Lawrence Mendelsohn - Chairman and CEO.

Jessica Levi-Ribner - FBR Capital Markets Steven Delaney - JMP Securities Robert Dodd - Raymond James & Associates.

Welcome to the Great Ajax Corp. First Quarter 2017 Financial Results Conference Call. [Operator Instructions]. And please note that this event is being recorded. I would now like to turn the conference over to Larry Mendelsohn, Chief Executive Officer. Please go ahead..

Thank you, very much. Thank you, everybody for joining us for our First Quarter 2017 Conference Call. I have with me Russell Schaub , President of Great Ajax, and also Mary Doyle, our CFO. Before we get started, I just want to refer everybody to Page 2, the safe harbor disclosure and discussion of forward-looking statements.

And with that, we can jump into the presentation and start talking about our business. Before I get into the quarter itself, I just want to give you a little bit of an overview about how we do what we do.

One of the most important things to understand is that unlike other places that buy loans, over 90% of what we buy, we do it private negotiated transactions, not outbidding in competition at large public auctions. So it's really important to understand.

Our sourcing network is very, very important for our ability to acquire the types of loans we want, and in the places we want them and at the prices we pay relative to others. And as you'll see as we go through the presentation, that the price discrepancy versus market prices, especially for clean pay, loans is pretty substantial.

We're, to some extent, data geeks. We analyze large amounts of data to determine target loan characteristics for performance forecasting and for patent recognition in -- constantly updating models, and also for determining our target geographic markets. Typical acquisition is 25 to 100 loans somewhere between $5 million and $20 million.

We have bigger ones and we also have some very small ones. And we'll see more of that later in this presentation as well. Also important to understand is our captive servicer, Gregory Funding is extremely important and has a material contribution to the significant outperformance of our loans versus forecasted.

And as you'll see, the amount of cash flow that is coming off of our loans is far greater than expected. We look at everything loan by loan, asset by asset. We're not pool buyers. Even if someone shows us 100 loans, we model each loan separately, not together. We use moderate non-mark-to-market leverage.

We're much less levered than a typical -- our corporate leverage actually declined from the fourth quarter. We are at 2.37x at year-end, and were at 2.27x at the end of the first quarter, and that's primarily due to significant loan repayment and continued outperformance of cash flows on our reperforming loan portfolio.

We've also done 8 securitizations, totaling almost $1 billion. We have a great group of bond buyers. We like non-recourse fixed rate funding. Our group of bond buyers, many of which actually also co-invest directly in loans with us, we're in the process of working out a relationship like that.

We have been working on, with the rating agencies, on a rated securitization and we're actually also working on a new unrated securitization at this time. Jumping to Page 4, we can talk more about the quarter itself. It was a pretty quiet quarter as we discussed on the call in early March.

The first 6 or 7 weeks of the year, banks and funds were really just trying to get the lay of the land post-election. Until at least 2 or 3 weeks post-inauguration date, the loan market was very quiet. Starting about the third week of February or fourth week of February it picked up dramatically.

And as you probably see from the press release, and we'll talk about it later in this call, it's been very busy on the acquisition front, many transactions for us. Interest income is up to about $20.8 million, net about $13.2 million, just under $8.5 million the income to common.

One of the particular items in here was about $0.5 million of loan transaction expense, and that is basically due diligence expense for purchase transactions.

And you'll see, because first quarter is quiet, most of that expense relates to transactions that will close in -- either already closed in April or will close in May, so we get the expense related to due diligence, but we don't get the interest income in the first quarter.

If we had actually had normalized transaction expense for the quarter, earnings probably would've been $0.47 versus $0.46. Taxable income increased again over Q4 to $0.38. In Q4, 2016, it was $0.33.

We continue to see strong payment performance from our loan portfolio with significantly less redefault than expected as a result of this increase in cash collections. It's also increased taxable income. More cash collections is great for the market valuable loans, so it's great for implied NAV, net asset value.

It does however, extend duration and reduces the percentage yield on our portfolio, but if we're going to have a problem, the problem I want to have is having more cash flow than expected. Book at the end of March was $15.28, and we had about $30 million of cash and cash equivalents at March 31.

Of course, we did do a convertible issuance a few weeks ago. So cash increased gross of acquisitions made subsequent to that convert transaction. Collections off of our portfolio and real estate sales, about $36.25 million in Q1. That's up from about $29 million in Q4, 2016. So it's a significant increase.

And if you think about how $36 million really is, annualized that's $144 million. If you look at our carrying value, of about $840 million or $850 million, it's 16% to 17% of the carrying value of our assets just in 1 quarter. So a significant amount of cash flow. And as you can see, that had effect on taxable income as well.

On Page 5, our portfolio overview. The trend continues. We continue to increase our percentage of purchased reperforming loans. It's now almost 93.5% of our portfolio, while purchased nonperforming loans are creeping down and are only about 6.5% of our portfolio. And you can see it's similar from the property value side.

We also have about $40 million of either, for sale or rented real estate in our balance sheet. Talking specifically about reperforming loans. It's the largest part of our balance sheet. Reperforming loans continue to grow. If you look at our portfolio, our purchase price represents about 64.5% of the initial collateral value.

Keep in mind that's not including home price appreciation. And also 79% of principal balance. And when you think about the amount of cash flow these loans are throwing off, 79% of principal balance is really a pretty low price relative to where markets price in paying loans right now.

It gives us the ability, because of our sourcing and our servicing and the way we look at data to understand, it gives us the ability to play offense and defense at the same time. On the nonperforming side, we haven't really bought many nonperforming loans. We bought a few in the fourth quarter. It continues to decline as a percentage of our portfolio.

The remaining nonperforming loans are on our balance sheet at about 56% of the initial underlying property value, again no HBA. So we like the price, we own them. But we think reperforming loans are a better value at the marketplace for new acquisitions. From a target market, our target markets have not changed from Q4.

The data suggests still -- that they've stayed consistent. Our California continues to represent nearly 30% of our overall portfolio, with Santa Barbara and South being about 75% to 80% of that 30%. So about 24% of our portfolio, Santa Barbara and South in California.

And we expect the concentration of California to actually, marginally increase after the acquisitions in April and May. On the next page, I'll call it portfolio migration, and this is a really important dynamic. It's one of the benefits of significant relow or redefault on our reperforming loan portfolio.

If you were to look at the current UPB of loans that have paid 12 straight payments to us or 24 straight payments to us, it's about $475 million, which is up about $50 million quarter-over-quarter, which is a pretty remarkable increase just quarter-over-quarter.

The other -- a few other things I want to add is, this is a chart of payments made to us, not to prior servicers. So any loan purchased less than 12 months ago can't possibly have made 12 payments to us.

If you were to increase -- if you were to also take into account payments made to prior servicers for us, it would be close to 70% of our portfolio would have made at least 12 consecutive payments.

When you look at loans that have made 12 consecutive payments out in the marketplace, and in larger pools, we've seen a number of them trade in the fourth quarter, and then in -- the agency sold about $2 billion of them in late February, early March.

And then there are 3 or 4 large portfolios of clean paid loans that were sold in competition in April. We've seen these transactions be in the yields between 4% and 4.5% yields. Basically swaps plus 200 to 220.

Relative to where we own loans, about 79% of UPB, current clean paid loans trade somewhere about 10 points to 15 points higher than where we are carrying loans. So it has a significant impact on NAV.

And we've actually have looked at some of our portfolio, and subject to REIT rules, have thought about making some small sales as loans into that hot reperforming clean pay market. A few other things to talk about for portfolio migration.

All these loans that are paying 12for12 and 24for24 to us, in addition to increasing the cash flow to us each month and each quarter, the significant outperformance of these loans also lowers our cost of funding over time.

It enables us to do rated securitizations, it also enables us to do securitizations with a little higher advance rate and a little lower yield and also enables us to get cheaper repurchase agreement funding.

So you'll -- based on that, you will see -- you saw it in this quarter, and you'll see it over time, that our cost of funding is likely to come down because of the significant outperformance of our loans. As I mentioned before we're working with a few rating agencies and working through the process to do a rated securitization.

A rated securitization would, for those loans in the transaction, the idea is to set up a programmatic structure with the rating agencies. We expect that would reduce our funding cost by 1% to 1.5% for those loans over time.

And we've also begun working on an unrated securitization as well, and we think we'll be able to get similar leverage at lower rates as a result also. Now on Page 10, this is something that you see every quarter in our presentations.

It's another way to think about NAV other than just kind of where loans are, and clean paid loans in large pools, where they sell, which is how we talked about NAV on the previous page.

This is a way of saying, okay, how does the structured credit market value our portfolio? What does it say our portfolio is worth? We've updated this page to our 331 2017 portfolio, the structured credit market. Also, the way they look at this also has implications for what I'll call return on average equity.

If we were to sell all our subordinate bonds for a little less than current market -- and what we've used here is we've basically reached out to third parties for approximate marks on subordinate bonds.

If we were to sell them at a little less than current market, the return on average equity for our loan portfolio for our ownership would be extremely high. Basically, if we sold the subordinate bonds, we'd have about a $41 million basis and a $260 million portfolio of UPB.

When you think about that, it means that at cash basis, if we were to sell our portfolio, we'd have a cash basis of 4 points in UPB, which is -- would be remarkable on the leverage. Also, it would be a remarkable increase in NAV. If we look through the pages here, it's somewhere about $3 to $3.5 a share difference.

And you own 25% of UPB for 4 points and your underlying collateral, our loans are 94% reperforming and 70% of which are at least 12for12 in their current payment stream. On Page 11, talk about subsequent events. January and February, as we discussed, were pretty quite. Late February and early March, we were inundated with loan pools.

As of today, we've already closed 6 transactions and have 12 more scheduled to close in May and June. Our purchase price to collateral value continues to decrease rather than increase. We also expect additional small balance commercial loans to close in May and June that are in the pipeline and in the underwriting process.

So through last Friday, the end of April, we've already closed on just under $100 million of UPB, with almost $150 million of underlying collateral. So very low LTV loans. Purchase price 56% of collateral value, 84% of UPB. 500 loans, 5 transactions. So again, kind of that 25- to 100-loan typical transaction.

When you look at what's in the pipeline for acquisitions, we have 12 more transactions already agreed to, another 800 loans purchase price to collateral value, 60%. UPB of $164 million and collateral value of $240 million.

So we really have kept up the pace, and have really seen a number of banks and funds looking for liquidity for whatever reason in this quarter. We've had a number of sellers who need, for whatever reason, May 31 closings and we're able to accommodate that. We announced a couple of weeks ago, a $0.28 a share dividend.

Keep in mind taxable income in Q1 was $0.38 and in Q4 of '16 was $0.33. A lot of that came from the amount of cash flow coming off of our loans. And while taxable income is a lot harder to forecast than GAAP income, those are not unreasonable numbers. We already mentioned the convertible that we did a couple of weeks ago.

$87.5 million, about $84.5 million of proceeds. That money has been primarily put to work, on an unlevered basis, closing loans in April and over the next few months, so we get levered up as well for additional return on equity through our balance sheet. Last pages are our income statement and our balance sheet.

And with that, I'm happy to open up for questions..

[Operator Instructions]. Our first questioner today is going to be Jessica Levi-Ribner with FBR..

Just on the -- your last comments on the taxable income, with $0.38 of taxable income, and then your -- I'm just going to interpret what you're saying that, that's a reasonable number. There's a lot of room there for the dividend.

How do we kind of think about your policy?.

Sure. Kind of two pieces to it. One, obviously our REIT rule requirements, which are you have to pay out in -- for a taxable year, 90% of your taxable income. So that's one. Number two is our board is very bullish on the investments we're seeing. And so our expectation is that they will follow the 90%, not 99% or 100% of taxable income.

So it's -- if the dividend -- if the taxable income continues to be in the mid-30s or higher, obviously 90% of that number is higher than $0.28, and the dividend would have to go up. But we wouldn't want to tell people that we're going to pay 100% of taxable income. Our oard has told us that they're looking to follow the 90% of taxable income..

All right, fair enough.

And then, can we assume that some of the loans, the investments that you preannounced, that were in the pre-announcement, are actually moved to the second quarter?.

The -- well, in the announcement we made 2 weeks ago, we talked about how there was this -- a small number of loans closed as of March 31. And then, the 17 or 18 transactions scheduled for April, May and early June, we've closed -- in April, we closed, let me see, let me jump through the subsequent events page.

In April, we closed just under $100 million of the about $265 million we have under contract. And then, we have 12 more transactions that we expect to close a -- probably about 25% of them in the -- or to 30%, in the middle of May. We would expect about $60 million of that to close right at the very end of May.

And then, I would expect the balance to close in the first few weeks of June. At least that is what we see right now. And that's also subject to us not agreeing to acquire anything else other than these 17 transactions..

All right. Fair enough..

Which, I can't promise..

I understand. One last one is just, the price to the percentage of UPB that you're paying is going up.

Is that a function of kind of the competition you're seeing or the types of loans you're buying?.

Types of loans. We're actually seeing in what we buy, which is 3 of 3 through 11 of 11, we're actually seeing less competition than we used to see. The real competition that's been created is in nonperforming loan lands, where the prices have gotten much higher for -- but for different reasons.

Goldman Sachs has been the big buyer and for separate reasons. But in the performing space, it's really the clean pay, 12 of 12, MBA current. Those prices have continued to go up and competition continues to increase in that space. In our space, that's not what we're seeing. What we've done is we've gone out of our way to buy much lower LTV loans.

We're a little more neutral, in our opinion, on what housing markets will do. So as a result, we've gone out of our way to buy much lower LTV loans and to have our purchase price be a much lower number as a percentage of collateral value.

So if you look at our RPL portfolio, for example, on Page 6, our portfolio at the end of Q1 was 64.5% of collateral value. And if you look at our acquisitions, they're at 56% of collateral value. So we've reduced our purchase price relative to property value by 9 points, and that's on purpose..

And our next questioner today is going to be Steve Delaney with JMP Securities..

Congratulations on a lot of progress, at least -- both in the quarter, but post-quarter has been really exciting. Larry, so I'm looking at $84 million or so of net proceeds from the convert.

And when I look at what you've purchased, the $99 million and the pending, a little over $160 million, and let's just slap a $86 million point price on UPB, it looks like a cost of somewhere around $225 million. So that alone on the $84 million looks like leverage of 2.7x or whatever.

I mean your -- you -- I guess what I'm asking is, with this activity, do you think the $84 million will be fully deployed by June or do you think -- will you still have some dry powder after you apply all your financing?.

We'll still have some dry powder. We're -- with a couple of securitizations in progress, our expectation is the underrated securitization will happen in either May or June. And the rated will either happen in either June or September.

And between the execution that we are seeing in those markets and where our repurchase agreement refinancing availability is , we think that we'll have some additional cushion even after these acquisitions.

The one thing we have done, however, is we used the convertible proceeds to acquire these loans on an unlevered basis so that we're not paying interest on the convert and interest on financing until we, then, still lever those acquisitions themselves later on, at closing.

So the -- a significant portion of the convertible proceeds has been put to work on an unlevered basis already. And then, they'll be put to work on a levered basis, as May progresses and June progresses..

Got it. And credit -- you mentioned your securitizations, it seems like credit across the board has really tightened in. Just curious, as you've talked to the rating agencies or you talked to your senior note buyers, despite the fact that you were paying a higher price for UPB, are they -- 2 questions there.

Are they going to appreciate -- the note buyers, are they going to appreciate the lower price-to-collateral value, number one.

And number 2, do you think the spread tightening in the ABS market, that lower cost of funds, is that going to help you try to deliver the same kind of net ROE that you have been when you were paying 75% of UPB?.

Yes. There's no question that the spreads have tightened in ABS and that our ABS funding costs will be reduced upon both securitization, relative to repo as well as securitization in the call of previous securitizations, when we relevered them.

So it also, when we acquire loans, we have a much more -- much less attractive opinion of securitization market. So as a result, we don't assume the tightening of spreads when we're looking at things. We look at everything on an unlevered basis. So the tightening of spreads is only a good thing for us.

We expect the continued outperformance of our loans to reduce our funding cost, both on an unrated and rated basis. More so on a rated basis. We expect that could be as much as 1 point to 1.5 points per year on each loan that goes into a rated deal versus where it's funded now.

And on an unrated basis, we think it's probably about 0.5 points a year cheaper..

That's helpful. And one final thing, small balance commercial, you've always mentioned it but you seem to be talking about it a little bit more. Could you talk on the $2.5 million? Just give us some rough sense about rate and terms that you're seeing on those loans. And I'd love to know how you're sourcing those. You describe it as an origination.

So how do you connect with the borrower?.

Sure. Sure. One of the benefits of having a concentrated portfolio in basically 8 or 10 cities, is it enables us to have people on the ground and have a lot contact with people in those markets. It's also -- overlaps with where we want to have our small balance commercial, our inner-city small balance commercial.

So by being focused in the exact same markets is a big sourcing help. Number two, we have a lot of both institutional shareholders as well as bond investors, who refer people in those markets who are trying to get them into invest, they refer them to us, which is a big help.

From a economics perspective, the typical loan is approximately 2.5 years to 3 years. And yes, they tend to be relatively shorter-term. So call it 36 months. And they were getting a coupon somewhere between 7.5 and 9.5 and somewhere between 1 and 2 points..

Got it. Okay, very nice.

And is there -- have you already -- I know you don't have a high volume of these, but have you started thinking about possibilities of a credit line to finance these while you're carrying them?.

Yes. We already have a facility that we can put these on. We can put them on -- put them -- we can and have put some on our Nomura facility. We also in our securitization that we did in October of 2016, we actually, 12% of that securitization, it was 88% residential and 12% of it was small balance commercial.

So we put those in as of way of not having to aggregate a very large amount, where we could secure ties and lock in fixed-rate longer term financing. So we can mix them into residential deals if we want. We can't put 50% into a residential deal but we can put 10% to 20% into a residential securitization..

[Operator Instructions]. And our next questioner today Robert Dodd with Raymond James..

Larry, just first, a semi-housekeeping one. On the convert, obviously the coupon, 7.25, what's -- do you have an estimate yet on what the effective GAAP yield is going to be on that? I'm thinking somewhere in the, call it, 8.5 kind of range [indiscernible] and then the equity cost, is....

Yes. If you factor in -- if you split the convert into kind of what's the call option worth versus what's the bond amount, it's about 9%..

9%. Got it..

Now theoretically, as time goes by, the call option's worth a little less. That's just Black Scholes. But GAPP doesn't allow you to make that change..

Right. You're just stuck with more CapEx..

That's exactly right. The cost actually decreases over time, but not according to GAAP..

Right. On the other -- kind of following up on the other questions. When you look at the price of UPB, and you look at the price to collateral, obviously, like you said, the price to collateral going down, the price of UPB going up, but that's kind of evening it. I wouldn't say an even trade but a pretty deep and good trade.

When you look at the pricing, and you mentioned that the 12for12s you're seeing, that you may start to sell into 10 points to 15 points higher than where you've got -- where you acquired them.

What's -- is there a big variation there on what that price for those is depending on the price-to-collateral value or is it just the payment stream? So let's say, 12for 12 or [indiscernible].

The #1 thing is the payment stream. The buyers tend to be less loan interested than we are. For us, we hate losing money. So we're extremely cautious about the way we look at loans and we look at them one-by-one-by-one. And when we see -- when someone shows us $100 million, we end buying $50 million or $60 million and we pick the ones we want.

When you go out with a larger pool of clean pay loans, it's really more about where are the rating agency enhancement levels, based on characteristics. And the loans themselves, I don't want to say this and sound demeaning, but the loans are almost an inconvenience in the process.

It's really about where rating agency enhancement levels are based on certain loan characteristics. So when people are looking at the loans, they're looking at them based on the characteristics relative to the enhancement levels, not in what they like, which is a very different way of looking at loans. For us, it's the exact opposite.

We look at loans like -- as we have to own these forever. And if we have to own them, every single house, we have to be willing to do that, too. So it's just a different process. The -- if you look at -- coupon has a high yield impact. HSBC sold a portfolio of loans with a 7 coupon and that sold at around $104 million.

And then, there was a pool of $800-some million sold of primarily California loans, with a 4 coupon and that sold at $99.5 million. And then there was a portfolio of 12 of 12 or better clean pay that was weighted average LTV in the low-90s, and it had about a 3.7, 3.8 coupon and that's rated in the $94 million, $95 million range.

So really is based on characteristics of the loan versus where the rating agency credit enhancement levels are. And we can certainly reverse-engineer that for sales if we choose to. But for us, our bias is we like to own the loans we like. So -- and the loans we bought, we bought for a reason, relative to the loans we didn't buy.

And as a result of that, it's less -- when you see the purchase prices in these clean pay loans. It's less about price-to-collateral value than you would think. It's really about rating agencies have enhancement levels and then where something yields versus swaps..

Okay. Got it. Just one more if I can. On liquidity, you could sell some B tranches of securitizations. You've got some of these loans that you could sell. You've got Veo that you can sell. The question is, there's lots of things you could liquidate.

How would you rank where you -- what the probability -- obviously you've already said you plan on exiting the Veo but that's the smallest of the 3. But where would you rank those in kind of the order you'd like to do them and maybe the last? I am not trying to pin you down, just kind of rough idea [indiscernible] on the timing of those things..

Sure. Selling the REO, that's something we do consistently every quarter. And that's just as we get it, we renovate it, or rehabilitate it and then we put it up for sale and it sells, and that's just a process. The other 2 pieces, the subordinate bonds, we can -- we could sell them, we could put them on financing facilities also if we choose to.

It's relatively inexpensive financing, but it's mark-to-market and we, as a company, generally don't really like mark-to-market financing. But it's cheap financing if we wanted to use it. The other thing is selling some clean pay loans.

Obviously there's REIT rules and there's safe harbors and there's limited amounts that you can sell during certain periods of time.

And we never want to even be close to those REIT rules, because if someone comes to you with something that you can't resist, that you want to buy, you always want to have room, if you need to, to sell something to go buy back, because it's so much cheaper. I think we're probably -- the REO will just keep going.

And I think we'll do a little bit of everything. We'll do a little bit of financing our subordinate bonds and we'll do a little bit of selling some of the superclean pays..

Okay. Got it. And now, and weird question, right? Obviously when you exit these, on the clean pays, if you exit them on the GAAP level yield, it starts to affect that. You talk of the cash flow, obviously, and your liquidity.

It can affect your level of yield, depending on whether it -- where it is versus the timing that was built into the yield already.

Anything weird that we should look at there?.

That's right. I guess it's the -- I guess, it would have a positive impact on level of yield. It would also create some taxable income..

This concludes our question-and-answer session. I would like to turn the conference back over to Larry Mendelsohn for any closing remarks..

Thank you, everybody for joining us on our conference call regarding first quarter 2017. If anybody has any questions, feel free to reach out to us, and we'll answer whatever we can. And thank you, again..

The conference has now concluded. Thank you, all for attending today's presentation. You may now disconnect..