Ready Capital Corp (RC) 2014 Q4 法說會逐字稿

Good day, everyone, and welcome to the ZAIS Financial fourth-quarter earnings conference call.

Today's conference is being recorded.

For opening remarks and introductions, I will turn the call over to Scott Eckstein. Please go ahead, sir.

Thank you, Operator.

Good day, everyone, and welcome to the ZAIS Financial Corporation's conference call to review the Company's results of the fourth quarter ended December 31. 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 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 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 include 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 filed 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 thank you for joining us for today's call.

Today, we will review ZFC's fourth-quarter financial results and key business activities. Fourth quarter of 2014 marked an important inflection point for ZFC with the closing of the GMFS acquisition on October 31, 2014. Adding complimentary mortgage origination and servicing capabilities to our existing expertise brings us several important benefits. First, ZFC can now directly source newly originated mortgage loans.

For those of who you are not familiar with GMFS, LLC, it is a Baton Rouge, Louisiana-based mortgage Company that is already licensed as a mortgage originator in 29 states. Presently, it primarily 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 GMA securitizations.

At the same time, this transaction brings with it financial benefits, such as diversifying our revenue streams to include origination activities and mortgage servicing rights investment income. We continue to expect the GMFS transaction to be accretive to earnings in 2015 and also to provide important strategic advantages to ZFC over the long-term.

Turning to our financial performance, our residential whole loan strategy continued to produce strong results. For the quarter, we reported core earnings of $4.1 million, or $0.46 per diluted weighted average share outstanding. On a GAAP basis, net income for the quarter was $0.2 million, or $0.02 per diluted weighted average share outstanding. On a year-to-date basis, GAAP net income was $29.9 million, or $3.08 per diluted weighted average share outstanding.

As of December 31, 2014, book value per share of common stock and OP unit was $21.73 compared with $22.11 at September 30, 2014. The December 31, 2014 book value includes $3.6 million, or $0.40 per share of common stock and OP unit in dividends payable related to the December 19, 2014 dividend declaration. Please note that these financial results also include two months of operating results of GMFS. Paul will discuss these financial results in more detail.

In our evolution into a mortgage operating Company, we continue to focus significant resources on the loan purchase program for newly originated, non-agency mortgage loans. We will continue to broaden our operational capabilities as we execute on our residential mortgage market strategy.

We believe newly originated, non-agency mortgage loans will be an important investment strategy for the Company going forward, and we remain committed to ramping up this non-agency loan conduit. Ultimately, we believe this initiative and the other more recently implemented operating strategies that I described will become an increasingly larger component of our overall financial performance.

So, in summary, our legacy whole loan investment strategy continued to provide us a solid foundation for future growth, generating strong results in 2014, including both core income and book value gains. At the same time, we remain focused on executing our evolving business strategy in the newly originated loan space and expect our new origination and investment initiatives will ultimately prove invaluable in driving ZFC's long-term performance.

Based on our progress to date, 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'll 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 fourth quarter ended December 31, 2014, the Company reported GAAP net income of $0.2 million, or $0.02 per diluted weighted average share outstanding, which includes two months of GMFS' operating results. Core earnings for the quarter were $4.1 million, or $0.46 per diluted weighted average share outstanding.

The difference between GAAP and core earnings for the quarter was primarily due to net unrealized losses on our portfolio held for investment, plus unrealized losses on MSRs net of tax and depreciation and amortization expense net of tax. 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 and 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 $5.8 million for the fourth quarter of 2014 compared with $5.7 million in the prior-year period. Interest income increased by $1.5 million to $10.3 million for the fourth quarter of 2014 compared with $8.8 million in the same period in 2013, due to having a fully ramped and levered portfolio in 2014, primarily allocated to residential mortgage loans held for investment and the addition of mortgage loans held for sale due to the acquisition of GMFS, partially offset by a decrease in interest income due to the sale of RMBS to fund the acquisition of GMFS.

The Company incurred interest expense of $4.4 million for the fourth quarter of 2014 compared with $3.1 million for the fourth quarter of 2013. The $1.4 million increase was due to additional borrowings under the loan repurchase facilities used to finance the residential mortgage loans held for investment, additional interest expense related to the GMFS warehouse lines of credit and a full-quarter impact of interest expense on the 8% exchangeable senior notes, which were issued in November of 2013. As of December 31, 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 4.02% for mortgage loans and 5.18% for non-agency RMBS and other investment securities.

The Company earned $4.7 million of non-interest income for the three months ended December 31, 2014 due to two months of operating activities of GMFS. So, there was no comparable revenue stream in the same 2013 period. Non-interest income was primarily comprised of $5.4 million of income from mortgage banking activities net, $0.9 million of loan servicing fee income net of direct costs, and a $1.7 million decrease in fair value of MSRs including a $1.4 million unrealized loss relating to a change in assumption for fair value.

During the fourth quarter, the Company recognized a net loss of $2.9 million in other gains and losses compared to a net gain of $6 million recorded in the prior-year period, which reflects a decrease of $9 million. The loss was primarily driven by unrealized losses on the RMBS portfolio of $5 million, partially offset by a realized gain of $3.2 million related to the sale of RMBS used to fund the GMFS acquisition, an unrealized loss of $0.8 million on mortgage loans held for investment, offset by a realized gain of $0.9 million related to loans that were paid off.

The Company incurred expenses of $8.2 million for the three months ended December 31, 2014 compared with $2.7 million for the same period in the 2013. The increase was mainly due to the addition of $3.8 million of salaries, commissions, and benefits relating to GMFS.

In addition, operating expenses increased by $1 million, primarily driven by the additional operating expenses related to GMFS. And, other expenses increased by 7 -- $0.7 million, primarily due to the additional transaction costs associated with the acquisition of GMFS and additional loan servicing fees resulting from the acquisition of additional whole loans.

That concludes our financial review. I would 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.

With the closing of the GMFS transaction in October, 2014, our balance sheet has been substantially repositioned. As of December 31, 2014, our capital allocation to residential mortgage loans held for investment, which is the seasoned loan portfolio we have acquired and managed since our IPO, was approximately 60%. At the same time, approximately 33% of our capital is now allocated to mortgage banking activities, primarily in the form of mortgage servicing rights and loans held for sale.

As of December 31, 2014, our portfolio of seasoned residential mortgage loans had a fair value of $415.9 million. During the quarter, we sold non-agency RMBS and other investment securities with a principal balance of $109.8 million to fund the GMFS transaction, leaving non-agency RMBS with a fair value of $148.6 million and other investment securities with a fair value of $2 million at year-end. On the mortgage banking side, our assets now include $97.7 million of loans held for sale, which are primarily loans eligible for securitization by Fannie Mae, Freddie Mac or Jenny May, and we also held mortgage servicing rights with a fair market value of $33.4 million as of December 31, 2014.

At December 31, we had a leverage ratio of 2.84 times, up slightly from the third quarter. Our borrowings were composed of $300.1 million outstanding under our loan repurchase facilities used to finance residential mortgage loans held for investment, $103 million outstanding under repurchase agreements secured by our RMBS portfolio and other investment securities, $89.4 million outstanding under warehouse lines of credit used to fund mortgage loans held for sale, and $55.5 million book value of convertible notes outstanding.

The loan repurchase facility, warehouse lines of credit, and repurchase agreements bear interest at rates that have historically moved in close relationship with LIBOR. While our interest rate hedging strategy has not changed, our derivative positions now include forward sales of agency MBS to hedge loans held for sale and interest rate lock commitments in addition to relatively small interest rate swap and swaption positions held in our investment portfolio.

In terms of fourth-quarter results, the credit performance of our seasoned whole loan portfolio continues to exceed our expectations. We expect continued housing gains and the recent drop in oil prices to produce tail winds for this segment of the portfolio. On the non-agency RMBS side, we did experience some additional volatility in the fourth quarter, as markets reacted to a combination of economic and geopolitical factors. That said, our non-agency RMBS holdings should continue to benefit from the same fundamentals as our seasoned whole loan holdings.

Finally, while our fourth-quarter results include only two months of mortgage banking activity through our GMFS subsidiary, the financial results in this business were solid, as origination volumes responded to lower interest rates and margins remained firm. We are very pleased with the GMFS performance to date, and as Mike mentioned, we expect this segment of our business to be accretive to ZFC earnings in 2015.

Our strategy for the mortgage banking business and newly originated loan investment portfolio can be summarized in three key points. First, GMFS will continue to originate loans eligible for securitization in the government and agency programs through its existing lending channels, including a significant retail presence. We believe this core business, combined with continued growth of the MSR portfolio, will produce attractive results over time.

Second, we expect to expand non-agency credit offerings through the GMFS platform and fund those loans in our investment portfolio. We believe this proprietary source of credit investments will prove attractive for the ZFC portfolio while maintaining important elements of control.

And, third, we will continue to grow our purchase program for newly originated, non-agency mortgage loans across a broader network of originators in the coming months. We expect this purchase program will be a scalable and complimentary source of investments for ZFC.

In summary, we're very excited with the progress we've made in our mortgage strategy during 2014 and with ZFC's competitive positioning for the coming year. For 2015, we intend to continue expanding our loan origination abilities and building out our non-agency loan purchase program.

We expect this will drive growth in newly originated whole loans and MSRs and create the basis for solid, long-term financial performance. We are very excited for our prospects and look forward to updating you on our continued progress on our next earnings call.

That concludes our prepared remarks. We will now open it up for your questions.

(Operator Instructions)

We will go first today to Steve Delaney with JMP Securities.

Thank you. Good morning, everyone, and congratulations on getting your mortgage Company off to a great start there. Thanks.

First thing I have, we noticed that in your seasoned held for investment portfolio, it looks like you were able to take your leverage up pretty nicely, from 2.2 to 2.8 and it took the ROE up to over 17%. So, were you able to find a new and improved credit facility? How were you able to take leverage up on that portfolio?

No, we -- if you go back for a few quarters, the leverage level that we're running that portfolio at now is roughly in line to where it had been back in early 2014. We had taken a little bit of leverage off during 2014, primarily as we built a cash position and liquidity to fund the GMFS closing.

Got it. That helps. Okay. So, that helps explain the lower leverage than September 30.

That's right.

Okay. Then, switching to the new non-agency strategy, which obviously is going to be benefited by GMFS, help me understand how you're designing products and pricing products to really make that a credit strategy rather than just a hybrid rate strategy?

Sure. Sure.

We've rolled out the first phase of that in terms of a product offering that offers some credit expansion beyond the core jumbo product that exists in the market today. I would characterize that as expansion around the edges, so we offer some higher LTV offerings. We go down in credit score a little bit. And then, there's some niches in the market where we expanded availability in things such as cash-out refinancing and second homes. So, that's really the first phase, which has been rolled out, and we're really at a stage now where we think we can start to build scale around those products.

I think as we look forward, we think that continued credit expansion is certainly warranted in the market and something that we want to be focused on and are focused on, and I think in the GMFS platform specifically, what that means is that we can start to really look at the underwriting process and expand credit in areas where we think that, for example, the government and agency programs have inefficiencies in underwriting or things that simply don't make sense.

And, I think that's a critical point as you look at our strategy and the GMFS acquisition, because those are very -- what I'd characterize as in the weeds-type credit expansion decisions, when you compare that versus simply going up in LTV or down in credit score. So, I would argue that adding the GMFS platform and being in the business of underwriting loans on a daily basis and seeing what the agencies are doing is really critical in helping us think through that next step in product expansion.

Brian, is the product you're offering, is it an ARM loan? Or, is it a fixed rate loan? Or, a combination?

We currently offer both.

A little bit of both, okay.

Yes.

To get to my point on credit versus rates, I guess your hope is that ultimately a securitization financing approach would enable you to lay off a lot -- whatever rate risk exists -- lay a lot of that off to AAA buyers would be the ultimate development?

Yes, that's correct.

Okay. Thank you for your comments.

We'll go next to Douglas Harter with Credit Suisse.

Hi, Doug.

Hello. Thanks.

When you look at your capital allocation going forward, are you still looking to make new investments in the legacy mortgage loans, or RMBS? Or, should we think about incremental investments coming out of mortgaging banking?

I think that we want to maintain the flexibility to be opportunistic in both of those segments. But, given our current level of capital, I don't see us making any large reallocations in those spaces absent some change in the market from where things sit today. I think that absent any significant changes in the market, what you'll likely see is a steady reallocation of capital out of those legacy assets and into the origination side of the business, as you suggested.

Got it. So, it's kind of as those businesses grow, as the MSR grows and you need the incremental capital, sort of think about it coming from those other pockets?

I think that would be my sort of base case. And, like I said, I think that if something changed in the market, we would want to maintain flexibility and be in a position to take advantage of that. But, obviously, we don't see that today.

Sure. And then, as you're ramping the non-agency originations, how are you funding that today? How available are financing lines against that type of collateral?

We've seen pretty good availability of credit lines on the new origination side of the business. We have a facility that we put in place last year that is essentially lined up with our existing product offering. So, everything we fund through the product offering that I previously mentioned can be funded on that warehouse line. And, generally, we have found pretty good availability and have been approached by other counterparties looking to finance those assets in a similar way.

Great. Thank you.

We'll go next to Mike Widner with KBW.

Hi, Mike.

Good morning.

A quick and hopefully simple one: on the operating costs, just trying to get a feel for the run rate going forward with GMFS on and everything. First question is, you mentioned $3.8 million of salary, et cetera over at GMFS. Is that -- well, then you also mentioned I think $0.7 million of acquisition costs. Just trying to get a sense for what a run rate there is? Is the $0.7 million a one-time thing? Or, how do we think about this going forward?

Mike, with regard to the GMFS salaries, commissions, and benefits of $3.8 million, obviously there's a fairly sizable variable component to that, which is the commissions. And, based on the strong production volumes through GMFS in November and December, that -- of that $3.7 million, about $1.3 million of it related to commission income.

So, as we've said in the past, we really don't give forward guidance on results, et cetera. But, that's going to be your delta. You'll see the offsets of that, obviously, up in the mortgage banking activities net to offset that.

And then, with regard to the acquisition costs, the $700,000 -- again, that was just some trailing costs related to the GMFS transaction. We had some investment banking fees that triggered with the close of the transaction.

Okay. So, as far as that $0.7 million, that's a nonrecurring item unless you go out and buy some more of these guys, I assume.

Yes, a portion of it. Probably about $400,000 or so was related to that.

I'm sorry. So, the -- again, I'm just trying to figure out if there's nonrecurring items here. You're saying $400,000 of the $0.7 million is nonrecurring?

That's correct.

Okay. So what was the other $300,000 then?

A lot of that's your servicing fees on the loan portfolio. They are like the two big drivers of that line item.

Okay. I'll have to go back and look at that again.

So -- then just I guess a related question. If I go to page 14 in your slide deck, the expenses you list on there associated with mortgage banking is $4.6 million. Again, for modeling purposes, I want to figure out how does that map to the various lines on the income statement right now? I assume that the $3.8 million that you talked about is a big chunk of that, but just trying to think of the way the rest of it goes.

Yes. Of the $4.6 million, $3.8 million of it relates to salaries, commissions, and benefits. And, again, the big driver in there is going to be your commission number that's coming through. There's then an additional $800,000 of operating expenses and the big drivers in that line item are going to be your occupancy, equipment, communication, related costs, as well as other G&A related to GMFS. And then, the final component is about $22,000 of just other expenses, pretty immaterial.

Okay, and so the $3.8 million I got. Just looking at the line items, the other $800,000 that falls into -- going back to the income statement, is that in the $1250 million other OpEx?

The $2.5 million -- ? (multiple speakers)

That's what I meant. Sorry.

$2.501 million, yes. The operating expenses include the $800,000. And then, your other expenses is very immaterial. It's like $22,000.

Got it.

That brings you up to the $4.6 million.

Okay. Excellent. Thank you.

And, the $5.4 million revenue, is this basically a gain on -- I'm just trying to think about how to think about it and how to model it. Is this basically gain on sales of originations and that -- basically that kind of income?

There's three components to that. Mortgage banking, activities net. So, the big piece obviously is gain on sale of mortgage loans net. So, of the $5.4 million, that's about $5.3 million of it.

We then also had an additional $200,000 of loan origination fees, and there's $100,000 offset to that, which is our provision for loan losses. So, we take a basis-point charge for new production for potential loan losses.

Got you. And, I didn't see anywhere in here -- I saw an annual figure for origination volume. Is there a -- I assume that's two months' worth of the $5.4 million and all this represents two months' worth of everything. Is there a loan origination volume you could give us that's associated with that?

I believe the amount of loans originated for the two months was $242.8 million. And yes, you did quote -- the 2014 and 2013 volume was $1.4 billion for each year.

Okay, great. Thank you. And then, I guess just one last one, if I could. Same page. Pretty big change in the MSR value there.

Is -- so I would imagine part of that is going to just be the amortization, the rundown. Haven't really seen the detail of how you are accounting for it. I would assume part of it's that. Then part of it is change due to higher prepays or just the usual fair value adjustment change due to input assumptions.

Do you break that out at all? To the degree that any of it is fair value adjustment due to input changes, do you hedge that? Or, are you expecting to hedge that going forward?

I can answer that. Paul, do you want me to -- I can just refer you I guess in our earnings release, so not in the presentation, but in the actual earnings release, we did have a table on the kind of MSR roll-forward. So, you can see that of the $1.7 million that you alluded to, about $1.4 million of that was true mark-to-market, and a little under $300,000 of that was amortization and paydowns of the existing portfolio. So, that table is in that earnings release.

Got it. I missed that one. And then -- okay. So then, the change in assumptions piece of that, the $1.4 million, any thoughts on hedging that or plans or just letting it float?

We haven't done anything to date. It doesn't mean we couldn't. I think that we're constantly looking and thinking about the size of that portfolio and the potential exposure both on the upside and the downside in rate movements and how that correlates to the production side of the business. So, as of right now, we haven't felt the need to put any additional hedges, recognizing that when that value goes down, we will see -- expect to see a corresponding increase in production volumes and potentially margin expansion in a lower rate environment.

Okay. Well, thank you. Nice job on the quarter. And, thanks for the comments, as always.

Thanks, Mike.

(Operator Instructions)

We'll go next to Jim Young with West Family Investments.

Hi, Jim.

Could you clarify for the $16.5 million of good will on the balance sheet at the end of the year, over what timeframe are you going to amortize this? And, what is going to be the quarterly impact on the income statement? I would assume it's going to be -- negatively impact your GAAP earnings, but will you exclude this for core earnings purposes?

No, Jim. With regard to the good will, we basically hold that and test that for impairment. So, there's no amortization of that good will. As part of the transaction, though, we did identify intangible assets of about $5.8 million, which will be amortized. And, right now, I think the impact of that is about $65,000 per quarter. I'm sorry. Per month.

Okay. And then, secondly --

I'm sorry. You did have another part of your question. That is an adjustment as part of our core earnings calculation. We are adding back depreciation and amortization net of taxes because that's held in a taxable REIT subsidiary.

Okay. On page 19 of the slide deck, you show about $0.71 a share negative impact due to the unrealized losses on mortgages loans, real estate securities, and other investment securities. How much of that was credit-related? How much of that was spread-related?

Brian, do you want to take that one?

I'm sorry. Jim, you said slide 19. What was the number you referenced?

$0.71 a share in total. There's $0.08, $0.56, and $0.07. The question is, how much of that is credit-related? How much of it is spread-related? And, have we seen any reversal, and how much in 2015 so far?

Sure. I think the easiest way to think about that is on the securities side. It's all, for the most part, spread-related is the way I would characterize it. And then, on the loans, we didn't see any real change in yield, so to speak, or discount rates on loans in the quarter. But, I do think when you look at those unrealized numbers, there's kind of a re-class element there. So, you have to combine the unrealized with the realized because the loans, for example, our change in unrealized was a negative, but we did have realized gains on that, primarily related to loans that paid in full during the quarter.

Okay. But, the net effect, have we seen any reversal to the positive side so far this year?

On the securities side, I think you that have seen some of that certainly. And, on the loan side, I would say that it's probably a little less clear, just given relatively few number of transactions at this point in the new year.

Okay, great. Thank you very much.

Thanks.

With no other questions in queue, gentlemen, I would like to turn it back to you for closing remarks.

Well, thank you all for your participation today and all of the questions as well. We very much appreciate that. We look forward to speaking with you again on our next earnings call. Have a good day. Thank you.

Ladies and gentlemen, this does conclude our conference for today. Thank you for your participation.