Ready Capital Corp (RC) 2013 Q3 法說會逐字稿

Welcome to the ZAIS Financial's Third Quarter 2013 Conference Call. At this time, all lines are in a listen-only mode. Following the presentation, we will conduct a question and answer session with instructions provided.

(Operator Instructions)

I would like to remind everyone that this conference is being recorded today. I will now turn the conference over to Mr. Scott Eckstein. Please go ahead.

Thank you, operator. Good day, everyone, and welcome to ZAIS Financial Corp.'s conference call to review the Company's results for the third quarter ended September 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 third quarter investor presentation is available for your review on the Company's website on the Investor Relations page. 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 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. The 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 in the accompanying tables, which have been furnished to the SEC through the Company's Form 8-K this morning and may also be accessed through the Company's website at www.zaisfinancial.com. Each listener is encouraged to review those reconciliations provided in 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. Thanks for joining us today. We're pleased to present our financial results for the third quarter of 2013, which shows the considerable progress we've made since our IPO in February, in executing our mortgage credit-focused investment strategy. During this morning's call, I'll briefly discuss our financial results, our progress to date with executing our investment strategies, including the achievement of our targeted whole loan portfolio allocation and the closeout of our Agency RMBS exposure. After that, our CFO, Paul McDade, will review our financial results in more detail and our CIO, Brian Hargrave, will discuss the mortgage credit market environment and recap our portfolio performance. Overall, the third quarter was certainly less volatile than the second; however, [fed] communication policy expectations continue to exert a strong influence across most markets. At the same time, housing market fundamentals remain strong despite rising interest rates over the past six months.

As noted in today's press release, for the third quarter of 2013, we reported core earnings of $3 million or $0.33 per weighted average share outstanding and we earned $0.2 million or $0.03 per weighted average share outstanding of roll income on our Agency TBA position. On a GAAP basis, we reported net income of $4.1 million for the quarter or $0.47 per weighted average share outstanding. The main difference between core and GAAP earnings was net realized losses on sales of Agency RMBS in closing out our agency position and net unrealized gain on our portfolio of RMBS mortgage loans and derivatives recorded under GAAP, which Paul will discuss in more detail. Book value per share of common stock and OP unit, as of September 30, 2013, was $19.92 compared with $19.95 at June 30, 2013. As previously announced, our Board of Directors declared a third quarter cash dividend of $0.50 per share of common stock and OP unit, which was paid on October 11, 2013 to stockholders and OP unit holders of record as of September 30, 2013. During the third quarter, we continued to execute on our whole loan strategy, expanding our residential mortgage loan portfolio to over $334 million of fair market value as of September 30, 2013. In line with our investment strategy, we've achieved our targeted equity allocation through residential whole loans with 53% of our equity now allocated to whole loan investments.

We also sold our remaining Agency RMBS position during the quarter and our portfolio is now focused on residential mortgage credit strategies consistent with our long-term business plan. During the quarter, we also took important steps to build out our newly originated loan purchase program. Our securities portfolio at September 30, 2013 had a fair market value of $196.6 million, down from June 30, 2013 value of $444.5 million. This reduction was primarily driven by selling our Agency RMBS positions and reallocating to whole loans. During the quarter, we also reduced our TBA securities position to a net notional value of zero as of September 30, 2013 from $62 million of net notional value held at June 30, 2013. Finally, I want to mention we have filed with the SEC a shelf registration statement covering 3.2 million shares of our common stock and OP units held by certain of our pre- IPO stockholders. This filing is required by our prior agreement with those stockholders and coincides with the expiration of the 270-day lock-up period following our IPO.

About 550,000 of the 3.2 million shares and OP units being registered are held by ZAIS insiders and I am unaware of any plans by those insiders to sell. The shelf registration will be kept current so any current stockholders will be able to sell from time to time depending on market conditions and their own investment needs. The Company is not selling stock and receives no proceeds from any sales pursuant to the shelf registration statement. The Company has no plans to file common stock offering at this time. In summary, we are quite pleased with our third quarter performance.

We continue to believe our focus on mortgage credit is well-suited for the current environment and our whole loan expertise and focus will produce attractive reserve returns going forward. While we've reached the targeted portfolio allocations that we discussed during the IPO period, we remain engaged and focused on evaluating new investment opportunities to enhance the portfolio. I look forward to sharing our continued progress with you on future conference calls. Now, I'll turn the call over to our Chief Financial Officer, Paul McDade, to review our financial performance.

Thanks, Mike. Good morning, everyone. As Mike already mentioned, for the quarter ended September 30, 2013, the Company recorded a GAAP net income of $4.1 million or $0.47 per weighted average share outstanding. Core earnings for the quarter were $3 million or $0.33 per weighted average share outstanding. The difference between GAAP and core earnings was due to net realized and unrealized gains of $1.1 million on our portfolio recorded under GAAP. You can reference the 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. As noted on our release and past earnings discussions, we believe providing investors core earnings information is important when assessing the performance of the quarter, as it offers greater transparency to the information that our Management team uses in its financial and operational decision-making process.

The Company recorded net interest income of $5.9 million for the third quarter of 2013 compared with $1.8 million in the prior-year period. Interest income of $8.3 million increased by $6.1 million from the $2.2 million recognized in the third quarter of 2012. The change was due to the addition of our mortgage loan portfolio, which increased interest income by $4.1 million and increased in our average RMBS portfolio, which increased interest income by $1.8 million and an increase in average RMBS portfolio yield, which increased interest income by $0.2 million. We incurred interest expense of $2.3 million for the third quarter of 2013 compared with $0.4 million for the third quarter of 2012. The change of $1.9 million resulted from additional borrowings under the loan repurchase facility used to finance residential mortgage loans and security repurchase agreements. As of September 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 3.5% for mortgage loans and 4.66% for non-Agency RMBS. During the third quarter, the Company recognized the positive change in unrealized gain or loss on real estate securities and mortgage loans of $8.4 million, as well as gains on derivative instruments and mortgage loans of $1.8 million.

These increases were partially offset by realized losses on RMBS of $9.1 million. Realized losses were primarily the result of the liquidation of our Agency RMBS portfolio. We incurred operating expenses of $3 million for the third quarter of 2013 compared with $0.5 million for the third quarter of 2012. The increase in expenses was primarily due to increases in professional fees, advisory fees, and general and administrative expenses of $0.9 million, $0.5 million, and $0.8 million, respectively. The increase in professional fees was primarily due to work performed for quarterly reviews and procedures performed for the 2013 audit.

The increase in advisory fees was primarily the result of a full quarter impact of the additional capital raised from the February 2013 IPO. The increase in general and administrative expenses consist of mortgage loan transaction costs, insurance expense, research fees, additional public Company expenses, and independent directors' fees. Loan servicing fees increased by $0.3 million, due to the addition of the mortgage loan portfolio. I'd now like to turn the call over to our Chief Investment Officer, Brian Hargrave, to discuss our portfolio and investment activities.

Thanks, Paul, and good morning, everyone. As Mike discussed earlier, the third quarter was an interesting one, with the market's expectations of the fed tapering of fed bond purchases driving a steady rise in interest rates through mid-September and the subsequent decline in rates after the delay of tapering at the September FOMC meeting. Despite these movements, the interest rate markets were generally less volatile than in the second quarter and as a result, more supportive of risk assets, including mortgage credit. In the mortgage credit markets, fundamentals remained quite supportive as the housing market rebound continued into the third quarter and the macroeconomic backdrop, while certainly not robust, remains positive. Our investment activity in the third quarter included the addition of residential mortgage loans with an unpaid principal balance of approximately $260.6 million, resulting in a whole loan portfolio fair market value of $334.8 million, as of September 30, 2013. In conjunction with the growth in our whole loan portfolio, the size of our RMBS portfolio was reduced significantly to [$196.6] million, as of September 30, 2013, from $444.5 million held as of June 30, 2013. During the quarter, we sold off Agency RMBS with a principal balance of $170.3 million, which represented all of our remaining Agency RMBS positions.

We also sold non-Agency RMBS with a principal balance of $80.2 million during the quarter and reduced our TBA securities position to a net notional value of zero as of September 30, 2013. We are very pleased to have achieved our long-term equity allocation target with respect to whole loans in the third quarter, as this is a key component of our investment strategy. It's our view that opportunities to deploy capital in this sector of the whole loan market continue to be extremely attractive, given strong supply of legacy, high-risk performing, and reperforming whole loans. 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. From a risk management perspective, we believe whole loan investments benefit from important elements of control and transparency into the loan acquisition and servicing processes. At September 30, we had a leverage ratio of 2.11 times, with borrowings composed of $240.5 million outstanding under our loan repurchase facility used to finance residential mortgage loans and $134.1 million outstanding under repurchase agreements secured by our RMBS portfolio. These borrowings all bear interest at rates that have historically moved in close relationship to LIBOR.

We continue to see ample opportunity to add borrowing capacity across both RMBS and whole loans. We have maintained some interest rate swap agreements to mitigate the effects of the increases in interest rates for a portion of our outstanding repurchase agreement. These two-off 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 $17.2 million of repurchase agreement borrowings as of September 30, 2013. In summary, we believe our portfolio is well-positioned to benefit from the ongoing recovery in the housing market and gradually improving economic fundamentals. As a Management team, we are focused on maximizing the value of our whole loan portfolio by working closely with the loan servicer. At the same time, we continue to actively assess the relative value of residential whole loan and potential RMBS investments and we'll opportunistically pursue attractive, risk-adjusted returns across these markets.

Finally, as Mike mentioned, we have taken important strides in building out our newly originated loan purchase program. Our efforts to date have focused primarily in the areas of product development and pricing, extension of our loan management technology, and early development of a loan seller network. We believe newly originated loans will become a key component of our strategy going forward and a key differentiator in our ability to source mortgage credit risk in the future. That concludes our prepared remarks and we will now open it up for your questions.

(Operator Instructions)

Mike Widner, KBW.

Just wonder if you could talk a little bit about maybe about how you see the funding side of the balance sheet shaping up over time? It looks like right now you're mostly repo financing, but any sort of plans for that; securitizations or other sort of long-term funding opportunities?

Yes, I think you're correct. We have both loans and the securities today financed in the repo market. The securities shorter-term, obviously, and the loan portfolio financed on a 364-day facility. To your point, we are very cognizant of securitization opportunities and obviously, term financing is something that is attractive, assuming the economics make sense. It's really that piece of the equation that we are focused on and want to be opportunistic around when we would enter such a transaction. But there is a market for securitization of these loans that we own and it's something we keep our eye on and could pursue if we believe it becomes more attractive.

For the mortgage loan piece, it looks like you're paying just under 3% on the repo financing. Any idea if you did try and securitize off the senior pieces what your effective cost of funding might be?

It would be meaningfully higher. I don't know, I could quote you a number of the top of my head today, but I don't think it would be meaningfully higher than the rate you pointed out we're paying today on repo.

Okay. You guys have also alluded to hitting your target allocation. What should we expect in terms of the portfolio at this point? By that, are you just sort of going to replace runoff as it occurs or possibly adding more loans and adding more leverage? Or if you did securitize, obviously, you could potentially add leverage there and having permanent financing. In general, a broad question is having reached your goal, now what?

I think we're, at this stage, more optimistic in terms of how we're looking at opportunities. I think if we saw compelling whole loan opportunities, we could move out of a portion of RMBS and over into whole loans and increase that allocation, but I think it's purely based on what we see in the market at this point. We're a little bit more opportunistic in terms of how we'll approach that today.

Yes. Just one final one, as far as the loans that you're buying, the whole loans, obviously you've built yourself a pretty good portfolio there, reasonably quickly. Any idea on what the total size of that pool is? Are we talking hundreds of billions? These are mostly reperformers, I believe you indicated, is this something you could raise a lot of equity and grow substantially? Or it works and you can build up just because of your small size, it allows you to make a huge part of your capital in that segment? Maybe if you could just talk about that a little bit?

I couldn't quote you the number for the size of that market, but we've seen pools trade, over the past 12 months, as large as $1 billion in size. It's a pretty sizable market if you think about just all of the credit distress that's moved through the system over the last few years. These reperforming loans, by definition, that past history of potential delinquencies or modifications doesn't go away, so we're really buying loans that may have been delinquent one, two, three years ago, maybe they've modified one, two, three years ago and those characteristics don't change despite the passing of time. We do see, in continued pretty strong flow in terms of supply in the market, and based on what we can see over the short term, don't believe that there's any reason that should cease to persist.

With that being said, you made it fairly clear in your comments that, at this time, you're not entertaining the notion of raising more equity, which, given where the stock's trading relative to book, I certainly understand. As you said, it's a big opportunity out there and it's probably not going to disappear anytime soon. What would you need to see to take or how would you take more advantage of it if not through a capital raise?

(technical difficulty)

Yes, this is Mike Szymanski at ZAIS Group. We have some weather here in the Red Bank area, which seems to have knocked out our building's telephone, so we are on a speakerphone right now. I'm not sure how many people are still on the line. We very much apologize for this. We were answering a question from Michael Widner regarding what we were doing in terms of the opportunity to continue to deploy capital. Let me just step in and give an answer. I'll have Brian follow-up as well.

We continue to see opportunities to put new capital to work and we're considering all of our alternatives. What might make sense, given where our stock price is right now and the current state of the market, but I think it's important, and we've underscored this in all of our communications with investors, that at this point, we don't have any plans to file a common stock offering. We're continuing to look at our alternatives to raise additional capital, because we do feel like we can deploy that capital, but, quite frankly, what we really also need to do is make certain that the investor community understands how we're executing our strategies. We're hopeful and constructive that our stock price will ultimately reflect those positive results. Hopefully, that's helpful.

Thank you I do appreciate that and it certainly makes sense to me.

Okay, sorry about that, again, to all of our investors, I apologize.

Douglas Harter, Credit Suisse.

You referenced a couple of expenditures or items that drove expenses higher in the quarter, like preparing for the audit and some transaction fees. I was wondering if you could help size those and give us an expectation as to whether we should expect those to continue in future quarters?

Sure. Just first off, with regards to the expenses quarter versus quarter, the quarter for 2013 was much different than the third quarter 2012. We were still operating as a private mortgage REIT during the third quarter of 2012 so first off, there were really no surprises with regard to the expenses that we recognized during the third quarter. Overall, the expenses recorded were the direct result of repositioning our portfolio in whole loans and continuing to build out a [VFC] as a public Company. As I mentioned, the expense quarter on quarter was very different due to the public REITs and building the mortgage loan portfolio out. Some expenses that were incorporated in there that were not in the prior year quarter related to new public Company expenses, items such as external audit quarterly reviews, we've incurred expenses related to internal audits and ensuring our Sarbanes-Oxley compliance, various other legal and compliance costs that were required during the quarter. Also, with regard to whole loan assets holding our portfolio of whole loans, we've had various different pool sourcing transaction costs, loan servicing costs, collateral and appraisal costs related to loans, et cetera.

We also do have some out of period expenses. In 2012 was when all of the audit-related costs were recognized in the first quarter of 2013. We've now gotten into more of a regular audit cycle such that some of the expenses related to the 2013 audit price interim price positive billings have been recorded in this quarter. We also have increased advisory fees due to a higher capital base with regards to the IPO that closed in February. The big message here is the fact that we now have three quarters of operating as a public company under our belt and our ability to enhance the precision related to expense accruals will be much more accurate as we continue to move forward. The big point here is, as we continue to scale the business, a lot of operating expenses, the start up expenses have been incurred and as we increase the capital base, we'll be able to reduce the volatility around the impact of expenses on a quarterly basis. But to answer your question, with regards to putting some numbers around there, our professional fees of $1.9 million, the bulk of that came from audit-related fees, so fees related to quarterly reviews, as well as progress [billing] so that's roughly about $700,000 of the $1.1 million in the professional fees line item.

We also had internal audit-related fees of about $100,000 in the quarter and then we had consulting fees related to updating appraisals on underlying collateral values of about $123,000. Our advisory fees were around $710,000 for the quarter. That's increased by about $500,000; again, that was purely directly related to the additional capital that was raised as part of the IPO. We had loan servicing fees of about $300,000 which were not incorporated in the prior-year result as we did not have a loan portfolio in the third quarter 2012. Our G&A expenses were about $844,000 for the quarter; the bulk of that coming from insurance, research fees, and whole loan transaction costs of about $280,000.

Great, thank you. Switching topics, can you talk about the thought process of the Board in setting the $0.50 dividend? Obviously, you guys earned less than that on a (inaudible) basis. Can you just talk about the thought process of the $0.50 dividend?

Yes. When we looked at that, obviously, we paid that out prior to the end of the quarter, so we'd have complete transparency into quarter-end results. But I think we set that based on what we thought the portfolio was going to earn on a net interest margin basis and then I think some of the numbers that Paul alluded to on the expense side were probably the bigger drivers in terms of the core numbers not matching up to that. The short answer is that we're targeting a number there based on what we saw as the earnings potential of the portfolio not having full visibility at that time into the timing of expenses.

Got it. Would you say that any of the portfolio repositioning that you guys did during the quarter, was there any drag on earnings power, just from the timing of sales of agencies versus the timing of the purchase of the whole loans?

No not at all.

Okay, thank you.

Jim Young, West Family Investments.

Regarding the expenses that you had discussed, it sounds like the $3 million that you realized for the three months ended September 30, that appears to be somewhat of a normalized expense level. Would that be correct?

Jim, we definitely, as I mentioned, there were no surprises with regards to the expenses. We haven't really established a real normalized run rate at this point. As I mentioned, there are still some components of start-up related costs. We have some other expenses that we'll incur going forward. As we mentioned, we're working on building out our origination platform so we'll be incurring some expenses with regard to that. I really can't give you a real good picture, a 100% accurate picture of what our run rate is going to be going forward. We do think that it won't materially deviate from what we recorded in this quarter, but we will, as I mentioned, as we've gotten three-quarters of operations under our belt, we'll be able to much more accurately, with precision, accrue our expenses on a go-forward basis.

Okay. With respect to the origination platform, can you talk about how you're thinking about building out this business and what do you see this business looking like out over the next like 12 to 18 months?

Sure. Really, what we're trying to build out on the newly originated loan side is a conduit flow purchase program for newly originated loans. We do not anticipate, at the time, being a direct lender per se, but rather purchasing closed and funded loans from originators. To do that, there are a couple of key pieces that need to be put in place. One is defining a product because this is a product will have a set of purchase criteria and we will underwrite loans to those criteria and purchase loans that fit into those criteria. We've got a fair amount of work that's been done to develop those criteria, as well as associated policies and procedures around it.

Secondly, and I think probably a point that may be somewhat underappreciated, is just the processing side of it and building a process that takes advantage of technology and is scalable in such a way that originators feel comfortable and confident in our ability to transact on a regular basis. That's something that's we've been spending a lot of time and energy on in getting that in place before we roll it out. I think from our standpoint, rather than rushing something out to the market, we want to have all the key pieces in place and feel confident around the execution and scalability of it before we roll it into the market.

All right, thank you. With respect to your leverage ratio of 2.11 times at the end of the September quarter, for mortgage loans, you showed a leverage of 2.55 times and for the non-Agency RMBS of 2.15 times. Given the underlying characteristics of the mortgage loans and the non-Agency RMBS that you own combined with the current market environment, what leverage ratio do you feel comfortable with using for the mortgage loans and for the non-Agency RMBS?

I think we're comfortable at our current leverage. Obviously, I think if you look at, on the non-Agency side, if you dig through the document, we do have some unencumbered or non-pledged collateral in our position that we hold for liquidity reasons. I think the ranges that we articulated at the time of the IPO were 2 to 3 turns on loans and 1.5 to 2.5 turns on non-Agency, so we're kind of right in the middle of the range on both of those, so I think those still apply. We've run, I'd say, for the past few quarters, a pretty conservative liquidity position. Our cash holdings our reasonably high and we've held unencumbered securities as a liquidity buffer as well. I think we've said in the past, given what we've experienced over the last several years in the whole loan market, we are comfortable running a little bit more leverage on the whole loan side. To the extent we shift the portfolio allocation into that sector, our overall leverage could move up a little bit.

Okay. Lastly, can you just talk about some of the underlying credit characteristics for the mortgage loans and for the non-Agency RMBS? I would think that, again, in the environment that we're experiencing with a modestly improving economy with higher home prices that the underlying fundamentals and credit characteristics for your mortgage loans and non-Agency RMBS should be improving, but can you elaborate on that? Thank you.

Sure. I think obviously, on the loan side, we have a lot more transparency into the collateral, so we can probably comment more extensively on that. But if you look at, in our slide packet, on page 10, we're providing a quarterly snapshot into the whole loan portfolio and you can just flow down through that. From a risk standpoint and therefore, driver of return, the things I would point out is our portfolio at September 30 had an effective current LTV of 130%. That's measured on a mark-to-market basis, taking an updated valuation on the underlying homes and versus the current loan amount. Those borrowers are still well underwater on their loans. However, still paying their bills, which is an important piece.

If you look down at the bottom, about 97% of the portfolio was performing at the end of the quarter. That's the single greatest risk characteristic in these loans. But it's also obviously the characteristic that benefits directly from HPA so to your point, that's really where we see opportunity and exposure to home price appreciation. Beyond that, the other thing I'd point out is the average FICO was around 660 at the end of the quarter. If you look at the new origination market today, it would be, across the GMC, FHA, or the private label market, average FICO's are well up into the mid- to high 700s. These are borrowers that have some credit sensitivity and impairment to them and that's a key source of risk, but also, a source of opportunity in terms of targeting borrowers, managing them aggressively through coordination with our servicer. We think that there's a fair amount of value to be captured as a result of that.

I can't comment in nearly as much detail on the non-Agency side, other than to point you to the slide packet. You can get a sense of the exposures we have in the various market segments. I think our portfolio has consistently been tilted a little up in credit, in prime, and in kind of the banged up prime sectors, as well as the alternative A market. Our subprime holdings, (inaudible) ARM holdings are relatively small.

All right, thank you.

As there are no further questions at this time, I will turn the call back to Management for any closing.

Thank you all for your participation today. Once again, the Company apologizes for the technical glitches. That seems to be something that is common, that's running through our culture right now. We'll fix that going forward. We look forward to speaking with you again on our next earnings call. Thank you.

Thank you. Ladies and gentlemen, this conference will be available for replay for one week. You may access the replay system at any time by dialing 1-800-406-7325 and entering access code 4648126. International participants may dial 303-590-3030. That does conclude our conference call for today. Again, we thank you for your participation and you may now disconnect your lines.