Great Ajax Corp.

Ladies and gentlemen, thank you for standing by. My name is Brent, and I will be your conference operator today. At this time, I would like to welcome everyone to the Great Ajax Corp. Fourth Quarter and Year-End Financial Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you'd like to ask a question at that time, simply press star followed by the number one on your telephone keypad. If you would like to draw your question, again, press star one. Thank you. It is now my pleasure to turn today's call over to Mr. Larry Mendelson, Chief Executive Officer. Please go ahead.

Thank you, Brent.

Thank you, everyone, for joining us for Great Ajax's four-quarter year-end 2022 conference call. Before we get started, I'd like to point out page two on the presentation and the safe harbor disclosure. With me here is Mary Doyle, our CFO, and also on the line is Russell Schaub, our president. A quick introduction before we get in. There's a couple of things to note before we get into the details. In Q4 2022, loan performance continued to increase in loan cash flow velocity from sales of homes by certain delinquent borrowers continued, and has also continued in the first quarter of 2023. Prepayments from borrowers refinancing continued to be slower, as you would probably expect. The regular payment performance of our mortgage loans and our mortgage loan JV structures in excess of our modeled expectations at the time of acquisition for loans purchased at a discounted UPV has increased previous GAAP income by accelerating purchase discount accretion because of the required allocation of CECL. This then reduces forward GAAP interest income in ROE thereafter, but not taxable income. At September 30, we had approximately $47 million in cash, as well as a significant amount of unencumbered securities loans, and I will go through that in more detail later on this call. With that, we jump to page three for the business overview. Our manager's data science guides the analysis of loan characteristics and geographic market metrics for performance and resolution pathway probabilities, and its ability to source these mortgage loans through longstanding relationships enables us to acquire loans that we believe have a material probability of prepayment and or long-term continuing re-performance. We've acquired loans in 375 different transactions since 2014 and three transactions and one larger one in Q4 of 2022. We own 19.8% of the equity of our manager at a zero basis and we do not mark to market our ownership interest on our balance sheet. As a result, our book value does not reflect the market value of our 19%. interest in our manager. However, should we ever internalize the management of Great Ajax, Great Ajax would record a material gap capital gain from their 19.8% interest. Additionally, our affiliated servicer, Gregory Funding, provides strategic advantage in non-performing and non-regular paying loan resolution processes and timelines and data feedback loop for our managers analytics. From today's volatile environment, Having our portfolio teams and the analytics group at the manager working closely with the servicer is quite essential. We have certainly seen the benefit of this with the significant increases in loan performance, our consistent prepayment from property sales, especially for delinquent loans, and with our 2022A and 2022B securitization structures, and now our 2023A securitization AAA rated structures that permit up to 40% of loans be greater than 60 days or more delinquent at the time of securitization. Like our 20% equity interest in our manager, we now have a 21.6% economic interest in our servicer at a very low basis as well. We don't mark to market our equity interest in the servicer on our balance sheet either. Our servicer currently is evaluating a private equity round as part of rolling out some new data and technology-driven programs through strategic joint venture. The data analytics and sourcing relationships of our manager and the effectiveness of our related servicer also enables us to broaden our investment reach through joint ventures with third-party institutional investors and thereby invest in larger transactions as well. The servicer's loan expertise is definitely appreciated by our JV partners as several of our JV partners pay our servicer for providing third-party due diligence services for other transactions they may be working on and have hired our servicer to solve problems may have with other servicers we still have low leverage at december 31 our year-end corporate leverage ratio was 3.3 times our q4 average asset-based leverage was 2.7 times and our mark-to-market leverage is primarily secured by class a1 senior bonds in our joint ventures we own a 22 percent equity interest in gaia real estate core guy is currently a private equity REIT that primarily invests in repositioning multi-family properties in specific markets and triple net lease freestanding veterinary clinic properties in conjunction with large national veterinary practice owners. We carry our GAIA interest on our balance sheet at a lower of cost for market. GAIA completed an additional round of equity about a year ago at a premium to our carrying value, but our balance sheet and income statement do not reflect any markup. We currently expect Gaia to raise additional private equity and ultimately become a public company in 2023. We move to page four. Net interest income from loans and securities, including 1.1 million of interest income from the application of CECL, was approximately 5.1 million in Q4. Our gross interest income, excluding the 1.1 million from the application of CECL, was 18.4 million, which is approximately $1.6 million lower than Q3 2022. There are three reasons why GAAP gross interest income is lower. First, we had approximately $35 million lower average interest earning assets on balance sheet in Q4 versus Q3 of 2022. Second, we're continuing to have significantly more delinquent loans than expected become performing. As delinquent loans become performing, they provide more cash flow but over a longer period. Since we buy loans at a discount, this increase in performance can extend expected duration, which lowers yield. However, in a recession and in a declining housing price environment, low LTVs provide material hedge as increased delinquency shortens duration and corresponding yields will increase materially. The third reason for lower interest income is the design of CECL. CECL was primarily designed for loans with a par basis. So that accelerating reserve recapture came after a write-down. Because we buy loans at a discount, requiring the acceleration of reserve capture under CECL decreases the remaining purchase discount to be accreted over the life of the loan, which lowers forward gap yield for CECL, gap yield under CECL for the required reserve recapture. A gap item to keep in mind is that interest income from our portion of joint ventures shows up in income from securities and not interest income from loans. For these joint venture interests, servicing fees for securities are paid out of the securities waterfall. So our interest income from joint venture securities is net of servicing fees, unlike interest income from loans, which is gross of servicing fees. As a result, since our joint venture investments have been growing faster than our direct loan investments, gap interest income will be lower than if we directly purchased the loans outside of joint ventures. by the amount of the servicing fees, and gap servicing fee expense will decrease by the corresponding offsetting amount. An important part of discussing interest income is the payment performance of our loan portfolio. At December 31, 79.6% of our loan portfolio by UPB made at least 12 of the last 12 payments, or 74% at June 30, and compared to a small fraction of this at the time we purchased the loan. Our NPL purchases over the last 12 months increased materially relative to RPL purchases. Previous increases in housing prices helps maintain these payment and prepayment patterns and leads to decreases in the present value of expected reserves and the related income recognition of $1.1 million of unallocated loan purchase discount reserves under CECL in Q4. And the additional reserve recaptures in each of the previous seven quarters as well. Also, approximately 60% of our full loan payoffs in Q4, and so far in Q1 as well, were from loans that were materially delinquent at the time of payoff. While loans that become regular repaying produce higher total cash flows over the life of the loans, they can extend duration, and because we purchase loans at discounts, this can reduce percentage yield on a loan portfolio, and therefore interest income. Loans that do not migrate to regular monthly pay status typically have materially shorter durations. We are seeing that prepayments from property sales for both regularly paying and non-regularly paying loans is continuing. Prepayment from rate term refinancing remains slow in Q4 for refinance eligible loans. Our weighted average cost of funds in Q4 was higher than Q3 by approximately 100 basis points. Some of this comes from the issuance of our fixed rate unsecured notes in late August 22 and having this on balance sheet for a full quarter.