Great Ajax Corp.

Ladies and gentlemen, thank you for standing by and welcome to the Great Age X-Corp Q3 2020 earnings conference call. All lines are currently in a listen-only mode. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question at that time, you may do so by pressing star and the number one on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to hand the conference over to Mr. Lawrence Middleton, CEO. Please go ahead, sir.

Thank you very much. Thank you, everybody, for joining us on the third quarter of 2020 Great Age X Corp earnings call. We appreciate you joining in, given all the other things going on in the world at this time. Before we get started, I want to just point out on page number two our safe harbor disclosure and disclosure about forward-looking statements. And with that, jump right into the presentation on page three. I'll give you a little bit of an introduction before I get into it. Third quarter was a strategically good quarter in many, many ways. We increased our mortgage investments both directly and through joint ventures. We completed another rated securitization that provides match-funded financing for the associated loans in that securitization at a materially lower cost of funds. Our asset-based cost of funds across the board decreased by nearly 50 basis points and has continued to decrease in the fourth quarter. Our loan performance and cash flow velocity increased significantly, which has continued into the fourth quarter as well. We continue to be in an offensive position with approximately $135 million of cash, as well as approximately $149 million face amount of unencumbered securities and another $34 million of unencumbered mortgage loans. The significant cash balance does create an earnings drag and a significant cash flow velocity from our mortgage loans and mortgage loan joint venture structures reduces our portfolio leverage, but we're well equipped for volatility and all the investment potential that that creates. With that, we can jump right into our overview. It's very important to understand our manager's strength in analyzing loan characteristics and market metrics for re-performance probabilities and pathways, and its ability to source the mortgage loans for us enables us to acquire loans that we believe have a material probability of long-term re-performance. We've acquired loans from 314 different transactions since 2014 and 12 in the third quarter of 2020. Additionally, we believe having our affiliated servicer provides a strategic advantage to us in non-performing and non-regular paying loan resolution and timelines, and also provides a data feedback loop for our manager, which enables their analytics to get more and more sophisticated each quarter. In today's volatile environment, having our portfolio teams and analytics group at the manager working closely with the servicer is very essential to maximize re-performance probabilities loan by loan, and we'll talk more about that later in this presentation. The analytics and sourcing of the manager and effectiveness of our affiliated servicer also gives us the ability to broaden our investment reach through joint ventures with third-party institutional investors. Our September 30, 2020 corporate leverage ratio was 2.2 times, and our Q3 2020 average corporate leverage was 2.1 times. Our Q3 2020 average asset-based leverage was only 1.9. Our leverage would have declined additionally from Q2, but we closed at $876 million joint venture structure with two institutional partners on September 25th, in which we invested $83 million. And our manager and servicer oversee that joint venture as well. On page four, I'll get into some highlights for the quarter. Net interest income from loans and securities, including a $4 million partial reversal of COVID-19-related loan and credit losses, this is only $3 million after deconsolidating approximately $1 million to non-controlling joint venture interests, was approximately $16 million. For the second quarter, we had only a small increase in our average balance of mortgage loans held due to prepayment and a flat average balance of investments in joint ventures that are on balance sheet of securities and beneficial interests. Our $83.4 million investment in our joint venture loan acquisition that closed September 25th was only on balance sheet for five days, so we received minimal benefit through earnings. This JV shows up in quarter-end balances as securities investments and investments in beneficial interests, but has little impact on average balances for the quarter since it was only on for five days. A gap item to keep in mind is that interest income from our portion of joint ventures shows up in income from securities, not interest income from loans. For these joint venture interests, servicing fees for the securities are paid out of the securities waterfall, so our interest income from joint venture securities is net of servicing fees. Our interest income from loans is gross of servicing fees. As a result, since our joint venture investments are growing faster than our direct loan investments, particularly so in Q2 and Q3, GAAP interest income will grow more slowly than if we directly purchased the loans by the amount of the servicing fee difference, and GAAP servicing fee expense will decrease by the same amount. An important part of discussing interest income is the payment performance of our loan portfolio. At December 31, 2019, approximately 76% of our loan portfolio by UPB made at least 12 of the last 12 payments, as compared to only 13% at the time we purchased the loans. At March 31, 2020, this number was 74% as a result of some COVID impact. And at June 30, 2020, approximately 72.6% of our loan portfolio by UPB made at least 12 of 12. In our Q1 2020 investor call, we mentioned we expected COVID-19-related economic environment would negatively impact the percentage of 12 to 12 borrowers. Thus far, the impact on payment performance has been materially less than expected, and the percentage of our portfolio that is 12 of 12 actually increased to 74.5 from 72.6. While regular paying loans produce higher total cash flows over the life of the loans on average, they can extend duration, and because we purchase loans at discounts, this reduces percentage yield on the portfolio and interest income. However, regular paying loans generally increase our net asset value, as we will see later in this call. They enable financing at a lower cost of funds, like our rated securitizations, and provide regular cash flow. Loans that are not regular monthly pay status tend to have shorter duration. However, we expect that this duration reduction will be less than typical due to the impact of COVID-19. As I mentioned earlier, most of our loans were purchased as non-regular paying loans, and the borrowers, our servicer and portfolio team, and our manager have worked together over time to reestablish these loans as regular pay. We also expect that given the low mortgage rate environment and the stability of housing prices, that higher prepayments will likely continue on both regular paying and non-regular paying loans. Our managers analytics group has compared the differences in the prepayment characteristics of loans pre and post COVID-19 time period, and there are differences as to loans characteristics that prepaid since COVID started versus loans that prepaid before COVID started. Our cost of funds in Q3 was lower than Q2 by 49 basis points. This was primarily due to spread reduction and LIBOR rate decrease for our repurchase facilities, as well as the rated securitization we completed in August. We expect our cost of funds trend to continue decreasing materially, especially as we call some of our older securitizations and resecuritize the underlying loans over the next few quarters. Net income attributable to common stockholders was $5.3 million, or 23 cents per share, after subtracting out $1.95 million of preferred dividends and $1.6 million of income attributable to non-controlling interests. A couple other things to note. We recorded very little flow-through income from our manager and servicer in Q3 2020, primarily due to the mark-to-market decline of our share price on shares owned by our manager and servicer. Our manager and servicer combined owned approximately 1.1 million shares of our common stock, and we own 19.8% of our manager and 8% of our servicer. This reduced income relative to Q2 by approximately $700,000, or about $0.03 per share. We expensed approximately $1.7 million relating to the gap required accrual of warrant put rights from our Q2 2020 issuance of preferred stock and warrants. Also, we repurchased and retired $2.5 million face of our convertible notes for $2.3 million, although we are required to accelerate the amortization of the related issuance costs to the securities repurchased. Book value is $15.35 at September 30, 2020. Later in this call, we will compare September 30 book value and September 30 fair value estimates of our balance sheet. As a spoiler alert, September 30 fair value estimates are materially higher than book value. Taxable income was 11 cents per share. The two leading drivers of less than normal taxable income for us in Q3 2020 were fewer foreclosures relative to REO sales, as well as increasing loan ownership through joint ventures. For tax purposes, we recognize a gain at the foreclosure date in an amount equal to the difference between our tax basis in the loan and the fair value before expenses of the property. As a tax accounting at foreclosure does not take into account liquidation expenses, a portion of this gain is typically reversed at sale. As a result of the COVID-19 effect on foreclosure timelines and very strong pay history of our loans, we have far fewer foreclosures, which reduces tax gains. Additionally, our joint ventures are accounted for as single loan pools with the purchase discount recognized over the remaining weighted average life. Under the tax law, the pricing speed and yield of the loan pool is required to remain constant over the life of the pool, and loan level gains are not recognized. Accordingly, the historical gains previously recognized at the loan level for a foreclosure or modification event are no longer recognized, and that income is recognized as original issue discount over time. At September 2020, we had approximately $135 million of cash, and for Q3 2020, we had an average daily cash and cash equivalent balance of approximately $148 million. Our surplus cash definitely tempers earnings, but this provides us with significant optionality, and the related earnings drag should decrease as we get the cash invested over time. In addition to cash, we also have approximately $149 million base amount of unencumbered securities from our securitizations and joint ventures, and approximately $34 million unpaid principal balance of unencumbered mortgage loans currently. As I mentioned earlier on this call, approximately 74.5% of our portfolio by UPB made at least 12 of their last 12 payments, compared to only 13% at the time of loan acquisition. I will discuss the importance of this in much greater detail when we get to pages 9 and 16 of this presentation. If we jump to page 5, You can see that we continue to be primarily re-performing loan driven with purchased re-performing loans representing approximately 97% of our loan portfolio. We strive for positive payment migration of purchased RPLs. And on page six, you can see that we continue to buy and own lower loan to value loans. Our overall RPL purchase price is approximately 55% of property value and 88% of UPB. This clearly does have an impact on the significant repayment perspectives that we have relative to payment patterns at the time of acquisition. On page seven, you can see that purchase non-performing loans have been declining relative to the total loan portfolio. But for NPLs on our balance sheet, our overall purchase price is 75.6 of UPB and 52.8% of underlying property value. On page eight, you can see our target markets. California continues to represent the largest segment of our loan portfolio. Our California mortgage loans are primarily in Los Angeles, Orange, and San Diego counties. We have seen consistent payment and performance patterns from loans in these markets. We have also seen consistent prepayment patterns, even more so in recent months. Since May 1st, California prepayments represent 10% more than California is as a percentage of our portfolio. We removed Las Vegas as a target market during Q1. Mortgages in Las Vegas are currently a small percentage of our portfolio, unlike five years ago. Our analytics suggest that COVID-19 will have a material economic impact on Las Vegas, given its tourism focus and the economic multiplier effect. This, however, could be partially offset by state income tax-related transitions from Southern California. We're also keeping a close eye on Houston as the combination of COVID-19 and oil industry struggles is having a material impact. It has not spilled into the single-family homes market as much as the apartment market thus far, but we have trimmed back Houston targets. We only added Houston to our target portfolio in the second half of 2019, so it still remains a very small percentage of our overall portfolio. We had been seeing material negative effects from the new tax loss SALT provisions in New York City Metro and in suburban New Jersey and Southern Connecticut home values and home sale liquidity. We've seen a quick positive turn in liquidity in these suburban locations as a result of COVID-19 as New York City apartment dwellers look for suburban residences. It's too early to tell, however, whether this is a short-term phenomena or a longer-term change in lifestyle as a result of COVID-19. Related to this, though, we have also seen demand for homes and home rentals increase significantly in parts of Florida, as well as the Phoenix, Arizona, Dallas, Texas, and Atlanta, Georgia metro areas. But we have not seen this for condominiums in those markets, just single-family homes. If you look at page 9, portfolio migration, At September 30, 2020, approximately 74.5% of our loan portfolio made at least 12 of the last 12 payments, including approximately 68% of our loan portfolio that made at least 24 of the last 24 payments. This compares to approximately 13% at the time of purchase. We saw a decline in these performance percentages in Q1 and Q2 of 2020, but a material improvement in Q3. Non-paying loans, which usually have shorter durations than paying loans, get timelines extended as a result of COVID-19. This affects the yield on true non-performing loans as extended resolution timelines can lead to more property tax, more insurance, and more repair expenses. Since we purchased most of our loans when they were less than 12 for 12 payment history, our servicer has worked with most of our borrowers over time. While it's too soon to understand the full impacts of COVID-19 on home prices and mortgage loan performance, so far the impact on our portfolio has been far less than anticipated, and we've seen demand for homes in our target markets increase. 12 for 12 loans in today's market trade at materially higher prices than even pre-COVID in February of 2020, and it's primarily related to the reduction in cost of financing for buyers of loans. As a result, our portfolio and related implied corporate net asset value estimates are materially higher than gap book value, which presents our loans at the lower of market or amortized cost. And we'll talk more about that on page 16. Subsequent to September 30, 2020, we purchased approximately $5.1 million of residential first mortgage loans in three transactions, and the purchase price for the loans is approximately 83% of UPB and 65% on value. We have another approximately $29 million of loans under contract to purchase in 11 transactions, subject to due diligence. Of this, approximately $10 million UPB is small-balance commercial mortgages. The purchase price is approximately 91% of underlying principal balance and 46% of underlying property value. We are sticking to our principles of buying relatively lower loan-to-value loans. We declared a cash dividend of 17 cents per share to be paid on November 30 to holders of record November 16, 2020. There's a couple of financial metrics I want to talk about. First, average loan yields excluding reserve capture declined by about 20 basis points. This is primarily as a result of duration extension from both more loans paying and from the duration of non-performing loans extending because of COVID resolution restrictions. Also remember that yield on debt securities and beneficial interest is net of servicing fees. Yield on loans is gross of servicing fees. Debt securities and beneficial interests is how our interests in our joint ventures are presented under GAAP. As our JVs increase, as they did in 2020 relative to loans, the GAAP reporting will show lower average asset yields by the amount of the servicing fee. Our leverage continues to be low, especially for companies in our sector. We ended Q3 with asset level debt of 2.0 times, and average asset level debt for the quarter was 1.9 times. Our asset level debt cost of funds was lower in Q3 than Q2 by almost 50 basis points, and the cost of our asset level debt has further declined so far in Q4, and we expect that trend to continue materially. As we get our surplus cash invested, we should see material increases in interest income and net interest income as well. A new slide that we added is page 13, our securities and loan repo funding. Our total repo-related debt at September 30 was almost unchanged from year-end 2019. At September 30, we had approximately $269 million unpaid principal balance of securities on mark-to-market repo, of which 86% were Class A senior bonds in our joint ventures. Of the $145 million of mortgage loan repo financing, only $44 million is mark-to-market financing. At September 30, we had $149 million face amount of unencumbered bonds, as well as $86 million of upb of unencumbered equity certificates and 34 million upb of unencumbered mortgage loans combined with 135 million in cash at quarter end we have significant resources for being on offense as well as a very stable balance sheet for defense if we jump to page 17 We've added another slide that people have asked for. And then, as I mentioned earlier on the call, we estimate that the fair value of our balance sheet equity is materially higher than our book value. The explanations and discussion of fair value are included in Note 6 Fair Value in our 10Q. We invest in mortgage loans at discounts to UPB based on our manager's analytics. Our servicer works with borrowers and helps get loans back on track. When they become regular paying loans, they become significantly more valuable. Our GAAP balance sheet shows our investments at the lower of amortized cost or market. Based on current performing loan market prices, we estimate that fair value is approximately $100 million higher than book value. Also, we own approximately 20% of our manager at a zero cost basis and 8% of our servicer plus warrants for another 12% of our servicer at a basis of less than $3 million. The estimated fair value of these holdings together is likely another 15 to 20 million. And with that, I'm happy to take any questions that anybody might have. And thanks again for being on the call.

As a reminder, if you'd like to ask an audio question, you may do so by pressing star and the number 1 on your telephone keypad. Again, that is star 1. We'll pause for just a moment. The first question will come from the line of Mike Smith with B Reilly Securities.