Ready Capital Corp (RC) 2013 Q2 法說會逐字稿

Good day, ladies and gentlemen and thank you for standing by. And welcome to the ZAIS Financial Corporation second quarter 2013 conference call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions.

(Operator Instructions)

This conference is also being recorded today, Tuesday August 13, 2013. I would now like to turn the call over to Mr. Scott Eckstein. Please go ahead, sir.

Thank you, operator. Good day, everyone, and welcome to ZAIS Financial Corp.'s conference call to review the Company's results for the second quarter ended June 30. On the call today will be Michael Szymanski, President and Chief Executive Officer, Paul McDade, Chief Financial Officer and Treasurer and Brian Hargrave, Chief Investment Officer. As a reminder, this call is being recorded and also being webcast through the Company's website, www.zaisfinancial.com. Additionally, a copy of the Company's second quarter investor presentation is available for your review on the Company's website.

Before we begin, I'd like to remind everyone that during the course of this conference call, both in our prepared remarks and in answers to your questions, we may make certain statements and assumptions that contain or are based upon forward-looking information pursuant to the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are subject to numerous assumptions, uncertainties and known or unknown risks which could cause actual results to differ materially from those anticipated. These risk factors are more fully discussed in the Company's filings with the Securities and Exchange Commission. Forward-looking statements included in this conference call are only made as of the date of this call and the Company is not obligated to publicly update or revise them.

In addition, certain terms used in this call are non-GAAP financial measures, reconciliations of which are provided in the Company's earnings release and the accompanying tables which have been furnished to the SEC through the Company's Form 8-K this morning and may also be accessed the Company's website at www.zaisfinancial.com. Each listener is encouraged to review those reconciliations provided in the earnings release, together with all other information provided in the release. I will now turn the call over to Michael Szymanski. Please go ahead, sir.

Good morning, everyone, and thanks for joining us today. We're pleased to present our financial results for the second quarter 2013 which shows the considerable progress that we've made in executing our initial growth phase following our IPO in February. During this morning's call, I'll provide an overview of our financial results, discuss what we've been seeing in both the housing and capital markets, and then I'll provide an update on progress to date with executing our investment strategies. After that, our CFO, Paul McDade will review our financial results in more detail and our CIO, Brian Hargrave will recap our portfolio performance.

As noted in today's press release, during the second quarter 2013 we reported core earnings of $2.9 million, or $0.33 per share, and we earned an additional $0.8 million, or $0.09 per share of rolling comp on our agency TBA positions. These two items combined reflect what we believe is the best estimate of our net investment income which totaled $0.42 per share. On a GAAP basis, we reported a net loss of $7.6 million for the quarter, or $0.85 per share. The primary difference between core and GAAP earnings was unrealized losses on our agency and nonagency RMBS portfolios recorded under GAAP, which Paul will discuss in more detail. As previously announced, our Board of Directors declared a second quarter cash dividend of $0.45 per share per common -- I'm sorry, per share of common stock OP unit which was paid on July 23, 2013 to stockholders and OP unit holders of record as of July 9, 2013.

During the second quarter, we continued to execute on our whole loan strategy, expanding our residential mortgage loan portfolio to over $120 million of fair market value as of June 30, 2013. Subsequent to June 30, we announced the acquisition of an additional whole loan portfolio with an unpaid principal balance of approximately $167.8 million. Building the whole loan portfolio remains a critical component of our strategy, and the purchase announced in July puts us in an approximate equity allocation of 38%. We expect to achieve our target equity allocation of 50% to 60% in the third quarter of 2013.

Book value per share of common stock and OP unit as of June 30, 2013 was $19.95 compared with $21.50 at March 31, 2013. After adjusting for our first quarter cash dividend, which was declared and paid in the second quarter, the decline in our book value per share was 6.2%. This decline was primarily due to unrealized losses on agency and nonagency RMBS, which Paul and Brian will discuss in more detail. Our securities portfolio at June 30, 2013 had a fair market value of $444.5 million, down slightly from March 31, 2013 value of $455.9 million.

During the quarter, we reduced our TBA position to a net notional value of $62 million as of June 30, 2013 from $104 million held at March 31, 2013. As you are aware, the second quarter was a volatile one as the market reassessed expectations for future Fed policy, resulting in a sharp rise in interest rates and a general increase in risk premiums across asset classes. At the same time, fundamentals in the housing market exhibited continued strength and the overall economic climate exhibited modest improvement. We believe our expertise and focus on mortgage credit opportunities is well-suited to this environment and will produce attractive returns going forward. We believe that asset selection remains critical to producing attractive returns in the mortgage credit space, and we remain diligent and focused in our approach to evaluating opportunities.

ZFC's on track to reach a targeted portfolio allocation of an estimated 50% to 60% equity allocation to whole loans, 30% to 40% in nonagency RMBS, 0% to 5% to agency RMBS and 5% to 10% to cash and other assets in the third quarter of 2013. We look forward to sharing our continued progress with you on future conference calls. And now, I'll turn the call over to our Chief Financial Officer, Paul McDade to review our financial performance.

Thanks, Mike. Good morning, everyone. Before I review our second quarter results, I'd like to remind everyone that the second quarter ended June 30, 2013 was the first full quarter in which the Company operated as a public mortgage REIT following its February IPO. Accordingly, we were still in our initial capital deployment phase, and our second quarter results are not representative of expected results in future periods.

As Mike already mentioned, for the second quarter ended June 30, 2013, the Company reported a GAAP net loss of $7.6 million, or $0.85 per weighted average share outstanding. Core earnings for the quarter were $2.9 million, or $0.33 per weighted average share outstanding. The difference between GAAP and core earnings was mainly due to unrealized losses of $15.6 million which we recorded on our agency and nonagency RMBS portfolio. In addition to these core earnings, we earned a roll income on our TBA position of $0.8 million, or $0.09 per share. So, combined with core earnings, this represents $0.42 per share, which is roughly in line with our second quarter dividend of $0.45 per share. You can reference this section of our press release entitled Use of Non-GAAP Financial Information for a further explanation of core earnings, which is a non-GAAP financial measure.

The Company recorded net interest income of $4.8 million for the second quarter of 2013 compared with $1.9 million in the prior-year period. Interest income of $5.9 million increased by $3.6 million from the $2.3 million recognized in the second quarter of 2012. The change was due to an increase in our average RMBS portfolio which increased interest income by $3 million and the addition of our mortgage loan portfolio, which increased interest income by $0.9 million. These increases in interest income were partially offset by a year-over-year decline in average RMBS yields which decreased interest income by $0.3 million. We incurred interest expense of $1.2 million for the second quarter of 2013 compared with $0.4 million for the second quarter of 2012. The change of $0.8 million was due to additional borrowings under repurchase agreements and the loan repurchase facility. As of June 30, 2013, the weighted average net interest spread between the yield on the Company's assets and the cost of funds including the impact of interest rate hedging was 1.21% for agency RMBS, 4.46% for nonagency RMBS, and 3.84% for mortgage loans.

The Company incurred expenses of $1.8 million for the second quarter of 2013 compared with $0.7 million for the second quarter of 2012. The increase in expenses was primarily due to increase in advisory fees and general and administrative expenses. The $0.5 million increase in advisory fees was primarily the result of a full quarter impact of the additional capital raised from the February 2013 IPO. The $0.7 million increase in general and administrative expense is related to mortgage loan transaction cost, insurance expense, additional public company expenses and independent director fees which were not incurred in the prior-year period. I'd now like to turn the call over to our Chief Investment Officer, Brian Hargrave, to discuss our portfolio and investment activities.

Thank you, Paul, good morning, everyone. As Mike mentioned in his opening comments, the second quarter was a challenging one with the market's reassessment of future Fed policy driving a significant back up in interest rates. This interest-rate volatility had the follow-on effects of increasing risk premiums across a broad spectrum of asset classes and triggering some portfolio deleveraging. While the mortgage market was certainly at the center of the resulting market moves, a wide range of assets were affected including corporate debt, emerging market debt and equity, municipal debt and commodities.

Our investment activity in the second quarter included the addition of approximately $134.5 million in unpaid principal balance to our whole loan portfolio, resulting in a portfolio fair market value of $120.8 million as of June 30, 2012. Due to volatile market conditions, we reduced our agency TBA exposure to $62 million of net notional value at quarter end from $104 million as of March 31, 2013. The size of our RMBS portfolio was relatively stable at $444.5 million as of June 30, a slight decline from the $455.9 million held as of March 31, 2013. During the second quarter, we acquired agency RMBS with a principal balance of $48.2 million and nonagency RMBS with a principal balance of $108.7 million. During the same period, we sold agency RMBS with a principal balance of $45.2 million. We did not sell any nonagency RMBS during the second quarter. As of June 30, the fair values of our agency RMBS and nonagency RMBS were $174.5 million and $270 million, respectively.

We continue to see attractive investment opportunities in the whole loan market. Subsequent to quarter end on July 25, 2013, we acquired a residential mortgage loan portfolio with an unpaid principal balance of approximately $167.8 million. We utilized approximately $98.7 million of our Citibank loan repurchase facility to fund a portion of the purchase price. As it represents a key component of our strategy, we are pleased to be on track to achieve our long-term equity allocation target of 50% to 60% with respect to whole loans in the third quarter. Supply of legacy high risk re-performing and performing whole loans has been strong through the first half of 2013, and we believe the opportunities to deploy capital in this sector of the whole loan market continue to be attractive. As an asset class, we believe it offers attractive carry at current market prices and retains meaningful upside potential from improved credit performance and rising home prices.

On the prepayment front as of June 30, the six month -- the three and six month, excuse me, CPR averages for our agency RMBS were 4.56% and 6.67%, respectively, and were 18.09% and 14.43%, respectively, for our nonagency RMBS. The nonagency RMBS CPR includes both voluntary and involuntary amounts. At June 30, we had an effective leverage ratio of 2.55 times, including $62.8 million in fair value of agency RMBS exposure acquired through TBA securities. We had repurchase agreements outstanding of $308.5 million secured by our RMBS portfolio as well as $89.1 million of borrowings outstanding under our loan repurchase facility. These borrowings all bear interest at rates that have historically moved in close relationship to LIBOR. We continue to see ample opportunity to add repurchase agreement capacity across both RMBS and whole loans.

We've used interest rate swap agreements to mitigate the effects of increases in interest rates for a portion of our outstanding repurchase agreements. These swap agreements provide for us to pay fixed interest rates and receive floating interest rates indexed off of LIBOR, effectively fixing the floating interest rates on $225.7 million of repurchase agreement borrowings as of June 30, 2013.

In summary, we continue to favor credit-oriented investment strategies in the residential mortgage space. We expect to increase our equity allocation to whole loans to the targeted levels of 50% to 60% in the third quarter and at the same time, we expect to reduce our agency RMBS allocation to a relatively small liquidity bucket representing 0% to 5% of equity. At present, nonagency RMBS prices have recovered from the recent bout of volatility somewhat more slowly than other fixed income credit sectors and as a result, we see attractive investment opportunities persisting. We continue to actively assess the relative value of potential nonagency RMBS and residential whole loan investments and will opportunistically pursue attractive risk adjusted returns across these markets.

Finally, we are increasingly focusing resources on the purchase of newly originated mortgage loans in the adaptation of our existing whole loan systems and work flows. We believe the new origination market is in the early stages of a very broad restructuring due to the much referenced pending GSE reform and also, significant overcapacity in a higher interest rate environment. We expect the new origination market will be a source of significant opportunity for ZFC going forward. That concludes our prepared remarks, and we will now open it up for your questions.

Thank you, sir.

(Operator Instructions)

Douglas Harter, Credit Suisse.

I was wondering if you could give us a little bit more clarity on the pipeline that you're seeing in whole loans that gives you confidence that you'll be at your target allocation by the end of this quarter?

Yes. We have a pipeline of loans in process of due diligence at this stage that would get us to that target. So, those -- that portfolio addition has been identified and is in the process of being really transaction negotiated and due diligence completed.

Great, that's helpful. And then can you talk about your plans for your swap portfolio as you continue to reduce the size of the agency? MBS portfolio?

Sure. I think we tried to make the point in the presentation that the rate backup that we saw had two effects. One was that a simple interest rate shock that flowed through the market, and the second was a bout of increased volatility that affected risk premiums across a number of markets. So, I think as we look at the portfolio going forward, we do think that there is -- continues to be negative duration in credit-oriented investment products in the mortgage space, but the pace of the sell off can have a much broader effect in the short-term than the rate move itself. I guess we probably -- we have not firmly laid out the restructuring of the swap book after the loan portfolio comes on board, but I would anticipate that we would retain some exposure through swaps and other instruments, just given the potential for a very volatile move higher in rates as opposed to a more measured and controlled sell off, which I think would have a very different effect.

Great. And then just on the new loan production, the new jumbo production, is that something you would look to buy both pools of loans or would you look to set up a conduit?

We'd tend towards the latter. I think we would be more comfortable managing and evaluating risk on a loan by loan basis. And so the trade-off there is it takes a little longer to set up the infrastructure to complete that type of a business plan but I think ultimately, that's an approach we're more comfortable with.

Great. Thank you.

Mark DeVries, Barclays.

First question, are the returns you're seeing on the whole loans that you're looking at now comparable to the returns you outlined on slide 13 where you can get 17.5% levered return?

Yes. I think if you look at the gross yield that we're showing there of 6.78%, that's before servicing fees. The servicing fees are flowing through the expense line on the income statement. So, you'd have to net that out. But I think that puts you at low end of the range that we had articulated on the roadshow back in February, which was 6.5% to 8% on an unlevered basis. And I think that we should be somewhere in the context of the low end of that range, would be my guess, given what we have today and what we have coming on.

Okay. But you don't see any meaningful compression in what you're looking at today relative to what you already have?

I don't think -- no. I don't think it will be a huge material difference.

Okay. Is there any reason you couldn't go beyond the 50% to 60% allocation to whole loans? It looks like you're getting a reasonable premium, at least on a levered basis, from holding the whole loans. Is it a liquidity or risk management that might keep you from going to a higher allocation?

No. I think that's right. I think that there's a liquidity component to it, certainly. Non agency RMBS are more liquid than whole loans. But I do think that once we achieve that 50% to 60%, there's nothing that says we have to stop. At that point we can be I think a little more reactive to relative value in what we see in the market on both sides of the portfolio.

Okay, great. And is there any color you can provide on the default assumptions that are embedded in the pricing of the whole loans and what type of scenario for housing you'd have to see to negatively affect your expected returns there?

I'm not prepared to give you direct numbers on the portfolio we own today. I would say that the range of defaults can vary pretty significantly, depending on the type of loan pool that we see and the credit of the underlying borrowers and the effect of LTVs of those borrowers. I think in the slide pack, there are some statistics on our loan portfolio that will give you some sense of the general risk characteristics of that piece of the portfolio. That's on slide number 10. But certainly, if you look at the average LTV as a portfolio we owned at this end of the second quarter of 140%, that's on a mark to market basis versus the current home value. You do have meaningful exposure to a decline in home prices as well as any uptick in -- downtick in consumer credit. You're going to have exposure on both of those, and they're not necessarily out of the money exposure, meaning that I would expect that you would see direct correlation; if home prices took another dip, you would see the expected returns come down from that move. There wouldn't be a period of really adjustment, I guess, or comfort zone where credit performance doesn't really change.

Okay, got it. Thanks.

(Operator Instructions)

Jim Young, West Family Investment.

Can you talk about your leverage targets for the portfolio at 2.55 times for the portfolio? Given today's environment, where are you comfortable taking the leverage to and then post the September Federal Reserve meeting, what kind of leverage are you comfortable running at going forward? Thank you.

I think in the roadshow back in February, we have articulated a target leverage of 2 to 3 turns on a debt to equity basis. We are obviously now right in the middle of that. I think we're a little more comfortable running slightly higher leverage on the whole loans versus the non agency RMBS, because the pricing tends to be less volatile and there's less potential for margin call on that book of the business. Obviously, as we move out of agency RMBS, that's going to reduce overall leverage. I think we'll be comfortable in that 2% to 3% range. As we move into loans, leverage may move up slightly from where it is today, but I would expect it to stay in that range.

Great. And for the whole loan portfolio, how much leverage are you comfortable putting on that part of the portfolio?

I think that in the current market, depending on the -- I think on average basis, the leverage that you can achieve that we are allowed to get on that book of business is around 3 turns on average. It depends somewhat on the underlying loan characteristics, and it's tiered. So, higher quality portfolios can be leveraged more. But I think in and around that number of 2.5 to 3 turns is probably where we'd be comfortable today.

And it appears -- there is a follow-up question. Douglas Harter, Credit Suisse.

Now that you've started to accumulate some size to your whole loan portfolio, is the securitization an option there and if so, what type of leverage could be available there?

It is an option. I think to answer the last part of your question first, I think that the leverage probably wouldn't be that different than what we can achieve through our financing facility, just in terms of outright leverage. The cost piece of it is the issue, and I think that we want to be opportunistic around how we approach that. We have some experience as a firm doing securitizations of these legacy assets. It's something that we've done and can do again. I think that what we've seen in the new issue market for both legacy securitizations as well as newly originated loan securitizations is a pretty substantial widening in financing costs. And so I wouldn't expect, all else being equal, that at these levels we would rush to do that. But if that financing became more attractive or as we became even more concerned about potential backup in short-term rates, we could certainly move in that direction.

Great. Thank you.

Jim Young, West Family Investment.

You mentioned the capital allocation thoughts with respect to that agency moving away from agencies towards more whole loans. How are you thinking about your share price, given that you are trading at a significant discount to book at about 17% and using incremental capital for a share buyback?

We don't -- we're not all that focused on share price at this moment because we're still building out the portfolio. What we --we have not considered at this point in time a share buyback because we see really attractive opportunities to deploy capital in the secondary whole loans space. And as Brian mentioned, after the recent backup in interest rates, we're seeing really interesting compelling opportunities in non agency mortgages. So, just from a pure corporate finance perspective, we're much more focused on deploying capital in these opportunities than buying back shares. Moderator, are there any other calls in the queue?

There are no further questions.

Well then, thank you so much for joining us in the dead of summer for the second quarter call. As I said in my prepared remarks, we really do look forward to engaging with you on the next conference call regarding our progress. Once again, thank you very much.

And ladies and gentlemen, that does conclude the ZAIS Financial Corporation second quarter 2013 conference call. If you would like to listen to a replay of today's call, please dial (303)590-3030 or 1(800)406-7325 with the access code 4632980 and the hash tag. Thank you so much for your participation. You may now disconnect.