Rithm Property Trust Inc. (RPT) Q4 2018 Earnings Report, Transcript and Summary

Good day everyone and welcome to the Great Ajax Corp Fourth Quarter and Year-End 2018 Financial Results Conference Call. All participants will be listen only mode. [Operator Instructions] Please note that today's event is being recorded. I would now like to turn the conference over to Lawrence Mendelsohn, CEO. Please go ahead.

Thank you very much. Thank you everybody for making the time to join our Great Ajax's fourth quarter and year-end 2018 conference call. I want to have everybody to a quick look at Page 2, our forward-looking statements disclosures and with that we can move on into the presentation. Before I get to on Page 3, I just want give you a brief introduction. Overall, we had a very successful net asset value and intrinsic value building quarter in many facets of our business and our investment as well. We've bought loans at good prices and good price to collateral values, while at the same time expanding our seller base. We added nearly 600 million in co-investment joint ventures with the credited institutional partners. We close three securitizations with good pre-arranged executions, both in cost of funds and advance rates, and these are completed despite the large pick-up and structured credit markets in November and December. The joint ventures also have more value effect than just income. We own a significant percentage of our servicer and our servicer's value increases materially from servicing loans for these joint ventures. Other than noise from interest expense on prefunded debt for our December acquisitions to lock in low cost of funds, uncertainty, and our typical expected ROE or impairments as required by GAAP and the little bit of noise from few loans in our 2014 NPL acquisitions, all of which I'll discuss during this call. The quarter was all positive and this continues to be the case in first quarter of 2019 as well. And with that, let's jump right into Page 3. Our loan sourcing network is really, really, really important, I can understate it to our ability to acquire the types of loans we want and that the prices that we want. Our sellers in the past quarter and in the coming quarter, our sellers, our banks, their loan originators as well as funds, and they sell for many different reasons and we have long relationships with most of them. We analyze the large amount of data to determine the target loan characteristics and to develop a pattern of algorithms for both pricing loans and servicing loans. We own a 20% interest in our manager as well, and most recently Q4 third-party have reached out to the manager regarding providing analytics on loans as a service, and that would be good for our 20% interest in the manager as well. Our affiliated servicer, the servicers' performance has created significant brand value and is led to institutional investors coming to us for loan purchased joint ventures and third-party servicing. In Q4, we increased JVs by nearly 600 million and we will be close to that number in Q1 2019 as well. This materially increases the servicers' value. We own 20% since our investment in Q1 and Q2 of 2018 in the servicer, if servicing portfolio was on track to increase by 50%. We use moderate non-mark-to-market leverage, asset leverage for Q4 2018 was 3.2 times and asset base leverage only was 2.9 times. Page 4 highlights also some detail on some of the noise. There is several important pieces to the per share earnings math for Q4 2018. First, probably the most important piece and that we spoke a bit about on the November of 2018 call. We knew that we are going to have significant increase in loan purchases and in joint venture loan acquisitions in late December of 2018. Early in the quarter, many of our regular loan seller customers have given us a heads up and by mid October, we are already under contract for 500 million plus unpaid principal balance subject to due diligence. We decided we didn't want to wait to take November or December structured credit market risk of execution. So, we added asset base debt in early Q4 and get a small convertible bond to add-on in early November to effectively prefund much of our December acquisitions. Because of the prefunded debt, we at one point carried over a 100 million of cash in mid-Q4. This means, we had more interest expense relative to the asset growth until we actually would close the purchases of the assets. We also in our 2018 F securitization prefunded one of the purchases $90 million worth our share was approximately 20 million, a month ahead of time to lock in the cost of funds in bond structure. This prefunded pool didn't close until January, so we had a month of interest expense on the prefunded account without any related loans. We basically made a decision to borrowing early as pre-December cost would be much cheaper in the long run, but with distort interest income versus interest expense for 1 to 2 months. Functionally, it was a debt funding hedge but all booked in one quarter rather than overtime, combined these borrowings increased Q4 interest expense by approximately $0.03 to 0.04 per share, with no related purchase loans until December. Second, our quarterly REO impairment was approximate 700,000 or $0.037 per share. As we have mentioned in previous quarterly calls, REO impairment happens first under GAAP and any things happen second. Our REO portfolio continues to have expected future gains net and we have decided to keep some of our small multifamily REO that is in specific urban markets and that also delays gains. Additionally, any foreclosure that results in the third-party property sales rather than becoming an REO is accounted as a loan pay-off in pool accounting under GAAP and does not offset any REO impairments in our income statement. In our portfolio, third-party sales happen approximately 50% of the time on average. In Q4 2018, we had 38 foreclosure outcomes of which 18 ended up as third-party sales and 20 became REO. The profits of the third-party sales go through interest income, not net current quarter, but over the life of the loan pool. It doesn't even get accelerated and it's not accounted for in REO gains or losses. There is a pattern in our REO impairments, a small number of REO account for the overwhelming majority up impairment. They typically occur in higher end properties in New Jersey and New York, where borrowers have just walked away from maintenance and were property value has been significantly impacted by changes in deductibility of property tax or they are in rural second-home locations where borrowers just walk away. Just about all of this quarter's impairments matched the New York, New Jersey sophistication. In the third case, we took an impairment of $0.042 per share on the remaining 23 million UPB from our 100 million plus purchases of NPLs in the fourth quarter of 2014 and early 2015. 2015. These impairments are driven by very small remaining pool sizes for pool accounting in which cash flow fluctuations and individual loans is not offset by the remaining pools. As percentage of income from these pools overtime, this is a tiny fraction. One loan secured by a condominium in downtown Miami that has some internal damage accounts for nearly half of the total impairment. We are in litigation with the insurance carrier regarding the insurance claim and with the building association as well, and we hope to recoup some or all of this overtime. As our portfolio performance overall indicates and will see this in a later slide, this impairment is not reflective of our overall portfolio. In fact, we're seeing the opposite. Loan performance has significantly outpaced expectations, but we don't write -- get to write up the market value of our loans, we only get to write it down. From a GAAP perspective, if we were to account on a 100% mark-to-market basis similar to many other companies that own securities in the mortgage REIT space. The aforementioned impairments we blended into our large built-in gain on their loan portfolio, we choose not to mark close to market because loans unlike securities do not have readily available dependable marks. As a result, we get to take charges for the negatives, but we don't get to write up for the positive. Walking back to our comparable quarter-to-quarter earnings pathway, these three items together are approximately $0.12 per share, which normalized EPS about $0.46 to $0.47 per share. Some highlights to the quarter. We've formed 586.2 million of joint ventures, and we kept our interest of the 126.5 million in the varying classes. We created the joint ventures in structured credit format so that our joint venture partners can put them in any investment buckets they want and get their remarks. One thing I want to say, those interesting come from our portion of the joint ventures shows up in income from securities not from loans. Also, since servicing fees for securities are paid out of the securities waterfall, our interest income from securities is net not gross of servicing fees unlike loans. As results, as our JVs grow, it causes interest income to appear lower by the amount of the servicing fees. In Q4, this difference is about 77 basis points on average invested amount in securities. The Q4 JVs all closed in December and were on the balance sheet for an average of 18 days. Taxable income was $0.23 a share. Fourth quarter taxable income is usually a bit lower than the other three quarters for two reasons. Number one, there is a lot fewer foreclosures in the month of December than any other month during the year on purpose. And two, there is part viewer pay-offs in the month of December than any other month of the year as well. From a cash flow perspective, we collected 57.1 million of cash from our portfolio. We held 55 million of cash at December 31. Our December 31, '18 cash on hand was approximately the same as our September 30th cash on hand; however, we invested approximately 200 million in between. We jump to Page 5, our portfolio overview. You'll see on the left hand side of it, re-performing loans are about 97% of our loan portfolio and non-performing loans about 3% and that number is -- that percentage comparison is pretty much the same it was last quarter. On the property side REO is principally held for sale alternative to cash over relatively short period of time. REO increased from Q3 to Q4 but not because of more foreclosures or fewer REO sales instead we purchased 4 commercial properties for approximately 9 million. One thing to keep in mind is as our property portfolio grows from purchases of small commercial properties, we will see an increase in non-interest income and growth of interest income will slow. On Page 6, we look at our re-performing loan portfolio. One thing to take a look at is our purchase price of property value at December 31, 2018 was 60.1% and our purchase price on our portfolio relative to PUB is 82.4%, that's pretty much the same number as it was a year-ago and pretty much the same number as it was two years ago. We continue to by lower LTV loans with overall RPL purchase price of approximately 60% of property value. The price of property value does not include home price appreciation, if any since our acquisition. Just like pre-funding our December acquisitions early in the quarter, we continue to play offense and defense when buying loans. On the NPL side, NPLs have been declining in absolute dollars invested in our loan portfolio although we did buy some NPLs in our 2018 B transaction in a joint venture in June of 2018. For our NPL portfolio, purchase price of property value is approximately 56%. As you might imagine, higher LTV NPLs become REO sooner, and lower LTV NPLs become REO later, if that all, because LTV NPLs are far more likely to become RTLs or to pay off as NPLs. On Page 8, our portfolio concentration has not really changed to other than California continues to represent the largest segment of our portfolio, primarily Los Angeles, Orange and San Diego counties, receiving consistent payment and performance patterns in those markets, particularly in California urban centers. We also have seen consistent prepayments, especially for certain borrower characteristics subsets in the California market. The California percentage of our portfolio have increased in late Q4, as our 2018 G joint venture of 240 million was 89% California loans. Page 9 is a very, very, very important chart is to me the most striking. First, 1.15 billion of our portfolios is 12 consecutive payments or better, approximately 1.2 billion is 7 consecutive payments. For the loans that we buy in the way our servicer manages these loans, our data suggest that once the loan becomes seven-of-seven, there was a 91% to 93% probability that becomes 12-or-12. Approximately 77% of our loans are 12 or 12 or better and approximately 83% are seven-of-seven are better. Keep in mind that at acquisition 10% were 12-to-12 or better. So the intrinsic value of loans has increased on average extremely materially since acquisition, 10% 12-of-12 going to 77% 12-of-12. In addition to increasing cash flow in NAV, the significant outperformance of our loans also lowers asset base cost of funds overtime. We have seen this from our securitization and our JVs. We did three in Q4 and we did two in Q3 of '18. We've been able to increase advance rates, lower cost of funds, and have -- even have the loan purchase pre-funding accounts for loans that don’t let exists. Asset level debt cost in Q4 was the same as Q3 even though structured credit markets were quite stressed in the second half of Q4. So the portfolio migration and the intrinsic value it implies in terms of built-in NAV gain on or loan portfolio is pretty striking to me. Page 10 subsequent events. First on the left-hand side, acquisitions closed since 12/31. The most notable is the 60 million of that was purchased as NPLs. It was prefunded in our 2018 F joint venture securitization in early December. It was prefunded as approximately $100 million portfolio, but post due diligence, it ended up being a $60 million portfolio and the remaining money was returned to ourselves and our joint venture partners on January 25th. Under contract, we had a very busy Q4 and you can see it continues in Q1. We already have 15 transactions either close or in process and are evaluating 4 to 5 others. One very consistent pattern however is low-priced to collateral value. In RPLs 55.4% collateral value and in NPLs 49.9% to collateral value, and small balance commercial of 54.5% of collateral value. The other I would say is the collateral values typically in market-by-market are in deciles 3.75 to 6.75 in each particular location. We're also in the due diligence phase of three more small balanced commercial properties, one Atlanta, one in Baltimore and one in Raleigh. We also announced a $0.32 per share dividend that we paid on March 29th, to stockholders of record of March 15th. Page 11, this page gets more and more complicated for a number of reasons. One, the more joint ventures we invest in. The more securities we own even though they're really the economics of loans they don't show-up that way for accounting purposes. Yields on loans are net of impairment of 800,000 when you look at the average loan yields, so that 8.5% is net of that 800,000, so actual yield would be higher. And yields on debt securities that you see is net of a servicing fee of 0.77 because debt securities you received your payment after servicing is paid, and loans you receive your payments before the servicing is paid. The more JVs, we participate in with our institutional partners the more distorted this ratio becomes, number one. Number two is, as you can see our JVs increased by approximately a 120 million in Q4, although they are not on average but on ending. And that number would we expect to anticipate will grow dramatically also, in Q1 of 2019. So, this table will become a little more distorted than it is this quarter, which is already more so than last quarter. If you notice average -- our total average debt cost even though there's more debt was unchanged, and return on average equity, net of impairments just declines because of the interest expense increase as we increase debt to prefund assets 1 to 2 months before purchase as well as the additional 15 million of convertible bonds we added in early November. Ending leverage ratio was higher as well both from an additional asset base debt and from the convertible add-on, but again the average debt cost was unchanged. On Page 12 is reconciliation of Page 11 to all the consolidation requirements and Page 13 and 14 our financials. And with that, I am happy to turn over to questions that anybody might have.

And we will now begin the question-and-answer session. [Operator Instructions] And today's questioner will be Timothy Hayes with B. Riley FBR. Please go ahead.

My first question. Can you just comment on the pace of JVs going forward? You touched on 1Q so far, but just in your normal going forward. And can you also touch on where the supply of loans is coming from?

Sure. The supply of loans is coming from -- might be a question to first. The supply is coming from three different places. Number one is banks and banks operate out in two different reasons. One is large banks who still have significant RPLs on their balance sheet 10 years later, and who see that home price depreciation has allowed them to be able to sell loans and recover the reserves they took many years ago. They don't get back pars but they are able to recapture reserves and get yield out best. And the other source is from banks is the consolidation you're seeing in the banking sector almost every merger has target bank as they target not that buying banks, acquiring banks that wants target bank to take certain assets off their balance sheet as part of sale. And as a result, we are out to take a look at those and our target bank portfolios to provide liquidity around acquisition closing. The buying bank when it acquires the target bank effectively gets to take a one-time charge and they can put any losses that selling banks the target bank has from selling those into that one time frame. So, those are the kind of the bank reasons. We've been told by the banks obviously consolidation is continuing at a pretty rapid pace. So, we've been told by the larger banks as well that they expect to be extremely large sellers at least for another 18 months, so that will be a significant amount of supply. Number two is originators. We buy a fair amount of chunks -- not in $100 million slugs, but in smaller slugs what I'll call agency kick out where borrower A got a Fannie Mae loan within the 30-day period were originator was going to sell to Fannie Mae and borrower A went and got a car loan and his debt ratio no longer works for Fannie Mae loan, and we're able to buy loans like that. And then number three is liquidity provider for funds we have a lot of sellers, who come to us for whatever reason who need specific dollar prices or specific amount of proceeds and they like to spend just a $250 million pool of loans and say, can you get to a $91 price and get the 80 million of proceeds. And then we can work through those loan pools be able to buy -- put to together a subset carve of the pool to meet the requirements of the seller. Because we're currently capital entity we're not seeing as competitors for fundraising provided these sellers and so they come to us. In terms of where we see JVs continue, you'll see JVs continue at this pace, and I think for a while either we have a number of institutional investors tell us how much they would like to buy through us in joint ventures, if we would have sum the number I don't know if there's that many loans. So, we would anticipate that that this pace will continue at least for a few more years would be my guess, based on conversation we've had with investors, but there's no way we can set satisfy the demand that all of the investor and institutional investors that have reached out to us. Let me put it that way. It's not something where -- where we can go and find 5 billion a quarter or 3 billion a quarter, but we can find 400, 500, 600, 700 million.

And I'm going to keep building off of, of that last part there. Of the three, just three JVs this quarter, were those across three different separate institutional partners? Were they all the same partners? And can you maybe talk about how many partners you currently have and the amount of potential partner you are talking to today?

We have four partners that we've already done transactions with. All the ones in December were with the one partner, and but we've had four that we've done transactions with, and we have two others who have reached out to us and we have made -- that we have also made large pool of bids both with the agencies and some large banks as well.

And so I assume that the loans you've agreed to acquire so far in the first quarter that you just mentioned and identify that would be acquired to JV or all going towards new JVs and not any of the existing one?

The small balance commercial loans and properties are all our own the -- if you see acquisitions close, the 8.5 million of RPLs are not in the JV the small balance commercial loans are not in JV and acquisitions under contract. If you see the 299 million of RTLs about 35 plus about 270 of those are in joint ventures and about 30 or not and in NPLs all of the NPL or one transaction as a joint venture.

And then you talked about the performance of the loans and it sounds like your expectations for cash flow are continue increasing despite the seasonal headwinds in the fourth quarter and other blips there. How do you see…

It's really in October and November cash flow pay-offs were the same, it's really just pay-offs slowdown in December and that happens every year. And I guess people are buying gifts rather than paying up their mortgage.

I guess that works for some. But how do you -- my question there is, how do you see the dividend is trending in 2019? And how do you think about dividend coverage? Because it seems like you would have been well within the re-requirements without the special this year, but you paid it anyway and so as you goal to pay out near 100% of taxable income?

I think we would expect the taxable income to increase over the course of the year and to be probably ahead of last year's taxable income, particularly given where the value is on some of these loans. I would imagine that sometime in 2019 similarly to 2018, we will sell some loans or at least look at buying some loans. If you remember we sold about 90 million of loans in September of 2018 and had about a $5.5 million gain of which taxable was a million -- or about 2.5 million of it. And I would anticipate that we will look at selling loans again, probably not Q1 but during 2019 is when we look at the migration chart 24, 24 NBA current loans are basically part of loans in today's world, and we would look at selling some side-by-side to doing greater transactions and funding and cheaply with that over long time and kind of do a comparison.

[Operator Instructions] And our next questioner today will be Steven Delaney with JMP Securities. Please go ahead.

I wanted to ask you about the small balance properties. I know it's in the lot of dollars, but obviously it's kind of ties in definitely with the small balance lending as well in terms of your valuation analysis. Just before you brought in the fourth quarter and the three that you're looking at, and it appears there sort of in the $2 million to maybe $3 million price range. But could you talk about the property types I mean are they mostly multifamily? And if you're buying these, what kind of occupancy situation and are you having to get in and put some cap improvement in and then lease or you're buying things that have leases in place?

Sure. It's very much like our small balance commercial loan strategy similar locations about 6 or 8 markets very urban with the, what I'll call it 4 to 10 year horizon, not what's the neighborhood that is changing right now, but what's the next neighborhood to emerge. So I think for people in New York think of Bedford-Stuyvesant 12 years ago rather than Bedford-Stuyvesant 3 years ago or 4 years ago.

Right.

So, we are looking for those neighborhoods and space on the bunch of analytics we run, based jobs growth and demographics and age and things like that. The typical properties either going to be a small multifamily somewhere between 8 and 4 years, depending on the market, in some places 40 units is 3 million or 2 million, in some places 40 units is 5 million in some places 40 units is 25 million, right. But for us, it's they are going to be 30 to 40 units. I would say most of them are probably less than 25 units. $We are buying them substantially least with what we would consider to be below market lease but also properties that have need a little bit of love but not a lot of love is the way I would describe them that they're really location driven and it's a kind of what I'll call an alpha investment based on location as opposed to just straight income today.

And what kind of target cash on cash return do you have when you look at as that kind of property?

Depending on what it is and how tenant dependent on it is. We buy them anywhere between the 5 and an 8 cap.

Got it, it's a cap rate. Okay, and thanks for the comments, Larry.

Some of it depends on what we think the upside to the property is versus on a relative comparison basis, and this is some of…

And our next questioner today will be Kevin Barker with Piper Jaffray. Please go ahead.

It's actually Peter Stettler on for Kevin. A lot of my questions have been answered but just maybe a two quick ones. As it relates with the February securitization debt sales, I was wondering what your net exposure to those securities are following the sales?

Say, it again I'm sorry.

So, on the debt securities -- selling debt securities…

Yes, the debt securities we sold in February?

Right, I was just curious about what the net exposure to those securities are following the sale?

Sure. So, we in our 2000 -- one of the things about our joint ventures as we create three classes of bonds, we create our joint ventures and what I'll call in ABC structure where the A is just a senior bonds, the B and C are stapled together. The B is a mezz with an outside coupon. We've put a 5 in quarter coupon on the B and the C is the equity certificate. And in, we as the risk retainer in the JV are always required to hold at least 5% of all three classes. But for example, in our 2018 E&F transactions, we kept 20% but then in early February, we sold 15% of our class A bonds in those two securitizations prior at a cost to look at a premium for the insurance price. So, as a result, they actually selling them lower to the cost of funding to us, but they are just as if definitely issued basically senior bonds like selling them rather than holding them. So, there is no -- there will be no difference and if we just sold them in the first place and as issued as opposed to kept 20% and then sold them later. One of the ways we've structured the JVs is, we and our institutional partners can do anything we want with the class As. We want to go sell and we can, if we want to borrow against we can. But the class B and Cs, we have a right of first refusal on the institutional partners bonds, if they ever want to sell.

Got it. That's helpful.

And we retained all of the call rates of the bonds without solely.

And then, are you able to quantify the potential incentive fee that the manager could earn, if I think if the returns exceed I think if 8%?

The answer is, yes. It's not particularly material. It's probably but right now it's perhaps earned somewhere between $100,000 and $130,000.

[Operator Instructions] And there looks to be no further questions, so this will conclude our question-and-answer session. I would now like to turn the conference back over to Lawrence Mendelsohn for any closing remarks.

Great, thank you. Thanks to everybody for joining us on our fourth quarter and year-end 2018 conference call. Feel free to reach out to us, if you have any additional questions over the coming days or weeks, and we're always happy to talk about Great Ajax and the manager and servicers' relationship and expertise, and I hope everybody has a good day and will talk to you soon. Take care.

The conference has now concluded. Thank you for attending today's presentation. And you may now disconnect your lines.