Rithm Property Trust Inc. (RPT) Q2 2018 Earnings Report, Transcript and Summary

Good afternoon, everyone, and welcome to the Great Ajax Corporation Second Quarter 2018 Financial Results Conference Call. [Operator Instructions]. Please also note, today's event is being recorded. At this time, I'd like to turn the conference call over to Mr. Lawrence Mendelsohn, CEO. Sir, please go ahead.

Thank you very much. Thank you, everybody, for joining us on the Great Ajax Second Quarter Conference Call. Before we get started, I just want to point everybody to Page 2 in the presentation, the Safe Harbor disclosure about future statements. And with that, I'll get started on Page 3. We had a very successful value-building quarter. We bought loans at good prices. We expanded our loan seller base. We created $220 million of coinvestments with institutional partners, including executing two securitizations at very good, well, better-than-market outcomes. Closed - we also closed the second stage of our investment in our servicer, Gregory Funding, and we, most importantly, increased our net interest margin. Other than some expected REO impairments that we talked about last quarter and we'll talk about again this quarter, the quarter was all positive. With that, on Page 3, you'll see that we closed six transactions in Q2 that does not include 2018-A and 2018-B securitizations we did with institutional partners. If you add that in, it's significantly larger, and we'll talk about that in a few minutes. But our sourcing networks is really important. You'll also see that in our subsequent events how many different transactions are coming in Q3 from a number of different sellers - new sellers. Our sourcing network allows us to find loans we want in the locations we want and at the prices we pay relative to others. We couldn't do what we do if we didn't have such a broad and diverse sourcing base. And we certainly couldn't do the number of transactions and the smaller transactions that we do. We keep growing our analytics group. We analyze, it seems like, infinite - this large amount of data to determine target loan characteristics and to develop pattern recognition algorithms for these loans that we're looking for. This helps drive both the acquisition strategies, but it also helps drive the servicing strategies that we use, and you'll see that - the success of that in our migration charts later in this presentation. I mentioned about our servicer. We now own 8% of our servicer, Gregory Funding. We have warrants on another 12%. We closed the second part of that transaction in late May. We think the servicer has significant value optionality. And as a result, the warrants were extremely important to our outside directors as part of the negotiations. And we think the optionality, especially given the growth of our institutional coinvestment partners, we think that optionality is sooner rather than later. We use moderate nonmark-to-market leverage. And for the second quarter in a row, our leverage actually decreased versus both Q1 '17 - or Q1 '18 and Q4 '17. If we jump to Page 4, our quarter highlights. Outside of the coinvestments with our institutional partners, we bought about $15 million of RPLs. Purchase price of UPB was about $92 million. The purchase price of property value was about $57 million, a pretty good weighted average coupon in good locations, and we're excited to have those. Interest income was up. Considerably, net income of $7.5 million and earnings per share of $0.40. There's several important pieces to understand in the per share earnings map of Q2: First, and probably the most important piece, we increased our net interest margin as cash flow velocity on the loans accelerated materially. This increased loan yields despite an average loan - a lower average loan balance during the quarter. On the flip side, you'll also see a small uptick in interest expense, smaller than the increase in interest income. The higher interest expense resulted from accelerating the amortization of deferred issuance costs of our securitized debt as a result of the higher cash flow on the loans. The more - the faster you get cash around the loans, the shorter the bonds are outstanding. And as a result, you have to amortize the underwriting fees and legal fees and other related issuance costs faster. So the increase in interest expense came from the paydown of these more - or the faster paydown of the related debt rather than rate increases on debt, which is a little bit different than the marketplace. Second, our quarterly REO impairment was approximately $0.04 a share. As we've mentioned on previous quarterly calls, REO impairment happens, first, under GAAP; and sales gains happen second. Our REO portfolio continues to have expected future gains net. Additionally, when we look at NPLs, any foreclosure that results in a third-party property sale, and we had a large number of those in the quarter, rather than REO, is accounted for as a loan pay-off in loan full accounting for GAAP and does not offset any REO impairment in our financial statements. Approximately half of the REO impairment comes from a single property in Western Passaic County, New Jersey. The interior of the property seems to have been purposely impacted during the resolution time line. Third, and this is a little bit different, we received less Home Affordability Modification program, or HAMP, related fees in Q2 by $0.01 to $0.02 per share. This isn't a permanent change. It merely reflects that HAMP pays us when HAMP pays us. We don't get to accrue HAMP fees. HAMP fees continue to grow, but the HAMP administrator pays the - when the HAMP administrator pays us. We don't get to choose. Altogether, with normalized REO impairment, our $0.40 a share approximately $0.44 to $0.45 a share taking out the REO and putting in normal HAMP numbers. Cash collections were $56.5 million during the quarter. And if you think about how much money that actually is relative to our portfolio, when - if you were to annualize that number, it's about 20% of our entire basis in our portfolio, which is a very large number. And as you might imagine, that pays down debt quickly. At quarter end, we had $34.7 million of cash. As of a few days ago, as of Friday, we had $46 million of cash. So cash flow at the portfolio has continued on into this quarter as well. Ending quarter leverage ratios asset level is 2.76. It's 2.8 here because one decimal place was 2.76 down from the previous quarter and down from the quarter before that. I'd mention that we bought the second stage of our interest in our servicer, Gregory Funding, and also the second stage of warrants, so we now own 8% of the servicer and have warrants exercisable for an additional 12%. In April and in late June, we did two joint investments with institutional third parties. We acquired in - the 2018-A transaction, which happened at the end of April, 9.36% of all the classes, and we also serviced the assets in - or the operating partner. The 2018-A transaction was primarily RPLs. The senior bond was done at 80% of UPB at 3.85% coupon issued at par with no step-up in coupons for the life of the transaction. It closed in late April. One of the interesting things about it is, when it closed in late April, and this goes back to kind of how much faith institutional investors have with us are institutional coinvestors, 90% of the structure, when it closed, was set up as a prefunding account for loan purchases to occur and close in the month of May. So when we closed that transaction, it was only 10% loans going into it on day one at the end of April and 90% to be bought during the month of May. Again, 80% of UPB is 3.85% at par, no step-up. Our 2018-B transaction, which closed the last week of June, is 88% NPLs, 12% RPLs, about $95 million of UPB. The senior bond, keeping in mind, this is an NPL transaction primarily, is 70% of UPB at 3.75% coupon also issued at par and also with no step-up for the life of the transaction. So again, significantly better than market executions, and so a good show of the faith that our institutional coinvestors have in us and our ability to post good outcomes with loans. On Page 5, you can see our portfolio. This does not include those two second quarter institutional third-party joint ventures. You can see, RPLs are about 96.8% of our portfolio, and NPL's about 3.2%, keeping in mind, that we acquired 20% interest in about $95 million of NPLs in late June. On the REO side, you'll see that REO is $25.5 million at the end of the quarter. REO is principally held for sale and turns into cash over a relatively short period of time. At June 30, we had 14 rentals, primarily multiunit, including a 32-unit multifamily property in Phoenix that we purchased. We also purchased in July, we'll see that later in the presentation, a 10-unit multifamily property in Miami. On Page 6, this will show the reperforming loans. One - a couple things to keep in mind. One is purchase prices on reperforming loans. If you look from June of 2015 to June of 2018, our purchase price relative to property value is down from 69% to 62%. We continue to buy lower LTV loans with overall - with the overall RPL purchase price representing 62% of property value and approximately 84% of UPB. The price per property value does not include any HPA since acquisition. Basically, we continue to play offense and defense at the same time. What we found is lower LTV loans, and especially those with higher absolute dollars of equity, tend to perform better over time and have more predictable, better financeable cash flows. On our NPL portfolio, our purchased NPLs have been declining in absolute dollars, although, as I previously mentioned, we acquired with institutional investors approximately $100 million of NPLs in an 80-20 structure in late June. In the second quarter, we had 48 foreclosures, of which 21 properties sold to third-parties. So I've mentioned property selling to third-parties in foreclosure sales, and those go through loan accounting as if they are payoffs on loans, not sales of real estate. So they don't offset any real estate impairment. And that's how we get GAAP accounted. 27 properties became REO, and we sold 34 properties in the second quarter. For the NPL portfolio, the purchase price to property value is about 52.6%. As you might imagine, higher LTV NPLs become REO sooner, and lower LTV NPLs become REO later or are more likely to become RPLs. Page 8. Our markets have not changed that much. 80% of the portfolio was still in our target markets. California continues to represent the largest segment of our portfolio, primarily Los Angeles, Orange and San Diego counties. We're seeing consistent payment performance patterns in those markets, particularly in California urban centers. California still represents approximately 28% of our portfolio, of which 75% of that is in Southern California. Page 9 is my favorite page. It's really kind of an exhibition of kind of, what I'll call, value creation. Right now, we have about $1.02 billion of loans that are 12 for 12 or better, up approximately $70 million from first quarter and $370 million from December. About $1.12 billion of 7 or 7 or better for the loans that we buy. And the way our servicer manage these loans, our loan data shows that once the loan becomes 7 for 7, there's a 91% chance that it becomes 12 for 12. And that's a big value difference. Once a loan becomes 12 for 12, it also changes the financing ability and makes it very easy to put into a rated yield structure, which also lowers financing costs. In addition to increasing cash flow and net asset value, the significant outperformance of loans also lowers asset base cost of the funds. We've seen from our a December 2017 securitizations and from our two in second quarter of 2018 that our loan cash flow velocity enables us to push advance rate up and lower costs on the actual financing. While our total average debt cost increased in Q2, it was driven by the cash flow velocity of the loans, causing more rapid amortization of issuance costs rather than rate. On subsequent events, there's a couple things I want to point out. Number one is if you look at the price value to collateral value in all the different parts of acquisitions closed or acquisitions under contract, you're going to see numbers that start with 4s and 5s as opposed to numbers that start with 7s, 8s and 9s, which is what you see in other places. We're continuing the pattern of low LTV loans and low purchase price to property value throughout our portfolio. And if you look at the SBC loans that we bought $7.2 million so far this quarter and we have another $9.5 million that should close in the next week or two, those are loans that have rates in the high 9s. And if you look at our SBC loans originated, those are loans in Long Beach California for acquisition bridge financing and renovation of small, urban multifamily units. So again, a lot of different transactions from a lot of different sellers at attractive good yield prices. Additionally, you can see SBC purchase property. We bought a 10-unit apartment building in the Wynwood neighborhood of Miami at the very end of July. We have dividend of $0.30 payable on August 30, 2018, to our stockholders of record of August 15, 2018. One thing I'll go back to, taxable income was $0.35. Last quarter, it was $0.37. In REIT land, you have to pay 90% of your taxable income. So our dividend at $0.30 for each quarter. If the taxable income were to continue with the same pattern, that has positive implications for dividends later this year. On the financial metrics, I'm going to go through Page 11, which is easier to understand than Page 12. Page 11 is not consolidating our 2017-D transaction that we own 50-50 with a third-party institutional investor. And Page 12 is the consolidated, which is harder to understand. A couple things to point out. One is average loan yield increased materially from 8.6% to 8.9%. Continuing materially increasing cash flow velocity on the loans is good for yield, and it's also good for NAV creation. Average asset-level debt cost, you'll see, also increased as - interest margin. But remember, the debt cost increased because the increased cash on the loans causes to pay down debt quickly, more rapidly than immediately forecasted. And as a result, we take more issuance costs than we amortize them more quickly and not by rate increases. If you look at return on average equity net of impairments of REO, it's 11.5%, up from 10.1%, keeping in mind that our leverage has gone down from 2.9% at the end of the year to 2.8% to now 2.76%. So the ROE going up while the leverage going down is a positive development as well. And quarter ending leverage is lower. We have a lot of leverage capacity, as you might imagine, when you pay down senior debt very quickly. It gives you - it deleverages your portfolio. But it also - at call dates. And our 2016 securitizations are either already callable or soon to be callable. And we would expect that we'd be able to reissue securitizations back by those loans at lower rates than our 2016 transactions, lower all-in deals and better advance rates as well. Our financial statements are on Page 13 and 14 and - which you can go through. At this point, I'm happy to open it up to any questions anybody might have.

[Operator Instructions]. Our first question today comes from Tim Hayes from B. Riley FBR.

First question, the UPB of loans committed to the JVs this quarter just kind of looks a little bit lower than expected - or than I expected. Just - I know some loans are going to be kicked out, but it just seems more than usual. Am I wrong with that assumption?

No, no.

But if not, kind of what happened there?

In the April transaction, originally, it was going to be about $30 million more loan - $30 million UPB more than that. And when we did the due diligence and went to look at all the houses, we came to the conclusion that the seller wasn't necessarily completely upfront with the evaluations.

I'd love to see that.

So it goes - and it's one of those things where it goes back to nobody cares like the people whose money it is. You have to go look at the houses.

All right, okay. And so was there an earnings headwind to this quarter just from the kind of expenses incurred from the diligence you did on those loans versus not actually earning any interest on them?

Yes. I mean, it wasn't as bad as it would've been had we been 100% owner of those loan versus had third-party coinvestors with those loans. But we did have costs related to those loans that we paid our share for loans that never happened, yes.

Got it, okay. And you mentioned that your taxable income is tracking well ahead of the dividend at this point. And it seems like cash flows and foreclosures, both of which triggered taxable earnings, should be going up. Just what do you feel you need to see before raising the dividend? Is it just kind of getting another quarter under your belt to see how 3Q shakes it out before saying, are we really going to do this? Or what else are you looking to see?

Yes, taxable income is a little harder to predict because timing of things, the date things occur matter, like the dates of foreclosure or the dates of a reinstatement, things like that, or dates of a modification. But I think if third quarter comes in as a similar taxable income level, which we don't have a reason to believe it would be materially different, I think that would be a likely decision-making point regarding the dividend.

Okay. And would you ideally be looking to pay out closer to 90% of taxable or closer to 100%?

Obviously, not less than 90%. I don't think our board will be prepared to pay 100%. But obviously, not less than 90%.

Okay. And then my last question here. I know you guys had a board meeting in July. Just wondering if there were any main takeaways there. Were there - were you given the green light to pursue any strategic alternatives or vice versa?

It was a long board meeting. The answer is yes on a number of different fronts. One is they want us to pursue growing our urban mixed-use and small multifamily property portfolio. They look at it almost like single family to rent, but more scalable because of density in specific urban locations. And those locations match up with great overlap over the locations of our residential portfolio already. So we have intimate knowledge of those spots, and we have feet on the ground that - and a lot of data to drive the particular kind of neighborhoods and blocks within the neighborhood. So they would like us to grow that part of our business. They like the securitization executions and like our coinvestments with our institutional partners, who also are large bond investors in securitization markets as well. And we've - a couple of additional institutions have seen those transactions and reached out to us kind of out of the blue about joining in and growing that part of our transactional business as well. Keeping in mind that, that was one of the reasons - demand for that structure from institutional investors is one of the reasons why our board insisted that before permitting it, they wanted to own a piece of our servicer with optionality through the warrants. They - we also had discussions about kind of the REIT market in general, REIT structures and the way REITs trade and have looked at maybe in the open market buying some shares of either public or private REITs that we think are at significant discounts to the asset values.

Okay. Yes, that's a lot that you guys talked about, I'm sure. And so at...

Yes. The other thing that we talked about is we spent a lot of time talking about the New tax code and the opportunity zone pieces of the new tax rate and investments and potential investments for being able to source some assets a little less expensively because of the tax advantages to a seller because of opportunity-zoned entity structures, and the board authorized us to set up an opportunity zone entity underneath the Great Ajax operating partnership as well.

I'm sorry, can you just repeat that last sentence? I kind of just cut off a little bit.

Yes, yes. The board has authorized us - actually, told us to go set up an entity underneath Great Ajax operating partnership for investments in tax advantaged opportunity zones as - which would also give us the ability to be able to source some properties cheaper because sellers have significant tax advantages both from the sale of their property and from partnership units in an opportunity zone.

Okay, understood. And - but did - is it safe to say at this point that Great Ajax is not pursuing a C Corp conversion?

We're not pursuing it at this time. I think our board wants to see more time go by into the new tax rules, maybe see it in election in November and see what the mood is. And also depending on how the growth of the property portfolio in urban centers and the opportunity zone to take all that in kind of strategically over time rather than just deciding in parts.

[Operator Instructions]. Our next question comes from Pierce Dever from Piper.

Hi, my questions were all answered. Thanks for the time.

No worries.

[Operator Instructions]. And ladies and gentlemen, at this time, and showing no additional questions, I'd like to turn the conference call back over to management for any closing remarks.

Thank you very much for joining us on our second quarter conference call. We're always around to answer questions if - to the extent you have them. And we love talking about our company. It's an exciting time with a lot of opportunities going on. We appreciate you joining us very much. Thank you.

Ladies and gentlemen, that does conclude today's conference call. We do thank you for attending. You may now disconnect your lines.