Ready Capital Corp (RC) 2013 Q4 法說會逐字稿

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the ZAIS Financial Corporation fourth quarter 2013 conference call. During today's presentation, all participants will be in a listen-only mode.

(Operator Instructions)

This conference is being recorded today, Wednesday, March 5, 2014. I would now like to turn the conference over to 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 fourth quarter and full year ended December 31. On the call today will be Michael Szymanski, President and Chief Executive Officer; Paul McDade, Chief Financial Officer and Treasurer; and Brain Hargrave, Chief Investment Officer.

As a reminder, this call is being recorded, also being webcast through the Company's website, www.zaisfinancial.com. Additionally, a copy of the Company's fourth-quarter investor presentation is available for your review on the Company's website on the Investor Relations page.

Before we begin, I would 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 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 and accompanying tables which have been furnished to the SEC through the Company's Form 8-K this morning. They may also be accessed through the Company's website at www.zaisfinancial.com.

Each listener is encouraged to review those reconciliations provided in the earnings release together with all of the 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 fourth quarter 2013, which demonstrates the strength of our mortgage credit focused investment strategy.

During this morning's call, I'll briefly discuss our financial results and our other achievements during the quarter. 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. Despite the announcement of the Fed's decision to begin tapering bond purchases, interest rates remain range bound in the fourth quarter and volatility was subdued.

Economic fundamentals strengthened during the quarter, although we have seen times in early 2014 that this strength may have been somewhat fleeting. The same time, housing fundamentals remain solid, appearing to have largely shaken off higher interest rates in 2013. As noted in today's press release, for the fourth quarter 2013 we recorded core earnings of $3 million, or $0.31 per diluted weighted average share outstanding.

On a GAAP basis, we reported net income of $9 million for the quarter, or $0.98 per diluted weighted average share outstanding. The main difference between core and GAAP earnings was net realized and unrealized gains on our portfolio of mortgage loans and RMBS recorded under GAAP which Paul will discuss in more detail. Book value per share of common stock and OP unit as of December 31, 2013 was $19.98, compared with $19.92 at September 30, 2013.

As previously announced, in the fourth quarter our Board of Directors declared a regular cash dividend of $0.40 per share of common stock and OP unit, and an additional special cash dividend of $0.55 per share of common stock and OP unit which were paid on January 15, 2014 to stockholders and OP unit holders of record as of December 31, 2013. The Company declared the special cash dividend to distribute taxable income from 2013 attributable to the termination of interest rate swap contracts.

In November of 2013, we successfully completed the issuance of $57.5 million in convertible notes. This is an important transaction for ZFC as we expect it to be accretive to earnings. At the same time, it provides us with additional capital to pursue our residential mortgage credit investment strategies consistent with our long-term business plan.

Also, our success in completing this transaction speaks positively on the differentiation of our strategy, given our continued ability to access capital in this market environment. During the fourth quarter our capital allocation to whole loans remained relatively stable at 54%. Our securities portfolio at December 31, 2013 had a fair market value of $226.2 million, up from September 30, 2013 value of $196.6 million.

Importantly, we saw significant gains in both our whole loan and our non-agency RMBS portfolios in this quarter. As a result, we grew book value in the quarter while declaring a total of $0.95 per share in regular and special dividends.

During the quarter we also continued to invest resources in our whole loan platform. We believe this investment provides us with the ability to grow further our legacy whole loan portfolio, while also moving us closer to launching our newly originated loan purchase program.

I will now 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 December 31, 2013, the Company reported GAAP net income of $9 million, or $0.98 per diluted weighted average share outstanding. Core earnings for the quarter were $3 million, or $0.31 per diluted weighted average share outstanding.

The difference between GAAP and core earnings was due to net realized and unrealized gains plus $6 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 in 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 $5.7 million for the fourth quarter of 2013, compared with $1.8 million in the prior-year period.

Interest income of $8.8 million increased by $6.6 million from the $2.2 million recognized in the fourth quarter of 2012. The change was primarily due to the deployment of capital raised in the February IPO and the acquisition of our mortgage loan portfolio, which increased interest income by $5.5 million. Other factors which increased interest income included increases in our average RMBS portfolio and average RMBS portfolio yield, which raised interest income by $0.7 million and $0.4 million, respectively.

We incurred interest expense of $3.1 million for the fourth quarter 2013 compared with $0.3 million for the fourth quarter 2012. The change of $2.8 million resulted from additional borrowings under the loan repurchase facility used to finance residential mortgage loans, security repurchase agreements, and the convertible notes.

As of December 31, 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 3.91% for mortgage loans and 4.61% for non-agency RMBS. During the fourth quarter, the Company recognized a favorable change in unrealized gain or loss on mortgage loans and real estate securities of $4.7 million, as well as realized gains on mortgage loans and RMBS and gains on derivative instruments of $1.3 million.

We incurred operating expenses of $2.7 million for the fourth quarter of 2013, compared with $2.2 million for the fourth quarter of 2012. The increase in expenses was primarily due to several factors related to the Company's IPO and transition to a public company. These factors included increases in professional fees, advisory fees, and general and administrative expenses, partially offset by a decrease in the interest on common stock repurchase liability.

Professional fees incurred increased by $0.8 million, primarily due to work performed by the independent auditors for quarterly reviews and procedures performed for the 2013 annual financial statement audit. Advisory fees increased by $0.6 million due to an increase in stockholders' equity as a result of the Company's February 2013 IPO. General and administrative expenses increased by $0.5 million, primarily due to transaction costs, insurance expense, research fees, trustee fees, and independent director's fees.

Loan servicing fees increased by $0.5 million due to the acquisition of whole loans consistent with our investment strategy. Increased expenses were partially offset by a $1.8 million decrease in interest on common stock or purchase liability due to the repurchase of common stock in the first quarter of 2013.

That concludes our financial review. I would now like to turn the call over to our Chief Investment Officer, Brain Hargrave, to discuss our portfolio and investment activities.

Thank you, Paul, and good morning, everyone. As Mike discussed earlier, despite the Fed tapering announcement in December, interest rates were relatively stable and volatility subdued during the fourth quarter. This interest rate environment was supportive of risk assets.

Our whole loan and non-agency RMBS positions generated solid gains, benefiting from the general market environment, as well as from positive macroeconomic fundamentals. While we have seen increased market volatility subsequent to quarter end, mortgage credit markets remain constructive.

Our investment activity in the fourth quarter was somewhat limited with the addition of $41 million in non-agency RMBS during the quarter, reflecting a partial investment of the proceeds from our note issuance. The fair value of our whole loan and non-agency RMBS positions stood at $331.8 million and $226.2 million, respectively, at December 31, 2013. This put our capital allocation at approximately 54% to whole loans at year end.

Going forward, we expect to finish deployment of the convertible notes proceeds in early 2014, and continue to pursue opportunities to increase the allocation to whole loans throughout the remainder of the year. At December 31, we had a leverage ratio of 2.42 times, with borrowings composed of $236.1 million outstanding under our loan repurchase facility used to finance residential mortgage loans, $138.6 million outstanding under repurchase agreements secured by our RMBS portfolio, and $54.5 million book value of convertible notes outstanding.

The loan repurchase facility and repurchase agreements bear interest rates that have historically moved in close relationship to LIBOR. We continue to see ample opportunity to add borrowing capacity across both whole loans and RMBS.

We have maintained some interest rate swap agreements to mitigate the effects of increases in interest rates for a portion of our outstanding repurchase agreement. These swap agreements provide for us to pay fixed interest rates and receive floating interest rates indexed off LIBOR, effectively fixing the floating interest rates on $17.2 million of repurchase agreement borrowings as of December 31, 2013.

Our whole loan activity to date has focused on higher risk performing and reperforming whole loans originated prior to the financial crisis. As this portfolio has begun to season on our balance sheet, we are pleased with its performance from a credit perspective. We continue to see this asset class as an attractive source of income and capital appreciation for our portfolio.

In addition, we have continued to invest resources in our newly originated loan purchase program and expect to launch this initiative in the coming months. New regulations, a weak securitization market, and lack of initiative on GSE reform all continue to pose challenges for the non-agency lending market. However, we believe strongly in the long-term opportunity set, and we will continue to seek to position ZFC to benefit as that opportunity set evolves.

That concludes our prepared remarks, and we can now open it up for questions.

Thank you, Sir.

(Operator Instructions)

And our first question comes from the line of Mike Widner with KBW.

Hello. Good morning, guys. Was wondering if you could just maybe talk a little bit more about how we should think of leverage going forward, and particularly just the mechanics of the way the convertibles flow through that?

Should we still be thinking about 2.5 times leverage as the right number? Or is it a higher number now with the capital structure a little different?

I think it probably will be a little different going forward. I think we will, given that, that convertible is a little longer term and fixed rate, we will probably target similar leverage at the asset level, and then will you have the additional leverage from the convert on top of that. So I do think that, that will increase, and in some ways, that convert will be treated more like equity from a capital standpoint.

Okay, yes. So I mean, that's I guess the question that resonates. Because you guys talked about not having fully deployed that yet, which certainly I can understand given the timing.

But just trying to figure out, you said it would be accretive to earnings, and so obviously carrying an 8% interest rate I think would you need to have some leverage on there to get it accretive to earnings. Just trying to make sure that we tune the expectations properly going forward.

I mean is what you're saying --

Sure.

-- to treat it as equity and think of it as equity even though it gets mechanically calculated as debt in the calculation?

Yes, I think that, generally speaking, how it will probably flow through.

Okay. Appreciate it. Then as far as the current allocation, for all practical purposes, you're fairly close to 50/50. Do you have a preference in terms of which way it leans going forward?

I think we made a comment that we'll look at opportunities to increase that allocation to whole loans. I think we want to be a little opportunistic around that and do it where we think it's sort of accretive and helps our overall positioning, both from a return and a risk standpoint. I think our bias would be more towards increasing that allocation over time, to loans specifically.

Yes, okay. Well, appreciate it, and thanks.

Thank you.

Thank you.

(Operator Instructions)

Our next question comes from the line of Jim Young with West Family Investments.

Yes, hello. As you completed your first year as a public company and you reflect upon the past year, what surprised you the most? If you could roll the clock back, what would you do differently?

I'll start off and then I'll hand it off to Brian. I don't know that we had many surprises. I think we said in previous calls, we would have loved to have been able to deploy faster in the credit sensitive asset classes, specifically whole loans.

Realistically, we met the targets that we laid out when we were out with the IPO by getting to that target allocation by the end of the third quarter. I think that we're realistic about being a public company, meaning that being a public company has a certain amount of expense related to it.

So the important -- we firmly believe in what we're doing. We see it every day, the differentiation and opportunities in secondary market whole loans. We're feeling that there are real opportunities in the newly originated space, and we have all those capabilities lined up and we have clear strategies.

Our job is to continue to differentiate the story of ZFC in the marketplace so that the market understands it. That we ultimately grow in scale, and that we can absorb the cost of being public company going forward. We're committed to that, and we're very confident we're going to be able to do that.

In terms of portfolio construction, I'm not sure. I'll hand it over to Brian.

I don't know that I have a lot to add to that. I think, like Mike said, we set a goal around ramping up the whole loan portfolio. We met that goal. Would we have liked to have done it quicker? Sure.

I think the Fed announcement in the middle of last year around the accretive, the tapering expectation, threw a lot of turmoil into the market in general. So I feel like we were positioned as best we could to manage through that as best we could. I guess the other thing I would comment on that was, maybe just build a little bit on Mike's point, is just I think where we've learned a lot is just around the investor communication process and when we can and when we cannot speak with investors, which is very different than the world we're used to living in on the private fund side.

We're used to being able to have this open dialogue. So I think that we're learning more around that more investor relations part of it probably.

Okay, thank you. Speaking of expenses, Paul, could you discuss a little bit on the -- out of the $2.7 million from professional fees, advisory, loan servicing, G&A, are there any of those expenses would you consider one-time due to the IPO? I'm just trying to get a sense as to what the normalized expense level looks like going into 2014?

The $2.7 million that we saw, obviously, the numbers that we're comparing to our press release the prior-year quarter, we're sort of comparing apples to oranges in the fact that the prior-year quarter we were still a private entity. We did have one out of period adjustment with regard to the repurchase of common stock from one of our investors, which added $1.8 million to the bottom line.

But the expenses that we see coming in the quarter of $2.7 million, they're in line with expectations that management had for the quarter. So there were really no big surprises with regard to those expenses. If we compare those expenses to the prior quarter, prior quarter in the third quarter we had expenses of just about $3 million for the quarter, so we're favorable by about $250,000.

If you look across the lines, our professional fees, again, they reflect the cost of quarterly reviews by our accounting firm, putting fees related to the 2013 financial statement audit and audit of our 10-K. We've also added expenses related to an internal audit function for the entity. So those are in line with what management expected for the quarter.

Our advisory fees are in line with our -- the increase in the stockholders' equity related to the IPO, so that reflects the 150 basis point advisory fee that we collect. The loan servicing fees, what you are seeing here in the quarter is the first full quarter impact for loan servicing fees with regard to our portfolio. We did have pools that we had purchased in the third quarter, so you're seeing the full fourth quarter -- or full quarter impact of those loan servicing fees.

Then our general and administrative expenses, they're the cost of, as Mike mentioned, running the public company. We have insurance related costs, we have trustee fees, outside director fees, transaction costs related to pools, et cetera. So that's basically the story with regard to the expenses.

Okay. Then when you look at the slide presentation that you've put up, on page 10, it looks like the non-performers have been trending up from 100 basis points at June, 270 basis points at September, and 310 in the December quarter.

What does that trend look like going into this year? In the performing segment, are there any issues we should be aware of with respect to 30 days plus delinquent?

No. To be clear, in this type of a loan portfolio, where we're buying current loans at a significant discount to par, and the reason they're priced there is they have a lot of embedded credit risk. That's something that we expect to be able to manage over time.

In that type of a portfolio, you will see loans go delinquent. In some ways, this portfolio, because we're only buying current loans, is positively selected. Over time, you will have loans that move into delinquency.

If you look at our actual performance versus our initial projections at the time of purchase, we don't have -- it's not a lot of data at this point, but we've slightly outperformed our baseline expectation. So you will continue to see, I would expect that performing/nonperforming mix to move a little bit towards nonperforming.

We do expect some amount of these loans will go into default. So I would say that there's nothing that we see that we're alarmed about there, but I would expect that trend to continue going forward.

Okay. But again, what I'm hearing is that the underlying credit trends are performing better than your expectations?

Yes, I think they're slightly better at this point. Again, we've owned this portfolio in aggregate now for a few months, so I wouldn't be comfortable making a huge extrapolation from that.

Just based on the numbers we look at, which is really, for this portfolio what we look at is that rate of migration into delinquency on a monthly basis. That's kind of the key early indicator of any potential issues.

Okay. Then lastly, when you think about your current quarterly dividend, your core earnings hasn't covered that dividend to date. Can you give us a sense as to over what kind of time frame do you think that you will be able to cover the dividend on a core earnings basis?

Yes, I think we had the ramp up post-IPO and the reallocation into loans, and we had really just finished that and then we did the convert issuance. So now I think we're back into a little bit of a ramp-up mode, albeit a much more condensed, probably, ramp-up process.

You can see at the end of the year we didn't have all of that capital allocated. So that allocation is going to drift into the first quarter. It will have a little bit of a carry over into the first quarter, but absent any other developments or activity, I would think that certainly as we get deeper into the first quarter, that will have kind of faded away at that point.

Okay, thank you very much.

Thank you.

Thanks

Our next question comes from the line of Douglas Harter with Credit Suisse.

Thanks. This is actually [Tafoul Majrah] standing in for Douglas Harter. Given the slowdown in the whole loan activity in the fourth quarter, can you guys just comment on your pipeline and what you're seeing in terms of pricing trends? Thank you.

Yes. Our slowdown in purchases was really a conscious decision relative to reaching our targeted equity allocation, and then at that point, becoming much more opportunistic about when we might reallocate capital out of RMBS and into whole loans.

I would say, in general, the supply environment for loans has been quite active as we've come back since the beginning of the year. The pricing, I mean, you can see in our results the pricing of our whole loan portfolio has gone up. That contributed to our gain. That's representative of the market.

We do think that there are attractive opportunities out there. The supply is relatively stable. There's transparency into the forward supply, and we think that it's a little more similar maybe now to how we would characterize the RMBS market where we feel like security selection really matters in terms of generating forward returns.

I think the loan market, you could argue, maybe a year ago, it didn't matter so much what you buy, it was just the fact that you bought something. Here, I think we're in an environment now where the selection of the assets you purchase is probably much more of a driver of returns going forward.

Thanks.

Thank you. This concludes our question-and-answer session. I would like to turn the call back over to management for any closing remarks.

Well, once again, thank you all for your participation today, and again, we look forward to speaking with you on our next earnings call. Once again, thanks so much.

Thank you. Ladies and gentlemen, this does conclude our conference for today. If you would like to listen to a replay of today's call, please dial 303-590-3030, or 1-800-406-7325.

With access code 4669315. Thank you for your participation today. You may now disconnect.