Rithm Property Trust Inc. (RPT) Q3 2020 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by and welcome to the Great Ajax Corp. Q3 2020 Earnings Conference Call. All lines are currently in a listen-only mode. After the speaker’s remarks, there will be a question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to hand the conference over to Mr. Lawrence Mendelsohn, CEO. Please go ahead, sir.

Thank you very much. Thank you everybody for joining us on the third quarter of 2020 Great Ajax Corp earnings call. We appreciate you joining in given all the other things going on in the world at this time. Before we get started, I want to just point out on page number two, our Safe Harbor disclosure and disclosure about forward-looking statements. And with that jump right into the presentation on page 3, I'll give you a little bit of an introduction before I get into it. Third quarter was a strategically good quarter in many, many ways. We increased our mortgage investments both directly and through joint ventures. We completed another rated securitization that provides much funded financing for the associated loans, in that securitization at a materially lower cost of funds. Our asset base cost of funds across the board decreased by nearly 50 basis points and has continued to decrease in the fourth quarter. And our loan performance and cash flow velocity increased significantly, which has continued into the fourth quarter as well. We continue to be in an offensive position with approximately $135 million of cash as well as approximately $149 million face amount of unencumbered securities and another $34 million of unencumbered mortgage loans. The significant cash balance does create an earnings drag and a significant cash flow loss from our mortgage loans and mortgage loan joint venture structures reduces our portfolio leverage, but we're well equipped for volatility and all the investment potential that that creates. And with that, we can jump right into our overview. It's very important to understand our manager strength in analyzing loan characteristics and market metrics for reperformance probabilities and pathways and its ability to source the mortgage loans for us enables us to acquire loans that we believe have a material probability of long-term reperformance. We've acquired loans from 314 different transactions since 2014, and 12 in the third quarter of 2020. Additionally, we believe having our affiliated servicer provides a strategic advantage to us in non-performing and non-regular paying loan resolution and time lines, and also provides a data feedback loop for our manager, which enables their analytics to get more and more sophisticated each quarter. In today's volatile environment and having our portfolio teams and analytics group at the manager working closely with the servicer is very essential to maximize the reperformance probabilities loan-by-loan and we'll talk more about that later in this presentation. The analytics and sourcing of the manager and effectiveness of our affiliated servicer also gives us the ability to broaden our investment reach through joint ventures with third party institutional investors. Our September 30, 2020 corporate leverage ratio was 2.2 times and our Q3 2020 average corporate leverage was 2.1 times. Our Q3 2020 average asset-based leverage was only 1.9. Our leverage would have declined additionally from Q2, but we closed an $876 million joint venture structure with two institutional partners on September 25, in which we invested $83 million and our manager and servicer oversee that joint venture as well. On page 4, I'll get into some highlights for the quarter. Net interest income from loans and securities, including a $4 million partial reversal of COVID-19 related loan and credit losses. This is only $3 million after deconsolidating approximately $1 million to non-controlling joint venture interests, was approximately $16 million. For the second quarter, we had only a small increase in our average balance of mortgage loans held due to prepayment and a flat average balance of investments in joint ventures that are on balance sheet of securities and beneficial interests. Our $83.4 million investment in our joint venture loan acquisition that closed September 25 was only on balance sheet for five days. So we received minimal benefit through earnings. This JV shows up in quarter-end balances as securities investments and investments in beneficial interest, but has little impact on average balances for the quarter since it was only on for five days. A GAAP item, to keep in mind is that interest income from our portion of joint ventures shows up in income from securities, not interest income from loans. For these joint venture interests, servicing fees for the securities are paid out of the securities waterfall. So our interest income from joint venture securities is net of servicing fees. Our interest income from loans is gross of servicing fees. As a result, since our joint venture investments are growing faster than our direct loan investments, particularly so in Q2 and Q3, GAAP interest income will grow more slowly than if we directly purchase the loans by the amount of the servicing fee difference and GAAP servicing fee expense will decrease by the same amount. An important part of discussing interest income is the payment performance of our loan portfolio. At December 31, 2019 approximately 76% of our loan portfolio by UPB made at least 12 of the last 12 payments as compared to only 13% at the time we purchased the loans. At March 31, 2020 this number was 74% as a result of some COVID impact. And at June 30, 2020 approximately 72.6% of our loan portfolio by UPB made at least 12 of 12. In our Q1 2020 investor call, we mentioned we expected COVID-19 related economic environment would negatively impact the percentage of 12 out of 12 borrowers. Thus far the impact on payment performance has been materially less than expected and the percentage of our portfolio that is 12 of 12 actually increased to 74.5% from 72.6%. While regular paying loans produce higher total cash flows over the life of the loans on average, they can extend duration. And because we purchase loans at discounts, this reduces percentage yield on the portfolio and interest income. However, regular paying loans generally increase our net asset value as we will see later in this call. They enable financing at a lower cost of funds, like our rated securitizations and provide regular cash flow. Loans that are not regular monthly pay status tend to have shorter duration. However, we expect that this duration reduction will be less than typical due to the impact of COVID-19. As I mentioned earlier, most of our loans were purchased as non-regular paying loans and the borrowers our servicer and portfolio team and our manager have worked together over time to reestablish these loans as regular pay. We also expect that given the low mortgage rate environment and the stability of housing prices that higher prepayments will likely continue on both the regular paying and non-regular paying loans. Our managers' analytics group has compared the differences in the prepayment characteristics of loans pre and post-COVID-19 time period, and there are differences as to loans characteristics that prepay since COVID started versus loans that prepaid before COVID started. Our cost of funds in Q3 was lower than Q2 by 49 basis points. This was primarily due to spread reduction in LIBOR rate decrease for our repurchase facilities as well as the rated securitization we completed in August. We expect our cost of funds trend to continue decreasing materially, especially as we call some of our older securitizations and resecuritize the underlying loans over the next few quarters. Net income attributable to common stockholders was $5.3 million or $0.23 per share after subtracting out $1.95 million of preferred dividends and $1.6 million of income attributable to non-controlling interests. A couple of other things to note. We recorded very little flow-through income from our manager and servicer in Q3 2020, primarily due to the mark-to-market decline of our share price on shares owned by our manager and servicer. Our manager and servicer combined owned approximately 1.1 million shares of our common stock and we own 19.8% of our manager and 8% of our servicer. This reduced income relative to Q2 by approximately $700000 or about $0.03 per share. We expensed approximately $1.7 million relating to the GAAP required accrual of warrant put rights from our Q2 2020 issuance of preferred stock and warrants. Also we repurchased and retired $2.5 million face of our convertible notes for $2.3 million although we are required to accelerate the amortization of the related issuance costs to the securities repurchased. Book value was $15.35 at September 30 2020. Later in this call, we will compare September 30 book value and September 30 fair value estimates of our balance sheet. As a spoiler alert September 30 fair value estimates are materially higher than book value. Taxable income was $0.11 per share. The two leading drivers of less-than-normal taxable income for us in Q3 2020 were fewer foreclosures relative to REO sales as well as increasing the loan ownership through joint ventures. For tax purposes we recognize a gain at the foreclosure date in an amount equal to the difference between our tax basis and the loan and the fair value before expenses of the property. As the tax accounting at foreclosure does not take into account liquidation expenses a portion of this gain is typically reversed at sale. As a result of the COVID-19 effect on foreclosure time lines and very strong pay history of our loans we have far fewer foreclosures which reduces tax gains. Additionally our joint ventures are accounted for a single loan pools with the purchase discount recognized over the remaining weighted average life. Under the tax law the pricing speed and yield of the loan pools required to remain constant over the life of the pool and loan level gains are not recognized. Accordingly, the historical gains previously recognized at the loan level for a foreclosure or modification event are no longer recognized and that income is recognized as original issue discount over time. At September 2020 we had approximately $135 million of cash. And for Q3 2020 we had an average daily cash and cash equivalent balance of approximately $148 million. Our surplus cash definitely tempers earnings but this provides us with significant optionality and the related earnings drag should decrease as we get the cash invested over time. In addition to cash we also have approximately $149 million face amount of unencumbered securities from our securitizations and joint ventures and approximately $34 million unpaid principal balance of unencumbered mortgage loans currently. As I mentioned earlier on this call approximately 74.5% of our portfolio by UPB made at least 12 of their last 12 payments compared to only 13% at the time of loan acquisition. I will discuss the importance of this in much greater detail when we get to pages nine and 16 of this presentation. If we jump to Page 5 you can see that we continue to be primarily reperforming-loan driven with purchased reperforming loans representing approximately 97% of our loan portfolio. We strive for positive payment migration of purchased RPLS. And on Page 6 you can see that we continue to buy and own lower loan-to-value loans. Our overall RPL purchase price is approximately 55% of property value and 88% of UPB. This clearly does have an impact on the significant repayment perspectives that we have relative to payment patterns at the time of acquisition. On Page 7 you can see that purchased non-performing loans have been declining relative to the total loan portfolio. But for NPLs on our balance sheet our overall purchase price is 75.6% of UPB and 52.8% of underlying property value. On Page 8 you can see our target markets. California continues to represent the largest segment of our loan portfolio. Our California mortgage loans are primarily in Los Angeles, Orange and San Diego counties. We have seen consistent payment and performance patterns from loans in these markets. We have also seen consistent prepayment patterns even more so in recent months. Since May 1, California prepayments represent 10% more than California is as a percentage of our portfolio. We removed Las Vegas as a target market during Q1. Mortgages in Las Vegas are currently a small percentage of our portfolio unlike five years ago. Our analytics suggest that COVID-19 will have a material economic impact on Las Vegas given its tourism focus and the economic multiplier effect. This however could be partially offset by state income tax-related transitions from Southern California. We're also keeping a close eye on Houston as a combination of COVID-19 and oil industry struggles is having a material impact. It has not spilled into the single-family homes market as much as the apartment market thus far but we have trimmed back Houston targets. We only added Houston to our target portfolio in the second half of 2019. So it still remains a very small percentage of our overall portfolio. We had been seeing material negative effects from the new tax law SALT provisions in New York City metro and in suburban New Jersey and Southern Connecticut home values and home sale liquidity. We've seen a quick positive turn in liquidity in these suburban locations as a result of COVID-19 as New York City apartment dwellers look for suburban residences. It's too early to tell however whether this is a short-term phenomena or a longer-term change in lifestyle as a result of COVID-19. Related to this though, we have also seen demand for homes and home rentals increased significantly in parts of Florida as well as the Phoenix Arizona Dallas Texas and Atlanta Georgia metro areas. But we have not seen this for condominiums in those markets just single-family homes. If you look at Page 9 portfolio migration. At September 30 2020 approximately 74.5% of our loan portfolio made at least 12 of the last 12 payments, including approximately 68% of our loan portfolio that made at least 24 of the last 24 payments. This compares to approximately 13% at the time of purchase. We saw a decline in these performance percentages in Q1 and Q2 of 2020, but a material improvement in Q3. Non-paying loans which usually have shorter durations than paying loans get time lines extended as a result of COVID-19. This affects the yield on true non-performing loans as extended resolution timelines can lead to more property tax, more insurance and more repair expenses. Since we purchased most of our loans when they were less than 12 for 12 payment history our servicer has worked with most of our borrowers over time. While it's too soon to understand the full impacts of COVID-19 on home prices and mortgage loan performance so far the impact on our portfolio has been far less than anticipated and we've seen demand for homes in our target markets increase. 12 for 12 loans in today's market trade at materially higher prices than even pre-COVID in February of 2020 and is primarily related to the reduction in cost of financing for buyers of loans. As a result, our portfolio in related implied corporate net asset value estimates are materially higher than GAAP book value which presents our loans at the lower of market or amortized cost. And we'll talk more about that on page 16. Subsequent to September 30, 2020 we purchased approximately $5.1 million of residential first mortgage loans in three transactions and the purchase price for the loans is approximately 83% of UPB and 65% on value. We have another approximately $29 million of loans under contract to purchase in 11 transactions subject to due diligence. Of this approximately $10 million UPB is small balance commercial mortgages. The purchase price is approximately 91% of underlying principal balance and 46% of underlying property value. We are sticking to our principles of buying relatively lower loan-to-value loans. We declared a cash dividend of $0.17 per share to be paid on November 30 to holders of record November 16, 2020. There's a couple of financial metrics I want to talk about. First average loan yields excluding reserve capture declined by about 20 basis points. This is primarily as a result of duration extension from both more loans paying and from the duration of non-performing loans extending because of COVID resolution restrictions. Also remember that yield on debt securities and beneficial interests is net of servicing fees, yield on loans is gross of servicing fees, debt securities and beneficial interests is how our interest in our joint ventures are presented under GAAP. As our JVs increase as they did in 2020 relative to loans the GAAP reporting will show lower average asset yields by the amount of the servicing fee. Our leverage continues to be low especially for companies in our sector. We ended Q3 with an asset level debt of 2.0 times and average asset level debt for the quarter was 1.9 times. Our asset level debt cost of funds was lower in Q3 than Q2 by almost 50 basis points and the cost of our asset level debt has further declined so far in Q4 and we expect that trend to continue materially. As we get our surplus cash invested, we should see material increases in interest income and net interest income as well. A new slide that we added is page 13, our securities and loan repo funding. Our total repo related debt at September 30 was almost unchanged from year end 2019. At September 30, we had approximately $269 million unpaid principal balance of securities on mark-to-market repo of which 86% were Class A senior bonds in our joint ventures. Of the $145 million of mortgage loan repo financing, only $44 million is mark-to-market financing. At September 30 we have $149 million face amount of unencumbered bonds as well as $86 million UPB of unencumbered equity certificates and $34 million UPB of unencumbered mortgage loans. Combined with $135 million in cash at quarter end, we have significant resources for our being on offense as well as a very stable balance sheet for defense. If we jump to page 17, we've added another slide that people have asked for. And then as I mentioned earlier on the call, we estimate that the fair value of our balance sheet equity is materially higher than our book value. The explanations and discussion of fair value are included in note six fair value in our 10-Q. We invested in mortgage loans at discounts to UPB based on our manager's analytics. Our servicer works with borrowers and helps get loans back on track. When they become regular paying loans they become significantly more valuable. Our GAAP balance sheet shows our investments at the lower of amortized cost or market. Based on current performing loan market prices, we estimate that fair value is approximately $100 million higher than book value. Also we own approximately 20% of our manager at a zero cost basis and 8% of our servicer plus warrants for another 12% of our servicer at a basis of less than $3 million. The estimated fair value of these holdings together is likely another $15 million to $20 million. And with that, I'm happy to take any questions that anybody might have. And thanks again for being on the call.

[Operator Instructions] The first question will come from the line of Mike Smyth with B. Riley Securities.

Hey, Larry. How is it going?

Good. How are you?

Good. Doing well. So my first question would be on JV activity. So it really picked up during the quarter. I was just wondering -- if you could provide some more color on what exactly drove the pickup. And any changes on pricing structure or how much you're retaining compared to pre-COVID JVs?

Sure. We acquired two pools of loans that we agreed to price on in August from Fannie Mae. And we did it with two institutional partners where we are the operator our manager oversees it and our servicer services it. The total purchase price was about $835 million. We took a little over a 10% interest. Our institutional partners took the remainder 89 point something. And if you look at where that purchase was done relative to the next Fannie Mae sale which occurred a month later, our purchase was about 5.5 points lower loan call it apples-to-apples than where the next Fannie Mae sale was. So it was kind of an ideal time because there was a lot of buyers still with liquidity issues during the summer. And as a result we were able to buy two pools: one, a pretty solid performing pool and the other, a pool that was very much in line with our target markets and property values and overall locations. And so we acquired that. That closed September 25. So we didn't get much benefit for it in the quarter. But obviously, starting September 25 we have earnings that will come from that -- our share $83 million investment.

Okay. That's helpful color. And then any incumbents on your outlook for JV formation into the fourth quarter as we bridge your end?

Sure. We have demand for JVs that is right now so much capacity that it would be unlikely that we could ever fill it. Subsequent to that Fannie Mae sale, we've been contacted by six or seven additional partners who would also like to do joint ventures with us. So, it's all good problems. Now, the question is realistically, we can't find tens of billions of loans we can only find billions of loans. So, it's just -- it's a good position to be in but we could never take advantage of 100% of the demand for our JV services and our servicer.

Got you. That's helpful. And then I think you mentioned last quarter that 15% of the portfolio is forbearance, but 80% had made regular payments. I am curious if I missed this but would you provide updated stats for this quarter?

We didn't -- in the presentation there will be updated stats in the 10-Q. And what you'll see is that the forbearance requirements have come down a little bit, but the -- and the payment of the loans has gotten better.

Okay, cool. That's good to hear.

And a lot of it ties back to having lower LTV loans in what I'll call the middle decile ranges in our target markets. So, as a result the borrowers tend to have more equity and more savings because of the nature of the characteristics of our loans.

Got you. Okay and then just one more for me. With the stock trading around 50% of book, what are your thoughts on buying back stock at current levels? Just kind of given your cash balance and outlook for the investing environment.

Two things. One we did buy some of our converts back at a discount and we do plan on in the open market buying some stock as well.

Thank you for taking my questions Larry.

Sure.

The next question will come from the line of Stephen Laws.

Hi, this is Tanner on for Stephen.

Hi, how are you?

I'm good. First, could you -- you kind of maybe touched on this on the last couple of questions. But can you just talk about the competitive landscape for RPL acquisitions in general? And then where you're seeing -- I know you were talking about the target markets but where you're sourcing most of that assets lately?

Sure. So, for clean pay loans in large pools, the prices are very, very high, higher than they were in February when we thought they were high. A clean pay pool -- I mean I'll give you an example. The last Fannie Mae loans that traded with a 4% coupon and 80% LTV traded at -- almost $1.04. And so having -- our strategy we buy loans that aren't clean pay and we work and make them clean pay creates a lot of value and hence our portfolio becomes extremely valuable once we get them to be clean pay. The purchase price for less than clean pay loans it's really strange. The purchase price for true non-performers is also very high. What's in between non-performers and clean pay is probably where the greatest value is and that's where we spend most of our time focusing. It's very hard to buy pools since about early October. It's very hard. It's very large well-paying pools what I would call a value investment. It's really become a momentum investment and it's about your financing cost and structure and not about the loans themselves. For us, we've been buying a lot of scratch and debt. You can see in subsequent events $29 million of loans and a large number of transactions right $29 million UPB in 11 transactions. So, we've been buying a lot of scratching debt loans. One of the things we've seen is there's a lot of originators who are so busy originating agency loans that there's a higher percentage of loans that close and then the agencies don't buy to get kicked out for something. If those loans are fixable to be deliverable to an agency, they tend to -- they tend to trade in the high-90s so they can be delivered to the agencies at 1-0-something after they're fixed. If they're not fixable they trade 10 points less than that. So, we've been able to buy a lot of scratch and dent where we think the loans have good characteristics but they're not fixable to deliver to an agency. And we've had good success buying those. The other place we've seen a lot of demand is the community banks are much less active providing bridge financing to people acquiring small apartment buildings. And so we've been able to buy or to fund some small what I'll call $1 million to $3 million acquisitions of apartment buildings at pretty good rates and spreads and low LTVs to step in for what community banks used to do when they had capacity and they didn't have other credit issues in their portfolio. So that's been we've always bought small balance commercial loans and now we're seeing the opportunity to provide some interim bridge financing what I'll call kind of two-year bridge financing for some of these acquisitions. So, that's another place where we're finding loans. I think it's unlikely that we would buy really good paying loans in today's market versus being a seller into that market.

Got it. That's great color. And then just a housekeeping thing but could you walk through everything that's going into the other expense line on the income statement?

Okay. Let me pull out the income statement. Okay. The other expense line. Yes. So, the largest piece of that is about $1.7 million is the amortization of the warrant expense in our preferred with warrants. And then there's about $240,000 of insurance expenses. And then there's about $200,000 of amortization costs for shared grants to people who work for our manager and servicer about 100 is director grants. And then the balance are just licenses and internal audit expenses things like that. There's a table that details it in the 10-Q. The draft of the 10 that will be filed later today, which is table six other expense.

Great. Thanks for taking the question.

Sure.

[Operator Instructions] The next question will come from the line of Kevin Barker with Piper Sandler.

Hello.

Hi, Kevin.

So I mean you mentioned you're going to buy back stock. Could you how much…

Yes.

How much you have remaining outstanding with the stock that you could -- that you're authorized to do right now?

Sure. Our Board has given us what I would call a price and quantity range. But we have approval to buy back as much as about $20 million worth. And we can also buy back our convertibles bonds as well.

How much of the convertible bonds can you buy back?

We could buy back all of them.

Okay. And then with regards to the $20 million in stock I mean given where you're trading today it seems like you can get a lot more aggressive on buying back your stock. What are some of the hesitations that you have in doing something above $20 million in stock buybacks knowing full well -- there's liquidity issues and so forth?

Yes. So the only reason why it's $20 million for now is the Board wants to see how realistic it even is to acquire that in the open market with all the limitations given how illiquid our shares are, they all the limitations on daily volume and things like that. Number 2 is in REIT world when you buy back stock, you can't replace it. It's capital that's gone. And in a world of COVID-19 and lockdowns and political struggles and things like that and given the harshness of the call it market volatility that we saw in late Q1 and Q2, the Board wants to make sure that we can always play offense and defense not just offense or defense. So as a result they want to make sure that we always have capacity. So -- which is why they gave us a kind of a short-term -- "short-term" limitation to be then determined after that whether to extend or not.

Okay. And then given the fair value of your assets which say was -- correct me if I'm wrong, $100 million above?

Plus the servicer and manager, right?

Right. So I mean why my not accelerate sales of assets in order to cement the value of that fair value. I know you have…

Sure. We can do that. Right. There's REIT tax rate requirements, you can't sell more than 20% in any one year and a rolling 10% of tax basis over a three-year period, an annual 10% over a three-year period. So there are limitations. That being said some of our joint venture securitizations where we re-securitize by selling off bonds from those we will trigger gains and they will be sales of assets as well. Number three is when we get the liquidity, we also want to be able to put the money to work and get yield. And as a result, we want to make sure that there's plenty of -- we'll get more liquidity just from re-securitizing assets because they've delevered so much. So then the question is if we were to sell assets on top of that and get more liquidity, we don't want to have -- right now we have $135 million of cash and call it $200 some odd million of unencumbered assets. We don't have -- we don't want to have $400 million of cash and $200 some odd million of unencumbered assets. So we want to make sure that we can put the money to work relatively quickly as well.

Okay. All right. And then on the non-controlling interest, can you detail some of the some of the main drivers on why it would increase or decrease relative to?

Sure. So it's all based on two of our joint ventures are consolidated on balance sheet. So when we have significant improvements or negative effects in those two particular joint ventures that are consolidated a portion of it gets allocated to the part of the JV that we don't own. So in this case this $4 million reversal of previous COVID-19 expected impact about $1 million of that is represented in a consolidated joint venture that we would have to allocate to the third party partner.

Okay. So when we think about the reversal of the provision we should essentially net out a large portion?

Right. So it's really a $3 million reversal as our earnings go, $4 million as GAAP requires.

Got it. Okay. Questions have been answered. Thank you. Thank you, Larry.

And one more thing, Kevin. So that $1 million does show up in controlling the -- as going to a controlling interest on our income statement. So it gets backed out when you get to net income.

To common.

Right.

And we are showing no further audio questions at this time.

Well, thank you very much everyone for joining us on our third quarter conference call. Feel free to reach out to us to the extent you have additional questions. We're always happy to talk about our portfolio and our business. And it's an exciting time for all of us here with all the optionality in our balance sheet and cash and unencumbered asset position. Thank you again and everybody have a good night.

This does conclude today's conference call. We thank you for your participation and ask that you please disconnect your line.