Rithm Property Trust Inc. (RPT) Earnings Call Transcript

Good day, everyone, and welcome to the Great Ajax Corp. Q1 2023 Financial Results Conference Call. At this time, I would like to hand things over to Mr. Larry Mendelsohn, CEO. Please go ahead, sir.

Thank you. Thank you, everyone, for joining us for our first quarter 2023 investor call. Before we get started, I'd like to point out Page 2, the safe harbor disclosure for forward-looking statements. I apologize for my voice. The allergy season in Portland is [ waning ] right now. Before we get started, I want to give you a little introduction. Q1 of 2023 was as expected and predominantly as we discussed on the March 2 call. A couple of things to note before we get into the details though. In the first quarter, loan performance continued to increase and loan cash flow velocity from reinstatements on delinquent loans and from sales of homes by borrowers, particularly in March. This continued into the second quarter of 2023 as well. Prepayments from borrowers refinancing the mortgages, however, continued their slower pace as you would expect. The regular payment performance of our mortgage loans and mortgage loans in our JV structures, in excess of our modeled expectations at the time of acquisition, for loans purchased at a discount to UPB has increased previous GAAP income by accelerating the purchase discount accretion because of required application of CECL. This then reduces forward GAAP interest income and return on equity thereafter. However, the increase in cash flow velocity in the first quarter, particularly in March, has increased even the post-CECL GAAP yields a bit. We've seen this in the second quarter as well so far. At March 31, we had approximately $49 million of cash as well as a significant amount of unencumbered securities and loans, which I'll point out later in the table. On Page 3 business overview. Our managers data science guides our analysis of loan characteristics and the geographic market metrics for performance and resolution, probabilities and the ability to source these mortgage loans through long-standing relationships has enabled us to acquire loans that we believe have a material probability of prepayment and/or long-term continuing reperformance. We've acquired loans in 378 different transactions since 2014, only 3 transactions, however, in the first quarter of 2023. We own 19.8% of the equity of our manager at a 0 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 almost 20% interest. Internalizing the management of Great Ajax would result in recording a material GAAP capital gain from our 19.8% interest in our manager. Additionally, our affiliated service for Gregory Funding provides a strategic advantage in non-performing and non-regular paying loan resolution processes and timelines and data feedback loop for our managers' analytics. In today's volatile environment, having our portfolio teams and the analytics group at the manager working closely with the servicer is essential. We've certainly seen the benefit of this with the significant increases in loan performance, our consistent prepayment from property sales by borrowers especially for delinquent loans, and with our AAA-rated structures that permit up to 40% of loans to be greater than 60 days or more delinquent at the time of securitization. Like our 20% interest in our manager, we now have a 21.6% economic interest in our servicer at a very low basis as well. In January, we increased our direct ownership in the parent of our servicer from 8% to 9.6%, and we also own warrants for an additional 12%. We don't mark-to-market our equity interest in the servicer on our balance sheet either. Our servicer is currently evaluating a private equity round as part of rolling out some new data technology-driven programs through strategic joint ventures and MSR joint ventures as well. We still have low leverage. At March 31, our year-end corporate leverage was 3.3x. Our quarter 1 asset-based leverage was 2.6x. We own a 22% equity 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 several large national veterinary practice aggregators. We carry our Gaea interest on balance sheet to lower cost per market. Gaea completed an additional round of equity in the first quarter of '22 at a premium to our carrying value, but our balance sheet and income statement do not reflect any markup. We currently expect Gaea to raise additional equity and ultimately become a public company. Our current environment of bank runs and commercial real estate loan opportunities create significant optionality for Gaea. On Page 4, just some highlights for the quarter. Net interest income from loans and securities, including $0.6 million of interest income from the application of CECL, was approximately $4.1 million in the first quarter. Our gross interest income, including the $0.6 million from the application of CECL was $18.5 million. There are 3 reasons why GAAP gross interest income is lower. First, we had approximately $50 million lower average interest-earning assets on balance sheet in the first quarter versus the fourth quarter of '22. Second, we're continuing to have significantly more delinquent loans than expected to 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 declining house price environment, low LTV loans provide a material hedge as increased delinquency shortens duration and significantly increases corresponding yields. The third reason for lower interest income is the design of CECL. CECL was primarily designed for banks with loans with a par basis so that accelerating reserve capture came after a write debt. We established an allowance under CECL when we acquire new pools of loans, if the NPV of the loan pools contractual cash flows is greater than the NPV of our expected cash flows. And net allowance is allocated to part of our purchase discount. If the expected cash flows on those 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 cash flows reduces future yields and discount accretion. We also accelerated discount accretion when loans pay in full. Despite the application of CECL, yield on interest-earning assets increased a little due to increased prepayment and reinstatement, particularly in the month of March. A GAAP item to keep in mind, though, 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 purchase loans outside of joint ventures by the amount of the servicing fees, and GAAP servicing 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, 81.3% of our loan portfolio by UPB made at least 12 of the last 12 payments for 74% at June 30 of '22 and 79.6% at December 31, '22. This compares to 13% at the time we purchased the loans. Our NPL purchases over the last 15 months increased materially relative to RPL purchases. Previous increases in housing prices helps maintain these payment -- prepayment patterns and leads to decreases in the present value of expected reserves. And related income recognition of $0.6 million of unallocated loan purchase that reserves under CECL in the first quarter, and the additional reserve recaptures we've had in each of the previous 8 quarters. While loans become regularly 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 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 regularly paying and nonregularly paying loans is continuing and even increasing. Our weighted average cost of funds in the first quarter was higher than the fourth quarter by approximately 40 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 increases in SOFR. We expect a significant percentage of floating rate funding will be reduced through rated securitizations in Q2. The other reason weighted average cost of funds are up is because as we delevered the unsecured debt that we issued in late August becomes a higher percentage of our total debt outstanding, which increases the weighted average cost of funds. Net income attributable to common stockholders was negative $7.9 million or $0.34 per share. There are several items of note that had an impact on earnings in the first quarter. To make it a little easier to follow, we have a table that ties GAAP to operating income on Page 16 of this presentation as well as in our 10-K. Operating earnings was negative $2.1 million or $0.09 per share. Taxable income net of preferred dividends was $0.05 a share. Taxable income decreased in the first quarter for 2 primary reasons: first, significant increase in monthly performance in delinquent loans, which extends taxable income yield duration, even more than GAAP yield duration as taxable income per performing loans is based on contractual duration of the loan. So the loan has 30 years remaining to maturity, taxable income comes in equal installments over 30 years unless the loan prepays. Second, we saw prepayments increase on performing loans, which typically have a higher tax basis relative to prepayment on nonperforming 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. This is the first quarter where we've seen significant increase in property sales for performing loans versus delinquent loans. We recorded a loss on investments in affiliates of $100,000 as a result of the flow-through of the mark-to-market decline in the price of our common shares owned by our manager in the first quarter. Our manager receives a significant portion of its management fee in shares and changes in market value of those shares flows through to us based on our 20% ownership interest percentage. Other income declined as we recorded $3 million loss from the sale of Class A senior debt securities in one of our joint venture transactions in February as we discussed in our subsequent events section in our March 2 earnings call. $2.2 million of this was already reflected in book value at December 31. In our joint venture structures, we and our partners buy loans into multi-tranche securitization structures and we each retain a pro rata vertical slice of each tranche of securities, including the equity tranche. The Class A senior is usually the lowest coupon and is priced at market coupon and yield at that time. This Class A senior bond thereby had a low coupon and had negative carry from repurchase agreement funding, and it made sense to sell the Class A senior security and redeploy the capital for higher returns. Book value per share was $12.58 at March 31. Book value decreased primarily by our GAAP loss and dividends paid with an offset from a positive mark-to-market adjustment of our joint venture debt securities. There is a table on Page 17 in this presentation that details the change in book value. We do not mark-to-market our ownership interest in our manager and servicer and have close to a 0 basis on their balance sheet, their market values are significantly above 0, but book value would not reflect that. In February, we refinanced our unrated 2019 -E, -G and -H joint ventures into Ajax Mortgage Loan Trust 2023A. 2023A is a rated joint venture structure. We retained 5% of the AAA securities as required by vertical risk retention rules and 20% of the AA through B-rated securities and equity of the structure. At March 31, we had approximately $49 million of cash. And for Q1 of 2023, we had an average daily cash and cash equivalent balance of approximately $50 million. We had approximately $44 million of cash collections in the first quarter. At March 31, we also have significant amount of unencumbered securities from our securitizations and joint ventures and unencumbered mortgage loans, and we'll discuss this more in detail on Page 12. Approximately 81.3% 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 79.6% at December 31 and June 30 of 74.2%. This is despite buying significantly more NPLs and RPLs for the last 15 months. This increases life of loan cash flow, 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 lowest current cash flow [ comp ] well. Purchased -- if we go to Page 5, purchased RPLs represent approximately 89% of our portfolio at March 31. They represented 96% a year earlier. We primarily purchased RPLs that has made less than 7 consecutive payments, and NPLs at a certain loan level and underlying property specifications that our analytics suggest lead to positive payment migration, early property sales and related prepayment on average. We typically buy well-seasoned lower LTV loans. Since November 22, we have seen residential loan prices increase materially, especially for regular paying loans but also for nonperforming residential 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 would expect an increase in delinquency and default at some point. And therefore, an increase in availability of subperforming and nonperforming loans. As a result, we have been hesitant to be aggressive in residential loan acquisitions as we expect a better opportunity set will develop. One thing we have seen is that significant home price appreciation 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 frequently seen mortgage borrowers pay credit cards and auto loans and HELOCs before paying first mortgages in times of financial stress. However, as a result of significant increases in absolute dollars of equity for older loans, we are now seeing increased delinquency for their credit cards and auto loans and the opposite for their first mortgages. Commercial real estate loans have not fared as well, and we are beginning to see opportunities. We believe there will be significant opportunities of sub-performing and nonperforming commercial real estate loans in many markets as we get later into this calendar year and thereafter. As we mentioned on the third quarter and fourth quarter 2022 earnings calls, we see one of the material market risk as the Fed breaking the system. We have seen a preview of this in the last few months and is having a less talked about effect on midsized and sub-midsized bank liquidity and loan portfolio performance. They frequently have higher percentages of their loan portfolios with commercial real estate exposure. We are beginning to see CRE loans for sale from these institutions and expect that opportunity set will grow. We also expect that resulting bank consolidation will stimulate this as well. We have joint venture partners that would like us to find $1 billion-plus of commercial opportunities as they develop. From these same banks, we are seeing agency and non-agency MSRs being put up for sale in sub-1 billion 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 2 to 4 months to sell. One thing to note, however, is many of these small offerings now are not actually trading as the MSR bids are below current marked value at 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 are in discussions with several institutional MSR administers on joint venture structures. On Page 6, we own lower LTV loans but we did not buy many loans in the first quarter. Our overall RPL purchase price is approximately 42% of current property value and 90% 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 has become even more important in a recessionary environment. On Page 7. Since the third quarter and fourth quarter of 2021, we significantly increased our NPL purchases versus RPLs. NPLs, on average, can have shorter duration than RPLs. For NPLs on our balance sheet, our overall purchase price is 89% of UPB, 84% of the owning balance, including arrears 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 our NPLs. As I mentioned earlier, for both RPLs and NPLs, purchasing age low LTV loans at 50% discounts to property values. And that our significant absolute dollars of equity provides a natural credit hedge to housing price declines and recession as resulting increases in delinquencies, shorten duration and increases corresponding yields quite materially. On Page 8. At March 31, 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 spent nearly 40% of all prepayments in 2021, 2022 and first quarter of 2023. Our California mortgage loans are primarily in Los Angeles, Orange and San Diego counties. Florida represents approximately 17% of our portfolio and Miami, [ Fort Lauderdale ] and Palm Beach counties are approximately 75% of that. We continue to see demand for homes in our price range targets in our markets, both for potential homeowners and single-family rental buyers. On Page 9. At March 31, approximately 81.3% of our loan portfolio made at least 12 of the last 12 payments as compared to under 74.2% a year ago. Approximately 72% of our loan portfolio made at least 24 of the last 24, compared to 69% 3 months ago. Over 83% have now made at least 7 consecutive payments. This compares to a small fraction the time of purchase. The significant increase in monthly performance is more notable given that since Q3 of '21, we purchased primarily 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 home price appreciation for each market in dollars. Historically, we have seen that when our purchase loans reached 7 consecutive payments, they typically get to 12 consecutive payments more than 92% of the time. 7 consecutive payments have been the statistical turning point. Subsequent Events on Page 10. We have 18 million UPB of RPLs and NPLs under contract at a price of approximately 83% of UPB and 54% of underlying property value. We expect these to close in the next week. We declared a cash dividend of $0.20 per share to be paid on May 31 to holders of record on May 15. We expect that taxable income will likely exceed GAAP income as a result of CECL as cash yield loans exceeds CECL impacted GAAP yields on loans. To the extent the Fed continues significantly raising rates, the impact on remaining floating rate financing will have some offsetting effect on taxable income. However, credit tightening and resulting recession will likely increase taxable income by shortening loan duration. And the securitizations we have in the pipeline will replace more expensive floating rate funding and, thereby, likely increase taxable income also. We also see investment opportunities [indiscernible] as a result of recession risk and banking sector risk issues as well. On Page 11, some financial metrics. 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 March and also so far in April. For debt securities and beneficial interests, 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 JVs are presented under GAAP and have increased in 2020, '21 and '22 relative to loans. Since we purchased loans at a 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 home price appreciation in our target markets, on average, both accelerated prepayment from home sales on delinquent loans. And led to material reperformance in excess of expectations, which reduces ongoing yield for loans purchased at a discount. The sale of underlying properties by borrowers with delinquent loans with certain minimum absolute dollar amounts of equity in underlying geography, and borrower demographics has been steady. But it was marginally lower in January and February, and it has increased again in March and April. Leverage continues to be low, especially for companies in our sector. We ended the first quarter with asset level debt of 2.6x, which is lower than it was at year-end '22. Our total average debt cost was higher in Q1, primarily the result of rising SOFR base rates for repurchase agreement funding and the issuance of our unsecured notes in August, since they were a higher percentage of total outstanding debt as asset debt pays down from loan prepayment. Fixed rate securitized debt at March 31 is more than 60% of our total debt. We expect fixed rate debt to continue increasing as a percentage of our total debt as we have 3 securitizations in the pipeline. So far in '23, we have seen a significant recovery in securitized senior bond credit spreads relative to the fourth quarter as well as in rate levels for those funds. On Page 12. Our total repurchase agreement related debt at March 31 was approximately $418 million, down from $446 million at December 31. $209 million was non-mark-to-market, nonrecourse mortgage loan financing and $198 million was financing, primarily on Class A1 senior bonds in our joint ventures with remaining expected lives of less than 2 years. We also have significant unencumbered assets. We expect the amount of our floating rate debt to continue declining relative to fixed rate debt significantly, now that securitization markets are more functional. And with that, I'd be happy to answer any questions anybody might have.

[Operator Instructions] We do have a question. It comes from Matt Howlett, B. Riley.

I'm intrigued by the comments on your expectation in the residential and of course, the commercial loan market. Just walk me through. Loan residential holding price is still well bid, but do you think there's going to be -- when these banks start selling, I know they've already started. What do you think the catalyst is to see sort of more supply come out? I mean when do you think it will come out and what do you think prices can go? I mean, can you -- do you think you could get unlevered yields, the teams from these whole loans or commercial? I mean, some people are out there are saying 15%, 20%. I mean what type of products are we talking about if you believe that's the case?

Sure. It depends on the specific type of commercial. I don't think you're going to see unlevered teams in residential. You will, however, I think, see more supply as delinquency increases as it leaks from credit cards into single-family and as you see bank consolidation. It's one of the things we've seen both in residential and commercial over the years is when bigger bank buys a smaller bank, it wants the classified assets off the balance sheet of a smaller bank before closing. And that way, it can flush through the loss in the purchase price at a onetime charge. In commercial, depending on what it is and what kind of liquidity risk profile it has. So for example, on $500 million office buildings, there's -- people are going to need to make a lot more than they will off of buying a portfolio of business purpose, DSCR loans, for example. So -- but I think you're going to see a significant opportunity, definitely double-digit unlevered in some strip mall loans, in some mixed-use loans. You'll see them in some broken office, not just loans that you'll see double-digit teens unlevered, no questions about that. When will you start to see that. We're starting to see it leak as banks are looking for liquidity, although the one thing we're seeing is that the banks are selling the things they can sell the quickest and the closest to their current mark versus other things. But we think that probably in -- by the Q3, Q4 and 2024, it's really going to be picking up in probably 2024 more so than 2023. It depends on the number of waves, is how I describe it in this, what's going on in banking [indiscernible]. One of the things we've seen like in '94 and '98, '04 and '08 is everything was multiple waves that went over periods of time. And the question is how many, how long and what's the severity between them all? So it's a pretty interesting time, and we certainly have had a bunch of our big institutional partners and also bond investors reach out to us. And we've set up kind of here's what we want to buy together-type structures.

And I'm assuming on the residential side, you've looked to the securitization market. You have it opened -- it's open to you. I'm assuming these are private deals that you're doing. Just give us an update on the state of securitization market. And is it still -- what's your outlook for? Do you think it's going to come in more?

So the AAAs have tightened and obviously, the treasury curve has come in significantly in what I'll call kind of 3-year, 4-year-type expected lives. And most of our AAAs that we issue are expected lives between, call it, high 2s in 4 years. And that those in rates have come in dramatically and AAA spreads have tightened. So the transaction we did in February, we did a plus-150 to the expected life of I think 3.4 years. That market has been pretty strong for our RPL deals. We have what I'll call a regular group of buyers. For 2 of the 3 deals, 80% of the seniors are pre-subscribed, so it's really the other -- 2 of the 3 deals, the other 20%. And the third deal, which is actually the first one we're going out with, we'll just bring out to [ fold ] these market.

Got you. It makes a lot of sense. And then I guess the last one, Larry, for you. So I get this phenomenon, the prepayments, I think you sort of started to pick up in March, and I get this phenomenon. What's going on with the way, the yields are on the performing loans are weighing on your taxable, your GAAP end even more so your taxable income. And of course, you have the repo, which is just about probably done here, the Fed. It's probably done here. If not, they're probably going to be cutting in the next move, if not sooner rather than later. My question to you is, how should we look at taxable income and the dividend, how we think about that trajectory for the rest of the year?

Sure. So taxable income, when you think about prepayment, prepayment on performing loans, okay? Since we have a higher tax basis on performing loans, actually generates less taxable income than prepayment on nonperforming loans. So right, which is -- so it's really tax. You should pay more for nonperforming loans than performing loans at a high tax basis, pertaining to capture less discounts sooner and the taxable income from prepayment is all about the tax, and the discounted tax basis. So the -- and one of the things that's weird is for taxable income, when loans pay like clockwork, you take it over the contractual life of the loan unlike GAAP, which is over the expected life of the loan, right? And prepayments just accelerated. So until the loan prepays, our $360 million month loan, you're taking [ 1 360 ] into tax basically -- or actually it's based on the principle that we see, which is very little in the early years.

These are going to be level yield with a fixed [ prepayment ] and assumption yield regardless, and it's dictated by the deal document for securitization transactions. And then we have other pools of loans where every time you get a payment, you basically take a percentage of discount and at great cover. Literally, is it a 780 month mortgage or...

Over 780 month -- so it's not based on expected life like GAAP. So when loans pay like [ clockwork ] taxable income is less. And when loans don't pay and you also get big lumps from, for example, liquidations or property sales that accelerates taxable income.

And unlike GAAP, for taxable income, it requires a fixed year yield and prepayment assumption at closing. It may not change over the life of the pool of the loan.

Right. Unless the loan goes away.

Unless the loan goes away.

Right. So it's unlike GAAP, where as borrowers take behavior expected life changes in tax, expected life doesn't change.

I got you. At some point, they all have to emerge, right? I mean at this point...

Yes, yes, yes. When both loans are gone, they're the same. When the borrower pays off, tax and GAAP are the same for that loan.

Right. Well, they're starting to get more velocity, right, it sounds like taxable income is going to -- absolutely. But taxable income should be moving up and we get more velocity, that sort of what...