Great Ajax Corp. (AJX) CEO Lawrence Mendelsohn on Q4 2019 Results - Earnings Call Transcript
Great Ajax Corp. (NYSE:AJX) Q4 2019 Results Conference Call March 3, 2020 5:00 PM ET
Lawrence Mendelsohn - CEO
Conference Call Participants
Tim Hayes - B Riley FBR
Stephen Laws - Raymond James
Good day, and welcome to the Great Ajax Fourth Quarter 2019 and Year End Financial Results Conference Call. All participants will be in a listen-only mode. [Operator Instructions] Please note, this event is being recorded.
I would now like to turn the conference over to Lawrence Mendelsohn, CEO. Please go ahead.
Thank you very much, and thank you, everybody for joining us for the Great Ajax fourth quarter 2019 conference call. Also, happy Super Tuesday to everybody. On Page 2, I just want to point out, before we get started, the safe harbor disclosure about some of the statements that we’ll be talking about.
As an introduction, Q4 2019 was a very good net asset value building quarter. We bought loans from multiple sources, primarily closing in late December and we expanded our joint venture structures pretty significantly. We continued to approve the rates and terms of our asset-based financing enclosed, including closing our third rated long-term securitized bond structure and the first AAA rated structure for loans with all non-clean pay histories. The market value of our assets continues to increase and we will discuss further when we look at loan performance migration on this call and talk about a current market conditions. Intrinsic NAV grew significantly in the fourth quarter and it continues to grow even more so in the first quarter of 2020.
And with that we'll jump to Page 3 and we'll do a brief overview and then get into the highlights of the quarter and year end.
We continued to buy and privately negotiate transactions. We've made 297 transactions over our lifetime here at Great Ajax. We closed nine transactions in Q4 2019. Our sourcing network is very important to our ability to acquire the types of loans we want. Our sellers are more banks than ever before, originators and funds. We have seen an increase in selling from the larger banks as C-E-C-L. CECL has approached and is now in force and we expect later this year that will be the case with some of the smaller banks as well.
We use our managers’ analytics -- very important. We analyze a large amount of data to determine target loan characteristics and to develop pattern recognition algorithms for choosing loans, pricing loans, and driving the servicing of those loans through our servicer Gregory Funding. Our JV partners really rely on our managers’ analytics and the oversight that it enables us to provide. We own 19.8% of the equity of our manager at zero cost basis, and as a result, it's value as we've mentioned before does not show up in our book value.
Similarly, with the servicer, the analytics of our manager really helps to drive service or performance and has created significant NAV increases, that we'll talk about later today to our loan portfolio. And it also causes institutional investors to approach us as JV partners. We also own 20% of the economics of our servicer. We use moderate non mark-to-market leverage, for the most part, average leverage over the quarter, including corporate level leverage. For Q4 2019 was 2.9x and asset-based leverage was 2.6x. Leverage increased in December as we did some securitizations, and to the closing of the two joint ventures. That being said, leverage is still pretty low and that alone brings a significant opportunity in the current environment for us.
For the quarter, if you look at the first ballpoint, we acquired $309 million of loans in joint ventures, all of those closed in December. So, we didn't receive a significant income from them, but they're all quite important. On the net interest income side, net interest income in Q4 2019 decreased by approximately $200,000 versus Q3 '19. This was primarily driven by $600,000 decrease in gross interest income, which was partially offset by $400,000 decrease in interest income.
Most of our fourth quarter purchasers closed in December. If we had purchased these assets early in the quarter, net interest income actually would have increased. For the quarter, we had a lower average balance of investments in mortgage loans than in Q3, but we had a higher average balance of our joint venture investments.
Because we have a high average balance of our joint venture investments, it's important that GAAP items, keep in mind, the interesting come from our share of joint ventures shows up in income from securities and not loans. And for these joint venture interests, servicing fees for securities are paid out of the waterfall. So, our interest income from joint ventures is actually net of servicing fees, unlike interest income from loans, which is gross of servicing fees. As a result, since our joint venture investments are growing faster than our direct loan investments, GAAP interest income will grow slower than if we directly purchase loans by the amount of the servicing fees on the joint venture interests.
For Q4, we also had an average cash balance of $66 million during the quarter, which was a considerable drag and for a portion of Q4, we had significantly more cash than this as well. The most important part of discussing interest income is the payment re-performance of our loan portfolio. However, as of December 31, 2019 more than 76% of our loan portfolio by unpaid principal balance or UPB made at least 12 of the last 12 payments, as compared to only 13% at the time we purchased these loans. This significant payment status improvement leads to three important financial issues I want you to discuss.
First, loans that default have much shorter duration than loans that clean pay and as a result of extending duration, percentage yields decrease and therefore the current interest income decreases. Second and more important, 12 month paying loans have a market value above par, especially loans with our lower weighted average LTV and weighted average coupon of 4.55%. Our amortized cost basis is approximately 89% of UPB. We will go through the numbers more specifically in the NAV effect in more detail on page 9 though.
Third, paying loans overtime generate significantly more cash flow than defaulted loans and ultimately lead to much lower cost of funds for financing them as well. As we call securitizations and reissue in rated structures, our cost of funds financing these loans will continue decreasing significantly.
Additionally, 12 of 12 loans are much more likely to prepay and although prepayment was slower in Q4 2019 leading to duration extension. Based on current market conditions and new Fannie Mae par rates, we would expect prepayments for these loans to increase significantly in the second quarter of 2020.
On the cost of funds side, our overall cost of funds decreased by approximately 18 basis points during the fourth quarter of 2019, primarily due to issuance of our rated securitization Ajax Mortgage Loan Trust 2019-F as well as from lower interest rates on our repurchased credit on both loans and retained joint venture interests. As LIBOR has decreased materially, the cost of our repurchase lines of credit has decreased commensurately as well. In Q4 2019, we put in place an additional repurchase line of credit for our joint venture securities as approximately 65 basis points lower cost. We expect our interest costs relating to financing joint ventures to decline as we continue to rotate securities to that facility.
Given recent declines in treasury yields and significant decline in interest rate swap levels, we anticipate our cost of funds will continue to decline materially at the asset base and corporate level. Net income attribute to common stockholders of $6.7 million. Net income was about $0.313 per share. There are a few distorting factors in this number, which cost approximately $0.07 to $0.08 per share, so normalized would be about $0.38 or $0.39. In the quarter, we took an impairment of 600,000 on Florida Waterfront residential loan that has been a 2015 non-performing loan acquisition pool.
The loan became performing in 2017 and then purposely stopped in late 2019. Since this is one of the few remaining loans in an early 2015 nonperforming loan pool, there are no loans to offset the impairment in that small pool. Strangely, however, under the new rules of CECL which took effect in Q1 2020, we would not need to book this impairment as it's immaterial to our larger loan portfolio grouping and loss reserves. However, in Q4 2019 CECL was not in effect and we are required to take the impairment of approximately $0.03 per share.
We also accelerated 247,000 of differed issuance costs from calling our 2017-A securitization and re-securitizing pricing the underlying collateral. This would have been amortized over 12 months instead of taking the full charge of $0.013 per share in Q4 2019. However, the re-securitization over time will materially reduce funding costs for the related collateral. We took an REO impairment of approximately 400,000 or approximately $0.02 per share. REO impairments come before REO gains, as we don't get to write up REO, we only get to write it down. Also, the best REO that collateralizes nonperforming loans rarely becomes REO. These loans usually re-perform or the property sells to a third party at the foreclosure sale, which is then considered a loan payoff rather than an REO sale.
In November of 2019, we completed a private capital raise for our former wholly owned subsidiary Gaea Real Estate Corp. Gaea raised 66.3 million of new common equity. Great Ajax continues to have a 23.2% ownership in Gaea, but as a result for a little more than a third of the quarter, we only received 23.2% of Gaea’s income rather than historically receiving 100% of Gaea’s income. Gaea, you may remember invest primarily in urban multifamily and mixed use properties, triple net lease properties and property repositioning, mezzanine loans. A subsidiary of our manager, one thing to keep in mind, a subsidiary of our manager manages Gaea. Since we own 20% of our manager, we indirectly own 16% of Gaea’s manager as well.
Taxable income was $0.14 a share. That was really -- the decrease in taxable income really driven by two things. First, we sold 25 REO properties versus only nine newly created REOs through foreclosure. Selling REOs generally causes tax losses in creating REOs through foreclosure generates generally -- creates taxable income. Second, as more loans pay and fewer loans default taxable income gets extended to contractual maturity of the paying loan and equal installments rather than early on through foreclosure or short sale. There is a true up when a performing loan prepays. Loan payments in the first quarter of 2019 were lower than the third quarter of 2019. Pre-payments similar to foreclosures capture cost discount more quickly for tax purposes. Prepayments in the second half of Q1 2020 have increased, and based on current mortgage rates we would expect prepayments to increase materially in Q2 2020.
If we look at Page 5, we continue to be primarily RPL driven. However, Q4 of 19 our acquisitions of direct loans of RPLs and NPLs was about 50-50. REO rental, you can see on the right hand side has decreased significantly in Q4 versus Q3. Mostly as a result of consolidating Gaea Real Estate Corp as part of the 66 million equity capital raise at Gaea. And also from selling REO. REO held for sale, which typically results from foreclosures continues to decline as we sold 25 and only created 9 new.
On page 6, you can see that we continue to buy lower LTV loans with our overall RPL purchase price of approximately 62% of the property value and 87.5% of UPB. Keep in mind, as we talked about, we buy RPLs based on a number of analytical criteria, that we help use -- our servicer use as well to drive the re-performance later on and to increase the value of those loans overtime through re-performance.
On the NPL side, purchased NPL have been declining in absolute dollars invested. This is one of the reasons for having to take the loan impairment we did. For pre Q1 2020 CECL accounting, we pool loans by RPL and NPL and by the quarter in which they were acquired. The loan we recorded impairment on was a first quarter 2015 NPL, one of few remaining, so there was no pool offset. Under CECL, pooling is done through a far larger aggregate and can be offset by pool loan loss reserves as well.
If you look at our nonperforming loans that remain on balance sheet or purchase. The purchase price of the property value is still 56% and the purchase price to UPB is approximately 74%. Our portfolio continues to have California representing the largest segment, both in residential RPLs and small balance commercial loans. Our California assets are primarily in Los Angeles, Orange and San Diego counties. Those are locations we're seeing consistent payment and performance patterns, particularly in the urban centers. We've also seen consistent prepayment patterns, especially for certain borrower characteristic subsets.
We've not seen any impact on our portfolio from the recent wildfires of Q4 in our portfolio. We are seeing however, that the new tax law, the SALT provisions is having material effects on higher end property values with four states really singled out New York, Connecticut, New Jersey and Illinois. We're definitely seeing a decrease in value differences between higher end and middle property deciles. The other thing we're seeing is less flight capital in the Florida market, both from trade conflicts and emerging market currency declines. This is affecting higher end homes and condominiums in Florida and especially Southeast Florida.
Page 9, my favorite page. If you look at our loans that are 12 of 12 or 24 or 24 payments, $1.02 billion UPB of our loan portfolio is 12 for 12 payments or better, compared to only 13% or $170 million of these loans at the time of our purchase. Our cost basis on these loans is approximately 89% of UPB. Market value based on recent transactions is over par for 12 of 12 or better with approximately 80 LTV and 445 coupons. Since, we don't mark-to-market our loan portfolio, except when it's bad for impairments, none of this built-in value shows up on our balance sheet.
Number two, in addition to increasing cash flow and the NAV materially, the significant loan performance improvement also lowers our asset-based financing costs, both through securitization and loan repurchase facilities. It allows us to get high advance rates for our senior classes of securitized bonds relative to our cost basis.
If we turn to Page 10, on subsequent events, a couple of points that I want to talk about. Number one, it's going to be a very busy second half of March. We continue to buy lower LTV loans as purchase price to collateral values continue to be in the low 60s or 50s for what we're doing. We have 337 million of RPLs under contract with expectation of closing in late March and we have 105 million of NPLs also expectation of closing late March.
We have 3 million of small balance commercial that’s also closing. Our Board declared a $0.32 dividend record date, March 17th, payable March 27. Given the pay performance and the intrinsic value and the expected prepayment coming on performing loans, our Board is very comfortable with maintaining the dividend based on expectations for taxable income. The other thing is on February 28, our Board of Directors approved a stock buyback up to 25 million of our common shares, obviously depending upon market conditions and availability of those common shares as well.
If we jump to the financial metrics page. There’s a couple of things I want to point out. If you look at average loan yield, net of impairments from Q3 ‘19 to Q4 ’19. It went from 8.7% to 8.1%. Part of that is driven by the 600,000 loan impairment we previously discussed. And the other part is driven primarily by extension of duration due to -- in odd way too many loans performing. If you look at average debt securities and beneficial interests, that stayed approximately the same. It's also net of 65 basis points servicing fee. So if you wanted to compare it to interest rates on loans, you'd have to add in the 65 bps average servicing fee versus the loan yields. Because debt securities official interests are -- the way we present them under GAAP, the servicing fee is net.
If you look at our asset level debt cost, in the middle of that page, it's gone from 4.5% to 4.2%. This will decrease even further. We continue to expect the asset level debt cost to decrease both through securitization and the repurchase facilities on our joint venture securities, as well as we repurchase facilities on loans. Those costs are coming down, some of it directly related to LIBOR but will declines, but swap spreads now have declined almost a 100 basis points since middle Q4.
From the leverage itself, if we go closer to the bottom of the page, we significantly delevered over the last 12 months, with so many loans, 12 of 12 or better. However, we're very comfortable with more asset-based leverage and we expect to increase this through securitization, especially now given financing rates have come down so materially in the last few weeks.
And was that, I'm happy to take any questions anybody might have.
[Operator Instructions] Our first question will come from Tim Hayes with B Riley FBR.
My first question, I just want to touch on the trajectory of taxable income. You highlighted that you expect repayments to pick up given the move in rates and then, the REO held for sale portfolio continues to work its way down and the NPL portfolio is pretty small, so eventually you won't see as much net sales activity I guess there. Can you just maybe tie all that into the potential impact from today's fed cut and the impact that that might have on credit and cash flows and taxable income and when you really see taxable income starting to take off, especially as you do more JVs versus on balance sheet investments?
The taxable income is not that different from JVs versus actually owning the loans directly, because we still own the equity certificates in the joint ventures pro rata with our JV partners so we get our proportionate share. The big place for taxable income occurs is two places. One is just regular interest payments versus the cost of being in business and interest expense. And two, is capturing discount from our purchase price. If you look our tax basis purchase price is actually low -- our GAAP basis is 89 but our tax base is actually materially lower than 89 of UPB.
So as a result, any acceleration of capture that discount generate significantly significant taxable income. Our tax GAAP difference is about 3.5 or 4 points. So on a 1.2 billion basis, call it, it's about 50 million, 60 million of tax GAAP difference right now. And that's largely because performing loans, you take tax in equal installments through contractual maturity. So on a 360 months loan, you take effectively one 360 each month where for GAAP purposes, you take it based on expected life of the loan you take GAAP income. So it creates a tax GAAP difference.
Now, given where current interest rates are, we would expect given that the Fannie Mae par rate today is 2.56, we would expect a material amount of loan pre-payment occurring starting about 60 days from now, because of the time lag for loan originations and our weighted-average coupon on our performing loans is about 4.45%. The second thing I want to mention is that in 2019 forward, because we are building up this large tax gap difference, we working with Deloitte came up with a tax methodology where we can, from 2019 forward for loans acquired 2019 forward, closer match the tax and the GAAP on performing loans by creating the discount for tax purposes. It's not exactly identical for GAAP, but its closer and that will narrow the gap also as well as prepayment narrowing the gap.
You know ultimately, tax and when a loan pays off tax and GAAP over the life of ownership, are identical. So that tax GAAP difference obviously closes at the time of payoff. Or if we were to sell a loan as well, which given we had a high percent of our portfolio is worth materially over par in this environment and probably since mid Q4, that's certainly something. Now REITs do have restrictions on limitations of what they can sell. So it's not like you just capture that all at once, but you capture some of it by selling some assets and some of it by making the interest rate spread materially bigger by refinancing existing facilities, and by the way less interest expense increases taxable income.
And I guess the one point of the question that maybe you could shed a little bit more light on is just the impact you expect the fed cut to have on cash flows…
So, there's two things that we can see from the fed cut, and we started getting based on some factors that we look at in our analytics and some of our long time investors’ owned businesses and the insights they provide. We started to see this kind of coming in mid to late fourth quarter, which is one of the reasons why we built up cash in the fourth quarter because we lined up plenty of liquidity for the first quarter and second quarter. If you look at the fed’s cut two things. One, you're clearly going to see based on the shape of the yield curve and where swap rates are and where new origination of mortgages are. I mean, you can get -- I got four emails today offering me 10 one arms at 2.7% IO.
So, as a result you're going to see significant amount of prepayment get generated on a lag to today's markets and even more strangely, loans that were done several years ago call it three, four years ago when 30 year mortgage rates were 3.5% fixed and everybody was presumed to be completely immobile and to never refinance those loans now they can refinance those loans in the current market because the Fannie Mae par rate is now 256 versus the 350 that they're in. So we expect that we'll see significant prepayment as a result of where the curve is. And if you look at the euro dollar curve in four and three month LIBOR rates, you would expect that absent and material change in credit spreads on mortgages, you'll see rates even lower maybe in June than they are now, which would even accelerate prepayment into the summer.
Number two however is the part that the leverage loan and how you have market is showing that the mortgage market isn't showing, which is credit spreads have actually widened significantly in high yield bonds and leverage loans have actually sold off a little bit, even though rates have rallied and the number of leverage loans transactions have been pulled. And that is what does the fed rates cut actually mean and about economic slowdown and is there a multiplier effect to re-defaults in RPL land from that. Based on the purchase prices that we have of our RPLs and NPLs basically in the low sixties on property value, more defaults would actually increase our yield in the near term and increase taxable income in the near term but on the flip side, it would decrease NAV on the related loan.
So that it would provide you -- it would raise yield but for a shorter period of time effectively.
And you’d also be able to sell the loan versus have the loan effectively prepaid through default. RPLs do have versus kind of a newly originated Fannie mortgage Freddie mortgage, RPLs do have a higher kind of re-default multiplier effect relative to small negative changes in GDP than do a Fannie Mae loans. You know RPL loans were all at some point in the last 10 or 11 years nonperforming for a period of time, and they're a little more subject to a multiplier effect than a newly originated Fannie Mae loan. But on the flip side that would actually increase our yield but it would negatively affect the total intrinsic value of the loan.
Got it, that's helpful a lot of detail there. And so just putting that all together, how do you think about your dividend here, given the trajectory of taxable income that you've kind of led out despite GAAP earnings not covering the dividend this quarter?
Well, the reality is over time we're not going to have a choice the dividend is going to go up, because we have $50 million to $60 million GAAP tax difference, and the intrinsic value would suggest that that gets matched up overtime. Whether that's driven by prepayment sales, combination of both or re-defaults, that I would predict all three. But what the relative amount versus right now that is a little hard to determine and takes a little more kind of this cycle to figure out. But I don't think there is -- I think our Board's pretty comfortable with this kind to be in the floor on the dividend as opposed to being the ceiling on the dividend.
And then, I'll ask one more and get back in the queue, but can you just touch on the recent market volatility, you mentioned that the pipelines being bolstered by CECL going into effect, but are you seeing any impact on your pipeline from the recent volatility? Are you seeing more cautious or forced selling? And are you able to get assets and more attractive yields?
We're seeing a couple of different things, some driven by CECL because the smaller bank is not as big deal yet because it’s not as enforceable as traditionally the larger banks. But we'll see it from both smaller banks later this year. From the bigger banks, the bigger banks have been large sellers for about a year now and they continue to be large sellers and CECL is one of the two reasons. The other is in a very flat curve environment, the larger banks use selling some of these loans where they recapture reserves and capital ratios and they can manage earnings. If you sell a big enough pool -- big enough number of loans, you can manage earning by 0.5% or 1% for the larger banks in any quarter. So we're clearly seeing that also in what the larger banks are selling and they're selling specific kinds of pools coming from that.
Number two, we're seeing a couple of different reactions from the marketplace on the loan buying side. We see some buyers, especially very, very, very large funds who raised a lot of money as almost panic buyers and the price is merely just an arbitrage to where they think they can get rating agency enhancement levels as opposed to what's the value of the loans. And as a result, they're just playing a spread game as opposed to a value game. On the other side, we've seen a lot less total buyers as most people don't have the cost of funds to someone like we have or the analytics or the relationships for that matter of being able to negotiate loans in smaller pools and in subsets and direct transactions with institutional sellers, whether they’d be banks and funds.
So we're seeing a little bit of both. We're seeing kind of panic selling or panic buying from people who are afraid they're going to miss out and we're seeing which by the way if you're long loans you'd like that, like we are at big discounts. But on the flip side, we're seeing those buyers very focused on pools of $100 million and larger and we see almost no one paying attention to pools that are kind of call it 40 million, 30 million and smaller anymore. Over the last three or four years, the smaller buyers has really gone away.
Got it. Okay, great. Well, thanks again for taking my questions.
Our next question Stephen Laws with Raymond James.
Great, couple questions kind of thinking about leverage, I guess two things going on. One, you mentioned better performing loans so that would warrant increasing the leverage behind that. But I believe the JV investments you're taking the securities and that's not consolidated on your balance sheet, so certainly lower leverage associated with that. So how do we think about those things trending? Are we in a good spot currently and we're just going to see a little bit of a shift in mix here? Or kind of how do we think about capital allocation across those two strategies going forward?
Sure. I think the JV allocations will increase faster than direct loans will and part of that is demand for JVs. Part of that is by owning 20% of the manager and servicer we pick up additional revenue in other ways from our equity investments in those entities in the JV structures. The other piece though is both in JVs and loans our JV are structured in securitization structure so we can take those securities and we can bundle them and securitize them or we can individually finance each security. And the cost of that financing has come down dramatically as both LIBOR has come down and as we've created new securities financing facilities, and in rated securitization land with swap rates where they are kind of at 0.8%, a new AAA bond deal will be right around two and change percent which is 70 or 80 basis points lower than where it was three or four months ago.
So we can continue to get with our cost basis about 89% of UPB if we wanted to sell through single A we could probably get six or seven times leverage kind of in today's market sub 2.5%. And on a repurchase facility basis with LIBOR now down, three month LIBOR down to 115 or 120 you're going to see financing still the costs come down dramatically as well since LIBOR come from effectively down 40 or 50 basis points in the last three months so that over time and lenders for better or for worse are getting more aggressive. If you're, big bank right now, it's very hard to earn spread and there's been a lot of pressure put on to stand or repo facilities and both by lowering costs and increasing advance rates earn more spread at the banks and we're seeing that phenomenon as well. Now that being said, the mortgage industry goes in cycles that it never from, so we always like that opportunity set that it creates.
Sure. Well, I appreciate the color there, Larry and details. And second question I have this afternoon, the stock buyback you announced are authorized. How do you think about the current valuation versus what you view as intrinsic NAV that reflects the value for the service or the manager ownership and other things aren't reflected in a GAAP book value number? So how do you view the discount intrinsic NAV versus the opportunity for returns on new investments using that capital?
Sure. There’s a couple of different pieces. We actually used our ATM a little bit in Q4 when the stock was around 1,550, 1,560 and not out of necessity, we just could sense from seeing some of our – the commodity pieces we follow, some of the shipping pieces we follow and some of our long time investors who have industries across multiple continents, you could see that there was going to be something going on in the first quarter we didn't know it was going to be caused by a virus, but you could see that some of the things we follow were indicating that you want to have liquidity in the first quarter.
So we use the ATM a little bit to create some liquidity to get ready for the first quarter as you can see from what we're buying at the end of March, a lot of people needed some liquidity in the first quarter. Now with the stock down based on what's going on in the market, we think that it makes sense to buy some stock in and we're also likely to buy some of our convert and given the cost of capital to the company, so much lower than where the convert currently trades. So we're also likely to buy some of the converts in in the open market as well.
Thanks for the comments there Larry. Take care.
This concludes our question-and-answer session. I would like to turn the conference back over to Lawrence Mendelsohn for any closing remarks.
Thank you everybody for joining us on Great Ajax fourth quarter 2019 and year-end 2019 conference call. We appreciate the time given Super Tuesday, a fed rate cut, a virus and all the other things going on in the world at this time. And if you have additional questions, feel free to reach out to all of us here. We always like talking about our business, and thanks. And have a good night.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
- Read more current AJX analysis and news
- View all earnings call transcripts