Ready Capital Corp (RC) 2014 Q3 法說會逐字稿

Good day, and welcome to the ZAIS Financial third-quarter conference call. Today's conference is being recorded. At this time, I'd like to turn the conference over to 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 would like to remind everyone that during the course of this conference call, both in our prepared remarks and in our 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 the Company 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 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 provide you an update on this morning's call, including an overview of ZFC's third-quarter financial results and a discussion of several key steps we have completed in our residential mortgage loan strategy. These steps include the acquisition of GMFS and the operational rollout of our conduit purchase program for newly originated mortgage loans. During the third quarter, we continue to see solid performance in our existing portfolio of residential mortgage loans and securities.

For the quarter, we reported core earnings of $3.1 million, or $0.35 per diluted weighted average share outstanding. On a GAAP basis, net income for the quarter was $1.3 million, or $0.14 per diluted weighted average share outstanding. On a year-to-date basis, GAAP net income was $26.5 million, or $2.99 per diluted weighted average share outstanding. GAAP and core earnings for the third quarter both reflect increased transaction costs related to the GMFS acquisition, as well as higher professional fees for the closing of a loan purchase facility with Credit Suisse.

As of September 30, 2014, book value per share of common stock and OP unit was $22.11 compared with $22.37 at June 30 2014. The September 30, 2014, book value includes $3.6 million, or $0.40 per share of common stock and OP unit in dividends payable related to the September 18, 2014, dividend declaration. Paul will discuss these financial results in more detail later in the call.

In addition to our strong operating performance, we are excited to have completed several important strategic steps towards implementing our long-term business strategy. This includes the recent completion of ZFC's acquisition of GMFS, LLC, a Baton Rouge, Louisiana-based mortgage company. We believe this transaction serves several strategic objectives, while also offering attractive financial benefits to ZFC shareholders. The acquisition accomplishes two of our primary goals in our evolution into a mortgage operating company.

First, it enables ZFC to directly source newly originated mortgage loans. At the same time, it diversifies our revenue streams to include origination activities and mortgage servicing rights investment income. Remember, GMFS is licensed as a mortgage originator in 29 states and it currently originates loans that are eligible to be purchased, guaranteed, or insured by Fannie Mae, Freddie Mac, FHA, VA, and USDA, through retail, correspondent, and broker channels. GMFS also retains mortgage servicing rights on Fannie Mae, Freddie Mac, and Ginnie Mae securitization.

Since we entered into the definitive agreement to acquire GMFS in August, our respective teams have been working together in integration and product development. As previously disclosed, we expect this transaction to be accretive to earnings beginning in 2015. We expect it to be slightly dilutive to earnings in 2014, primarily due to transaction-related expenses, of which $1.7 million have been incurred in the first three quarters of 2014. For additional details regarding the transaction financial terms, please refer to our November 3, 2014, press release and the investor presentation on our website.

During the third quarter, we also completed the operational rollout of our newly originated residential mortgage loan purchase conduit program. At this time, we've executed master loan purchase agreements and we've started accepting initial rate locks from four mortgage originators. We have a pipeline of additional sellers already in the seller approval process. Our belief is that over time, this program will be a vital aspect of our loan sourcing strategy. First, it should offer us a steady flow of potential credit investment opportunities. Second, it should also provide us a strong compliment to the GMFS platform. GMFS will serve as our proprietary non-agency origination platform, but we also intend to purchase loans from a broader group of sellers to supplement GMFS' considerable resource.

On August 14, 2014, we took another important step when we entered into a loan repurchase facility with Credit Suisse for a commitment of $100 million. We expect to use this facility to finance newly originated residential mortgage loans. Brian will provide additional details on these business initiatives and their current status. In summary, our legacy whole loan investment strategy has continued to generate strong year-to-date results, including both core income and book value gains. At the same time, we remain focused on executing our evolving business strategy and we expect our capital investments in the newly originated loan space, while ultimately proven valuable in driving ZFC's long-term performance. We believe the Company is well positioned to capitalize on many emerging opportunities in the mortgage space.

We look forward to updating you as we continue to execute on our business plan. With that, 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 third quarter ended September 30 2014, the Company reported GAAP net income of $1.3 million, or $0.14 per diluted weighted average share outstanding. Core earnings for the quarter were $3.1 million, or $0.35 per diluted weighted average share outstanding. The difference between GAAP and core earnings for the quarter was due to net realized and unrealized losses of $1.8 million on our portfolio of 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 previously noted in our release in past calls, 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 $6.5 million for the third quarter of 2014, compared with $5.9 million in the prior year period. Interest income increased by $2.7 million in the third quarter of 2014 to $11 million compared with $8.3 million in the third quarter of 2013. This increase was due to having a fully ramped and levered portfolio, primarily allocated to residential mortgage loans in 2014, partially offset by a decrease in interest income from the RMBS portfolio due to the reallocation of capital to whole loans.

We incurred interest expense of $4.5 million for the third quarter of 2014 compared with $2.3 million for the third quarter of 2013. The $2.2 million increase was from additional borrowings under the loan repurchase facility used to finance distressed and reperforming residential mortgage loans and the convertible notes issued in November of 2013. As of September 30, 2014, 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 4.2% for mortgage loans, and 5.12% for non-agency RMBS and other investment securities.

During the third quarter, the Company continued to recognize a favorable change in unrealized gain or loss on mortgage loans of $0.9 million, and an unfavorable change in unrealized gain or loss in real estate securities and other investment securities of $3.2 million. It is worth noting that the favorable change in our mortgage loan portfolio is on top of the significant favorable change recorded in the second quarter. We also recognized realized gains on mortgage loans and real estate securities of $0.6 million and $0.4 million respectively. And losses on derivative instruments of $0.5 million during this timeframe.

We incurred operating expenses of $3.4 million for the third quarter of 2014 compared with $3 million in last year's third quarter. Loan servicing fees increased by $0.3 million from the prior-year period due to the addition of residential mortgage loans. Professional fees decreased slightly due to decrease in audit and consulting fees. These fee increases were partially offset by increased legal fees due to the closing of the loan repurchase facility with Credit Suisse. Transaction costs increased by $0.2 million due to the due diligence costs and professional fees related to the Company's acquisition of GMFS, which were partially offset by a decrease in whole loan transaction costs.

That concludes our financial review. I'd now like to turn the call over to our Chief Investment Officer, Brian Hargrave, to discuss our portfolio and strategic initiatives.

Thanks, Paul, and good morning, everyone. In the third quarter of 2014, our residential home loan portfolio continued to benefit from strong underlying credit performance. I would draw your attention to Slide 13 of our third-quarter earnings presentation, which illustrates the out-performance of our whole loan portfolio relative to modeled delinquency projections over time.

This was the main contributor to the generation of an additional $0.9 million of unrealized gains in the third quarter on the heels of a very strong performance in the second quarter. At the same time, we did experience some market value declines in our non-agency RMBS and other investment securities portfolios, which generated unrealized losses of $3.2 million in the quarter. While market volatility has increased somewhat subsequent to quarter end, the whole loan market, in particular, has been largely unaffected to date.

Changes to our investment portfolio in the third quarter were minimal. As of September 30, 2014, we held residential mortgage loans with a fair value of $430.1 million, a diversified portfolio of non-agency RMBS with a fair value of $243.9 million, consisting primarily of senior tranches that were originally highly rated, but subsequently downgraded, and other investment securities with the fair value of $13.4 million. Our capital allocation of whole loans remained at approximately 70% as of September 30.

At quarter end, we had a leverage ratio of 2.62 times, up slightly from the second quarter. Our borrowings were composed of $293.2 million outstanding under our loan repurchase facility used to finance residential mortgage loans, $165.6 million outstanding under repurchase agreements secured by our RMBS portfolio, and $55.2 million book value of convertible notes outstanding. The loan repurchase facility and repurchase agreements bear interest at rates that have historically moved in close relationship to LIBOR.

Our interest rate derivative position at September 30 was unchanged from the prior quarter. We held an interest rate swaption, which gives us the right, but not the obligation, to enter into a previously agreed upon swap contract on a future day. The notional amount of this option was $225 million as of September 30, 2014. Economically, this position gives us increased protection if rates start to move higher this year. We also have interest rate swap agreements that 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.

As Mike mentioned, we recently completed several important steps to put ZFC in a position to capitalize on current industry trends as the mortgage market continues to evolve. The GMFS acquisition and the rollout of our newly originated loan conduit program are both important to ZFC as it approaches the mortgage market. Taking a step back, we have approached the new origination business from 4 points of execution, all of which draw or build upon the skills, expertise, and infrastructure of ZAIS Group.

These points are summarized on Slide 8 of our investor presentation. First, from a product perspective, we have introduced expanded loan eligibility criteria compared to what is available in the jumbo market today. In addition, we are currently working to further expand credit eligibility, specifically through the GMFS platform. Second, from a process and technology perspective, we have rolled out a scalable web-based interface for pricing, reviewing, and closing new loans on a flow basis. Third, from a sourcing standpoint, we have approved four sellers into our program and have a number of additional parties at various stages of the review and approval process. This is based on a detailed seller review and approval process that we have established to vet our counterparties.

As you would expect, we anticipate GMFS will be an important component of our sourcing strategy going forward, but it will not be our sole source, as these steps indicate. Finally, we have adapted our existing servicing oversight and loan data management system to focus specifically on asset management of loans, once they have been funded by ZFC. In summary, we are very excited with the progress we've made in our mortgage strategy and with ZFC's competitive positioning today.

We look forward to updating you on our continued progress on our next earnings call. That concludes our prepared remarks and we will now open it up for your questions.

(Operator Instructions)

And we'll take our first question from Mark DeVries with Barclays.

Thanks. Sorry if I missed this, but could you help us quantify on a per-share basis the adverse impact to core earnings from the transaction expenses in the quarter that you referenced in the press release?

Sure.

Looking at expenses for the quarter, as I mentioned in my comments, transaction costs related to the GMFS transaction recognized in the quarter were $435,000 related to investment banking and legal related costs. Additionally, as part of our professional fees, we had about $530,000 of legal fees with regard to structuring and closing the repo credit facility with Credit Suisse First Boston. So if you basically consider those to be non-recurring and normalize the impact of those out, it's going to have about a 10% or 11% impact on core earnings for the quarter.

Okay. Got it. That's helpful.

If we back that out, do you think that gives us then ex that, a reasonable core OpEx run rate going forward? Or does the addition of GMFS add incremental expense that's not shown up yet?

Yes, consist with our policy regarding forward guidance, that's not really -- I really can't comment on forward-looking expenses.

Okay.

But as you mentioned, GMFS will factor into the equation as we bring them online.

Okay. Fair enough. And is there any incremental color you can give us on the accretion expectations around GMFS? Is it going to be just kind of modestly accretive? Or is there any color you can give us there?

I don't think we can get into too much specifics right now. I think at this point, all we can say is that the dilution is primarily a function of just the cost of getting a transaction done, and that will be recognized this year, and that we do expect it to be accretive. As you can imagine, the degree of accretion is going to be a function of the mortgage origination environment as we get into next year. But we do expect that it will be accretive to where we sit today.

Okay, and do you think that will be the case if we see kind of flattish volumes from where we are right now on a year-over-year basis?

Yes, I don't think flat volumes are necessarily a problem. I think that we would see a pickup in that environment.

Okay, got it. And then finally, Brian, if you could just give us any color on the returns you're seeing on new investments, and also what you expect from the whole loan strategy as you really start to ramp that?

Sure. I would say in our core business of reperforming, subperforming and higher risk performing whole loans, pricing has continued to be pretty strong. I mean, we saw -- you saw in our earnings in the second quarter pretty substantial mark-to-market gains, and it doesn't feel like the market's given much of that back. Now, the fundamentals have remained very supportive, and credit performance in our portfolio has been good and I guess in some ways justifies those valuations.

But we haven't seen any softness in those markets and are somewhat cautious, is a word I would use, as well as more opportunistic, as we look at opportunities to put capital to work in that segment of the market specifically. I think on the new origination side, the market in the core jumbo space is competitive, and I think that where we see better opportunities is outside that core jumbo product set, if you will. We think that the competition is less there and there's better opportunity to drive returns in those sectors.

Got it, and more specifically, what type of levered ROEs would you expect to generate?

Without getting too specific, I think that we see them up into the double digits. I think that in the jumbo space, it's hard to get to those types of returns today based on where those loans are pricing in the markets right now.

Okay. That's helpful. Thank you.

And we'll take our next question from Trevor Cranston with JMP Securities.

Hi, thanks.

And congratulations on all the new initiatives coming on board this quarter. To follow up a little bit on the new origination business, you commented on double-digit return expectations. Can you talk about how long you would anticipate holding loans on your financing line until you'd be able to achieve some sort of a contribution into a securitization or an exit through that route, and how much you think you need to acquire before you could do that?

Sure. I think that as we look at our business and what we're trying to accomplish on the new origination side, I think it's fair to say that we are prepared to hold those loans in unsecuritized form perhaps for a longer period of time than might be true of our peers. And I think that that's a function of two things. One is that we are moving slightly outside the box as it is defined today in the jumbo market and we may need to season those loans and demonstrate that performance to achieve what we think are reasonable economics on securitization.

The second thing I would say is the securitization market remains challenging. I think you're seeing in late third quarter, end of the fourth quarter, an increase in deal flow and in a lot of respects, a fair amount of softening in that market. So the depth of that market is still not that gray and what we've strategically made the decision to do is put ourselves in a position where we can warehouse those loans for a longer period of time without substantial give-up in economics and be opportunistic as we approach that market.

Got it. That's helpful. And with respect to GMFS, now that the acquisition is closed, can you give us any sense of kind of where the monthly origination volumes are running right now? Or is that something we'll need to wait for next quarter?

You know, I don't think we can give you specifics. We did disclose the first three quarters of origination volume, which if you annualize that, it's slightly below last year. But I think that will give you a pretty good sense as to how things are running.

Okay. And can you remind us what the UPB is on the MSRs that come as part of the acquisition?

I don't have that number right in front of me. I can get you that, though.

Okay. I appreciate it. Thanks.

And we have no further questions over the phones. I'd like to turn the conference back over to our speakers for any additional or closing remarks.

Well, thank you very much, all of you, for your participation today. And we look forward to speaking with you again on our next earnings call. Once again, thank you very much.

Thank you for joining us on today's ZAIS conference call. A replay of this call will be available November 12 at 12:00 central time, 1:00 eastern time, and through November 19. To access the replay, please dial 1-888-203-1112 and reference the pass code 7, pardon me, 6775388. Again, the number is 1-888-203-1112 and reference pass code 6775388. This concludes today's conference. We thank you for your participation.