatively stable core earnings as a result of reduced reliance on gain on sale income; a granular portfolio; continued adherence to a leverage target commensurate with the risk profile of its assets; and access to multiple sources of capital. Rating constraints include its less diversified business model focused on the CRE sector; a high proportion of secured, wholesale funding; reduced capital retention stemming from the parent company's REIT tax election effective Jan. 1, 2015; the absence of a track record as a standalone entity through a full credit cycle; and key man risk.

Triangle Business Model Intact

Fitch has a favorable view of Ladder's track record of originating conduit and balance sheet mortgage loans, purchasing investment grade CMBS, U. S. Agency and other securities, and acquiring net lease and other equity real estate as it provides business flexibility. The balance sheet continues to grow moderately, with total assets increasing to $6.0 billion as of June 30, 2016 from $5.9 billion as of Dec. 31, 2015 and $5.8 billion as of Dec. 31, 2014. With risk retention rules related to CMBS under the Dodd-Frank Act taking effect in December 2016, Ladder has indicated that it would be open to retaining risk in the new expected format, which could provide further opportunities for growth.

Granular Portfolio

Ladder was founded in October 2008 and has not yet managed through a full credit cycle. It has operated during multiple periods of market volatility without incurring credit losses since inception. Ladder's average loan-to-value ratios have remained relatively stable (64.9% on conduit first mortgage loans, 65.8% on balance sheet first mortgage loans and 73.7% on mezzanine and other CRE-related loans as of June 30, 2016) and low compared to other CRE finance peers, which Fitch views positively. In addition, the company's average loan balance was $17 million as of June 30, 2016, limiting individual loss exposures. However, lodging is currently Ladder's largest property type exposure (36% of loan balance as of June 30, 2016) and as noted in Fitch's 'U. S. Lodging Cycle Concierge' report dated Aug. 2, 2016, lodging fundamentals are decelerating and could turn negative next year, which could negatively impact hotel loan performance more broadly.

Diverse Access to Capital

Ladder remains reliant on wholesale funding sources, although there is growing diversity amongst Ladder's sources of capital. As of June 30, 2016, the company had five committed loan repurchase (repo) facilities, one committed and multiple uncommitted securities repo facilities, a corporate credit facility from numerous lending institutions, mortgage loan borrowings, borrowings from the Federal Home Loan Bank (FHLB), and access to unsecured notes and public equity.

During 2016, Ladder upsized its $75 million revolving credit facility to $143 million, replaced a $50 million credit agreement with a $100 million committed secured loan repo line maturing in 2019, upsized one of its loan repo lines from $35 million to $100 million and extended it through 2019 and upsized its outstanding committed securities repo lines to $400 million and extended that line through 2018.

Fitch notes the expected loss of FHLB membership by Ladder's captive insurance subsidiary effective February 2021 as an on-going funding consideration. While Ladder has multiple options at its disposal to either repay FHLB borrowings via securities sales or new debt arrangements, replacement funding is likely to be either shorter-term term (e. g., reverse repurchase facilities) or higher cost (e. g., additional unsecured notes), which could introduce additional funding and liquidity risk or pressures on profitability.

In the interim, Ladder has continued to take advantage of the low-cost funding afforded to FHLB borrowers, albeit only with maturities inside the 2021 expiration date. Interest rates on Ladder's captive insurance subsidiary's FHLB borrowings ranged from 0.38% to 2.74% as of June 30, 2016. Therefore, Fitch expects Ladder to continue accessing this capital source when financing certain first mortgage loans and investment grade CRE securities over the next several years in advance of the captive's loss of membership in February 2021. Fitch believes that Ladder's potential replacement of FHLB funding with repo borrowings would be a credit negative because it would increase liquidity risk, and conversely notes that a replacement of FHLB funding with long-term unsecured debt would be a credit positive as it would lessen liquidity risk, improve financial flexibility, and extend duration.

Leverage Increase Due to Increased Securities Exposure

Ladder varies its leverage depending on the risk profiles of and allocation levels to the various CRE asset classes in which it invests. Following the volatility in the credit markets in the first quarter of 2016, Ladder increased its exposure to 'AAA' and other investment grade rated CMBS securities, resulting in overall corporate debt to equity of 3.0x as of June 30, 2016, which is at the upper limit of the company's publicly articulated 2.0x-3.0x target.

Lower Reliance on Gain-on-Sale Income

Core earnings totalled $69.1 million during the first half of 2016 (1H16), down year-over-year from $100.2 million during the 1H15. The year-over-year decline is largely attributable to slowing CMBS activity leading to lower income from sales of securitized loans, lower gains on sales of securities, and net results from derivative transactions, partially offset by lower operating expenses. However, Fitch expects that gain on sale income will increase throughout the remainder of 2016 as Ladder has been building up its conduit loan portfolio for securitization contributions.

Core earnings to average equity was 9.3% in 1H16, down from 12.8% in 2015 and 16.3% in 2014; the decline was partially driven by a reduction in loan sale proceeds, including securitization profits.

Notably, the quality of Ladder's earnings has improved from a credit standpoint as net interest income after provisions represented 92.3% of net revenues in 1H16, up from 38.8% in 2015 and 36.6% in 2014. This meaningful increase was the result of a material decline in loan sale proceeds and gains on securities in 1H16 as well as net results from derivative transactions. Greater revenue diversity with reduced reliance on gain on sale income over a longer term period would be viewed favorably by Fitch.

Predominantly Secured Borrower, Adequate Liquidity

Ladder's secured debt represented 87.3% of total debt and 64.1% of total assets as of June 30, 2016, which limits financial flexibility. Unencumbered asset coverage of unsecured notes has remained stable following the company's August 2014 bond offering and was 1.4x as of June 30, 2016. Unencumbered assets and unrestricted cash totaled $776.3 million as of June 30, 2016.

As of June 30, 2016, Ladder had $1.0 billion of excess committed capacity under its debt facilities and its unencumbered pool could be pledged or liquidated (subject to applicable haircuts) to support unsecured debt repayment. Approximately $297.7 million of unsecured notes mature in October 2017.

Ladder's liquidity position remains constrained by its REIT tax election. Ladder is expected to retain a lower portion of core earnings when compared to the approximately 60% of core earnings retained prior to the REIT conversion. All else being equal, the REIT conversion increased after-tax core earnings because of a lower effective tax rate as a REIT, but this was somewhat offset by an increase in the company's annual cash dividend to $1.10 per share from $0 per share previously (in January 2016, the company also distributed its undistributed accumulated earnings and profits attributable to taxable periods prior to Jan. 1, 2015).

Key Man Risk

Key man risk is not unusual for mortgage REITs or similar finance companies. In Fitch's view, key man risk continues to reside with the Chief Executive Officer of Ladder. However, the company has a deep bench, and the six executive officers of the company average 27 years of CRE finance experience. The company elevated its former Chief Strategy Officer and General Counsel to Chief Operating Officer and its former Associate General Counsel to General Counsel in March 2016. Ladder's former Chief Investment Officer departed in 2015.

As of June 30, 2016, Ladder's named executive officers and directors held interests in the company comprising 11.9% of the company's total equity, aligning interests of management and shareholders.

RATING SENSITIVITIES

IDRS AND SENIOR DEBT

The following factors may have a positive impact on Ladder's ratings and/or Outlook:

--Greater revenue diversity with a sustained reduction in reliance on gain on sale income;

--Sustained profitability and asset quality performance through multiple market environments, while maintaining conservative leverage at the lower end of the 2.0x-3.0x target 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:

--A material reduction in long-term economic sources of funding;

--Material increase in exposure to more aggressively underwritten balance sheet loans or real estate equity investments without adequate reserves and commensurate decrease in leverage;

--A sustained increase in leverage beyond the company's articulated target;

--Sustained reduction in liquidity levels and/or unencumbered assets relative to outstanding unsecured debt;

--Sustained operating losses or material weakening of asset quality.

Fitch has affirmed the following ratings of Ladder Capital Finance Holdings LLLP and Ladder Capital Finance Corporation:

--Long-Term IDRs at 'BB';

--Senior unsecured notes at 'BB'.

The Rating Outlook is Stable.