Great Ajax Corp

NYSE:AJX

Earnings Call Transcript 2023-Q2

[Operator]

Good afternoon. My name is Rob, and I will be your conference operator today. At this time, I would like to welcome everyone to the Great Ajax Corp. Second Quarter 2023 Financial Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. Lawrence Mendelsohn, Chief Executive Officer, you may begin your conference.

[Lawrence Mendelsohn, Chief Executive Officer]

Thank you very much, operator. Thank you everybody for joining the Great Ajax Corp’s second quarter conference call. Along with me on this call are Russell Schaub, our President; Mary Doyle, our CFO. Before we get started, I want to point you to Page 2 of the presentation with the safe harbor disclosure.

In the second quarter of 2023, loan performance continued to increase, as did low cash flow velocity from reinstatements on delinquent loans and from sales of homes, particularly in the months of April and May. This has continued into the third quarter of 2023 as well. Prepayments from borrowers refinancing their mortgages continued their slower pace as you would expect, given current mortgage rates. The regular payment performance of our mortgage loans and mortgage loans in our joint venture structures in excess of our model of expectations at the time of acquisition for loans and purchases at a discount, effectively, which are credit reserve recapture has increased previous GAAP income by accelerating purchase discount because of the required application of CECL. This then reduces forward GAAP interest income and return on equity thereafter.

However, the increase in cash flow velocity in Q2, particularly in April and May, has increased even the all-in post-CECL GAAP yields a bit for the second quarter. At June 30, we had approximately $40 million of cash as well as significant amount of unencumbered securities loans. We currently have approximately $55 million of cash.

In Page 3, the business overview. Our managers’ 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 has enabled us to acquire loans that we believe have material probability of prepayment and/or long-term continuing reperformance. We acquired loans in 381 different transactions since 2014, including three transactions in the second quarter of 2023.

Our affiliated servicer, Gregory Funding, provides a strategic advantage in non-performing and non-regular paying loan resolution processes and timelines, and a data feedback loop for our managers’ analytics. We’ve certainly seen significant increase in loan performance, consistent prepayment from property sales, especially for delinquent loans. And with our AAA-rated structures that permit up to approximately 40% of loans to be greater than 60 days or more delinquent at the time of securitization.

We have a 21.6% economic interest in our servicer between shares and warrants. Our servicers currently evaluating the private equity round as part of rolling out some new data and technology driven programs through strategic joint ventures and MSR joint ventures. Our economic interest in the servicer was an important part of our Ellington Financial merger agreement as described in their press release of July 3.

We still have low leverage. At June 30, our corporate leverage ratio is 3.4 times. Our Q2 ending asset base leverage was 2.7 times. We also own a 22% interest in Gaea Real Estate Corp. Gaea is currently a private equity REIT that primarily invests in repositioning multifamily properties in specific markets, and a triple net lease, freestanding veterinary clinic properties in conjunction with large national owners of veterinary practices.

We carry our Gaea interest on our balance sheet at the lower of cost per market. We currently expect Gaea to raise additional equity and ultimately become a public company. The current environment of bank credit tightening and CRE loan disruption creates opportunities and more optionality for Gaea.

And now for a discussion of the second quarter. Net interest income from loans and securities excluding $2.86 million of interest income from the application of CECL was approximately $3.3 million in Q2 including recoveries from the application of CECL. It was approximately $6.2 million.

Our gross interest income excluding the $2.86 million for the application of CECL was $18.3 million. There are three reasons why GAAP interest income is a little lowered. First, we had approximately $23 million lower average interest-earning loans and securities on the balance sheet in the second quarter versus the first quarter. Secondly, we are 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 the case of a recession and a declining housing price environment, these loans provide material yield and cash flow hedge as increased delinquency shortest duration and the corresponding yields would increase materially.

The third reason for lower interest income is the design of CECL. CECL was primarily designed for banks of loans with a par basis so that accelerating reserve recapture would come after a previous write-down. We established and allows under CECL when we acquire new pools of loans, if the NPV of the loan goals contractual cash flows is greater than the NPV of our expected cash flows. And that will allow us to allocate it to part of our purchase discount.

If the expected cash flows on these loans increases in subsequent periods, we are required to reverse the related allowance into interest income. This immediate recognition of the increase in the change in expected cash flows to reduce future yields and discount accretion. A GAAP 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 securities are paid out of the securities waterfall.

So our interest income from joint ventures 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, GAAP interest income will be lower than if we directly purchased loans outside of joint ventures by the amount of servicing fees and GAAP 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 March 31, or I’m sorry, at June 30, 82.1% of our loan portfolio made by UPB made at least 12 of the last 12 payments or 74% a year ago and 81% three months ago. This compares to 13% at the time we purchased the loans.

Our NPL purchases over the last 18 months increased materially relative to RPL purchases. Increases in housing prices in 2021 and 2022 helps maintain these payment-prepayment patterns and leads to decreases in the present value of expected reserves and the related income recognition of $2.86 million of unallocated loan purchase discount reserves under CECL in the second quarter. And the additional reserve recaptures we’ve had in each of the previous nine quarters.

While loans that become regular paying 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 can reduce percentage yield on the loan portfolio and quarterly interest income. Loans that do not migrate to regular monthly pay status typically have materially shorter durations and therefore result in higher yields. We are seeing that prepayments from property sales for both regular paying and non-regularly paying loans is continuing, though.

Our weighted average cost of funds in the second quarter was higher than the first quarter by approximately 20 basis points. Most of this comes from the remaining floating rate repurchase agreements on loans getting ready for securitization and some joint venture securities repurchase agreements and related increase in SOFR.

Net income attributable to common stockholders was negative $12 million or $0.51 per share. There are several items of note that had an impact on earnings in this quarter. To make it a little easier to follow, we have a table that ties GAAP income to operating income on Page 16 in this presentation as well as in our 10-Q.

Operating earnings was negative $2.5 million or $0.11 per share. Taxable income net of preferred dividends was minus $0.02 per share. Taxable income decreased in Q2 for two primary reasons. First, the significant increase in monthly performance in delinquent loans to become performing loans extends taxable income yield duration even more than extends GAAP yield duration as taxable income for performing loans is based on contractual duration, not expected duration. So taxable income for performing loans is typically 30 over 30 years rather than the expected life.

Second, in Q2, we saw prepayments increase on performing loans which typically have a higher tax basis relative to prepayment on non-performing loans. Taxable income is not affected by the CECL-related reserve recapture. So when we actually receive cash payments from borrowers and capture purchase discount because of larger than contractual payments, it creates taxable income.

We recorded a loss on investments in affiliates partly as a result of the flow-through of the market to mark-to-market decline in the price of our common shares owned by our manager in the second quarter. Our manager receives a significant portion of their management fee in shares and changes in market value of those shares flow through to us based on our 20% ownership interest. There are a few one-time and unusual items in the Q2 numbers.

In July, we called eight joint venture securitizations and re-securitizing underlying loans into our 2023-B and 2023-C securitizations. The 2023-B was an unrated joint venture securitization and 2023-C with AAA DBRS-rated joint venture securitization. This resulted in a June 30 GAAP, but not cash charge that we then collect back over the remaining life of the underlying loans. Since the eighth called securitizations were joint ventures in which we owned a 20% interest, they were not consolidated on balance sheet as loans that held legally and under GAAP as securities and beneficial interests.

In the July 2023 re-securitizations to the new AAA-rated structure and unrated structure, we continue to own the same percentage, but the securities mark-to-market is lower. Because of this in Q2, we took an impairment equal to the difference between the securities carrying values and market values in June 2023 of $8.8 million or $0.37 per share.

This treatment is the same as our 2022 JV re-securitizations and our Q1 2023 JV re-securitization. The loans from the eight JV securitizations that were called are transferred from their eight joint venture trusts to our two new joint venture trusts with the same partners owning the same percentages in each.

We and our partner effectively sold the loans in the form of the exchange of securities from ourselves to ourselves, which triggers a non-cash loss under GAAP. It would go through book value, whether or not to sale under GAAP because of mark-to-market change. There is no difference in expected cash flow on the underlying assets, and we expect this mark-to-market non-cash sales loss amount is fully recaptured over the expected life of the two re-securitizations. This also doesn't reduce taxable income as we and our partner effectively sold the assets from ourselves to ourselves and is, therefore, a refinancing rather than a sale for tax, so there's no tax impact. It's only a sale for GAAP because we own the JV loan assets in the form of securities.

Book value was $11.86 at June 30. Book value decreased primarily by our GAAP loss and dividends paid with an offset from positive mark-to-market adjustment in our investment in JV debt securities. There is a table on Page 17 that details the change in book value. At June 30, we had approximately $40.3 million of cash. And for Q2 we had an average daily cash and cash equivalent balance of approximately $43.6 million. We had approximately $49.5 million of cash collections in the second quarter.

At June 30, we also have a significant amount of unencumbered assets, unencumbered securities from our securitizations and joint ventures and unencumbered mortgage loans which we’ll discuss in more detail on Page 12. Approximately 82.1% of our portfolio by UPB made at least 12 of their last 12 payments compared to a small fraction at the time of loan acquisition. This increased from 81% three months ago and 74% 12 months ago, despite buying significantly more NPLs and RPLs since the middle of 2021.

Reperformance increases life of loan cash flows, but the duration extension reduces yield and interest income in the current quarter. As more purchased delinquent loans reperform rather than prepay or default, this materially lowers taxable income as well.

As you probably all read or seen on June 30, we entered into a merger agreement with Ellington Financial Inc., in which Great Ajax shareholders would receive 0.5308 shares of Ellington Financial stock per share of Great Ajax stock subject to any adjustments as described in the merger agreement as well as a potential cash distribution depending upon certain potential repurchases of our securities prior to the closing. The S-4 for this was filed on August 2, 2023.

If we move to Page 5, purchased RPLs represent approximately 89% of our loan portfolio at June 30. 15 months ago, they represented 96%. We primarily purchase RPLs that had made less seven consecutive payments and NPLs at a certain loan level and underlying property specifications that our analytics suggest lead to positive payment migration, property sales and related prepayment on average. We typically buy well-seasoned lower LTV loans.

For residential loans, we continue to see stronger performance than expected in our portfolio. However, given the increase in interest rates credit tightening and the potential for material economic slowing, we’d expect an increase in delinquency and default at some point, although we have not seen an increase in delinquency thus far in our portfolio. As a result, we have been hesitant to be too aggressive in residential loan acquisitions as we expect a better opportunity set will develop.

One thing we have seen is that significant HPA and the resulting material increase in absolute dollars of equity, made borrowers more engaged and financially attached to their properties and therefore more determined to maintain regular payments. Historically, we have typically seen mortgage borrowers pay credit cards and auto loans and home equity lines of credit before they pay their first mortgages in times to financial stress. However, as a result of significant increases in absolute dollars of equity for seasoned loans, we are now seeing increased delinquency for the credit cards and auto loans but not for their first mortgages.

Commercial real estate loans have not fared as well, and we are beginning to see opportunities there. We believe there will be significant opportunities in sub-performing and non-performing commercial real estate loans in many markets as we get later into this calendar year and thereafter. We have seen a preview of this in the last few months, it is having a less talked about effect on mid-size and sub mid-size bank liquidity and loan portfolio performance. They frequently have higher percentages of their loan portfolios with CRE exposure. We are beginning to see CRE loans for sale from these institutions and expect that opportunity set will grow. We also expect that bank consolidation will stimulate this as well.

We have joint venture partners that would like us to find significant dollars of commercial opportunities. From the same banks, we are seeing agency and non-agency MSRs being put up for sale in sub $1 billion of UPB increments as well as large MSR offerings from larger banks and originators. As these banks look for predictable liquidity, they are marketing MSRs as MSR sales take two to four months to settle. One thing to note, however, is many of these smaller offerings are not actually trading as the MSR bids are below the current marked value at many of these banks. We think there is also going to be significant MSR opportunity set and having Gregory as a servicer and owning 21.6% economic interest in it will be beneficial.

We have put in place joint venture structures with several institutional MSR investors. We own lower LTV loans. In the second quarter, we purchased $16.3 million of RPLs at 48% of property value and 18.7% of UPB. Our overall RPL purchase price is approximately 42% of current property value and about 91% of UPB. We have always been focused on loans with lower LTVs with certain threshold levels of absolute dollars of equity and in target geographic locations. This is even more important for RPLs and NPLs to the extent that there is a potential recessionary environment.

Since Q3 and Q4 of 2021, we’ve significantly increased our NPL purchases versus RPLs. NPLs on average can have shorter duration. For NPLs on our balance sheet are overall purchase prices, 89% of UPB, 84% of the total owing balance, including arrearage and 47% of property value. As a result of the low loan-to-value and higher absolute dollars of equity on average for our NPL portfolio, we have seen significant reinstatement and reperformance on NPLs.

As I mentioned earlier, for both RPLs and NPLs, purchasing seasoned low LTV loans at 50% discounts to property values and that has significant absolute dollars of equity provides a natural credit hedge to housing price declines and recession as resulting increases in delinquencies, shortened duration and increases corresponding yields quite materially.

At June 30, approximately 78% of our loans were in our target markets. California continues to represent the largest segment of our loan portfolio at approximately 22%, however, California has been nearly 40% of all prepayments in 2021, 2022, and so far in 2023. Our California mortgage loans are primarily in Los Angeles, Orange and San Diego counties.

Florida represents approximately 17% of our portfolio and Miami-Dade, Broward and Palm Beach counties are approximately 75% of that. We continue to see demand for homes in our price ranges in our target our markets, both from potential homeowners and rental buyers.

As mentioned before at June 30, approximately 82.1% of our loan portfolio made at least 12 of the last 12 payments versus 74% a year ago. Approximately 75% of our loan portfolio made at least 24 of the last 24 payments compared to approximately 69% at the end of 2022 and 72% three months ago. Over 83% have now made at least seven consecutive payments. The significant increase in monthly performance is more notable given that since the third quarter of 2021, we primarily only purchased low LTV NPLs rather than RPLs. Much of this is likely due to Gregory Funding working with delinquent borrowers on a personal basis and to absolute dollars of home appreciation. As our target markets are significantly determined by data analytics that predict forward HPA for each market in dollars.

Historically, we have seen that when our purchase loans reached seven consecutive payments they typically get to 12 consecutive payments more than 92% of the time. Seven consecutive payments has been the statistical turning point.

We have a small number of NPL and RPL acquisitions under contract. As I mentioned earlier on the call, we are waiting for the opportunity set to expand. We are starting to see an investment opportunity set brewing as a result of some recession risk and banking sector risk issues particularly in CRE loans.

We declared a cash dividend of $0.20 per share and be paid on August 31 to holders of record August 15. As I described earlier on the call, we re-securitized eight joint venture securitization structures into two new joint venture securitization structures. Ajax Mortgage Loan Trust 2023-B and 2023-C while these closed in July of 2023 and appear on balance sheet in Q3 2023. The economics of these transactions for GAAP show up in the income statement for Q2 2023.

Average loan yields and average yields on beneficial equity interest in our joint ventures increased a little primarily due to significant loan cash flow in April and May. For debt security to beneficial interest, remember that yield is net of servicing fees and yield on loans is gross of servicing fees.

Debt securities and beneficial interest is how our interest in our joint ventures are presented under GAAP and have increased on balance sheet relative to loans since 2020. Since we purchased loans in discount, the increased reperformance of delinquent loans materially in excess of expectations can extend duration and reduce yield. The significant absolute dollars of equity for our loans, both from the types of loans we buy and the HPA in our target markets on average, both accelerated prepayment from home sales on delinquent loans and led to material reperformance in excess of expectations. The sale of underlying properties by borrowers with delinquent loans with certain minimum absolute dollar amounts of equity and underlying geography and borrow demographics has been steady, but increase in April and May.

Leverage continues to be low, especially for companies in our sector. We ended Q2 with asset level debt at 2.7 times. Our total average debt cost was a little higher in the second quarter, primarily resulting from the rise of SOFR base rates for repurchase agreement and the issuance of our unsecured notes in August of 2022 since they were a higher percentage of total outstanding debt as asset-based debt pays down from loan prepayment. Fixed rate securitized debt and fixed rate corporate debt at June 30 are approximately 65% of our total debt.

Our total repurchase agreement related debt at June 30 was approximately $413 million, $209 million was non-mark-to-market, non-recourse mortgage loan financing and $193 million was financing primarily on Class A1 senior bonds in our joint ventures with remaining expected lives of sub two years. We also have significant unencumbered assets. We expect the amount of our floating rate debt to continue declining relative to fixed rate debt.

With that, if anybody has any questions regarding the second quarter or other, please let us know and happy to answer.

[Lawrence Mendelsohn, Chief Executive Officer]

Thank you everybody for joining our second quarter 2023 conference call and the industrial presentation. Feel free to reach out to the extent you have any questions. We’re always happy to discuss our business and plans, and hope everyone has a good evening.

[Operator]

This concludes today’s conference call. Thank you for your participation. You may now disconnect.