Ladies and gentlemen, thank you for standing by, and welcome to the Great Ajax Corporation Q2 2020 Earnings Call. [Operator instructions] I would now like to hand the conference over to your speaker today, Mr. Lawrence Mendelsohn, CEO. Thank you. Please go ahead sir.

Thank you very much. Thank you everybody for joining us on our second quarter of 2020 earnings call. Before we get started on the presentation, I want to just have you take a look at page two for forward-looking statements disclosures. And with that we can get moving to page three our business overview. Q2, 2020 was a positive quarter in many ways. After navigating through March and April, we closed the second tranche of joint venture investment in loans that was purchased in a pre-funded securitization structure that we created in March of 2020. We raised $120 5 million in net proceeds of perpetual preferred shares; we paid down significant amounts repurchase facility debt in Q2 as a result of loan and mortgage bond cash flow. And beginning in late Q2, 2020, we've seen our cost of funds start coming down dramatically versus the average Q2 cost of funds. One thing I do want to add, volatile environments and declining economic times like we've seen in the last few months to really show how important and strategic having our directly aligned operating and loan servicing platform can be coupled with our value investing mentality. You can see this through the continued performance of our loan portfolio and the net asset value relative to book value. On page three, our manager’s strength in analyzing loan characteristics in market metrics for re-performance probabilities and pathways, and our manager’s ability to source mortgage loans enables us to acquire loans that we believe have a material probability of long term continuing read performance. We've acquired loans in 302 different transactions since 2014. Additionally, we believe having an affiliated servicer provides a strategic advantage in non-performing and non-regular paying loan resolution processes and timelines. In today's volatile environment, having our portfolio teams and analytics…

[Operator Instructions] Your first question is from Tim Hayes from B. Riley.

Hey. Good afternoon, Larry. Hope you're doing well.

Yes.

My first question here, just on the reversal this quarter, can you just help us understand what drove that? Was it as simple as just better collection rates than you expected? Or were there inputs like home values or interest rates that were the bigger drivers of the reversal? Just trying to understand how volatile this could be going forward and how likely the reversal could actually be reversed going forward?

It is primarily collection rates. And cash flows were significantly more than we had estimated when we -- in late Q1, early Q2, built our kind of COVID expectation model. That being said, we expect it to be volatile in the world of CECL. So, we took a reversal of a reserve that we thought was the proper reversal. The cash flows continued to be significantly better than we expected from COVID. But even through July, that being said, there's no way to know kind of how this all turns out as we come into the school season in the fourth quarter.

And can you maybe share why you think cash collection has been in -- and credit performance has been better than expected? I mean, does it just have to do with the demographics of your loans? Or is there anything more kind of from a macro perspective that you think is driving better credit performance? Just any color you could share on that would be helpful.

So far from discussions with borrowers and looking at performance, one of the most important things is our loans tend to be lower LTV and have more absolute dollars of equity. And as a result, on average, the borrowers are -- the borrowers personal momentum has been derailed a little less than lower-value properties. Our properties tend to be worth -- we talk about deciles. Our properties tend to be in deciles 4.5 through 7, kind of primarily for predictability and liquidity. And in this environment, we've seen that be an advantage in terms of absolute dollars of equity. I also think, to a smaller extent, much smaller extent, stimulus money has been helpful, although I think it's less available or have less of an impact on our portfolio than in mortgage land in general.

Okay. Got it. And then what is the current forbearance rate on the portfolio today? And how has that trended so far in the third quarter?

Sure. We've had -- for our portfolio, we've had about 15% of borrowers call, but about 80% of the 15% continued to make payments regularly. And about 3%, which is why you've seen our 12 of 12s go from 76% to 72.4%, have stopped making payments.

Okay. 3%, got it. And then, I don't know if you can disclose this or if there is a view internally. Understand this is a very opaque environment and a lot yet to be seen. But what loss rate scenarios are you using internally for whether it's just kind of cash flow or credit analysis that you're modeling internally?

It's loan by loan by loan. We build our models loan by loan by loan in terms of expected losses and cash flows rather than kind of a CPR/CDR mentality. We go loan by loan by loan. And based on loan characteristics, we have different probability paths of paying or not paying, and of not paying, what potential outcomes are and, of paying, what potential outcomes are. And that's -- so we base everything off of those individual loan-by-loan probability paths. So there isn't really what I would call a global prepayment or default rate. And then based on probability paths, the absolute -- property values versus the underlying loan amounts plus or bridges, if any, redetermine losses, if any, and time lines.

Okay. So you -- I guess the point -- what I'm trying to get at here is, your stock is obviously implying a massive amount of losses in your portfolio. And I'm just wondering, when you run your kind of probability scenarios and your loss rate scenarios that if you think the market got it right or if you think that they are severely over-discounting the stock based on what you expect and just kind of what's driving the...?

So our portfolio is kind of unusual. In that if we had 100% defaults, the yield would probably increase, but NAV would decrease. So -- because 100% defaults with shortened duration, which would mean yields would go up, because of the low LTVs. But we're much more focused on NAV and long-term cash flow. So we would never want that to happen. We would want the opposite to happen. We'd rather have 100% payment, even though it would reduce interest income in any given period, but it would increase NAV dramatically and reduce financing costs super dramatically. I mean, we've learned that if 100% of our loan was clean pay 12 of 12, we could finance the entire portfolio 1.88% and at 4.5x leverage with a cost basis on the loans in the 80s.

Right.

Right. And we've seen 12 of 12 prepaid [ph] loans recently sell for basically 3% yields.

Right. And I guess just on your comment there, though, about the inverse relationship with yields and NAV there. So maybe this is more reflecting -- or maybe this is what the stock is more reflecting is taxable income and the dividend here. The dividend was well covered by GAAP earnings this quarter, but taxable income, negative, and last quarter was very low. So you're paying out more than you need to. And just based on kind of -- I think you're probably looking back...?

But we also are paying out because we expect we'll have to.

Right. Okay. Well, I guess -- yes, that was my question was just, again, like touching on the view of taxable income in the second half of the year and how you're thinking about where the dividend is set here in that context? That's it. Okay. All right. Fair enough. I'm going to hop back in the queue, but thanks for taking my questions.

Yes. One thing I would add, Tim, is tax and GAAP, when you have no assets remaining, tax and GAAP, over the years, have to be the same. So tax eventually has to approach where GAAP has been. So we would anticipate that some of these securitization structures trigger loan sales as well -- trigger loan taxable income, prepayment increases will trigger loan taxable income. And the market value of our clean pay loans could very well trigger some taxable income at some point as well.

Got. Okay. Thanks for the color, Larry. Appreciate it.

The next question is from Stephen Laws of Raymond James.

Hi. Good afternoon, Larry. I hope you and all others out there doing well.

Yep.

I hate to beat up on the dividend, but I want to pursue ahead Tim's line of questioning. For the taxable income, I've got a negative $0.04 first half. I think it was an echo and then negative $0.09. And I just kind of want to understand your and the Board's thoughts on establishing the dividend where it is. And whether or not you're going to continue to review it quarterly. I understand you've got the cash flow to overpay taxable income. And I think in your prepared remarks, you talked about the 2020-B securitization will increase TI. But you also said you expect more JVs this year, which was one of the reasons more loans owned in JVs that you had signed at a lower tax in 2Q. So trying to, one, reconcile the right level, but also, you're raising money with the preferreds to deploy because you like the new investment environment. So would it make sense to reduce what you're paying out to have more cash that you can retain and put into new investments that you're not having to pay such a high fee for the -- like you are on the private placements?

So I could argue it both ways, and I think some of our institutional investors could argue with both ways as well from discussions over the years with them. We think there's a lot of opportunity, particularly for value investors in this environment, who can have a longer time line mentality in terms of buying things and monetizing. But on the flip side, from an NAV perspective, we have a material built-in gain, I would -- for lack of a better descriptive term. And if COVID-19 were to become very bad and we had a lot of foreclosures, our taxable income would soar. If we sold the loan, our taxable income would soar. And some of our rated securitization structures now will trigger some taxable income as well, a material amount of taxable income. As a result, we're -- our Board has taken the position where, let's keep it, the dividend, where it is for now until we see how COVID's impacts are on loan performance and whether that triggers more foreclosures or more defaults and, hence, more taxable income over time, or whether it keeps loans paying economically and our loans are -- continue to be less impacted, as we would expect, as we saw. But we're evaluating kind of tax planning strategies to accelerate taxable income to some extent because tax GAAP is so different. And what we don't want to do is wake up three years from now and have an enormous amount of tax relative to GAAP, because there's some giant catch-up that happens. So our Board is evaluating each quarter. And right now, they think that the $0.17 dividend is pretty descriptive of what we anticipate taxable income would cause distributions to be through the remainder of this year.

Very helpful. Thank you, Larry. And touching on the taxable income, but not quite for the dividend. But with the JV and the sales taking place there, what operations are taking place in a taxable REIT subsidiary, where you could technically, I guess, retain the earnings if you wanted? Or my understanding is you can dividend them up to the REIT level and distribute out. But how much income do you have taking place at the TRS versus at the REIT?

A fair amount takes place at the TRS. We do -- our multi-class cash flowing securities generates some income. But we have income that happens at the TRS from real estate and our interest in the manager and interest in servicer as well. So -- and the manager, we own 20% of the manager on a zero basis. So we pick up 20% of the manager's income through a TRS. And we pick up 8% of the servicer's income through the TRS.

Okay. That's helpful. Last question for me is on the expense side for two of them. Relative to...

And we have some securities in our TRS also, but not a material amount relative to our total securities.

Okay. And on the expense side, looks like real estate operating expenses, much lower than we've seen. On the other side, other expenses, a little bit higher than we've seen historically. Any color what's going on in those two line items? I haven't the full filings, so I apologize if I missed it out there somewhere.

Yes. Real estate impairments are down considerably in real estate, some of which happened -- is related to real estate selling quickly as a function of COVID-19, okay, number one. Also, we only have about $8 million of real estate owned remaining in our portfolio because so much is sold and so many loans are paying, very little new real estate is being created. And on the other expense side, you see an increase of other expense by about $1.2 million or something like that. That is the accrual of the warrant put-related expense.

Got it. That makes sense. Okay. Great. Thanks Larry. Appreciate the time and look forward to talk. Thank you.

You bet. My pleasure.

[Operator Instructions] We have a question from Kevin Barker of Piper Sandler.

Good afternoon, Larry.

Hi, Kevin.

Can you hear me okay?

Yes. You're getting range on in Chile?

It was pretty nasty out there. Really I'm out street down right here. So on the acquisition front, I mean, COVID has thrown a curveball on -- with foreclosure moratoriums and everything like that. Could you help us think about the timing of when you're going to see the best opportunities to make acquisitions over the next several quarters, just given the foreclosure moratoriums, changes in home prices, different appetites for real estate? I mean, there's a lot of things that are really changing right now in the real estate market. And I just would love to hear your thoughts on when do you think that ramp is going to occur?

Sure. Well, in Q3 so far, we've acquired about $45 million pretty cheaply in many different transactions. And we're finding there's a lot of small originators who have bigger problems than bigger originators have with scratch-and-dent loans. The other thing -- so from a value investment perspective, it's -- those purchases are -- it's still 2014 and 2015. In terms of real estate markets and kind of the opportunity set, the real estate market that we're seeing and from our discussions with borrowers and people on the ground, and also we have an interest in Gaea property REIT that we started, and we're seeing it from our apartment as well, is that each market is much more different than it was five, six months ago and in a magnified way. The -- for example, in Florida, we're seeing significant demand for homes, especially from people in the Northeast, on the East Coast of Florida, and the Midwest, on the West Coast of Florida, looking for homes, but not condominiums. So we've seen dramatic liquidity both for purchasing single-family homes, people purchasing -- people buying and selling single-family homes like us as REO. Or -- but even for rentals, we've seen dramatic liquidity increases, just like you've seen in the New York metropolitan area and probably in the Philly suburbs as well, where you are. In the New York metropolitan area, houses that might have been on the market for two years now have six offers in a weekend. And -- where in the city, rents are down and significantly less demand for high-rise buildings. So these are phenomena that have come dramatically around in the last 4 months. And it's hard to tell whether they're permanent, temporary or somewhere in between, or semi-permanent in that some piece of it will…

I mean, what -- do you see that as an opportunity to maybe recycle your existing portfolio for gains?

Yes. Yes. There's no question about it. That given our clean pay loans, to the extent we see significant opportunity to -- on the buy side, that increases yield given where clean pay loans trade in today's environment, we may very well recycle some of our portfolio.

Okay. So would this be a defining moment where you start to really -- we're going to see a significant amount of gains being generated, a higher amount of...?

Because remember, REIT rules, there's only so much you can sell in a year as a percentage of your tax basis, no more than 20% in one year and a 10% rolling three-year average. So there are limitations as to what you can sell.

Okay. So it seems like you're going to have elevated cash for the foreseeable future as you become more opportunistic down the road?

Yes. To quote one of our large shareholders, this is the time to have your Warren Buffett/Berkshire Hathaway hat on and think about what you can buy really cheap and monetize over three or four years versus what you can try to ride the wave on.

Alright. That's all. Its really helpful. Thank you, Larry.

There are no other questions in queue.

If there's no other questions, thank you everybody for joining our second quarter investor call. We're always happy to talk about our business. And we appreciate you joining us, and we appreciate the questions, and look forward to talking to you between now and our next call. And I hope everybody stays healthy and safe.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.