Ready Capital Corp (RC) 2015 Q2 法說會逐字稿

Welcome to the ZAIS Financial Corporation's Second Quarter 2015 Conference Call. Today's conference is being recorded.

At this time, I would like to turn the conference over to Marilynn Meek. Please begin.

Good day, everyone and welcome to ZAIS Financial Corp's conference call to review the Company's results of the second quarter ended June 30. On the call today will be Michael Szymanski, President and Chief Executive Officer; Donna Blank, Chief Financial Officer; 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 second 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 are based upon forward-looking information pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are subject to numerous assumptions, uncertainties, and known or unknown risks, which could cause actual results to differ materially from those anticipated.

These risk factors are more fully discussed in the Company's filings with the Securities and Exchange Commission. The forward-looking statements included in this conference call are only made as of the date of this call and the Company is not obligated to publicly update or revise them.

In addition, certain terms used in this call are non-GAAP financial measures, reconciliations of which are provided in the Company's earnings release and accompanying tables, which has 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.ziasfinancial.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 today for our second quarter results conference call. We are pleased with our financial and operating performance this period, which was highlighted by core income generation of $0.38 per diluted weighted average share outstanding and a 1.7% increase in book value per share.

During the second quarter, our Mortgage Banking segment continued its strong operating performance and market value gains in our MSR portfolio were a significant driver of the increase in book value per quarter. Both the mortgage banking business and our investment portfolio continued to benefit from a combination of relatively low interest rates, and favorable economic conditions which Brian will discuss during the call.

Now, turning to our financial performance for the quarter, we achieved core earnings of $3.4 million or $0.38 per diluted weighted average share outstanding. On a GAAP basis, net income for the quarter was $6.7 million or $0.65 per diluted weighted average share outstanding. As of June 30, 2015, book value per share of common stock and OP unit was $21.74 compared with $21.38 at March 31, 2015.

The June 30, 2015 and March 31, 2015 book value includes $3.6 million or $0.40 per share of common stock and OP unit and dividends payable related to the June 18, 2015 and March,19 2015 dividend declarations respectively.

Donna will discuss these financial results in more detail. The second quarter 2015 ZFC results demonstrate the revenue diversity of our mortgage operating company model. Our investment portfolio generated approximately $4.8 million of net interest income and $1.1 million of other gains in the second quarter. At the same time, ZFC generated approximately $17.4 million of noninterest income in the period, primarily attributable to mortgage banking activities, changes in fair value of mortgage servicing rights and servicing fee income.

With that, I'll now turn the call over to our Chief Financial Officer, Donna Blank.

Thanks Mike. Good morning, everyone. As Mike already mentioned, for the second quarter ended June 30, 2015, the Company reported GAAP net income of $6.7 million or $0.65 per share which includes operating results for GMFS. Core earnings for the quarter increased to $3.4 million or $0.38 per share compared to $3.2 million or $0.36 per share.

Our core earnings included the addition of GMFS mostly offset by declines in the net interest margin from the mortgage investment business due to prior year sales of assets to fund the GMFS acquisition.

The Company recorded net interest income of $4.8 million for the second quarter of 2015 compared with $6.4 million in the prior year period. Interest income decreased by $1.2 million to $9.6 million for the second quarter of 2015 compared with $10.8 million in the same period in 2014.

Interest income related to mortgage loans held for investment decreased $0.4 million primarily due to the principal amortization resulting from pay-downs, which was partially offset by a $0.8 million increase in interest income related to mortgage loans held for sale attributed to GMFS.

These gains were partially offset by a $1.6 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 GMFS acquisition.

For the second quarter of 2015, interest expense was $4.7 million compared with $4.4 million for the second quarter of 2014. The $0.3 million increase was primarily due to borrowings on the warehouse lines of credit used to finance the Company's mortgage loans held for sale. This was partially offset by a decrease in interest expense for borrowings on real estate securities.

At June 30, 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 4.81% for non-Agency RMBS and other investment securities.

The Company earned $17.4 million of non-interest income for the three months ended June 30, 2015 due to the inclusion of operating results for GMFS. Non-interest income consisted primarily of $12.1 million in income from mortgage banking activities net, which includes $11.8 million of gain on sale of mortgage loans held for sale, net of direct costs. In addition, there was $1.7 million of loan servicing fee income net of direct cost and a $3.7 million increase in the fair value of mortgage servicing rates.

During the second quarter of 2015, the Company recognized a net gain of $1.1 million in other gains and losses compared to a net gain of $22.7 million recorded in the prior year period. The year-over-year decline of $21.6 million was driven by unrealized gains on the portfolio of mortgages held for investment of $22 million in 2014. The Company incurred expenses of $13.7 million for the three months ended June 30, 2015 compared with $3.2 million for the same period in 2014. The increase was mainly due to the addition of $8.1 million of salaries, commissions and benefits and $1.8 million related to an increase in operating expenses, both relating to GMFS.

The Company's effective tax rate was 30.2% for the three months ended June 30, 2015, driven by the tax rate in the mortgage banking segment.

I'd now like to turn the call over to our Chief Investment Officer, Brian Hargrave.

Thank you, Donna and good morning, everyone. Economic and market fundamentals were supportive of both our mortgage origination business and investment portfolio performance in the second quarter. Mortgage banking activities were impacted by interest rates that remain near recent lows early in the quarter and then moved steadily higher in May and early June. A more robust housing market, as evidenced by recent growth in both seasonally adjusted new and existing home sales helped to drive a more robust environment for purchase mortgage transactions.

On the investment portfolio side, continued home price appreciation, lower consumer inflation, and continued employment growth were all supportive of our credit oriented investment portfolio.

Our capital allocation as of June 30, 2015 remained largely in line with the first quarter of 2015. At the end of the second quarter, approximately 57% of our capital was allocated to residential mortgage loans held for investment, which is primarily the seasoned loan portfolio we have acquired and managed since our IPO. At the same time, approximately 36% 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.

On the mortgage banking side, GMFS originated loans totaling $502.4 million in unpaid principal balance in the quarter, an increase of approximately 11% from the first quarter of 2015. At the same time, new interest rate locks for the second quarter declined approximately 16% to $566.7 million, reflecting the move higher in interest rates during the second quarter.

The origination mix for the second quarter of 2015 with approximately 66% purchase transactions with the remainder refinancings.

In the investment portfolio as of June 30, 2015, our residential mortgage loan portfolio had a fair value of $406.1 million and non-Agency RMBS and other investment securities had a fair value of $143.6 million.

On the mortgage banking side, our assets include $104.8 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 at the fair market value of $42.7 million as of June 30, 2015. The mortgage servicing rights portfolio consists of loans with an unpaid principal balance of $3.6 billion, approximately 64% of which are conventional Fannie Mae and Freddie Mac loans and the remaining 36% are Ginnie Mae loans.

At June 30, we had a leverage ratio of 2.76 times, down slightly from first quarter levels. Our borrowings were composed of $296.2 million outstanding on our loan repurchase facilities used to finance residential mortgage loans held for investment. $86.2 million outstanding under repurchase agreement secured by our RMBS portfolio, $96.1 million outstanding under warehouse lines of credit used to fund mortgage loans held for sale and $56 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 to LIBOR. Our interest rate hedging strategy also did not change materially during the second quarter. At June 30, 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.

We have previously discussed, our three-pronged approach to the residential mortgage origination investment businesses and are pleased with the significant process made in each area -- progress made in each area.

First, the GMFS operations continue to generate attractive returns, and we are also encouraged by the performance of the MSR portfolio in recent interest rate movements.

Second, we are moving closer to the launch of proprietary non-Agency origination products through the GMFS platform. In general, the market for non-Agency products outside the prime jumbo sector remains largely undeveloped and we believe opportunities in certain market niches are compelling.

Finally, we have substantially increased sourcing activity in our purchase program for newly originated non-Agency mortgage loans across a broad origination network. We are pleased with the early operational performance in the platform and are now focused on adding quality loan sellers to scale the platform.

In summary, we are pleased with the business model we have built within ZFC. We believe a credit focused investment strategy coupled with our growing loan origination capability puts ZFC in a unique position competitively. 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.

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

(Operator instructions) Trevor Cranston, JMP Securities.

I guess first question, and I apologize if this was covered in the prepared remarks, I missed the beginning. Kind of just looking at the core EPS from the first to second quarter and trying to understand the difference, looks like the main thing was the expenses going up in the second quarter. Was there anything one time in there or can you help us understand how to think about the expense level going forward?

Yes, I mean there was no one-time expenses, but you're right, there are some increases in expenses on a quarter-over-quarter basis. The other thing I would draw your attention to is the tax rate. In the first quarter the book tax was very small. And in the second quarter, the book income, I should say, was much larger. That is going to be a number that's difficult to plan just because of the change in the MSR originations which lead to a book income and therefore the tax provision. So that's, I think, the two things I would highlight with regard to the differences quarter-over-quarter.

Okay, got it. That's helpful. And then as we've seen some of your peer companies report this quarter, there's been several who've announced that they've gotten membership at various -- the branches of the federal home loan banks. Is that something that you guys are working on and would anticipate gaining in the future? And can you comment on how do you think that would potentially fit into your current strategies?

Let me start off and I'll have Brian talk specifically about term financing. Yes, we are following that trend. We think that availability or having access to the FHLB could be a very attractive financing alternative and we're evaluating that alternative. And when we reach definitive agreement, if and when we reach definitive agreement about such a facility, we certainly will be announcing that. In terms of the potential utility of that kind of financing, Brian, perhaps you can make a comment.

Yes, I think it has particular applicability to the whole loan portfolio. So I think in some ways it's a natural strategic fit for us and I think that in particular, the ability to term out financing away from the securitization market is something that is -- would be attractive, because I think we all know at this point that the securitization market is pretty -- in the residential side, it's still somewhat in its infancy and not completely reliable as a source of financing on a consistent basis.

Okay, got it. And then last thing, on the non-Agency loan strategy, it sounds like that's kind of starting to get up and running in terms of sourcing the loans. In the near term, is the expectation kind of that the bulk of loans will be coming from the conduit or would you expect more of them to be coming through the GMFS platform, kind of just as it gets going here in the third and fourth quarter?

I think on the non-Agency side, in the short term, it will come through the conduit first, I think we've discussed in the past that given GMFS' geographic footprint, the jumbo product is not terribly well suited to their business. So I think the short of it is that increasing non-Agency production through that channel requires more product development on our side versus kind of where we sit today and are able to source loans through the conduit.

Okay, thanks, guys, appreciate the comments.

Douglas Harter, Credit Suisse.

Just to follow up on the commentary about the expenses, I guess, how should we think about the levels going forward? Is there variability in that on the origination side, is there more scale to be gained? I guess just help us understand kind of where those expense levels could be going forward?

There is definitely some variability that's dependent on originations and obviously this quarter was a strong origination performance. So you will get some commission related expenses on that. So I think you should think about that relationship together and it's going to be heavily dependent on the volume that comes through.

And then sort of along those lines, can you talk about the pipeline or the outlook for originations and now that rates have gone up somewhat and just probably seasonally as we move into the back half of the year?

Yes. We actually added a slide this quarter to our presentation, slide 13, if you happen to have it in front of you, but we are showing kind of the movement in closed origination volume as well as the movement in locks and you can see that we've had kind of peak in locks in the first quarter, interest rate locks in the first quarter, and production volume moved up in the second quarter as interest rate locks moved down. So I think that you can see from that a little bit of foreshadowing of a slowdown in volumes just primarily due to the movement in rates.

I guess the other thing I would say is as we have now moved into more of a purchase market at these rate levels, there is a much heavier seasonality effect in originations of purchase loans as opposed to refinancing. So that seasonality will remain a little stronger as we head into the late summer, early fall and then you will see a significant fall off as we move into the winter. So those are the two things that will probably -- as we sit here today, drive volumes going forward.

And I think you mentioned in the prepared remarks, but what was your mix between purchase and refi?

It's about 66% purchase in the second quarter.

On that slide as well.

(Operator Instructions). Mike Widner, KBW.

I think you answered most of them, but let me just talk about the origination piece, and I think in your comments you said you were substantially increasing the sourcing capability and you talked about the credit focused strategies, moving more toward non-Agency product. Any sense for sort how that might ramp, how should we think about that in terms of volumes and maybe even how we should think about that in terms of the profitability of them relative to current activities?

I think on the ramping side, we've been very deliberate in how we've rolled out the product and we are rolling -- the product we've offered in the market is really an expansion of credit versus what's available in the jumbo market and that's a good thing, we think. The negative in terms of the roll-out is it takes more time. It requires more education of our originators and sellers. So my guess is that we will see -- my expectation is we'll see momentum pick up as we head into the second half of the year. I mentioned earlier with respect to GMFS and certainly applies to the conduit as well that there is a tremendous amount of seasonality in the purchase business. So as we kind of see that natural ramp-up in activity, it will somewhat be countered by the seasonality of the purchase market.

So I'm not sure that the financial impact on our results will be that material this year. I think that we will see a pickup in volume, but I'm not sure it will really move the needle from a financial standpoint. I think really that is a longer term growth initiative that will play out over time.

Got you that makes sense. And I guess with respect to sort of focus on the high concentration of purchase versus refi, is that kind of -- do you expect that to be the same across GMFS and your conduits as well or is that kind of more biased in one direction in kind of one place than the other?

No, actually I think it will be the case across both GMFS and the conduit, probably more so in the conduit, because it is I think really focused on some market niches that don't really fit the refinance market per se. So if you look at GMFS, their geographic footprint in terms of just demographics drives purchase volume, their business strategy drives purchase volume. I think on the conduit, it'll be a little bit more of a function of the product itself being more oriented to purchase transactions.

Yes, that certainly makes sense. And I guess one final one and this is sort of detailed. But looking at the expenses, I think you guys mentioned too that some degree of that is going to be proportional to the amount of originations or mortgage banking activity. Where does that piece fall? Does that sort of fall into the salaries and commissions or is that in op expenses or I'm just trying to look at category by category and think about what are the changes.

Yes, you'll see that in the salaries and commissions.

And then, so I mean there was a pretty sizable increase. I think in, OpEx, outside of that. So maybe you could just talk about that, it's $1 million, but percentage wise it's pretty big change.

Yes, I think they're definitely increases on the operating expense side, some of them are related to the expenses associated with being part of a public company, and I think the run rate might be a little bit lower on a go-forward basis, but we definitely had to make some investments on getting things in the right shape going forward.

Yes, converting GMFS from essentially being a private company to being a wholly owned subsidiary of a public company.

So of the $1 million increase, is that primarily where it was, it's just kind of on a GMFS side?

Yes. It's related to GMFS related side.

Yes. It was GMFS related to those kind of public company expenses.

And I mean by that you mean sort of accounting standard sort of stuff, is it just sort of back office?

Yes. There is the simple stuff like audit fees goes up, all of those kinds of things, there is just a higher level of cost associated with running a public company.

Appreciate the comments, guys, thanks.

Jim Young, West Family Investments.

On page 18 of your slide deck, you show the book value and looks like $0.30 out of the $0.36 improvement in book came from your MSRs. Could you talk about what changes in the valuation inputs or assumptions occurred during the quarter to generate that improvement and how are those parameters changed so far in the third quarter?

Sure. I mean, the overwhelming factor that's going to drive that MSR valuation is the prepayment assumption, which is a function of interest rate. So I think, if you -- for those three quarters that we've had this portfolio, if you look at its movement, it's obviously very well correlated with interest rates. There are a multitude of other inputs and assumptions, but that really drives the lion's share of the movement.

So I think as you move into the third quarter, not to oversimplify it, but you can kind of look at the 10-year note and you can get a pretty good idea of what's going on in terms of mark-to-market on that MSR portfolio.

Okay, great, thank you.

(Operator Instructions) Michael Howard, AllianceBernstein.

If I could go to the prior slide, slide 17, just a two-part question here. So if I look at it relative to the prior couple of quarters, core EPS has been pretty stable over the last three quarters in GMFS, in the investment segment it was down this quarter about $0.12, I think. Could you just talk about kind of the main drivers there? It seems like -- were you buying some credit risk transfer transactions and not choosing to lever those up, was that material there?

Yes. I think if you look at the change in the RMBS portfolio, really two things that occurred there during the quarter. One was, I guess to take a step back, we became a little bit more defensive overall and that drove really two changes. One is we moved out of some longer duration non-Agency exposure and into some of the credit risk transfer positions which as you know are floating rate positions, so they have less interest rate risk associated with them. And then two, we dropped the leverage overall a little bit when you look at the two buckets combined, combined RMBS and another investment securities, the leverage dropped by approximately half a turn. So that is what's driving that difference. I think on the mortgage loan side, there might have been a slight decline just due to amortization and pay downs on the loans.

Okay, that's helpful, thanks. And then my other question was on the mortgage banking segment. If I go to the page 12, if I look at the ratio of your expenses there to your -- the first line in the mortgage banking activities net, let's just call it the cost efficiency ratio, last quarter was 75%, this quarter on higher -- high origination volume, it was up to 80%. Just wondering what we can expect there and why -- was there some investment that really shows up in this format, in this page, in the expense line that's related to GMFS that's somewhat temporary?

As we said earlier, I think the -- there is some investment going on in the business related to them now being part of a public company. It might have been a little bit inflated this quarter just because of the work that's going on in terms of -- inflated in terms of being reflective of the new run rate. So there is a portion that I think won't be continuing, at least that's not what we're expecting. But there is definitely a higher level of expense associated with running that company as part of a public company.

Okay, that's helpful. Thank you.

And that concludes our question-and-answer session. I'll now turn the conference back over to management for closing remarks.

Once again, thank you all for participating today and thank you for your questions. We look forward to speaking with you again on our next earnings call. Have a great day and a great rest of the summer. Thank you.

And that concludes today's conference. We thank you for your participation, you may now disconnect.