Ready Capital Corp (RC) 2015 Q1 法說會逐字稿

Good day, everyone, and welcome to the ZAIS Financial Corporation First Quarter 2015 Conference Call. Today's conference is being recorded. At this time, like to turn the call over to Mr. Scott Eckstein. Please go ahead, sir.

Thank you, operator. Good day, everyone, and welcome to ZAIS Financial Corp.'s conference call to review the Company's results for the first quarter ended March 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 first 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 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 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 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 our first quarter results call; very pleased with our financial performance in the first quarter of 2015 and our continued progress in transforming ZFC into a mortgage operating company.

During the first quarter, our Mortgage Banking segment's strong performance combined with our ongoing strength in our investment portfolio led to core income generation of $0.51 per diluted weighted average share outstanding. Please note that our first quarter results also included the first full quarter of operating results of GMFS, a mortgage banking platform that we acquired in October of last year.

In addition to its strategic benefits, GMFS has added another revenue stream of fee income reflected in this quarter's results. These businesses benefited from a combination of lower interest rates and favorable economic conditions which Brian will discuss later in the call.

Turning to our financial performance for the quarter, we reported core earnings of $4.5 million or $0.51 per diluted weighted average share outstanding. On a GAAP basis, net income for the quarter was $0.4 million or $0.05 per diluted weighted average share outstanding.

As of March 31, 2015, book value per share of common stock and OP unit was $21.38 compared with $21.73 at December 31, 2014. The March 31, 2015, and December 31, 2014, book value includes $3.6 million or $0.40 per share of common stock and OP unit and dividends payable related to the March 19, 2015, and December 19, 2014, dividend declarations respectively. Paul will discuss these financial results in more detail.

With our current strategic positioning, we've successfully transitioned ZFC into a mortgage operating company business model, which combines strong capabilities in evaluating and managing mortgage credit investments with the expertise and operational infrastructure to source newly originated mortgage loans through proprietary origination channels as well as secondary market operations.

ZFC and its subsidiaries are now managing the credit performance of a seasoned mortgage loan portfolio held for investment, originating agency and non-agency mortgage loans for sale, and retaining mortgage servicing rights in the portfolio. Furthermore, we believe newly originated non-agency mortgage loans will be an important component of our strategy going forward. We remain committed to ramping up our non-agency loan conduit.

In summary, we've built the unique business model, which we believe presents many attractive growth opportunities and we remain focused on executing our evolving business strategy. We expect our initiatives in the newly originated loan space will ultimately prove invaluable in driving ZFC's long-term performance. Based on progress today, we believe that the Company is well positioned to capitalize on many emerging opportunities in the mortgage space and we look forward to updating you as we continue to execute on our business [model].

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 first quarter ended March 31, 2015, the Company reported GAAP net income of $0.4 million or $0.05 per diluted weighted average share outstanding, which includes the first full quarter of operating results for GMFS. Core earnings for the quarter were $4.5 million or $0.51 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, changes in contingent consideration net of tax, and amortization of deferred premiums and production and profitability earnouts net of tax.

You can reference the section of our press release entitled Use of Non-GAAP Financial Information for 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 $4.9 million for the first quarter of 2015, compared with $5.6 million in the prior-year period. Interest income increased by $0.2 million to $9.7 million for the first quarter of 2015, compared with $9.5 million in the same period in 2014. While we recorded an increase in interest income related to mortgage loans held for investment of $1 million primarily due to the purchase of an additional whole loan pool at the end of March 2014, as well as $0.6 million increase in interest income related to mortgage loans held for sale attributed to GMFS. These gains were partially offset by a $1.3 million decrease in interest income from the RMBS portfolio, primarily due to the reallocation of capital to whole loans and the sale of securities in the fourth quarter of 2014 to fund the acquisition of GMFS.

For the first quarter of 2015, the Company incurred interest expense of $4.7 million compared with $3.9 million for the first quarter of 2014. The $0.8 million increase was primarily due to an increase in borrowings on the warehouse lines of credit and repurchase agreements used to finance the Company's mortgage loans held for sale and investment, partially offset by a decrease in interest expense for borrowings on real estate securities.

At March 31, 2015, 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 4.05% for mortgage loans held for investment and 4.97% for non-agency RMBS and other investment securities.

The Company earned $9.4 million of non-interest income for the three months ended March 31, 2015, due to the inclusion of a full quarter of operating results of GMFS. Non-interest income primarily consisted of $11.2 million of income from mortgage banking activities net, $1.6 million of loan servicing fee income net of direct costs and $3.4 million decrease in fair value of MSRs, including a $2.7 million unrealized loss relating to the change in valuation inputs or assumptions used in the valuation model. The $11.2 million of income from mortgage banking activities net was primarily comprised of $11 million of gain on sale of mortgage loans held for sale, net of direct costs.

During the first quarter, the Company recognized a net loss of $1.9 million in other gains and losses, compared to a net gain of $1 million recorded in the prior-year period, which reflects a change of $2.9 million. The loss was primarily driven by unrealized losses on the portfolio mortgages held for investment of $1.2 million and a loss of $0.9 million on derivative instruments.

The Company incurred expenses of $12.2 million for the three months ended March 31, 2015, compared with $4.1 million for the same period in 2014. The increase was mainly due to the additional $7.4 million of salaries, commissions, and benefits and $0.5 million related to the increase in contingent consideration, both relating to the acquisition of GMFS.

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 terms of our first quarter results, the credit performance of our seasoned whole-loan portfolio continued to exceed our expectations. With home price appreciation appearing to have stabilized at a mid-single-digit percentage annual increase and consumer inflation well contained, we expect mortgage credit trends to remain favorable.

Mortgage banking activity was also strong in the quarter, with rates remaining relatively low and other factors, such as the FHA insurance premium reduction, having a positive effect. We remain very pleased with GMFS' performance to date and we continue to expect this segment of our business to be accretive to ZFC earnings going forward.

Our capital allocation as of March 31, 2015, remained largely in line with year-end 2014. At the end of the first quarter, approximately 58% of our capital was allocated to residential mortgage loans held for investment, which is the seasoned loan portfolio we have acquired and managed since our IPO. At the same time, approximately 33% of our capital at the end of the quarter was allocated to mortgage banking activities, primarily in the form of mortgage servicing rights and loans held for sale.

As of March 31, 2015, our residential mortgage loan portfolio had a fair value of $408.8 million and non-agency RMBS and other investment securities had a fair value of $147.9 million. On the mortgage banking side, our assets include $126 million of loans held for sale, which are primarily loans eligible for securitization by Fannie Mae, Freddie Mac or Ginnie Mae. We also held mortgage servicing rights with a fair value of $33.4 million as of March 31, 2015.

At March 31, we had a leverage ratio of 3.02 times, up from year-end 2014 levels. Our borrowings were comprised of $299.8 million outstanding under our loan repurchase facilities used to finance residential mortgage loans held for investment, $99.6 million outstanding under repurchase agreements secured by our RMBS portfolio and other investment securities, $116.9 million outstanding under warehouse lines of credit used to fund mortgage loans held for sale, and $57.2 million book value of convertible notes outstanding.

The loan repurchase facility, warehouse lines of credit and repurchase agreements bear interest rates that have historically moved in close relationship to LIBOR. Our interest rate hedging strategy also did not change materially during the first quarter. At March 31, 2015, our mortgage loans held for sale and interest rate lock commitments were primarily hedged with forward sales of agency securities. We also held a relatively small interest rate swap position in the investment portfolio.

I would like to reiterate our three-pronged strategic approach to the residential mortgage origination and investment businesses. First, GMFS continues to operate a subsidiary of ZFC, originating 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 provide attractive investments for the ZFC portfolio, while maintaining important elements of control.

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 complementary source of investments for ZFC. We're very excited with the business model we've built within ZFC. We believe a credit-focused investment strategy coupled with our growing loan origination capability put ZFC in a very unique competitive position. This is consistent with our view that the ability to evaluate and manage mortgage investments needs to be coupled with strong sourcing capabilities to achieve success. We are very excited with our prospects and 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.

Thank you, sir. (Operator Instructions) And we'll take our first question from Stephen Laws with Deutsche Bank.

Hi, good morning. And it looks like a nice quarter here. Wanted to start, looks like I assume the book value was down a little bit, and I think that maybe that's attributable to the mark on the MSRs. Is it correct to think about that with rate moving back? First quarter-end, that mark has likely reversed at 331?

I think it's correct to assume that, that MSR market value will move inversely with rate. So obviously, it would depend on where rates end up at the end of the quarter, but that general inverse relationship is certainly a fair assumption.

Okay, great. And target leverage, looks like we [spend] a little higher to roughly three times [for about 3.8]. Is there a place where you think this will settle? Is leverage maybe less meaningful given the loans held for sale, that may move around if you [people] are aware just at the quarter end, or how should we think about leverage in our model going forward?

Yes, I think your latter comment there is exactly right. If you look at it, and break it down by asset which we do in our investor presentation on slide 7, the leverage on our core portfolio holdings of seasoned loans and secondarily non-agency RMBS has been relatively constant quarter-over-quarter where you did see an increase was due to the balance of loans held for sale increasing. So that's a more highly levered portfolio because it's held for such a short period of time and turned over so quickly. And so, as you see with origination volumes, loans held for sale moving up and down, that will probably be the primary driver of leverage changes, absent any other developments.

Great. And then, lastly, on the origination volume or maybe mortgage volume, I haven't had a chance to look through the presentation in detail, apologize if this is in there. But can you guys provide maybe a split of how much that volume is from purchase buyers, how much is refinance activity or maybe another way to ask is, what's the sensitivity to your origination volume that we saw of 100 basis point increase in mortgage rate?

We've not provided that information, it's something we can certainly evaluate going forward. And then, could you just restate the second part of your question, around the [hiring]?

Well, yes, just the other way to ask would be if mortgage rates increase and so refinance volume dried up, what would we think about kind of a normal origination volume pipeline from purchased buyers and then non-rate [actual] refinance activity?

Yes, that's a tough question to answer. There's a lot of moving parts there. I think that probably the best way I can get at that without giving you any specific projections would be to think a little bit about the GMFS business over the last few years and the fact that their origination volumes were roughly flat, 2013 to 2014. So when we look at that, we see that because of a higher purchase volume concentration and a more significant retail presence in terms of origination channels, that volume, we believe, will be more stable than the market certainly, but we'd be hesitant to put real firm numbers around that.

That's helpful. And for the record, I'm in the camp that you're probably not going to see those higher rates, that much higher in the near-term anyway, but I'd just [follow] that. I guess that does it for my questions. Thanks very much.

Thanks, Stephen.

Thank you. We will take our next question from Mike Widner with KBW.

Hey, good morning, guys, and nice quarter and nice continued job transitioning to the operating model as you've talked about. I guess I was just going to ask a couple of follow-ups on the MSR, just that seems to be one of the bigger moving pieces here. I guess the first one is, I think last quarter, we talked about your views on hedging that. And I think at the time, you kind of said, that wasn't likely to be a focus right now. I mean if you thoughts evolved on that at all. I mean not suggesting that they necessarily should because of the volatility in MSRs. But I mean just wondering on your thought to that as we potentially head into a continued environment of rate volatility if rethought of where your reviews are right now?

Yes, I don't think our views have changed materially on that. We think that an important consideration around the hedging of that is the origination side of the business and kind of the relative sizing of the MSR portfolio versus what the origination platform is capable of producing from an income standpoint. So I think right now, we're comfortable with the size of that portfolio relative to the origination capabilities that the GMFS has and our ability to recoup a majority of those losses over a period of time through increased production volumes.

Okay. I mean, I guess, that makes sense in spirit. I guess, one of the things that a lot of people, other mortgage companies talk about in the mortgage business is the natural hedge, right. So when your MSR is going down and you're facing a lot of refinancing out, you tend to make up for it by higher mortgage originations. Now, that's -- I think you guys just discussed, that's less true for you, because you have a much more purchase-oriented piece. So I guess it just feels a little bit like, if you're going to have a purchase-oriented origination strategy, then you are sort of just left exposed, if you will, to rates, because you can't control who's going to refi your borrowers out. So I don't know that there's a question in there. I think it's more of an observation, but --

Yes, I think just to be clear, I think, I made a comment earlier about our purchase concentration being higher than the market, there is still significant refi volume and certainly in the first quarter that increased across the platform. So I think, as we look at changing production volumes versus potential increased amortization on the MSR portfolio, we're definitely mindful of that and feel like we're comfortable with that despite the fact that that purchase volume remains relatively high. And I think a key piece of that is there is a lag component as you probably well know around -- the MSR mark moves instantaneously with rates effectively, whereas the pickup in production volume has a lag effect in terms of the lock in closing of those loans and the recognition of the gain on those loans. So I think that certainly there's some of that still to come.

So we're looking for a blowout in production next quarter is what you're --

I did not say that.

I know. I'm just kidding there. So, I'm sorry, now, a little more, I don't know, I don't want to be nitpicky or anything, but I just want to make sure I understand the numbers. So I look at the reconciliation of GAAP to core and I look at the change in value of MSR resulting from valuation inputs, the number there is $1.6 million, and forgive me if I'm looking at the wrong number, there's something else that should be in there. But I'm trying to figure out what the relationship of that $1.6 million is the other numbers. There is a $3.4 million, I think was the overall change; and then, on your table, later on, you break that out into $2.7 million from the changes in input, $700,000 from amortization basically. So anyway, I mean, I'm just trying to figure out what does that $1.6 million represent? Where has it sort of come from?

Yes. The $1.6 million is actually the tax-impacted amount of the $2.7 million related to the change in assumptions for fair value. So we are taking the $2.7 million, applying a 40% effective tax rate and coming up with an adjustment to core of $1.6 million.

I think, I asked you that same question last quarter, you told me the same thing. So I appreciate that. And what did you say was the tax rate embedded in there; not that I can't do the math, but --?

40%.

Okay.

So we're picking up 60% of the $2.7 million adjustment to the MSR for fair value.

And I mean, I guess my last question -- maybe I need to think more about this, but why not consider that core, since the MSR is servicing is essentially part of your core business?

I think we tended to -- since it is a fair value asset and these are unrealized gains or losses, I think, our thought was that we would treat it like the other fair value assets that we hold for consistency purposes.

And it's an asset that we can effectively decide to keep or to sell based on how we want to construct the investment portfolio. So we very much think of it as a financial instrument rather than as a core element.

Yes, I think that makes sense. I'm going to have to think about it a little more, because just thinking about how the earnings flow through and is there some -- is it consistent or non-- I think a little more about the consistency there, but I appreciate the answer and I appreciate your answer and my same questions, I think this quarter is last, but again nice job on the quarter. Appreciate the transition to the operating business and keep up the good work.

No problem. Thanks, Mike.

And we'll take our next question from Doug Harter with Credit Suisse.

Thanks. You guys have a slide in your slide deck showing the roll rates of delinquencies on the seasoned portfolio. Has that sort of outperformance of credit already been reflected in the yield or is that still to come?

It's kind of a tough question to answer. I mean we certainly or constantly reevaluating our assumptions, as I think the market does around the performance of these loans. So those loans are fair valued. And so to the extent we believe that the market is recognizing this type of performance, then we're reflecting that in our marks and that's probably the best answer I can give you at this point.

I guess I understand it's reflected in the marks. I mean I guess what I trying to get at is, are your loans based -- I mean you would've had loss-adjusted assumptions when you bought the loans based on the price you paid. I guess do you change those assumptions as to kind of what would be the accretable portion of that discount that you purchased at? And I guess how do you treat sort of that accretion of the discount versus [ask it a little more clearly]?

I think the best way to think of that is, we certainly -- obviously, we do project delinquencies and losses for these portfolios. And if you think about the way we project cash flows of the loan level, if a loan that we deem has some probability of going delinquent in any given month, but it doesn't, that effectively would raise the cash flow projections going forward, right. So if I had to -- just to make it simple, if I had a single loan and I expected and it was a 3% probability of it going delinquent this month and it did not go delinquent, that would by definition increase the cash projections on that loan going forward because the compounding of that probability of going delinquent sort of increases the cash that you're expected to receive.

Got it. And then, sort of shifting, now that -- I guess how are you and the Board thinking about dividends, now that sort of a substantial amount of the earnings is coming from the taxable subsidiary and also assuming that that business is likely to be more volatile than the lending or sort of the investment portfolio. So I guess, how are you thinking about the dividend in light of those two factors?

Yes, I think, let me take a crack at that. We and the Board are actually monitoring how GMFS performs in our portfolio and we believe that it's prudent and we closed this transaction late in the fourth quarter. This is our first quarter. We think it's prudent to get a true feel for GMFS's mix of business through the next several quarters and really understand and dimension how we should think about its contribution on a stable go-forward basis to ZFC. So we're constantly thinking about the dividend, but right now, we're holding [pat] until we have effectively seasoned GMFS as a component of our portfolio businesses.

Great, thank you.

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

Hi, Trevor.

Hi. Thanks. Hey, I guess some of my stuff has been answered, but can you maybe give us some color on kind of where you're at in the process of building out the non-agency conduit and what's the remaining steps are that need to be kind of gone through and completed before and then we start seeing loans flow through to the balance sheet?

Sure. Yes, as I think we mentioned previously, we operationalize that purchase program in the fourth quarter last year and there has been an immaterial amount of volume to date that's flow through, but we really did get -- and we've been very deliberate and one of the reasons because it's kind of a long conversation and happy to have it, but for purchases of the call, we're very deliberate about how we roll that out and getting comfortable with the product and the process.

And I would say, over the course of the first quarter, we got that level of comfort. We've increased resources dedicated to bringing in new sellers and in managing that ramp-up of sellers and therefore volume in the field. So my expectation is that we should see that start to grow; and in fact, we've started to see our pipeline pick up here in the first quarter, not to and what I would say a even material levels at this point, but we're definitely seeing momentum build both on the product side, as well as in terms -- which I think is probably more important right now, in terms of seller interest in the program and the product niches that we're attempting to address.

Got it. That's helpful. And in terms of non-agency production at GMFS, was there any of the -- I know, the first quarter was primarily agency production. But was there any non-agency in there? And do you guys have any of the non-agency products kind of rolled out on that platform at this point?

There was some non-agency production in there, it wasn't material enough to break it out. We have rolled out our core non-agency product through them and we've started to see some lot volume from them on that product although again, relatively small to at this point but probably over the medium term. More importantly, we really started to ramp up our focus on new products that fit their platform, because at the very core of the jumbo product doesn't fit their platform that well given their geographic footprint. So that's where we've really started to spend more time. We expect we will see some jumbo production out of them in our non-agency product. But we think that where the real upside probably lies for them and for us, in combination is through proprietary products that we are not yet originate or sourcing today.

Yes. That makes sense. Okay, that's all I have for now. Thanks, guys.

Thanks, Trevor.

And we will take our next question from Jim Young with West Family Investments.

Yes, hi. Given that your stock continues to trade at one of the biggest discounts to book, I'm wondering, are there any measures under way or is that you're thinking about in order to narrow at this time.

I think that we'd always appreciate to see the stock price higher, but we don't have anything immediately in terms of specific initiatives planned other than continuing to execute on these strategies that we discussed. So there is nothing specific that we plan to do. And quite frankly, what we're really looking for is to deliver on what we talked about over the past several quarters, which is this mortgage loan conduit program and deliver in terms of showing volume through the program.

Okay. Great. And then, could you just remind us on the terms of your outstanding convertible and what role that plays in your capitalization going forward?

I assume, when you say terms, you mean the term of it, the term is out through --

November of 2016.

November of 2016, yes. And it's $57 million roughly of capital that was brought in through that offering.

Okay. And then, what price does that convert into common and will they have to be -- well, they have to be refinanced or what I guess, what are your thoughts, when you look out (inaudible) for about a year and a half?

I mean, I think it's premature, it was a three-year deal, we're about a year-and-a-half into it. We certainly are aware of it, it's something we want to keep on the radar, but I think it's premature to think about how we would approach that and refinance it. I think, as Mike said, our primary focus is in execution and we believe over the longer-term executing will be the best thing that drives stock price higher and would ensure that that thing would convert. We can get back to you with the exact -- the exchange ratio was affected by the special dividend we paid last year. We can -- okay, yes, it's -- let me come back to you in converting that to a price. We have the share conversion ratio, but I can come back to you on the price effect of a conversion rate.

Okay, great. Thank you.

Yes.

And that does conclude our question-and-answer session. At this time, I'd like to turn the call back to management for any additional or closing remarks.

Thank you so much for your participation today and we look forward to speaking with you again on our next earnings call. Have a good day.

And that does conclude today's conference. We do thank you for your participation.