Great Ajax Corp. (AJX) CEO Lawrence Mendelsohn on Q1 2020 Results - Earnings Call Transcript

Great Ajax Corp. (NYSE:AJX) Q1 2020 Earnings Conference Call May 5, 2020 5:00 PM ET

Company Participants

Lawrence Mendelsohn - Chief Executive Officer

Conference Call Participants

Kevin Barker - Piper Sandler

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Great Ajax Corp First Quarter 2020 Earnings Call. [Operator instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Lawrence Mendelsohn, CEO. Thank you. Please go ahead.

Lawrence Mendelsohn

Thank you very much. Thank you, everybody, for joining us on our first quarter 2020 earnings conference call. I want to point you to, on Page 2, the Safe Harbor disclosure and discussion of forward-looking statements. And with that, we can move on to Page 3 and the business overview.

Before I get into too much of the presentation, I want to do a brief introduction. First quarter of 2020 was a noisy one, predominantly because of the fixed income market conditions and the economic environment in the month of March. January and February were good net asset value-building months. In March, we navigated through the volatility, closed on joint venture loan investments that were purchased through a pre-funded securitization structure, and set ourselves up for Q2 and beyond.

And we'll discuss more about this later on the call. One thing I do want to add, though, is volatile environments like this that we've seen in the last few months really show how important it is and how strategic it is in having our directly aligned operating and loan servicing platform. And with that, I'll jump into Page 3. Our manager strength in analyzing loan characteristics and market metrics for reperformance probabilities and the pathways and its ability to source these mortgage loans in target locations through privately negotiated transactions really enables us to accumulate loans that we want in places that we want them.

We've acquired loans in over 300 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 the timelines. In today's volatile environment, having our portfolio teams and our analytics group at the manager work closely with the servicer is essential to aim to maximize returns and NAV for each asset, loan-by-loan, property-by-property. The analytics and servicing of the manager and the effectiveness of our affiliated servicer enables us to broaden our reach through joint ventures with third-party institutional investors as well.

Okay. Let's talk about the quarter. In Q1 2020, net interest income increased by approximately $900,000, or approximately $0.04 per share. This was almost entirely driven by a decrease in our cost of funds of approximately 21 basis points.

Most of our loan and joint venture acquisitions closed in March and were on balance sheet for approximately two weeks. As a result, they did not produce material interest income in Q1 2020. For the quarter, we had a lower average balance of investments in mortgage loans but a higher average balance of investments in joint ventures that are on balance sheet as securities and beneficial interests. 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 on securities that are paid out of the securities waterfall, so our interest income from joint venture securities is net of servicing fees, unlike interest income from our loans, which is gross of servicing fees. As a result, since our joint venture interests have been growing faster than our direct loan investments, GAAP interest income will grow slower than if we directly purchased the loans by the amount of the servicing fees, and GAAP servicing fee expense will decrease by the corresponding offsetting amount. An important part of discussing interest income is the payment reperformance 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 13% at the time we purchased the loans.

At March 31, 2020, approximately 74% of our loan portfolio by UPB made at least 12 of our last 12 payments. We would expect that current COVID-19 related economic environment will negatively impact the percentage of 12 of 12 borrowers in our portfolio over the next few months. The effect on interest income is difficult to quantify and forecast, however. While regular-paying loans produce higher total cash flows over the life of the loans, on average, they extend duration.

And because we purchase loans at discounts, this reduces percentage yield on the loan portfolio and interest income. However, regular paying loans generally increase our NAV, enable financing lower cost of funds, and provide regular cash flow. Loans that are not regular monthly pay status tend to have a shorter duration. However, we would expect that this duration reduction would be less than typical due to market conditions and 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 have worked together over time to reestablish these loans as regular-paying. We would expect, as this COVID-19 volatility reduces and the economic environment improves, we'll again see that result, over time. We also expect that, given the low mortgage rate environment and the stability of housing prices so far, that prepayments will likely increase on both regular-paying and nonregular-paying loans over time. However, it's also too early to predict the timing of these anticipated patterns.

We do anticipate, however, that given spread widening and financing markets that we'll likely not continue to see material costs of funds reductions in the near-term. From a net income perspective, net income was $0.4 million, or $0.02 per share. There is a lot of noise in the number, so I will go through each material piece. The biggest impact came from a $5.1 million, or $0.23 per share provision for duration extension and potential credit losses.

This allows for losses on our loan portfolio of beneficial interest securities is driven by potential impacts from COVID-19, such as the expectation of borrower payment deferrals and time and expenses resulting from duration extension of resolution timelines. This reserve reflects the macroeconomic impact of COVID-19 on mortgage loan and residential real estate markets generally, and it's nonspecific to any loan losses or impairments in our portfolio. This is a noncash reserve unless later realized. In the quarter, we took impairment on current REO properties of approximately $900,000, or about $0.04 per share.

This impairment is significantly larger than usual by approximately $0.02 per share. The bulk of this impairment is related to expected time delays in the marketing and sale of REO properties as a result of the COVID-19. Such delays lead to more property tax, insurance and repair expenses, as well as delays in repairs and evictions due to restrictions. This is also noncash.

We accelerated the amortization of approximately $400,000, or $0.02 per share, of deferred issuance costs from the repurchase of approximately $12 million, or face amount of our convertible bonds during the quarter. This is noncash. We sold 26 small-balance commercial mortgages with a UPB of $26.1 million during the quarter for a loss of $700,000, or $0.03 per share. The loss is equivalent to approximately 2.7% of the UPB of the loans.

We have reported a $1.27 million or approximately $0.06 per share flow-through loss from the 3/31/2020 mark-to-market of our manager's ownership of Great Ajax common shares. Our manager owns approximately 650,000 shares of our common stock and we own the 19.8% of our manager. So when the stock goes down in Q1 from December 31st to March 31st, we take a pro rata share of the manager's 650,000 share markdown. This is also noncash.

The sum of all these items is approximately $0.36 per share. Taxable income was $0.05 per share. The two leading drivers of lower taxable income were fewer foreclosures in Q1 2020 and more REO sales, as well as particularly slower prepayments in January and February. Prepayments picked up in March, but we would expect them to slow down for a period of time as a result of the impact of COVID-19.

However, and as I've mentioned previously on this call, the current low mortgage rates, we would expect prepayments to increase at some point. We just can't predict the timing of any increase. We expect the trend of fewer foreclosures, however, to continue for a period as a result of COVID-19. Book value per share declined from $15.80 at December 31st to $14.37 per share at March 31, 2020.

This decline almost entirely reflects the effects of $28.4 million noncash mark-to-market adjustments to our debt securities generally determined by marks provided by our financing counterparties. This is a noncash adjustment, as well. Additionally, so subsequent to March 31, most of these securities have increased in mark-to-market value. At March 31, 2020, we had $31.2 million of cash, and for Q1 2020, we had an average daily cash balance of $58.6 million.

The quarter-end decline in cash related to approximately $28 million of margin calls related to our mark-to-market financing facilities for our debt securities. Subsequent to March 31, 2020, some of these margin calls that have been reversed. These debt securities primarily relate to our joint venture investments. Total margin calls from loan financing, however, during the quarter were less than $200,000 total.

At March 31, 2020, our total mark-to-market financing was approximately $285 million, of which approximately $225 million was against the Class A1 debt securities. All securities of beneficial interest that we own are backed by loans we purchased ourselves with joint venture partners, and we retain the asset-related rights. We also have approximately $50 million face amount of unencumbered triple-B, double-B, and single-B agency-rated securities from our own securitizations. Our March 31, 2020 corporate leverage ratio increased a bit from 3.0 times at December 31, 2019.

Total dollars of outstanding debt has actually decreased during Q1 2020 despite our portfolio growth. But because book value declined, as I discussed earlier, debt as a percentage of book value increased. Average leverage during the quarter was three times. Average asset base leverage is 2.7 times.

So, currently we have approximately $115 million of cash on hand. If we jump to Page 5, you can see that we continue to be primarily RPL-driven, with RPLs representing approximately 97% of our loans. And importantly about RPLs, on Page 6, we continue to buy lower loan-to-value loans with overall RPL purchase price of approximately 56% of the underlying property value and 87% of the unpaid principal balance. And if we look at our NPL portfolio on Page 7, purchased NPLs have been declining in absolute dollars invested.

But for NPLs on balance sheet, they're at 73% of UPB and 51% of property value. We have a lot of built-in equity in our portfolio. In our target markets on Page 8, California continues to represent the largest segments of our loan portfolio. Our California mortgage loans are primarily in Los Angeles, Orange, and the San Diego Counties.

We have seen consistent payment and performance patterns from loans in these markets. We've also seen consistent prepayment patterns even in recent months. Thus far, the impact on our California loans from COVID-19 and its related economic effects has been relatively muted. We have 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 when we have aggressively purchased loans in Las Vegas. Las Vegas was positively affected by the new federal tax law, and we saw significant appreciation and prepayment as a result. Our analytics suggest that COVID-19 will have a material economic impact on Las Vegas, given its tours and focus and the economic multiplier effect. We are also keeping a close eye on Houston, as the 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 materially. We only added Houston in the second half of 2019, so it is a very small percentage of our portfolio. We've been seeing these material negative effects from the new tax law in New York City Metro, suburban New Jersey, and southern Connecticut home values and home sale liquidity. We have seen a quick turn in liquidity in these locations as a result of COVID-19 as New York City apartment dwellers look for suburban residences.

It is too early to tell whether this is a short-term phenomenon or a longer-term change in lifestyle target as a result of COVID-19. On Page 9, at March 31, 2020 of approximately 74% of our loan portfolio made at least 12 of 12 of the last - 12 of the last 12 payments, including 67% of our loan portfolio that made at least 24 of the last 24 payments. This compares to approximately 13% at the time of purchase. As a result of the economic impact of COVID-19, we have seen a small decline in these numbers.

During Q1 2020, we had a 2% decline in loans as a percentage of our portfolio that is 12 of 12 payments or just better. We expect that this number will continue to be affected, but it's too early to determine the materiality. Since we generally purchase lower LTV loans, and purchase price and property value averages in the high 50s percentage, we would expect the principal impact of a decline in regular-paying loans to be duration extension as borrowers with some loans that are paying but are not 12 months contractually current will have more difficulty refinancing. Since we buy loans at discounts to face amount of UPB, duration extension reduces the speed at which we receive the discount on the affected loans and, therefore, the interest yield.

COVID-19 duration extension can also affect the yield on true nonperforming 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 less than anticipated. We've seen more demand for homes in our target markets generally increase.

On Page 10, subsequent events; subsequent to March 31, 2020, we closed on $123 million UPB of first residential mortgage loans through a joint venture that was pre-funded in a securitization structure in early March 2020. The purchase price for the loans was 92% of principal balance and 60% on value of the underlying property. We own a 20% interest in the structure in our joint venture partner in the credited institutional investor owns 80%. We have declared a cash dividend of $0.17 per share to be paid on May 29, 2020 to holders of record May 15, 2020.

As a result of COVID-19 uncertainty and the related economic impact, taxable income is harder to forecast. On April 6, 2020, we closed a private placement of $80 million of preferred stock and warrants. We think that the uncertainty of markets and the economic impact of COVID-19 will lead to value investment opportunities over time. We believe analyzing and investing in these opportunities will require patience, a durable balance sheet, our value-oriented total return investment focus, and longer-term holding period horizons.

We think the structure and the institutional accredited investors that invested provide us greater ability to invest in these opportunities as well as in larger joint venture opportunities and provide us significant flexibility. The current joint venture partners continue to work with us seeking investment opportunities, and we anticipate additional joint venture transactions as well. So, briefly, a few financial metrics on Page 11. Average loan yield declined by about 60 basis points primarily as a result of duration extension from both paying loans and nonpaying loans.

As discussed earlier, the principal effects we're seeing from COVID-19 impact is duration extension. The average yield on debt securities and beneficial interest shows the effects of the reserve for future losses that we expensed in Q1 2020 and, as a result, is a negative market number for this first quarter but is not on an ongoing basis. Also, remember that yield on debt securities and beneficial interest is net of servicing fees, and yield on loans is gross of servicing fees. Debt securities and beneficial interest is how our interest in our JVs is presented under GAAP.

As our JVs increase, as they did in Q1 2020, the GAAP reporting will show lower yields by the amount of the servicing fees. Our leverage continues to be moderate, especially for companies in our sector. While the quarter-ending leverage increased slightly, it's because of our decrease in our book value from March 31st total book value - March 31st total liabilities that are lower than at year end of 2019. At this point, if anybody has any questions, we're happy to answer to the extent we can.

Question-and-Answer Session

Operator

[Operator Instructions]

Your first question comes from Tim Hayes with B. Riley FBR. Your line is open.

UnidentifiedAnalyst

Hi, Larry. This is actually Mike on for Tim. So my first question: have you seen any impact on RPL or NPL supply, given the spike in forbearances and the impacts CECL is having on the banks? Just wondering if you're able to acquire any assets at more attractive yields than you were, I guess, in the fourth quarter.

LawrenceMendelsohn

The answer is yes, yes, and yes. We're clearly seeing a lot of supply of loans right now. A big chunk of that - it's not come from the banks yet, but it will - a big chunk of it has come from people as it relates to margin calls, and we're seeing it from dealers who've been asked to find buyers for loans. Number two, we're seeing it from a lot of originators, particularly in non-QM business purpose and fix-and-flip flip markets who are having warehouse lender issues.

They tend to be smaller pools. I would call them, on average, between $10 million and $40 million, the ones from originators. And we expect that, after this June 30th, we will start to see a lot more coming from banks, and especially prior to 12/31. For smaller banks, CECL has been delayed, and we anticipate that the smaller banks really won't get going on selling some loans until later in the year.

And we also expect, on our community bank front, and we'll see a lot of smaller commercial mortgages come out later in the year as well.

UnidentifiedAnalyst

Thank you. That's very helpful. And kind of just given the deterioration in residential credit, the expectations for that, what's the sentiment toward - or demand like from your JV partners? Has it improved or how has it changed since February, the first half of March? Are they cautious or has the volatility created opportunities?

LawrenceMendelsohn

Sure. I would say from March 5th - or about March 25th to about April 15th, it was in suspended animation. Since about April 15th or 20th, it is go find me as many loans as you can find. So very different.

There's like a 20- or 25-day period where there was just structure illiquidity, and I think a lot of people saw that at the end of March and the beginning of April especially, so the last 10 days of March and the first 10 or - days of April. Now, there seems to be a fair amount of inflow into fixed income land, and we've had - a number of our JV partners ask us to find loans and create structures.

UnidentifiedAnalyst

Thank you. That's helpful. And just one more from me, so subsequent to quarter-end, you did the $80 million private placement. I'm just curious how much of this capital has been deployed? And then, as a follow-up to that, is the dividend set at a level that reflects earnings power as you redeploy proceeds from the preferred offering?

LawrenceMendelsohn

The dividend - well, I'll answer the dividend question first. The dividend question is - it's set based on an expectation of kind of taxable income, assuming only a small amount of the money is put to work. That being said, taxable income in an environment like this is pretty hard to predict. We don't want to bet on putting all the money to work.

One of the things that I'm hoping that a lot of people learned in the last 10 days of march and the first 10 days of April is that there's a lot of volatility that can happen in a short period of time, and as a result, we want to be patient in putting capital out to work because we - until we know whether this is the second inning, the fourth inning, or the sixth inning.

UnidentifiedAnalyst

Got you. That's helpful. And then any idea just how much of that capital has been deployed?

LawrenceMendelsohn

Only a small amount thus far.

Operator

Our next question comes from Kevin Barker with Piper Sandler. Your line is open.

KevinBarker

Thank you. Good evening. Good afternoon. Just a follow up on some of his comments about being patient and put capital to work. I mean, do you feel like the market has come back too quickly, just given spread tightening that we saw and where the underlying credit would justify some of those prices?

LawrenceMendelsohn

I think in certain subsegments of the market, it's come back. I mean, some of it - I mean, we're nowhere near where we were, say, in February, but it is improved to some extent since late March, I would say, by maybe a third of where it got to in late March. That being said, we - I think there's still potentially significant volatility in markets, and that we don't want to jump in and say this is the time where you should be getting in, all in, and taking the risk that there's not going to be another time. We think that there's a whole bunch of different opportunities that can present themselves in different seller types who, for regulatory reasons or liquidity reasons, over time they'll have differing circumstances.

And in Banking Land, community banks and the larger banks will also have different time periods in what they're trying to accomplish, or need to accomplish, based on regulatory frameworks and economics. Originators, same thing, but we've seen less - other than in what the Fed is buying, and we've seen less dramatic recovery for most things. That being said, senior bonds have come back significantly.

KevinBarker

Right. And then, just to follow up on your comments about prepay speeds picking up and then slowing down, and then you're not sure what's going to happen there. I mean, maybe could you pick up in prepay speed actually be a good thing in the near-term as it increases your cash, and it allows you to eventually put that cash to work at more attractive yields maybe in the later of the year when you start to see more product be put to work. So maybe in the near-term, you put the cash to work in joint ventures where there is liquidity, and then put more on the balance sheet later in the year, just given the pickup in prepay speeds?

LawrenceMendelsohn

Yes, I think that's right. We do expect that prepay speeds will increase pretty materially, given where mortgage rates are and given, so far, the stability. In fact, home prices on average are probably up a little bit in the last few months rather than down. So we do think prepayment speeds, those will pick up materially.

Our California speeds really haven't changed much. They haven't had the decline like some other states have but we anticipate they'll pick up. Also, we buy loans at discount, so prepay speeds actually raise yields pretty significantly and raise taxable income for us, as well as giving you cash to put to work and paying down these securitizations that you can call and issue a new securitization, effectively refinance as well. And that would correspond to kind of what we think is you really have to have what I'll call a 18-month to three-year mentality in this environment versus the quarter-to-quarter mentality.

KevinBarker

Okay. Okay. And then, given what you're seeing in some of the respective markets that you mentioned, would you expect recovery values on deposit loans be fairly resilient or are you fully expecting some significant declines of recovery values, just given the economic softness we're seeing out there?

LawrenceMendelsohn

So, in the reserve we took, we built in some economic decline in the recovery values. That being said, we've not seen it in actuality in any material aspect thus far. We've actually seen, to some extent, the opposite in terms of the liquidity in homes as well as increase in prices. What we have built in that reserve reflects an assumption of a little more delinquency and some home price decline in - related to loans that go delinquent.

So that being said, we've not necessarily seen it in actual outcomes yet.

KevinBarker

Okay. And then, obviously, you're acting almost like a special servicer on a large portion of your loans. Have you - how have deferrals, or maybe forbearance, have changed from where your baseline was and where it is now?

LawrenceMendelsohn

Well, it's interesting, because we bought these loans, on average, where only 13% of them had made 12 consecutive payments. And we got it up to 76%, and it's 74% now. And so, I would say we probably didn't expect it to get to 76% when we bought them with only 13% 12 for 12. So far, the requests for forbearance have been less than we would have anticipated, and certainly less than what the HSEs have seen and what - the numbers we've seen in the press.

And I think that in total forbearances so far, it's been a relatively limited number. I would say total for forbearances so far are about less than 5% of our portfolio. And actually - yes, total forbearances so far are less than 5%. And even then, only 2% have actually not paid during that period.

So, we would anticipate that number will now increase, and we've built that into the model and to the reserves. But that being said, we've been, I want to say, a little bit pleasantly surprised that it's more muted than we anticipated. And so, the one thing I will also add is, and this is a little disappointing, is that 5% to 10% of the calls we're getting requesting forbearance, the people, in fact, have not been affected, and they're just not - wanting to not pay. So part of the special servicers are making that delineation as well.

KevinBarker

So how does the 5% compare to your baseline typical forbearance rate?

LawrenceMendelsohn

We built in that that 76% number will decline by about 25%.

Operator

There are no further questions at this time. I'll now turn the call back over to management for closing remarks.

Lawrence Mendelsohn

Thank you, everybody, for joining our March 31, 2020 first quarter earnings conference call. I appreciate calling in and the questions. Feel free to reach out to us if you have additional questions over time, and we're always happy to talk more about our business. And with that, everybody stay healthy and we'll talk to you over time.

Operator

This concludes today's conference call. You may now disconnect.