Franklin BSP Realty Trust, Inc. (FBRT) Q4 2017 Earnings Report, Transcript and Summary

Hello everyone and welcome to the Capstead Mortgage Corporation Fourth Quarter 2017 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Lindsey Crabbe. Please go ahead.

Good morning. Thank you for attending Capstead's fourth quarter earnings conference call. The fourth quarter earnings release was issued yesterday, January 31st, and was posted on our website at www.capstead.com under the Investor Relations tab. The link to this webcast is also in the Investor Relations section of our website and an archive of the webcast will be available for 90 days. A replay of this call will be available through May 1st, 2018. Details of the replay are included in yesterday's release. With me today are Phil Reinsch, President and Chief Executive Officer; Robert Spears, Executive Vice President and Chief Investment Officer; and Lance Phillips, Senior Vice President and Chief Financial Officer. Before we get started, I want to remind you that some of today's comments could be considered forward-looking statements pursuant to the 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 the date of this call, February 1st, 2018. The company assumes no obligation to update any statement including any forward-looking statements made during this call. With that, I'll turn it over to Phil.

Good morning. Welcome everyone. I'll make a few brief comments and then we'll open the call up for questions. We reported EPS of $0.19 for the fourth quarter, up $0.06 from the third quarter. About $0.04 of this earnings improvement is attributable to higher net interest margins as a result of higher cash yields on our 100% adjustable rate portfolio and a 13% decline in mortgage prepayment activity. Together, these positives outpaced higher borrowing costs. We also benefited from the passage of tax reform, recording about $0.02 in alternative minimum tax refunds at are largely dormant taxable REIT subsidiary. Lastly, operating cost for our internally managed agency-only platform remain at industry-leading levels. While earnings were much improved this quarter, book value declined $0.31 to $10.25 per share as declines in portfolio valuations exceeded increases in unrealized gains on interest rates swaps held for hedging purposes. This was largely a function of shorter interest -- shorter term interest rates increasing considerably more than longer term rates during the quarter with two-year Treasury rates up 40 basis points, while tenure rates only increased eight. Given this drop, our stock price has traded at a considerable discount to book value in recent months. In response, we reactivated our $100 million stock repurchase program and repurchase 3.5 million shares in November and another $10 million worth in January. Together, approximately 101.5 million shares of our common stock was purchased or 1.6% of our outstanding shares. These actions provided a $0.01 of book value accretion in the fourth quarter and another $0.02 in 2018. We may continue to repurchase shares in the coming months depending upon market conditions including alternative capital investment opportunities. Note that since year end 10-year Treasury rates were higher by over 30 points, outpacing increases in two-year Treasury rates. Additionally, pricing for agency guaranteed ARM has been strong, such that thus far in 2018 changes in portfolio valuations have been relatively benign from a book value perspective and comparing quite favorably to portfolios containing a considerable amount of longer duration ARM or fixed rate investments. Regarding future earnings with upward trending mortgage interest rates, we anticipate that mortgage refinancing activity in 2018 will be less of a factor than has been in recent years, a potential positive for earnings. Aside from this important earnings driver, 2018 quarterly earnings will largely be a function of how aggressive the Federal Reserve raises the fed funds rate. With over half of our agency guaranteed ARM portfolio adjusting higher in coupon inside of the next 18 months, we should continue to see improving cash yields allowing for the potential recovery of financing spreads reduced by higher borrowing rates. For instance, as illustrated on the last page of our earnings press release, this currently resetting portion of our portfolio could reset higher in coupon by 50 basis points or so based primarily on six and 12 month interest rate indices in effect at year end. Importantly, these indices are considerably higher today than at year end and should continue to increase with higher short-term rates. In addition, we hold a sizable [Indiscernible] receipt variable swap book that helps mitigate the impact of higher borrowing rates, particularly as it relates to the rest of our portfolio that consists primarily of ARMs that are scheduled to reset and rate in between 18 and 60 months. In summary, our investment strategy of cost effectively managing the leverage portfolio of short duration agency guaranteed residential ARM securities seeks to generate attractive risk adjusted returns over the long-term. Key to our near-term success will be mortgage prepayment levels, the pace of future increases in short-term interest rates, and the shape of the yield curve. With that, I open the call up to questions.

Thanks. Good morning Phil and Robert and everyone. Thanks for taking the question. So, the buyback applaud the action by the Board, it certainly seems appropriate for the current market conditions. I'm just curious as you -- it looks like the fourth quarter you bought stock back at about 88% of book and then maybe here in the first quarter so far just roughly lower than that maybe 86% or so. I'm just curious Phil as the stock appears to be trading at about 80% -- well low 80s now a book, should we assume as we go into the first half of this year that if the share -- the price to book multiple continues to fall and lives down around 80%, should we expect the pace of the utilization of the buyback to pick up over the next couple of quarters? And I guess as part of that, the 10% authorization, is that something that you think the Board would revisit as far as increasing if we remain in this challenged environment for some time? Thanks.

So, we'll have to look in -- as far as where we go long-term, we'll have to evaluate that at the time and lot of it would be based on what we expect be happening in the ensuing quarters and how we can use our capital. The -- we bought back shares in November. December, our share price recovered somewhat, we didn’t really buy anything back and we did buy a lot of shares back in January. And our price for stock is weak right. We look at it from a trailing book value perspective and obviously what we can do at the capital at the time. So, you can probably expect to see a fair amount of buybacks in the coming period if our price continues to be--.

You certainly aren't alone in that situation given what we've seen in the group here in the last month or two. So, thanks for that color. Robert, on the prepays, obviously, a nice recovery in the fourth quarter. I think we were pretty close on expecting that around 22 or so. You -- last year y had a range of 22 to 26, I guess, something in that ballpark. We've got obviously much higher 30-year rates 50, 75 basis points higher than we saw the second half of last year. And I've heard you talk about burnout in the portfolio given that in terms of resets some of these things have now reset a couple of times, people have had opportunities. Could you give us any sort of thoughts about how you see the range of prepays over, say, the first half of 2017 would be helpful. Thank you.

Sure. If you look at generics in January, they dropped another -- in the ARM portfolio, they dropped another 5% or so from December. We expect that to continue to trend down over the next couple of months. And the low price should be in March before they start recovering to some degree. But like we said last year, we averaged around 24 CPR for the year. We're looking for lower price this year. There are a couple of -- the burnout story on season-post resets had been valid. Those bonds have dropped from the mid to high 20s to the low 20s. I would expect those over the next several months maybe to pick back up again because these borrowers are now are going to reset us another 50 basis points. But the initial shock of resetting 125 basis points is not there anymore. More of a story right now is our longer reset book that if you look at it, we have about 280 net coupon. So, those borrowers have about a 3.5% mortgage rate, 5.1 now increase in rates are up about 4.8 and a 30-year cost is up about 4.5. And so those borrowers for the longer term 5.1 rates hung around in a 3.38 to 3.58 range and then fixed rates were high 3s to 4-ish area. And so those guys had incentive to rebuy. In some cases either as a new ARM or a fixed rate mortgage, that's gone. So, if you look at the components of our book, you could easily see our longer reset securities trend down in the mid-teens, they were low to mid 20s last year and I would look at our post resets and shorter resets potentially being in the mid-20s area. And so it kind of flip-flop in where we are a year. So, hopefully that answers your question.

No, that's helpful. So, I mean something in the neighborhood knows it's just a -- ballpark in, but something maybe on a blended basis, something could -- sounds like it could say dip down to about 20% in that range give or take 1%, that's been reasonable?

That's going to plausible and realistic [Indiscernible] effort.

Okay. Well, thanks for the color guys. Appreciate it.

[Operator Instructions] And our next question comes from Eric Hagen with KBW. Please go ahead.

Thank you. Good morning. Just a follow-up on the buyback question that was very nice to see. How do buybacks potentially change your thoughts on just the overall size of the portfolio, I guess I'm speaking directly about leverage. Thanks.

Well, if we're going to keep the leverage at the levels we're at, you're not going to see much future earnings improvement coming out of the buyback. What you get is the book value creation and that's about it. So, if we can buy bonds that have reasonable returns in the financing market allows for it, such that we're not just redeploying capital from runoff that'll improve our earnings longer term. Obviously, with the exposure of running a little bit higher leverage whether we get there or not remains to be seen.

Got it. Thanks. It looks like the hedge ratio ticked down slightly from the end of last quarter. It was slight, so I don't want to make a humongous deal out of it, but is that just a timing difference on older swaps rolling off or are you guys seeing something out there that makes you more comfortable with fewer hedges relative to the size of your borrowings?

I think our duration gap moved out maybe half a month or something like that. A lot of that is just the inherent duration extension of our longer reset book. Having said that it is much more difficult right now to make a lot of sense of 5, for instance, 5.1s and swapping them out for spreads are fairly tight. And so we haven't lately done as much of that trade, but we still are going to keep our duration gap fairly short. I mean yes, so we went from, call it, just inside three months to 3.4 months. I wouldn't look for it to drift much longer than that.

Right. Okay, that's helpful. And then I feel like a broken record here with my third question, but you gave us some color on book value that was helpful. But can you just elaborate a little bit more on the price sensitivity since the end of the quarter for both current reset and longer reset ARMs? If you can also just address kind of what you were just talking about with the extension on the longer resets. Just given the move that we've seen in your Treasuries and LIBOR. Thanks.

Sure. Since year end, current market ARMs have tightened at decent amount on the REIT spread basis seven or eight and so far this year, they're trading shorter than their implied duration. And so generically, 5.1 are down about five eighth of a point right now. Those resets are pretty much unchanged. There's a strong bid for post reset paper. It's not uncommon in the first quarter to see ARMs tighten. So, they underperformed fixed rates in the fourth quarter. So far, they are substantially outperforming the fixed rates in the first quarter and also supply is extremely low as the yield curve flattened at the end of last year, originators weren't making as many ARMs. And so you look at going from third quarter where monthly volume was say 3 billion and the fourth quarter monthly new issue volume was around 2 billion. In the first quarter, it's going to be significantly lower than that. So, a combination of the curve steepening, lack of supply, and then underperformance of ARMs in the fourth quarter has basically combined to cause and perform very well first quarter this year -- in the first month this year I should say.

Great. Robert can you just give me a sense for kind of a realistic scenario that would really deliver a meaningful blow to the price of current reset ARM.

Well, you saw in the fourth quarter, for instance, short rates went up 40, 45 basis points and long rates only [went up 8]. And so ARM spread didn’t widen, but fixed rates tied in ARM spreads. So, the bonds traded a little longer than you would expect them to. So, if you just extrapolate a scenario like that or say short rates went up 75 and long rates went up 10, that would be a very bad scenario 5.1, 7.1, anything. That would be a bad scenario for [Indiscernible] as well. So, I think the fourth quarter kind of gives you a pretty good snapshot of an environment that is not favorable for ARMs. So, just expand on that and make a lot worse. And I think you kind of get there.

Yes, that's helpful. And I appreciate the comments as always.

Sure.

And there are no further questions. At this time, I'd like to turn the conference back over to Lindsay 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.