Franklin BSP Realty Trust, Inc. (FBRT) Q4 2015 Earnings Report, Transcript and Summary

Good morning. And welcome to the Capstead Mortgage Corporation Fourth Quarter 2015 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Lindsey Crabbe, Manager of Investor Relations. Please go ahead.

Good morning. Thanks for attending Capstead's fourth quarter earnings conference call. The fourth quarter earnings release was issued yesterday, January 27th, and is posted on our website at www.capstead.com under the IR tab. The link to this webcast is also in the Investor Relations section of our website, an archive of the webcast will be available for 60 days. A replay of this call will be available through April 28, 2016. Details for the replay are included in yesterday's release. With me today are Andy Jacobs, President and Chief Executive Officer; Phil Reinsch, Executive Vice President and Chief Financial Officer; and Robert Spears, Executive Vice President and Chief Investment Officer. Before we get started, I want to remind you that some of today's comments could be considered forward-looking statements pursuant to Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995, and are based on certain assumptions and expectations of management. For a detailed list of all the risk factors associated with our business, please refer to our filings with the SEC, which are available on our website. The information contained in this call is current only as of today, January, 28. The company assumes no obligation to update any statements, including any forward-looking statements made during this call. With that, I will turn the call over to Andy.

Thank you, Lindsey. Good morning everyone and welcome to our fourth quarter earnings call. Interest rates were quite volatile throughout 2016 as everyone knows and the fourth quarter is really no exception and after much anticipation throughout the year, finally the Federal Reserve increased its target Fed Funds right in December. And as a result the 10-year treasury moved higher by almost a quarter of a point during the quarter to close the year at 2.27%, while at the same time the two-year treasury was higher by 42 basis points, closing the year at 105. In a statement yesterday the FROMC stated that economic conditions will evolve in a manner that will want only gradual increases in the Fed Funds rate. Okay, so that’s - I guess that’s really not [indiscernible], but it’s slower than anticipated. As of today the Fed Fund futures are actually pricing them in about one more increase in 2016 and kind of slowing the pace of increases over the next three years following that. So that’s up higher [ph] to do for our business model, but as the Fed also said yesterday, the actual path of the Fed Fund rate will depend on the economic outlooks as informed by incoming data which is everybody fully understands that I know, what that means. So anyway, fourth quarter our net income totaled $28.4 million or $0.26 per common share compared to the third quarter where we had 21.1 million or $0.18 per common share and the improvement was primarily in our net interest margins. They improved 6.4 million to 33 million, as mortgage prepayments slowed considerably. Yield from our investment portfolio increased 20 basis points, 18 basis points of which was the result of lower premium amortization as prepayment on a CPR basis decreased to 19.6% from 23.2 CPR in the previous quarter. And as I’ve stated in previous calls, each full percentage point in CPR quarter-over-quarter it’s worth upward of about $1.5 million in quarterly premium amortization and that goes both ways. So 3.6 CPR decreased in the fourth quarter, represented the vast majority of the improvements we saw in net interest margin. Average cash yield on our portfolio benefited as coupon interest rates on a portion of our portfolio, underlining our securities reset higher. Most of these loans reset annually based on interest rates such as 12-month LIBOR, which itself increased nearly 33 basis points during the fourth quarter, so another positive. And if you look on page 13 in our press release, what’s demonstrated there is a sizable portion of our portfolio is scheduled to reset in rate at least once over the next 18 months potentially resulting in higher yield on this portion of our portfolio as if they were based on the interest rates that were [indiscernible] at the end of 2015. A 4 basis point increase in our borrowing rate offset the improvement as just discussed on our cash yield. The increase in borrowing rates was widely attributable to market conditions, primarily the Fed Funds increase in mid December. Now, in addition to the adjusted rate nature of our investment portfolio, our exposure to writing short-term interest rates relative to our borrowing comp is further mitigated by the use of two-year swap agreement and longer maturity secured borrowings. And just to be - trying to be clear here, so excluding $1.7 billion notional amount of swap set that you see in the gross number in our statement, but excluding $1.7 billion that expired in the first week of January, we hold $6.7 billion notional amount of two-years swap agreement with maturities between now and the first quarter of 2018 and we hold about $1.5 billion in secured borrowings with remaining maturities of greater than six months with a weighted average remaining maturity of eight months. In August 2015, we began supplementing our borrowings under repurchase agreements with advances from the Federal Home Loan Bank of Cincinnati, through a captive insurer that we created and as of December 31 we had total advances of 2.88 billion. Much to our disappointment, earlier this year the Federal Housing Finance Agency the FHFA, the regulator of the Federal Home Loan Bank System finalized rules originally proposed in 2014 that generally precluded captive insurers, which is what we had created from remaining members in the system, with transition rules they will require outstanding advances to be repaid upon maturity or by February 2017, so basically a year. In response to this finalized ruling, we have already, at this point, reduced our exposure to that Federal Home Loan Bank System by 1.58billion to where now we have 1.3 billion remaining with the system as of yesterday’s earnings announcement and anticipate migrating the remainder of this over the course of the year. All in all, market conditions in the repo markets have been supportive of this and this transition was financing for agency-guaranteed, mortgage-backed security, while available at a very attractive and reasonable rates. Regarding our portfolio, our book value declined 4.5% during the quarter driven by a $0.78 reduction in the value of our investment portfolio partially offset by about $0.24 improvement in the value of our interest rate swap agreement held for hedging purposes. During the quarter we increased our investment portfolio to 14.2 billion, which together with the net $0.54 decline in book value just discussed resulted in an increase in our leverage ratio to 9.28 times, our long-term investment capital. As we’ve said before we are comfortable with this level of leverage given the current health and breathe of the financing market for agency-guaranteed mortgaged securities and the composition - our short duration composition of our portfolio. The duration of our portfolio remains one of the lowest in the industry, on the asset side our duration is at 11.34 months and after considering an eight-month duration on related borrowings, our net duration on our investment portfolio is only three and three quarters a month. Now, everybody knows, so far in 2016 it has been quite a volatile market of just about anything in the stock market and it has been difficult, very difficult market for the monitory, one of the reasons is –because of the proposed ruling by the FHFA regarding the captive insurance. Our stock price - as a result of a lot of things, our stock prices recently traded below $0.75 based on our book value at year-end, which we believe represents an attractive investment opportunity. In response our Board authorized yesterday the repurchase of up to $100 million of common stock provided the capital was available and if not needed for liquidity purpose and can be advantageously deployed into stock/share repurchases. I want to remind everybody that we are internally managed, so we are not completed as many of our externally managed peers maybe and additionally management hold the meaningful stake in the company’s stock. So you can be confident that we’ll be focused on what is in best interest of our shareholders. And with that, I will open it up for questions.

We will now begin the question and answer session. [Operator Instruction] The first question comes from Joel Houck of Wells Fargo. Please go ahead

Good morning guys, thank you for taking the questions. So prepayments speeds came in as you guys guided to, I guess I’m wondering if you could talk about or reconcile the decline in book value for the quarter because on a fundamental basis it would seem that lower prepay speeds would serve as a buffer to your securities and in particular given the short duration of your assets, it’s a little perplexing to see 4.5% decline, so is this something technical with your assets that occurred in the fourth quarter or is there something we are missing from the fundamental perspective.

No, Joel– I mean that was basically in the fourth quarter, the curve flattened and short rates went up, you saw two-year treasury go up over 40 basis points, one- year LIBOR was up 35 and so our short reset will have some duration and so if you look at our very short resets they probably have a duration of little over half a year. What happened in the fourth quarter on a - our short resets position lost about three eighth of a point, our longer resets securities lost closer to a point. If you look at that versus our duration you would have expected it to be a little less than that, but probably close to a quarter of a point that was due to spread widening, which happened pretty much at the end of the third quarter, early fourth quarter and then it just kind of started from there. So you never really saw much moment between early in the fourth quarter - till the end of the fourth quarter, so it was the combination of short rates going up and spreads on ARMs widening by 10 basis points.

Okay, that’s helpful and then as a follow-up, you know, we think kind of expectations for rate increases coming down here in the first several weeks of 2016 is there some improvement if you will, given what’s happened with the front end of the forward curve in terms of your assets.

Yes, sure I mean security prices generically are up, if you look at just the ARM portion shot reset paper, it’s pretty much unchanged as you go out to new issue 51they are up a little more than half a point in price, if you out to new issue 71, they are up about three quarters of a point in price. So pretty much hierarchical, if you look at short resets kind of unchanged and that 51up a little more than half a point you can kind of extrapolate it between and see where our security prices are heading right now, but yes they’re upon the year.

Okay, thank you and on stock repurchase authorization, I mean obviously you have given your new book value; you’re still below 75%. I’m not sure, if that’s - there is a reason here as to I can’t remember the stock being that big of a discount to book. How should we think about modeling share repurchases, is this something to think about you know ratable amount each quarter over the year or is there potentially increased stock repurchases and in at what point would you suspend stock repurchases on a valuation basis.

So the Board authorized the $100 million depending on how all that works I mean later in the year you could do something else that was appropriate. But from the standpoint of - we haven’t seen and I think your analyst community, we haven’t seen book values relative - trading relative to book value at this level in a very long time, probably some of our peers, newer peers have never seen it trading anywhere near this level, but we have long time ago though, but you know so the question would be with the results and - be in the Federal reserve is going to be relatively measured and gradual in the way they - we perceived this year with interest rates, which I think is a positive for the nature of our business, the question will be if what impact will that have relative to our stock price. And with that volume back we could - we could be back in - back towards normally where we traded over the last few years be it $0.90 and $1 dollar or whatever, but it is all relative of where our stock is trading and how big the discount is versus what are the opportunities to buy attractively priced mortgage securities in our day-to-day acquisition are - just keep in touch with the market, but at this level when it is trading in the low 70s, it is really hard to compete for - with mortgage securities the better investment is to repurchase your shares, so we will be looking at that, but we see a good profit in stock market in our stock and we are going to be in a position to where we’ll definitely pull back a little bit of that as we see appropriate, but just like what I said because we are internally managed it is - we are not incentive to maintain our platform at a certain size, it doesn’t impact our compensation in any way from that standpoint and so where we can be very measured and we are going to do what is in the best interests of the shareholders and that’s what you should be able to take from this. We are going to shareholders it is going to be the best interest of our shareholders.

All right thank you guys.

[Operator instructions] The next question comes from Steve DeLaney at JMP Securities, please go ahead.

Good morning everyone thanks for taking the question. So Andy, the FHFA news you know while may be not surprising outcome, it is certainly was disappointing in terms of the lost opportunity for the industry. I’m curious is as you guys - you’re up - it is good to see you are having success moving the collateral back to the street, but can you give us some sense of economically, I call that a lost opportunity, what would it mean for, say an annual earnings if you had been able to keep to say $3 billion of financing with the Home Loan Bank versus repo can you make an estimate of what the EPS impact just roughly the benefit might have been if you had that funding.

Well, I mean it is hard to say - this is Robert

Hey, Rob.

Obviously the financing at the Home Loan Bank was attractive, but you can’t really model that, you don’t know if that spread would’ve stayed constant and I don’t think we would have had much more than 3 billion on anyway. I think if you just kind of said that if it is essentially was say maybe 10, 15 basis points or something like down 3 billion, but you don’t know because its price loss of their agency debentures and you don’t really know where that is going. Having said that, it wasn’t a problem at all to move the repo back to dealers because if you think about it we moved it away from them in the first place and we still have dealers wanting more collateral. And so we really didn’t - other than the lost opportunity we didn’t pay a penalty to move it back, I mean we are pretty much generically repoing our collateral in the low 60s and we did pay a premium to move it back and we still have excess capacity and so we are not concerned. So it is kind of your know the focus on what might have been or what will be or whatever we’re just happy that we are able to and make a little extra money for a few months and then we had a seamless transition moving it back.

Yeah, we are back to where we were six months ago when we didn’t - before we became a member we just did the same thing we did it before. So it is kind of ordinary course of business from that standpoint.

Right, that’s helpful and Andy as far as the next step, I mean Merva [ph] made it pretty clear that this was Congress’s decision and he actually in his FAQ along with the rule made some I thought constructive comments about the role of mortgage rates do you guys as a industry, do you have any type of bolus organization in place to begin or lobbying effort in Congress on this.

We obviously communicate with the guys on the Capitol Hill and from a regulatory side and we are very confident from the standpoint of what the mission of the Federal Home Loan Bank system we set that very well. Then we have to - we created that captive to gain membership is I know it is little odd as it seems like we make sense for Congress to at some point and hopefully not to just in the future to make a change to where they have been because of the mission that we had brought in with the rest of the guys. But it is an election year, there is not a lot going to - not going to be happening in DC, you hit a lot of snow here and there.

Understood, but it would be reasonably to think that at least that attempt will be made when the time is when you can get the attention of somebody on Capitol Hill.

Yeah.

Okay and just to follow up on Joel’s question on the buyback. Let’s say you guys just I’m thinking back to ‘05, ‘06, hard to believe that we’re talking to each other back that long ago, but back then you sort of put the portfolio in run-off and you’re pretty active buying back stocks. I mean would one approach simply be just to say okay, we have already got leveraged at 9.3, maybe that’s we should be go much higher would it make sense that you just not reinvest say the 800 and some million in the fourth quarter and just use the capital freed up and let the pace of the buyback sort of follow the run-off of the portfolio. So provided that your stocks stays down here below the 75% above.

Yeah, Steve that is a good point I think we are not looking to increase leveraged from here and so obviously for buying back stock the - if you keep leverage constant or lower either sell bonds or let the portfolio run-off and in all likelihood we are looking at probably letting the portfolio run off and looking at it on a monthly basis and as that going time whereas our stock trading and where we can buy bonds and making a decision at that point, but I don’t think we are going to push the lever - we are not going to push leverage higher, so it is probably a run-off of the portfolio.

That is good. Okay and should I assume something roughly around 5% as the capital that’s freed up or sort of equal to the fare cut, does that make sense

On run-off, yeah there are fare cuts that are little lower than that, it’s close to that.

Yeah, and run-off I mean we are at the lower end of our run-off range but it is been running closer 250 million lately, but on an average it’s over I think 250 million, 300 million, call it 275 million and you can kind of back in to the map from there what’s the potential purchases would be on the stock back.

Okay thanks guys. That is very helpful color to this today appreciate it.

Thanks, you are welcome.

The next question comes from Eric Hagen of KWB, please go ahead.

Hey guys, good morning this is Bose George actually, how are you?

Hi Bose.

Just a quick follow-up on buyback just can you discuss your thoughts on just on the buybacks versus other concerns like liquidity of the shares et cetera, just trying to think about how much you could end up potentially buying if shares remain - it bit remains attractive.

You have regulatory limitations as to how you buy shares and when you can be in the market towards the beginning of the day or two at the end of the day and you have limitation that generally are basically 25% of previous trading volume measured. I think with the SEC, they measured like over the previous four weeks, so you’re limitation - we’ve been trading between 900 and a million shares a day, so on a daily basis we have somewhere 250 plus or minus thousand shares on a daily basis. And so that we got a buyback and it is just like what Robert was talking about is to portfolio run-off and not wanting to increase leveraged, so all of that you just have to keep it kind of its balanced and in your success with that. And our success is also measured by where our - how much our stock price runs up in here which we’d like to see, but we could do - we could probably turn a 50,000 shares a day and as long as the stock price is down at these levels we definitely would be trying to take some of those shares.

Yeah, Bose we had 90 - this is Phil, we have little over 95 million shares outstanding and 100 million of at these pricing levels or little higher would be equivalent to about 12% of our outstanding shares so we still have a pretty sizeable market cap if we had implemented 400 million buyback.

Okay, makes sense thanks a lot guys

This concludes our question-and-answer session. I would now like to turn the conference back over to Ms. Crabbe for any closing remarks.

Thanks again for joining us today. If you have further questions, please give us a call. We look forward to speaking with you next quarter.

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.