Rithm Property Trust Inc. (RPT) Q2 2019 Earnings Report, Transcript and Summary

Good day, and welcome to the Great Ajax Second Quarter 2019 Financial Results Conference Call and Webcast. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Mr. Lawrence Mendelsohn, Chief Executive Officer. Please go ahead.

Thank you very much, and thank you, everybody, for joining for the Great Ajax second quarter conference call. I want to do a quick reference to Page 2, the safe harbor disclosure and forward-looking statements. And with that, we can jump right in. A quick prelude, Q2 2019 was another very good quarter. We bought loans from multiple sources at very good prices, sold approximately $200 million of primarily non-clean-pay loans into a joint venture with good institutional partners at good prices. And we continued to improve the rates in terms of our asset-based financing. The market value of our assets continues to increase, and we believe net asset value and intrinsic value grew materially in Q2 2019 and has continued to grow in Q3 2019. One of the core pieces of our business is the sourcing of product. We've made 284 acquisitions since inception of Great Ajax, and we closed 11 transactions in the second quarter. Our loan sourcing network is very important to our ability to acquire the types of loans we want at the prices we want. Our sellers are banks, originators and funds. You can definitely see this in the prices we paid for our loans in Q2 of 2019. And all of the 11 transactions in this quarter, in quarter 2, were private transactions. None of them were public auction transactions. We use our manager's proprietary analytics to price each mortgage pool on a loan-by-loan, asset-by-asset basis. We analyze a large amount of data to determine target loan characteristics to develop pattern recognition algorithms for pricing and servicing loans. Third parties and JV partners rely on our managers' analytics and oversight as a service. We own 20% of the equity of our manager at zero basis. As a result, its value does not show up in our book value. Similarly, our affiliated servicer services loans asset by asset and borrower by borrower. Our services performance has created significant NAV increases to our loans as well as brand value and has helped bring institutional investors to us as loan purchase partners and for third-party servicing. We own 20% of our servicer including warrants. Since our investment in our servicer in the first quarter of 2018, our servicer has increased its portfolio by more than 50%. Our goal is to maximize returns asset by asset using our analytics in driving the -- both the acquisition and the management of the assets process. We use moderate non mark-to-market leverage. Average leverage including corporate-level leverage for Q2 was 3.2x, and asset-based leverage was 2.9x. Over the quarter, our leverage decreased by approximately 10%, very un-mortgage like -- mortgage REIT like in this environment. Quickly jumping to Page 4 and talking about Q2 itself. We purchased $90.7 million of reperforming loans, RPLs, in 11 private transactions. The new loans were on our balance sheet a weighted average of 20 days, so very little income from these assets as they primarily closed in the month of June. However, the purchase price was 56% of property value and 85% of UPB. And we think just since those acquisitions, the values of those loans have increased materially due to, if nothing else, market conditions. Number two, we sold $176.9 million of primarily non-clean-paying loans as of May 1, 2019, into a joint venture with 2 institutional partners for a gain of $7 million. We own 1/3 of the new joint venture. Parts of the proceeds were used to fund the call of our 2016 securitization on May 24, 2019, and to remove certain of these loans from their repurchase facilities. As part of calling our 2016 securitization, we accelerated amortization of $182,000 of deferred issuance costs. As a result of the transaction dates, selling as of May 1 and paying down debt as of May 24, we didn't receive May or June interest income from the loans that were sold into the joint venture, and we paid 24 days of May interest expense on the portion of the loans called from our '16-C securitization and from the loan repurchase agreements. If we didn't sell the loans, net interest income would have been approximately $1.8 million higher. So economically, the $7 million gain equals approximately $5.2 million plus the $1.8 million of net interest income. We ended the quarter with about $1.2 billion of mortgage loans and $198 million of investments in debt securities and beneficial interests. Debt securities and beneficial interests is how we carry for GAAP our interest in joint ventures with our institutional partners. We also acquired one multifamily rental property for $2.3 million in Baltimore. On the interest income side, interest income was $28.1 million. I noted already that net interest income from the loans put into the joint venture or sold into the joint venture, we lost 2 months of interest income on those. And I'll go into a little bit more detail in a moment. A couple of things to keep in mind regarding interest income and net interest income. Interest income from our portion of our joint venture shows up as income from securities, not loans. Also, since servicing fees for securities are paid out of the securities wallet, so our interest income from securities is net of servicing fees, unlike interest income from loans which is gross of servicing fees. As a result, as our JVs grow, interest income will grow slower by the amount of the servicing fees, and servicing fee expense will decrease by the corresponding offsetting amount. Now more detail about the loans in our joint venture. The stated net income of $13 million is $0.67 per share including the gain on sale of loans to the joint venture. If the loan sale had never occurred and we just earned net interest income on the loans and didn't call our 2016-C securitization and we didn't pay down repurchase agreements to take the loans often put into the joint venture, basic earnings per share would have been approximately $0.43. Instead, because we did sell the loans, it's $0.67. Taxable income is $0.75 a share. At the end of Q2, we have year-to-date taxable income of $0.86 a share. Book value is $15.85 at June 30, 2019. We collected about $60 million of cash in the quarter predominantly from loans and our joint venture securities. We continue to have significant cash flow from our loan and from our joint venture portfolio. And as you may have expected in the current interest rate environment, prepayment has increased, and cash flow continues to significantly exceed expectations. Average cash held during the quarter was approximately $50 million. On Page 5, you can see we continue to be primarily RPL driven. RPL still make up the predominant portion of our balance sheet. You'll see that REO was principally held for sale, turns into cash over relatively short periods of time. REO has increased over the last 6 months but has not increased from foreclosure or because we've been selling less REO. Instead, we purchased urban multifamily properties. As our property portfolio grows, we will also see an increase in our noninterest income as well. And on the reperforming loan side, we continue to buy lower LTV loans with overall RPL purchase price of approximately 62% of property value and 87% of unpaid principal balance. In the second quarter, we paid 56% of property value and 85% of UPB for $106 million UPB of loans. Our purchase price to property value and our purchase price to UPB are very low. And it kind of goes back to one of our fundamental tenets is that playing offense is easy, playing defense is hard. We have in our portfolio managed to play very good defense and have offense as well. On the NPL side, NPLs have been declining in absolute dollars invested. For our NPL portfolio, purchase price to property value is approximately 57%. As you might expect, higher LTV NPLs become REO sooner, and lower LTV NPLs become REO later, if at all, as lower LTV NPLs are much more likely to become paying loans or to prepay entirely. We continue to have over 80% of our portfolio in our target markets. We don't want to be an index fund and own loans where loans exist. We want to own them where our data evaluation suggests there's stability in liquidity and home prices, and there's positive demographics and other data points indicating stability. California continues to represent the largest segment of our loan portfolio both in residential RPL and in small-balance commercial mortgage loans. Our California assets are primarily Los Angeles, Orange and San Diego counties. We're seeing consistent payments and performance patterns in these markets particularly in California urban centers. We've also seen consistent prepayment especially for certain borrower characteristic subsets. We actively seek the loans that match those subsets from banks and funds and originators. We've added to our Houston and Dallas investments as well as to our Houston-Dallas infrastructure as well. And one thing we are seeing primarily from the new tax law is having material effects on higher-end values in New York, Connecticut, New Jersey and Illinois. We're definitely seeing a decrease in value differences between higher and middle property value deciles. So if you look at property values and make them deciles 1 through 10, 10 being the highest, we've seen the principal effect being in deciles 8, 9 and 10. And we've seen the difference in price between, say, decile 8 and decile 5 and 6 compact significantly. Portfolio migration on Page #9, very, very, very important and really kind of highlights what the data analysis we do on the manager side and the way servicer analyzes and servicers services loans, how much of a difference it makes. We have -- approximately $1.2 billion of our loans are 12 for 12 or better. Only $230 million of this was 12 for 12 when we bought it. For the loans that we buy based on our analytics and the way our servicer services the loans, our data suggests that once one of our loans becomes 7 for 7, there is a 93% chance that it becomes 12 for 12. At acquisition, 12% of our loans were 12 for 12. The intrinsic value of our loans has clearly increased materially on average since we acquired them and since our servicer began servicing them. In addition to increasing cash flow and net asset value, the significant outperformance of our loans also lowers asset-based funding costs and increases securitized bond senior class advance rates. As I will discuss on the next page, our 2019-D securitization clearly shows this premise. We had a very busy Q2, and it's continued into Q3. We continue to buy low LTV loans as purchase price to collateral value is 55% for our Q3 acquisitions so far. We expect the bulk of these already-identified acquisitions to close in September. We also continue to grow our urban center small-balance commercial property portfolio. We have approximately $18 million through 6 properties under contract in that asset class. On July 26, we closed Ajax Mortgage Loan Trust 2019-D, a new rated securitization. As I previously mentioned on the call, our overall RPL purchase price is approximately 87% of UPB. That's an important number to remember because the advance rate on our newest securitization, 2019-D, for just the AAA through A was 81% of UPB with a weighted average cost of 3.01%. As a result, we'll get more leverage through securitization of these loans, and our cost of funds on these loans declines by approximately 120 basis points versus repurchase transactions. Dividend. Our Board approved $0.32 a share to be paid on August 30 to common stockholders as of August 19. Dividends for the first and second quarter, at $0.64 a share, taxable income through the same period is $0.86 a share. Some quick financial metrics to talk about on Page 11. Number one is yield on debt securities is net of servicing fee of approximately 80 basis points on debt securities basis. Debt securities, which is how our interests in JVs are presented under GAAP, as our JVs increase, the GAAP reporting of net service -- net of servicing, unlike loan interest income, distorts average asset yield lower and related ratios. So as a result, the more debt securities we have, it shows a lower yield, but that is because of the net of servicing. You can see from our average loan yield, our average loan yield has actually increased quarter-over-quarter. With so many loans paying, we're comfortable with a little more asset-based leverage although Q2 leverage decreased like almost 10%. Our 2019-D securitization, given the advance rate, will increase leverage a bit, and it also lowered debt costs. And we expect that the asset level debt cost will decrease in Q3 as a result of our 2019-D securitization also as a result of decline in LIBOR on our repurchase agreements. And with that, I'm happy to answer any questions anybody might have.

[Operator Instructions] Our first question today will come from Tim Hayes with B. Riley FBR.

Larry, a couple of questions here. My first one, you pointed out that taxable income is running well ahead of the quarterly dividend run rate so far in the first half of the year. I know there are a lot of moving parts that drive taxable income. But at this rate, do you expect you'll have to pay out more than the $0.32 run rate suggests? And would you be more inclined to raise the quarterly dividend, pay a onetime dividend or maybe pay periodic supplementals or some kind of combination of those if you were to pay out more than what you're running at right now?

Sure. I think our Board is predisposed to probably increasing quarterly versus special. Some depends -- some of that depends on what the continuing market environment looks like. Clearly, in the last 2 months, we've seen an increase in prepayment. You'll see, from just the rally in probably the last week or 2, 60 days from now an additional prepayment ramp-up. And so as a result, I think our Board, the only reason they didn't increase the dividend this quarter is they just want to see how the chaos in the world plays out for another month or 2.

Okay. Okay. Understood. And then, obviously, the loan sales were driving taxable income this quarter. How do you see the pace of additional loan sales playing out over the rest of the year or maybe in 2020? Was this just a one-off opportunity to maybe capitalize on a good opportunity? Or do you foresee additional loan sales supplementing investment and generating more taxable income in the coming quarters?

Sure. Probably both loan sales, perhaps not the number of loans. In this particular sale, it was primarily non-clean-pay loans, and a substantial part of our remaining -- portion of our remaining loans are clean-pay 12 for 12 loans, which actually have materially higher value. As you can see from our rated securitization, we decided with this $200 million of clean-pay loans, we looked at selling it, and we decided to securitize it instead and capture $2 million to $2.5 million less funding cost per year on those loans versus just selling it outright. And then if we had sold those loans, realistically, we have been forced to pay a very large special dividend. The -- selling the non-clean-pay loans, these were all loans that we had owned for at least two years, in some cases, four or five years, and we were not able, for the most part, to get them to be clean pay. And as a result, we didn't see the intrinsic value. It was going to jump 10 points from a non-clean pay. But relative to our basis, we still had substantial built-in gain. And we decided to sell it to a JV, and we, post sale, have owned one third of the joint venture. So it was a sale where we got good prices and where we also still have -- still own one third of the upside.

Got it. Okay. That makes sense.

Yes.

And then you've acquired -- or agreed to acquire a very small amount of RPLs so far in the third quarter. But I believe this is the first time I've seen -- or maybe I just don't remember, but first time I've seen you acquire RPLs at a premium to UPB. Just given your size and your relationships and your ability to enter into these privately negotiated transactions, you've always been able to buy RPLs at a discount. Has competition led you to -- is it a function of that? Or are these just really clean loans? Or either way, what's the thinking behind this?

Well, our purchase price -- for our Q3 acquisitions, our purchase price is 92.7% of UPB.

I must have misread something there.

Yes. So we have $163 million UPB, 92.7% purchase price, underlying collateral value of $273 million, so the purchase price is about 92.7% of UPB and about 55% on collateral value for our Q3 acquisitions. Again, this is another -- this group of transaction is privately negotiated and is about 55% California loans.

Okay. Yes, sorry about that. I must have picked up a wrong data point there but -- okay.

Sure.

And just one more from me, and then I'll hop out. But can you just give us some of the characteristics around the 6 properties acquired in the third quarter? I'm assuming they're all multifamily, but what level of transition, which geographies are they in or adjacent to qualified opportunity zones? And then any comments around what you expect stabilized value of those properties to be relative to your purchase price would be appreciated?

Sure. Sure. They are in Dallas, Boston, one in Saint Paul, Minnesota. They are the -- at purchase price, depending on which one, three of them are approximately 8 cap purchase price, and the other two are approximately 6 to 6.5 cap purchase price. The three that are eight cap, we will clip coupons for a while and get good financing. And it's a credit tenant. For the 2 multifamily, the one in -- the two multifamily, they are -- probably we'll do some repositioning not on day 1 but probably sometime a year or two in. And we think that, over time, they will be closer to 12 cap on cost versus a 6.25 to 6.5 cap on costs. So they're kind of long-term investments, three which provide significant income production -- I guess 4 that will provide significant income production and two which will provide some income production plus some benefit from repositioning over time. So we're pretty excited. None are in opportunity zones. One, however, is pretty much adjacent to an opportunity zone. One of the things we found is prices in opportunity zones have gone up pretty materially just because they're in the zones. And we found that small multifamily near opportunity zones, the people who live in the apartments don't care if they're in the opportunity zone. Only the owner does. And as a result, the adjacent to the opportunity zones, the rents increase in value as the opportunity zone actually gets developed.

Right. Right. No, I know that's the theme that we've -- or you've kind of talked about in the past. So just wanted to see if that was still the case. But I'm going to hop back in the queue.

Sure.

Our next question will come from Kevin Barker with Piper Jaffray.

You said -- what was the total taxable income for the first 6 months? Because I believe you said $0.86. Would that be right?

Yes, $0.86 for the first 6 months.

And then I had what -- well, in the first quarter, I had $0.23, and then you had $0.75 in the second quarter, so I must be getting that wrong, right? So -- okay. So $0.86, all right. And then...

Yes. So taxable income for the first 6 months is $0.86. So $0.11 in Q1 and $0.75 in Q2.

Got it. Okay. Clear about that. And then in regards to the net interest income and the cadence going forward, given the sale of the portfolio and then the moving parts, the $1.8 million that you talked about earlier, how do you think about getting back to the first quarter run rate given the portfolio sale and then the acquisitions you made so far going into the third quarter?

Sure. A couple of things. One, financing costs have come down pretty materially so far in Q3 just because of, if nothing else, the 40 basis point reduction in LIBOR plus 120 basis points on the loans in our 2019-D securitization. We also acquired $90 million of loans on the last business day in the month of June, so we didn't really get much benefit -- income benefit from it that we'll get in the second quarter. So the combination, my kind of prelim guess is it looks pretty good. The other thing that's happening is prepayment, as you might imagine, is coming in faster than we would have anticipated given what's going on in the interest rate market, which means we capture discount faster than we would have modeled when we bought the loans.

So we're going to see a little bit faster gains coming off. So when you look at...

Yes. Well, we'll see the prepayment generates some taxable income, but it also causes a shorter expected life. So you take the discount to a shorter expected life as a result.

Right. Right. Okay. So are you expecting...

So we would expect duration short -- we would expect duration to shorten on the loan side of the portfolio while, at the same time, the funding cost of the portfolio is going down.

Okay. I'm assuming you're letting these refinance away most of them, right? Or you...

Yes, yes. That's right. Yes.

All right. And then as far as leverage is concerned, I believe you mentioned to be a little more conservative given the current environment, or are you willing to bring down the leverage?

Leverage came down because of so much prepayment in the quarter as well as some of the sale proceeds of the loans paid down more than the allocated financing the pre-existed on those loans. The -- by choice. The securitization that we did in July 2019-D will increase leverage up a little bit. But as a whole, leverage is lower than it was in Q1.

Okay. And then just a bigger picture...

That is as you've seen that in the space.

Yes. You have fought between. So when you think about just bigger picture, there's been a lot of volatility in the market, right, a lot of uncertainty. And people are seeing housing slowing down and so forth. But when you look out, especially in your markets, in particular, what are you seeing within these properties and the bids for those properties and, just the overall, the pulse of the market within your markets today?

Sure. So you have to break down each market into deciles 1 through 10. And a decile 5 in New York is a different price range than a decile 5, say, in Indianapolis, right? What we're seeing is that deciles 4 through 6.5, 4 -- maybe even through 7, that market in our markets is pretty stable and probably still going up a little bit. And especially kind of what I'll call deciles 4 and 5, if you put a house on the market, it goes pretty quickly. Deciles 8, 9 and 10, especially 9 and 10 in 4 to 5 states have had a clear slowdown. And we've seen it probably most profoundly in New York, New Jersey, Connecticut and Illinois. We've seen it less in California than we anticipated, but most of what we own in California is in deciles 4, 5 and 6 for those markets, and we've seen that to be a very liquid market. And in fact, we see a lot of single family to rent buyers in that market in deciles 4 and 5 so -- which adds additional liquidity. The shrinkage in mortgage rates which causes monthly payment to be cheaper and certainly in deciles, call it, 1 through 5, 1 through 6, monthly payment matters a lot. The decline in mortgage rates is definitely going to provide more stability, assuming it doesn't correspond with a material increase in unemployment or something like that. The decline in mortgage rates will have a positive effect on the liquidity and stability in kind of deciles, call it, three through six in each of those markets as monthly payment comes down significantly. You'll see more people are able to qualify in a DTI basis because the payments are lower in number even though their income might be unchanged. So as long as there's no real hits to borrower income, we still think that kind of deciles 6.5 and under are pretty firm in our markets. Deciles 8, 9 and 10, we stay away from. And we think that we're not bullish on that.

Okay. And you mentioned the single-family REIT rental purchases.

Yes.

Are you seeing those as like going head to head as a competitor or more just like a stabilization of the market overall?

As a stabilization, it's interesting, every single foreclosure sale we've had in California in the last 2 months, the buyer for full credit bid on one of our loans -- on our loans that we foreclosed on has been a single-family rental buyer, every single one.

[Operator Instructions] At this time, there are no further questions in the question queue, and I would like to turn the conference back over to Lawrence Mendelsohn for any closing remarks.

Thank you very much for joining our Great Ajax second quarter earnings conference call. Feel free to reach out if you have questions, and have a great evening and the rest of the week. Thanks very much.

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