Altisource Residential Corporation (NYSE:RESI)
Q1 2013 Earnings Call
May 9, 2013 10:00 a.m. ET
Kenneth D. Najour - Chief Financial Officer
William C. Erbey - Chairman of the Board
Ashish Pandey - Chief Executive Officer
Good day, ladies and gentlemen, and welcome to the Altisource Residential Corporation’s First Quarter 2013 Conference Call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. (Operator Instructions) I would now like to introduce your host for today's program, Mr. Ken Najour, Chief Financial Officer. Please go ahead sir.
Thank you. Good morning everyone and thank you for joining us today. My name is Ken Najour. I’m the Chief Financial Officer of Altisource Residential Corporation, which we refer to as Residential.
Before we begin, I want to remind you that a slide presentation is available to accompany our remarks. To access the slides, please log onto our website at www.altisourceresi.com. These slides provide additional information investors may find useful. As indicated on Slide 1, our presentation may contain forward-looking statements pursuant to the Safe Harbor provisions of the federal securities law. These forward-looking statements may be identified by reference to a future period or by use of forward-looking terminology. They may involve risks and uncertainties that could cause the Company’s actual results to differ materially from the results discussed in the forward-looking statements. For an elaboration of these factors that may cause such a difference, please refer to the risk disclosure statement in today’s earnings release as well as the Company’s filings with the Securities and Exchange Commission, including our amended Form 10 registration statement, our yearend December 31, 2012 Form 10-K and the March 21, 2013 Form 10-Q we are filing today.
If you’d like to receive news releases, SEC filings and other materials via email, please register on the shareholders page on our website using the email alerts button. As indicated on Slide 2, joining for today’s presentation are Bill Erbey, Chairman of Residential; and Ashish Pandey, Chief Executive Officer of Residential.
I would now like to turn the call over to Bill Erbey. Bill?
Thank you, Ken. Good morning everyone and thank you for joining today’s call. For this call, I would like to address our business strategy and the importance of our strategic relationship with Altisource and Ocwen in creating a competitive advantage Residential. Ashish will address the size of the market opportunity, the economics of acquiring and operating single family residential properties and elaborate on our success in acquiring portfolios of NPLs. Then Ken will provide you with an overview of financial performance.
Slide 3 is an overview of Residential, its business strategy and value proposition. Our business strategy is to aggregate single-family rental properties through the acquisition of portfolios of non-performing loans, otherwise known as NPLs. There are three key drivers to the profitability of Residential. First, the ability to acquire properties at an attractive cost. Second, the ability to manage these properties nationwide at a competitive cost structure; and third, access to low cost capital.
We have developed a differentiated business model that leverages the capabilities of our strategic relationships with our partners, Ocwen and Altisource, which are highlighted on Slide 4. The key to our model is the existing operating infrastructure of our partners where Ocwen provides non-performing loan servicing to Residential and Altisource provides renovation, leasing and property management services to Residential. Those amongst you who know the lineage of AAMC and Residential will understand that operations is in our DNA.
Ocwen is one of the few players to have a successful track record in NPL acquisition and management. Throughout the 1990s Ocwen was one of the largest acquirers of non-performing loans. Today, Ocwen is the fifth largest servicer in the United States, servicing loans of $470 billion of Unpaid Principal Balance or UPV at March 31, 2013. With a focus on non-performing and difficult to service loans, Ocwen has been very effective in creating value by resolving approximately 70% of non-performing loans it services without foreclosing. This servicing effectiveness is attested by many organizations as depicted on Slide 5.
Ocwen’s operating cost of approximately 60% lower than average industry costs for servicing NPLs. Both operating efficiency and resolution effectiveness are very important to the success of Residential. One of our primary resolution methodologies is to modify NPLs. Modification and subsequent refinancing of NPLs generates near term cash flows as an optimal economic outcome for Residential, along with being a socially responsible business strategy. Altisource provides renovation, leasing and property management services to us.
Through Altisource, we have access to a full service nationwide platform for the acquisition, renovation and management of rental properties. Altisource has developed a differentiated technology based operating infrastructure to support Ocwen, which we believe creates significant and competitive advantages for Residential. Some of this technology is depicted on Slide 6.
When a loan service by offering goes into foreclosure, Altisource provides high quality property management, including repairs of properties disposition, at a low cost regardless of location. Altisource conducts these property management activities through its vendor network of approximately 10,000 service providers and completes an average of 170,000 inspection, maintenance and repair orders each month at 178 major markets across the United States. Through a separate network of inspection vendors, Altisource performs regular quality assurance inspections on properties and actively manages performance to drive quality and predictability results.
Altisource sold 46,000 homes in 2011 and 2012 to its national broker network and home sale website called Hubzu that generates over 1 million unique visitors each month. Altisource’s technology platforms support our tenants, most of which we believe source their rental properties over the internet. Altisource’s nationwide footprint allows Residential to be a geographically dispersed NPL portfolio that captures the lower cost of acquisition offered by the NPL market. We believe Residential’s contractual relationship with Altisource allows Residential to operate its rental properties at a low cost. We estimate the 40% lower than its competitors.
We believe the combination of these attributes should allow us to aggregate homes at approximately 17% lower cost to market and operate them with predictable and efficient property management expenses in markets which are conducive to rental resource and that are not exposed to oversupply. Ashish will cover some of the details regarding low acquisition basis and low operating costs later.
I would also like to spend a few minutes discussing the concept of accretion. Companies that can employ capital yields that exceed the market clearing dividend yield are expected to trade at a premium to book value. For example, a company that generates a 6% return on equity with the market clearing dividend yield of 3% should be roughly traded at 100% premium to book. Such companies can add value to shareholders through equity assurances that are accretive to book value and EPS.
The accretion effect is most powerful for companies that have a very large addressable investment opportunity which yields in excess of the market clearing dividend yield. Kinder Morgan is an excellent example of a company that has created tremendous value for its shareholders through accretive equity issuances. With the fullness of time and as we execute on our business plan, we believe that we should have a market clearing dividend yield closer to the average mobile family REIT. Single family properties should provide greater diversification of risk and greater potential for asset appreciation.
Any reduction in the market clearing dividend yield has a direct effect of increasing the premium at which our stock price trades over book value. As a second order effect, a reduction in the market clearing dividend yield also increases the impact of accretion, creating a virtuous cycle and a significant competitive advantage over non-public participants and purchasing NPLs who raise their capital at book value.
To summarize, we believe we have all of the ingredients necessary to win. First, our ability to acquire properties at a cost that is 17% less than market value. Second, our ability to operate rental properties at a cost that is 40% less than our competitors. Third, our cost of capital and the fourth, lenders that matter. With our recent portfolio of acquisitions, we’re off to a solid start and I look forward to the rest of 2013 as we guide residential in implementing its business strategy.
Now I’d like to turn the call over to Ashish. Ashish?
Thank you, Bill. Good morning and thank you again for being on today’s call. I plan to spend a few minutes discussing the size of the market opportunity and details regarding NPL pools that we acquired. I will also update you on the opportunities in the market.
Slide 7 highlights the market dynamics that are working in favor of single family rental markets. Single family rentals are a large market, representing approximately 40 million homes. In other words, 11% of all households live in rented single family homes. Current restrictive mortgage conditions are expected to tighten further, particularly with the passing of qualified mortgage regulations under (inaudible). These conditions are driving down home ownership rates by approximately 60 basis points per year. This decline translates into potential demand for 450,000 additional rental units per year.
The combination of these factors suggests we will continue to see a growing demand for single family rentals. In addition to existing 14 million single family rental units, the results will allow potential supply of single family rental properties underlying today’s inventory of non-performing loans. As depicted on the left graph on Slide 8, distressed inventory is comprised of 5 million loans. At a conservative estimate of $100,000 average value per home, non-performing loans potentially represent a $500 million addressable supply. We only need to capture a fraction of this market to achieve our goals. A significant percentage of the distressed inventory is held by large financial institutions. Many of these financial institutions are already exit sellers.
As Bill mentioned, we are off to a solid start with completion of the following offerings and the previously announced portfolio acquisitions. During the first quarter of 2013, as detailed in Slide 9, we acquired two NPL portfolios representing 690 first lien mortgage loans with underlying properties having an aggregate market value of approximately $133 million. We also completed an acquisition on April 5th of an NPL portfolio representing an additional 720 first lien mortgage loans with underlying properties having an aggregate market value of approximately $122 million. These acquisitions are consistent with our business strategy.
In the aggregate, we’ve paid approximately 66% of the market value of the underlying properties. We estimate that majority of the loans will go into our rental portfolio. Based on current rent estimates, our target levered net rental yield on rental properties is approximately 13.5%. We estimate this to translate into a 9% return to Residential’s shareholders after payment of AAMC expenses and incentive fee. We target higher returns on other loan resolution outcomes such as modifications and our REO sales.
Please turn to Slide 10 in the presentation deck and you will see the geography distribution and each profile of our portfolio. As you can see, the portfolio is widely distributed across the United States, with presence in markets such as California, Florida, the eastern seaboard and the Midwest. We are pleased with our geography distribution and average age of properties we have acquired. Our properties are located in what we believe are stable and mature market with a better supply demand balance than overbuilt markets such as Phoenix or Atlanta. The average age of our homes indicates presence in stable locations where tenants have lived for decades.
On May 1st, we completed a follow-on equity offering of 17.25 million shares at $18.75 per share from which Residential received net proceeds of approximately $310 million. We plan to deploy this capital to acquire additional NPL portfolios consistent with our strategy. A portion of the proceeds will be used to purchase non-voting preferred stock of new sorts, pay NPL management expenses and renovate the single family rental properties Residential acquires.
Slide 11 shows our potential avenues for loan resolution. Our resolution approach will likely result in three potential outcomes. Modification and subsequent refinancing of borrower by third party lender, conversion to rental properties, foreclosure and our REO sale. Loan modification and refinancing will likely provide the best economic outcome for us and is also a socially responsible business strategy. Given the profile of the loans we expect to acquire, we estimate up to 15% of NPLs to be resolved via this method. Of the remaining NPLs that are not modified, we expect a majority of them to be converted to rental properties that will generate long term returns.
However, since NPLs mostly trade in pools, we would invariably end up buying some loans that are neither amenable to modification nor are good rental candidates. Such loans would be resolved through the route of traditional foreclosure and our REO position. We expect these NPLs to deliver acceptable returns as we target 15% levered return on these loans at the time of purchase.
Please refer to Slide 12 in the presentation which illustrates the benefits provided by the NPL acquisition strategy in acquiring properties at a lower cost basis relative to traditional REO acquisitions. The lower cost basis is driven by two factors. First, by converting NPLs to rental properties, we do not incur real estate transaction costs like broker commissions, settlement costs et cetera which could be up to 10%. Second, NPLs are sold at higher discount rates than REOs as there are relatively few purchasers of NPLs as compared to REOs sold at auctions. Managing NPLs is a far more complex process than managing REOs and hence it is an oligopolistic market.
As illustrated in the graph on this page, even after accounting for NPL management expenses and carry cost, we estimate our basis in rental properties to be approximately 17% less than the market acquisition cost of REO.
Slide 13 represents the key variables impacting net rental yield. Starting with a market growth rental yield of 12% and adding the benefit from an approximately 17% lower acquisition cost, we arrive at 14.4% gross rental yield. From the gross rental yield, we subtract vacancy and bad debt related expenses amounting to 90 basis points, leasing and turnover expenses amounting to 80 basis points, property management and maintenance expenses amounting to 140 basis points, and finally property taxes and insurance amounting to 220 basis points, resulting in a 9% target net rental yield on an unlevered basis.
Assuming 50% leverage and a cost of debt at 4.5%, we arrive at a levered net rental yield of 13.5%. Our target of 13.5% levered net rental yield does not include any potential upside from HPA or some accretion that will cover their yield. We continue to see a robust pipeline of potential opportunities in the market and we believe we have a strong foundation to capitalize on these opportunities. In closing, our experienced management team is committed to the success of Residential which we believe will deliver value to our shareholders.
I would now like to turn the call over to Ken. Ken?
Thank you, Ashish. This morning we reported net loss attributable to stockholders of $984,000 or $0.13 per share for the quarter as shown on Slide 14. Our net loss is the result of $1.5 million of gains on mortgage loans at fair value less general and operating expenses of $2.5 million. The $1.5 million gain on mortgage loans at fair value includes $387,000 of realized gains on the resolution of 10 properties.
The $2.5 million of expenses include reimbursable expenses to AAMC of $895,000, NPL management expenses of $392,000 and NPL acquisition fees of $367,000. Please note that we acquired our first portfolio of loans in February but incurred expenses for the full quarter.
As disclosed earlier, Residential entered into and has a management agreement with AAMC to receive corporate governance, asset management and advisory services. AAMC provides these services in exchange for incentive fees payable only upon delivering dividends to our shareholders and reimbursement of certain overhead and operating expenses.
For the quarter, we did not incur incentive fee expense, but did incur $895,000 of expense reimbursement to AAMC for certain overhead and operating expenses. While we did not make any distributions to stockholders in the first quarter, we intend to elect and qualify to be taxes (inaudible) in 2013. This will require us among other things to distribute annually at least 90% of our REIT taxable income to our stockholders. As a REIT, we generally will not be subject to U.S Federal Income Tax on our taxable income that we distribute to our stockholders.
At this time, we would like to open the call up for questions. Operator?
Okay. Thank you everybody for attending the call today. Have a great day. Goodbye.
Thank you ladies and gentlemen for your participation. One moment. We did just get a question if you’d like to -- looks like they’ve removed themselves from the queue. Thank you, ladies and gentlemen for your participation in today’s conference. This does conclude the program. You may now disconnect. Good day.
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