Great Ajax Corp (AJX) 2015 Q3 法說會逐字稿

Good afternoon and welcome to the Great Ajax Corp. third-quarter and fiscal 2015 financial results conference call. All participants will be in listen-only mode. (Operator Instructions) After today's presentation, there will be an opportunity to ask questions. (Operator Instructions) Please note, this event is being recorded. I would now like to turn the conference over to Larry Mendelsohn, CEO. Please go ahead, sir.

Thank you very much. Welcome to the third-quarter conference call for Great Ajax Corp. This is our fifth quarter. We started in the third quarter -- or early third quarter of 2014, so this is our fifth quarter, and I appreciate everybody being on the call.

On page 2, I want to point out the Safe Harbor disclosure and forward-looking statements for everybody to read through. On page 3, I want to give you a little background. So we continue to use our sourcing and our long-standing relationships to acquire loans. We continue to have over 90% of what we buy to come in private sales -- just us and the seller. And in the five quarters, we have made 112 different transactions, which averages out to 22 transactions a quarter -- which, as you might imagine, is a lot.

We use the proprietary analytics that we have developed over time. During the third quarter, we also added some additional depth to our small balance commercial team and our analytics there. And that is over Thetis Asset Management, which, you might remember, we own 20% of.

We did loan-by-loan with sellers. We can, as a result, target what we buy to specific characteristics of loans in specific locations. And we typically -- our typical transactions are somewhere between $5 million and $20 million in terms of total purchase price.

Our affiliated servicer is really helpful -- asset-by-asset servicing. The other thing it does, now that we have even more history with loans and data collection on them, it helps generate a significant feedback loop for us to determine how to even sharpen our pencils and what kind of specific loans to target. And I will get into that in a few minutes.

We use moderate leverage. Our average leverage for Q3 2015 was 1.35, and end-of-quarter leverage was 1.43. We have done five securitizations. Our fifth securitization just closed this past Friday, October 30. It was a good execution for us. It was three days start to finish and materially oversubscribed.

On page 4 I want to go through some third-quarter highlights. Despite what we keep hearing about in terms of sale prices for loans going up materially, and more materially, and more materially, our third quarter, we actually paid lower prices for loans than we have paid at any point this year. We bought $91 million, almost $92 million principal balance of loans for a purchase price of about $66 million, $67 million. That works out to be about 72.9%, 73% on UPB and 61% on collateral value.

If you break it down, the lion's share was residential re-performing loans, about $64 million purchase price, $88 million UPB. And we bought those at 62% of property value and 72% of UPB. And the rest were small balance commercial loans, principally small apartment buildings in Miami. They are performing loans. We paid 80% on UPB, but only 54% on property value.

And I will talk about some of our targets. We have grown our portfolio dramatically. We own almost 3,000 mortgage loans now, with UPB of about $680 million. We also have 64 properties, 62 of which are just REOs that will be sold. We still have two properties that are small multifamily that we maintain as investments. The collateral value is almost $760 million, so we own at a significant discount to collateral value.

One thing we have done since about February of this year is we have very much been focused on buying the lower-LTV loans, particularly in middle and upper-middle housing area price range -- so what I will call deciles 4.5 or 5 through about 7.5. We think lower-LTV loans are a natural housing price hedge, given the action we have seen in housing; although I will say that much of that action we have seen is really as a result of limited supply and not as much robust demand as I think the press has been out there claiming.

Another thing we focused on is homes -- not just lower-LTV -- that have minimum absolute equity thresholds. We found from all of our feedback and analytics on loans we have owned over the last 10 years or so that performance and prepayment is not just tied to LTV, but it's actually tied to specific dollar amount of equity market-to-market -- market by market by market. And we spend a lot of time working on that.

$7.6 million of income. Our weighted average equity for the quarter is about 13.25 return on average equity, with leverage of only about 1.35 of times during that quarter. We think that is pretty good. The other thing is that, at the same time in the quarter, our weighted average cash on the balance sheet was $51 million.

So while at the end of Q2 we had cash in the low 30s, at the end of Q3 we have cash in the high 20s; for the quarter, we have cash in the low $50 million range. Now, some of that -- actually, a big chunk of that was driven by -- we closed a securitization, you might remember, on July 2, where we had extremely good execution. In fact, you might say the execution might have been too good because it gave us too much cash during the quarter.

And we invest cash at the same rate. So that cash was used to buy loans during Q3. As a result, our leverage at the end of the quarter was 1.43. So our leverage did not increase materially during the quarter other than from our July 2 securitization.

On the taxable side, our taxable income was lower. It was only $0.11 this quarter -- although, at the same time, we raised our dividend to $0.24 because the taxable income is really in this quarter a function of one specific pattern, which is: a lot of loans are paying, and we have very low recidivism.

And as a result, in performing loans taxable income is measured to maturity of the underlying loan rather than average life. The other thing is that when loans stop paying, you have foreclosures and you have modifications, which are typically taxable events. So it is kind of an odd conundrum in that more loans than we expected are paying like clockwork, which actually reduces taxable income -- although, as you might imagine, generates significantly more profit over time.

The other thing we did in the quarter, which is in the press release, is we changed our management fee slightly with our manager. And that was something the Board felt pretty excited about. And I will go through a brief description of the change.

The management fee had been 50%/50% cash and shares for the base fee and 100% cash for the incentive fee. Now, as we became -- as we are getting more levered, it is becoming apparent that the incentive fee becomes more likely. And the Board believes that they want wanted -- have always wanted to change that to get part of the incentive fee to be in shares. So as a result, in this management fee change, the incentive fee goes from 100% cash to only 80% cash and 20% shares.

The other thing it does is, it takes the base fee, which was 50%/50%, and says: for the first $4 million of base fee, it is 75% in cash; and then after that, there is a 100% catch-up in shares until it is 50%/50%, whether -- from any source. So for example, if the base fee is $4 million and three-quarters is paid in cash, then the next-dollar fee from anywhere is 100% in shares until it is 50%/50%. And then, from that point forward, it is 50%/50% in base and 80%/20% in incentive fee. So the Board decided this was a good time to do it, as we are getting more levered and incentive fee is becoming more likely.

From a portfolio overview, NPLs as a percentage of our portfolio continue their relative decline. And you can see that. We are down to about 15% as a percentage of property value in NPLs and about 16.5% as a percentage of UPB. So that is one development we have seen: that our performing portfolio continues to increase as a percentage of the total.

Part of that is our looking for low-LTV loans; part of it is targeting many more loans in nonjudicial states versus judicial states. We see more and more NPLs in judicial states, and we are seeing re-performing loans from everywhere. Thirdly, we are specifically targeting small balance commercial, particularly in five or six markets. And we acquired about $4 million of those in the third quarter as well and added some commercial depth to increase our penetration in small balance commercial.

On a UPB perspective, you can see -- similar to the previous pie charts -- that NPLs are not only shrinking on a relative basis, but shrinking on an absolute basis. Some of that is because NPLs go away much quicker, and some of it is because we are not buying as many. On a re-performing loan side, we are growing that portfolio in specific targeted markets, lower-LTV loans with absolute dollar-to-equity thresholds, and paying less for them -- which is actually something we are very proud of and attribute to the hard work of our people.

Our UPB growth in re-performers in the quarter was $86 million, and the property value growth in re-performers in the quarter was $102 million, $20 million more. Yet our growth in purchase price was only $60 million in reperformers. So as you can see, we paid a very low percentage of property value -- only about 60% -- and we are very low percentage of UPB, low 70%. So we are actually very proud of our re-performing acquisitions in the third quarter and, similarly, so far in the fourth quarter.

Nonperforming loans, you can see again, going down in absolute amount and cost, as well as UPB and property value, as they go away and we replace them at a slower rate. Concentrated markets, I mentioned a little bit that we are more focused on non-judicial states. Still, over 80% of our portfolio is in our specific target markets.

One big change that has happened over the last 2 1/2 quarters is that California has now over 20% of our total portfolio, and 80% of that is in Los Angeles, Orange, and San Diego Counties. So that is a significant increase in Southern California. Also, about 16% of our holdings are in Southeast Florida -- particularly, we have grown our small balance commercial and apartment loans there in Miami.

This page, building net asset value, I love. We had it in our presentation for the first time last quarter after our July 2 securitization. And what I have done here is -- we put two securitization scenarios. At the bottom is our July 2 closing, and in the middle there is our October 30 closing. So that is a securitization we just closed this past Friday.

And you can see we used a little bit of a different structure, and that is because we had a couple of bondholders who said if we changed the structure a little bit, they would be willing to take all of it. So we changed the structure a little bit, and the bondholders basically split it.

If we would take our entire portfolio and just securitize it, if we used our July 2 structure and outcome -- or execution -- and this is really a testament to how much lower we paid for loans in the third quarter and how much it reduced our overall basis relative to value -- we would actually control $170 million of UPB with a negative investment of $3.7 million, if we used our -- the structure we used July 2 and had the same execution.

If we took our October 30 execution, where we changed the structure a little bit, where we had a bigger senior bond and a smaller subs, at current market prices we would control $183 million of UPB with an equity cost of $12 million. As a result, we think that the fixed income market values us somewhere on an implied share basis, call it, somewhere between $3.75, about $4.50 a share higher than our $14.64 book. And you see book went up pretty dramatically, again, in this quarter.

So we're really proud of that. We are very focused on building NAV. We have a saying here, which is, every time we wire $1 million, we have to be comfortable that we already made $150,000. And I think that these numbers from the fixed income market, even in what I think a lot of people think is a difficult environment in the fixed income market, these numbers would suggest that so far we've been able to do that pretty consistently.

Post September 30 events -- we talked about our securitization already. We closed our fifth securitization just from the sale of seniors. We got 2.79 times leverage and the senior bond coupon of 3.875%. Three days start to finish between going out with the initial tape and pricing the deal, and it was materially oversubscribed.

October acquisitions were pretty low. That is really a function of September calendar more than anything else, with Labor Day being the last possible day it could be, and then the Jewish holidays being the next two weeks. The month of September really had one month -- or one week in it, the last week of September. So October acquisitions are really September, and November really includes a little bit of October.

So you can see on our November acquisitions: $48 million, collateral value $57 million, and to continue our price-to-property value, 63%. So again, very low relative to property value. Also very low acquisition of nonperforming loans during the same period.

Again, we continue to focus low-LTV loans. We continue to buy loans at low prices, not higher prices. The other thing we have done is, including our November acquisitions, approximately 50% of our portfolio will be either be adjustable-rate mortgages, step-rate mortgages, or hybrid ARMs. So we have a built-in partial interest rate hedge along with the low LTVs, which serve as a partial housing price hedge.

Financials are the same as in the press release. And as typical, our income statement and balance sheet are pretty straightforward. They look more like a community bank, probably, than a typical mortgage REIT. But probably the biggest focus is on our -- what kind of yields and average equity we are getting. Again, 13.25 on ROE on 1.35 times average leverage and 1.43 times end-of-quarter leverage. $51 million of cash during the quarter, which we would anticipate being a running cash total. But, again, our securitization in early July was, quote-unquote, too good an execution.

With that, I am happy to take questions that anybody might have.

(Operator Instructions) Jason Weaver, Sterne Agee CRT.

Congratulations on another solid quarter.

Thanks. I appreciate it very much.

First, I know it is a relatively small piece of the book right now, but can you talk a little bit more about the small balance commercial loan opportunity? Like, do you see this becoming a more significant part of the investment strategy? And, also, what type of returns do you think can be generated here?

Sure. To put it bluntly, we love small balance commercial, especially urban areas in five or six markets. We spend a lot of time studying demographic information, and educational information, and crime information, and things like that to figure out block by block where we want to be looking for specific small balance commercial.

We tend to focus on small multi-family or mixed-use, ground-floor retail with apartments above. We think that there is extremely attractive opportunities in that asset class for a number of reasons. Number one, it is really a mom-and-pop industry, small balance commercial, in urban areas. It is not an institutional. The properties themselves are $1.5 million and less -- sometimes as low as $300,000, $400,000, $500,000 in value. It is not an institutional business.

Number two is: a lot of the tenants in those markets pay rent in cash rather than pay rent through ACH or via check. And as a result, you have to have the ability as an owner of those kinds of properties to be able to accept rent in cash. Most institutions can't do that because they use a third-party manager. Also, lockboxes don't accept cash. You can't send cash to a lockbox for the same reason -- someone is opening the envelope.

We have built the ability through some software we wrote for our lockbox provider, Bank of America, where any tenant in any building can go to any teller at any BofA in the country, and they can walk up and make a deposit into our lockbox in cash and get a receipt. And as a result, over the years about 72% of all our tenants do that. And it is a significantly decreased turnover, which is the number-one issue you have with urban small balance commercial is turnover.

We like to buy loans in specific target markets. We are able to buy them very low LTV. It is not an institutional marketplace. It is -- mostly community banks are the owners of those loans. And because of our sourcing, we have access to those community banks.

We think that, on an unlevered basis, it is probably a 10% to 14% return. And then you can lever it up. We have, actually, in our Nomura financing facility, our non-marked-to-market facility, we put in $100 million sub limit for small balance commercial to be able to aggregate small balance commercial over time.

And we would like to see small balance commercial become 10% or 15% of our balance sheet, say, over the next 18 to 24 months. And to that end, our Board has instructed the manager to increase its depth at the manager in small balance commercial so we can further penetrate those markets and make acquisitions.

Okay. Great. That's helpful. Thanks. And, just second, I think you touched on it a bit during your opening comments, but what is your liquidity position looking like after the securitization funding, the dividend, and the closing of this most recent portfolio acquisition?

Sure. So if I were to -- this is not a scientific member. I didn't pull it off today's cash report, but if I were to take, say, our September 30 cash number of $28.5 million; and I were then to let out acquisitions and add in a securitization, what I will call cash-out refi proceeds, our cash position is probably about $40 million.

Okay. Thanks again, guys, and congratulations once more.

Paul Miller, FBR.

You touched on it a little bit. Can you touch talk a little bit about -- on the securitization, I believe you were getting it done at around -- in the 3 -- a little bit above 3, and now it was below 3. Was that because the buyers wanted to restructure it a little bit? Can you go into that in more detail?

Sure. So our securitization that we did in July -- we did a 55% senior and then two 10% subs. 55% of UPB. And we did that at 3 7/8% to yield 4%. And in this situation, two buyers came to us and said they would like to fatten the senior a little bit to make it more blended, as if there was some subordinate bond inside of it.

So what we did is we said, okay; but if we look at it, we want to split it as -- we want to price it as a blend, as if we were selling them separately. So what we did is we made a 63% senior, which is really priced as if it is a 55% senior and an 8% senior sub.

So we priced the 55% at 3 7/8% -- to yield 3 7/8%, and the 8% to yield 6% with a 3 7/8% coupon. So blended, it is about 4.5% or 4 5/8%. But it is cheaper as one bond than it is as two bonds for us to issue. So we issued it -- we issued it -- it is a better return -- it is a better financing to have done it as one bond than have to split it into a senior and a sub and sold the sub separately. So we effectively put the senior and the sub together and made it a little bit cheaper from our perspective.

But you are holding more of the bond --?

And we created two subs in addition to fattening the senior.

Got it. And can you sell that down the road, or do you want to keep it?

Yes. Right now, we just hold it. We can finance it if we want, and we can sell it if we want.

Okay. And then --.

But the entire 63% senior was sold.

And then on the seasonality of the loans, is the fourth quarter your busiest quarter relative to the third? I know you explained the third quarter, why the sales were down a little bit, but --.

Third is generally the slowest quarter of the year. Usually July/August are the two slowest months. This year September was slow because of the calendar, not because it would ordinarily be slow.

September was slow because Labor Day (technical difficulty) seventh, and then you had the Jewish holidays the next two weeks. So as a result, September only really had one business week in it. So that was kind of was a function of the calendar. That is being made up for in November.

What about the fourth quarter, though? Is fourth quarter your peak?

No. Generally, second quarter and fourth quarter are the two busiest. First quarter is the third and fourth quarter -- I'm sorry. Third quarter is usually the slowest, by far.

Okay. Thanks a lot, Larry. Good quarter.

(Operator Instructions) Brock Vandervliet, Nomura Securities.

The pricing dynamics just seem surprisingly good. Could you just spend a moment talking about them?

Sure. Let me split it between performing and nonperforming. So in nonperforming land, very large pools trade at ridiculous prices. And there has been three buyers who have really separated themselves from everybody else. And I would say there is probably three or four institutional buyers who, as a result, have just thrown in the towel and given up.

The other thing we have seen is there is still in nonperforming a fair amount -- not nearly as many as there used to be -- of smaller buyers. But regulatory changes have made it so much more expensive to exist that you are seeing less and less of that than you used to. But there are still some.

As a result, nonperforming loans seem to be -- their prices seem to be pretty stable if not still higher, even though, as you might imagine, nonperforming loans are becoming more and more judicial and less and less nonjudicial as nonperforming loans are in the cycle. On the performing side, we have seen -- there seems to be two different markets. Number one is: there are no small buyers of nonperforming loans or very few -- or, I'm sorry, of re-performing loans. There is very few small buyers of re-performing loans.

So you don't really have that segment. We are probably the dominant small buyer of re-performing loans, but you don't see that many. And we have lots of sources for them.

Number two is, in very large pools of re-performing loans, especially ones with -- which have material pay history, like 12 straight payments; 18 straight payments; and really, really, really 24 straight payments -- those trade at very high prices. So a loan that has 24 consecutive payments and a 660 or better FICO is going to trade close to par, if not higher than par -- which, by the way, we kind of like, given that we're going to have a lot of those from all our loans paying.

And 12 of 12 trades materially higher than, say, seven of seven. We spent a lot of time looking at re-default probabilities based on certain characteristics. And our loans are little bit positively selected versus, say, a national pool of loans. So our re-defaults are probably a little bit lower than, I would say, typical re-defaults on, say, a six for a six or seven for seven payment loan.

But we find very little material difference between a loan that is seven of seven and a loan that is 12 of 12; yet in the marketplace, there is an enormous pricing difference between those loans. So we made -- we are able to buy at significantly lower prices because we spend so much time looking at performance based on specific loan criteria, in specific places, with specific sizes, with specific locations, with specific coupons and structures, and absolute equity thresholds and things like that.

So I think a lot of it is us paying attention to the characteristics of loans and us being willing to buy loans in $300,000 increments and $10 million increments rather than $100 million and $200 million increments. Part of it is we spend a lot of time sourcing loans from sellers all over the place. They could be tiny sellers. They could be really big sellers, from buying one loan to buying 300 loans. We spend a lot of time doing that.

And, lastly, if you are one of the big nonperforming buyers -- or even one of the smaller ones -- loans that pay have a much longer average life, and as a result reduce your internal rate of return. So you need to sell them in order to generate cash flow and distributions and pay down debt. So as a result, we get to be a liquidity provider for those NPL buyers once their loans have paid six or six or seven of seven, or even three of three or four of our, because we have a price for those, too, based on a whole bunch of different data sets that we have built.

So I think that is really -- those are really kind of the background. We absolutely have seen it. The other thing I would add is: we have been buying more ARMs recently. And for some reason, people don't want ARMs. They are afraid of re-default should interest rates go up. And at the prices we pay on re-performing loans as a percentage of property value, a re-default is not a terrible outcome, even though we would much rather a borrower pay.

Got it. Okay. That's very helpful. And just as a follow-up, with respect to your comments on judicial states, I noticed your purchases in Florida seem to be in small balance commercial. Obviously, Florida is a judicial state. Is it just a factor of pricing that you are deemphasizing judicial state exposure, or something else?

We just think that the nonjudicial is much more predictable in terms of timelines. It is also -- you have less overall expenses along the way. And we have gotten to the point where, in parts of Florida, where you can model loans based on which judge is actually hearing the case, because different judges have different timelines.

And what we found is that in nonperforming loans, as you get deeper and deeper and deeper in the cycle, the non-performers tend to be a little more complicated, a little more contested, a little more difficult day by day by day than they would have been a few years ago. But separate from that, there is a lot of buyers of nonperforming loans that assume a certain amount of home price appreciation year after year after year. And we are an assumer of zero home price appreciation for what we do. The other thing is, as you can see by us buying much lower LTV loans, we are actually trying to hedge against a cessation of home price appreciation, let alone a prediction of more of it.

Got it. Thanks, Larry.

And this concludes our question-and-answer session. I would like to turn the conference back over to Larry Mendelsohn for any closing remarks.

Thank you, everybody, for being on our third-quarter earnings conference call. I appreciate your support. Thanks for all the good questions. And over the next few days, happy to talk to people who have questions and answer them to the best we can. Thanks again and look forward to talking to you and seeing you in person as well.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.