MMA Capital Holdings, Inc.
Q1 2013 Earnings Call Transcript

Published: 21 May 2013

[Operator:]

Good afternoon, ladies and gentlemen and welcome to the Municipal Mortgage & Equity, LLC First Quarter Conference Call. My name is Mike, and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We'll facilitate a question-and-answer session at the end of this conference call. Some comments today will include forward-looking statements regarding future events and projections of financial performance of MuniMae, which are based on current expectations. These comments are subject to significant risks, which include those identified in filings with the Securities and Exchange Commission, and uncertainties that could cause actual results to differ materially, from those expressed in these forward-looking statements. The company undertakes no obligation to update any of the information contained in the forward-looking statements. I would now like to turn the call over to Mr. Michael Falcone, CEO of Municipal Mortgage & Equity. Sir, the floor is yours.

[Michael L. Falcone:]

Thank you, operator. Good afternoon everyone and welcome. With me on the call today are Lisa Roberts, our Chief Financial Officer; and Executive Vice President, Gary Mentesana. Earl Cole, who normally participates in these calls, is traveling today, and unable to join us. Because our last investor call was held less than two months ago, our call today will be relatively brief, and will largely focus on a review of our first quarter results, which Lisa will cover shortly. Gary will spend a few minutes on our bond business, including the credit quality of our portfolio, and I will then close and take questions. The most notable item of discussion is our common equity balance of $94.8 million or $2.23 per share at March 31, 2013, which is $49.9 million higher than our common equity balance at year end 2012. Our common equity more than doubled during the first quarter of 2013 as compared to year end 2012, primarily due to a subordinate debt repurchase. As we discussed on our most recent call, during the first quarter of 2013, we repurchased the remaining $45.5 million of our subordinate debt, held by one lender for $17.4 million, which when combined with the prior repurchases from this lender, enabled us to recognize $37.9 million of additional common equity. In addition, our bond portfolio also improved in value by approximately $11 million during the quarter. Until last (inaudible) there have been no significant developments with respect to our international operations, and we continue to work with breaking escrow on our second South African fund. In terms of our bond portfolio, as we have emphasized in the past, a primary source of net income continues to be the interest income earned from our bond portfolio, less our interest expense, including the distribution to our preferred shareholders. Our bond portfolio is leveraged in the vast majority of our bonds that are pledged as collateral. At this juncture, we believe interest rate risk is our most significant business risk. We borrow money on a short term floating rate basis to finance our bonds, which are primarily long term and fixed rate. This differential or spread is how we earn money. A future rise in short term rates would increase our borrowing rate, while our income would remain unchanged. This would reduce our cash flow, and this reduction could be significant. Further, because our bonds are fixed rate, a rise in long term rates would decrease the value of our bonds, and thus cause our common equity to decline, while also increasing the risk in collateral costs, which would restrict our liquidity even further. We cannot adequately hedge the risk posed by rising rates. Therefore, we are exploring other ways to manage our interest rate risk, and once we have a clearer path forward, we will share that information with you. Before turning the call over to Lisa to review our first quarter financial results, I do want to take a minute to remind shareholders, that because we are passthrough entity for tax purposes, the disposition of bond investments through sales, redemptions, or securitizations, values in excess of an individual shareholders tax basis in the underlying assets, results in capital being allocated to such shareholders. Each individual shareholder's tax basis is a function of the price paid by the shareholder, to acquire shares of the company. The shareholder is most impacted by these capital gains, with those that bought the company's share, subsequent to the significant decline in share price, that began in 2008, typically referred to as low base of shareholders. And to hold these shares still in taxable accounts, shareholders should keep in mind that the capital gains that are allocated to them, will reverse and create capital losses upon the sale of their shares, which may or may not be in the same tax year. Shareholders are advised to consult their tax professionals for advise on these matters. Also shareholders should consult their tax advisor for advise on the appropriateness of holding shares in the company, in the tax deferred account, such as individual retirement account, rather than in a taxable account. I will now turn the call over to Lisa.

[Lisa Roberts:]

Thank you, Mike. Consistent with year-end, we have provided investors with a simpler presentation of our income statement, as part of our May 15 press release. I want to direct your attention to this summary, as my income statement remarks today will be based on that presentation. Our common shareholders' equity at March 31, 2013 was $94.8 million, as compared to $44.9 million at December 31, 2012. The $49.9 million increase in common equity, was mainly due to net income of $39.3 million for the quarter, largely driven by gains on extinguishment of debt. As Mike mentioned, during the first quarter, we repurchased $45.5 million of subordinate debt, for $70.4 million. At the repurchase date, the carrying value of this debt on our balance sheet was $56.9 million, which was higher than the legal amount due, because prior discounted repurchases will be recognized as the life of the debt, following the accounting for troubled debt restructuring. Because this most recent transaction resulted in the repurchase of all of the subordinate debt for this particular series held by single counterparty, we were able to recognize the prior discounted repurchases, as well as the current discounted repurchase. Common equity is also higher at March 31, 2013, as compared to year end, as a result of $11 million of gains recorded through other comprehensive income, which were primarily driven by unrealized gains recorded on our bond portfolio, as the yield continued to decline. At March 31, 2013, we recorded a cash balance of $58 million, which represents an increase of $7.1 million from our cash balance at year end. This cash amount include $47.7 million of cash held by TEB, a wholly owned subsidiary of ours that owns the majority of our bond portfolio. During the quarter, we generated about $4.8 million of operating cash and our cash balances increased another $2.3 million from net capital transactions. The more notable capital related transactions included the total return swap borrowing against our preferred share investment, which generated $36.6 million in proceeds that we used primarily to repurchase subordinate debt and to cash, collateralize a guarantee exposure that had been covered by a third party letter of credit. We also generated proceeds from TEB's preferred share issuance, most of which were used to repurchase and retire outstanding preferred shares, that had higher distribution rates than the new shares issued. Turning now to our income statement results; net income for the first quarter of 2013 was $39.3 million, up $35.5 million for net income of $3.8 million for first quarter of 2012, almost entirely due to the gain of $37.9 million recorded on the subordinate debt repurchase. The majority of our revenue is the interest income from our bond portfolio, and we recognized $17.1 million of interest income during first quarter 2013, which was down $800,000 from interest income of $17.9 million for first quarter of 2012, due mainly to declines in the size of the portfolio. At March 31, 2013, the weighted average pay rate was approximately 5.6% on the bond portfolio's unpaid principal balance of $1.1 billion. The income recognized from our preferred stock investment was $1.3 million for first quarter 2013, which was down $250,000 from first quarter 2012, due to redemption activity. At March 31, 2013, the weighted average pay rate was approximately 14.4% on the investment's outstanding balance of $36.6 million. As I mentioned earlier, during the first quarter of 2013, we entered into a series of total return swaps, which effectively provided us financing for these preferred shares, and at March 31, 2013, the weighted average pay rate on the $36.6 million on total return swaps was 4.3%. Asset management fees that we recognized from our South African fund, as well as our tax credit equity funds were $1 million for first quarter of 2013, which was down $700,000 from fees recognized in first quarter 2012, mainly due to lower fees from our South African fund, which declined pursuant to the terms of the fund documents. At March 31, 2013, we were earning fee from 1.5% on approved invested capital of $154.8 million. This core revenue was offset by interest expense, as well as operating expenses. During the first quarter of 2013, we recognized $12.7 million of interest expense, which was down $2.4 million from interest expense recognized during first quarter 2012, and is adjusted from our GAAP figures to include distributions on perpetual preferred shares, and interest paid on our interest rate swaps. The decline quarter-over-quarter was due to three main factors; one, we have been closing out our interest rate swap positions, and over the past year, we terminated or let expire interest rate swaps with a total notional amount of $283 million, which reduced our net interest expense by about $900,000. Two, over the past year, we had completed a series of transactions involved in TEB's preferred shares, including share remarketing, which had driven down our effective borrowing cost on the preferred shares, resulting in a reduction of interest expense quarter-over-quarter by about $800,000. At March 31, 2013, the weighted average interest rate was 5.4% on 253 million of outstanding preferred shares. Third, over the past year, we had completed several transactions with our subordinate debtholders, that have driven down our effective borrowing costs, associated with this debt, resulting in a quarter-over-quarter decline of about $600,000. At March 31, 2013, the weighted average effective interest rate was 7.2% on 142 million of outstanding subordinate debt. Operating expenses, which include salaries and benefits, general and administrative expenses, professional fees and other expenses were $8.8 million for the first quarter of 2013, up $2.4 million from $6.4 million in first quarter 2012. During the first quarter of 2013, our salary related expenses were higher than first quarter 2012 by about $800,000, as a result of certain employee stock option awards, which are accounted for under the liability method of accounting, whereby we mark-to-market invested the outstanding option award. At March 31, 2013, we have a liability recorded on our balance sheet of $1.4 million, whereas the liability was $400,000 at December 31, 2012. The increase during the first quarter is due to the increase in our share price. If these awards are settled in shares as opposed to cash, then our reported equity would increase by $1.4 million at that time. Other operating expenses were $1.3 million higher in the first quarter 2013, as compared to first quarter 2012, due to insurance proceeds collected in 2012 of $750,000 that were not repeated, and the nearly $400,000 of fees paid during the first quarter of 2013, related to TEB's preferred share remarketing. Other notable differences include loan loss recoveries of $3.4 million recognized during first quarter 2012, that were not repeated during first quarter 2013, as well as a gain of $2.9 million recorded during first quarter 2013, primarily related to bonds that were redeemed during the first quarter, whereas during the first quarter of 2012, we didn't have any bond sales or redemptions. We also recognized $1.5 million of a tax benefit during the first quarter of 2013, primarily related to a tax refund that we received in second quarter 2013. Effectively, we reinstated the full tax receivable balance at the end of first quarter 2013, when it became certain that we would collect the tax refund of nearly $1.8 million. I will now turn the call over to Gary.

[Gary A. Mentesana:]

Thanks Lisa. Looking specifically at the bond portfolio, the most significant first quarter events included the continued improvement in our bond portfolio evaluation, issuance remarketing and redemption of certain of our preferred shares, and one sizeable bond redemption. During the first quarter, we recorded $10.8 million of additional net unrealized gains on the overall bond portfolio, much of which was driven by our performing bonds, as market yields continue to decline. Our overall portfolio was priced just under par for 99.4% of unpaid principle balance or UPB at March 31. Approximately 80% of our bonds are performing, with no projected risk of future development. This portion of our portfolio has an average coupon of 6.25%, and at quarter end, the average market yield was 5.76%, which resulted in a premium pricing of approximately 104% of UPB. The remaining 20% or so of our bond portfolio is either defaulted or (inaudible) management as a potential risk of default, and therefore we value the underlying real estate securing these bonds, as a means of (inaudible). For this group of bonds, the pricing was approximately 83% of (inaudible). In February, TEB closed on both, an offering and a remarketing of its preferred shares with various existing and new institutional investors. TEB issued $74 million of Series A-5 shares, generating $73.3 million of net proceeds. These shares have a distribution rate of 5%, a maturity date of 2028 and are subject to remarketing on January 31, 2018. $70 million of these proceeds were used to repurchase and retire $70.2 million of shares then outstanding, with a weighted average distribution rate of 7.87%. Also in February, TEB completed the successful remarketing of its Series B shares, which have an outstanding principal balance of $47 million, reducing the distribution rate from 7.32% to 5.75%. As a result of issuing the new A-5 shares, and remarketing the existing B shares, TEB's weighted average distribution rates declined from 6.5% to 5.4% on the $253 million in liquidation [part and thus] shares outstanding at quarter end, thereby saving $2.7 million in annual distribution costs. Lastly in March, sizeable bonds were redeemed, which generated net proceeds to TEB at bondholder of $16.3 million, including contingent interest of $6.6 million, and resulting in a gain of $3.6 million of (inaudible) to common shareholders. As Mike mentioned in his opening remarks, the company bond portfolios are subject to interest rate risk, both from a valuation standpoint and from an earnings perspective. The company's bonds are predominantly fixed rate and generally as long-term rates rise, our bond values decline and vice-versa. Although TEB has $55.8 million of excess collateral pledged for its securitization debt at March 31, 2013, to the extent bond values decline in a material manner, we may be subject to collateral calls or other liquidity needs. If rates move materially, we might not be able to meet our collateral calls, as substantially all of our assets are pledged or restricted in some manner, which limits our ability to raise cash. In terms of earnings risk, substantially all of our bond-related debt is variable rate debt, and as a result, when short-term rates rise, (inaudible) cash flows will decline. Turning to the credit quality of our bond portfolio, the most notable event during the first quarter related to the new bond defaults. As Earl discussed during our last call, given that we have seen an overall improvement in the performance of the rental property serving as collateral to our affordable bonds, near the end of 2012, we started to see an increase in the number of defaulted bonds, due specifically to property developers from tax credit indicators, being unable or unwilling to continue to fund (inaudible). This trend continued into the first quarter. More specifically, based on UPB at March 31, 15.8% of our total portfolio was in [default], bonds that are 30 days or more past due in either principal or interest, which is up from 13.7% at December 31, 2012. This increase is due to four bonds of UPB of $19.9 million of (inaudible) in the first quarter. Despite an improving economy, housing market, and multifamily bond portfolio performance, there is risk of additional defaults among properties to operate significantly below breakeven. In our affordable bond portfolio at March 31, performing bonds with UPB of $69.9 million, representing 7.6% of our performing portfolio, we are operating with debt service coverage ratios of less than 0.9 times, and being kept current by a combination of property developers or tax credit indicators. However, keeping these bonds, because the property developers or tax credit indicators stopped reporting debt service, we would still expect to receive a substantial portion of a required debt service to each month from property cash flows, and we would have the right exercise our default remedies, including foreclosure. We have a number of reasons to expect that property performance will improve among the defaulted bonds. This expectation is generally due to the company's intensive asset management, which may include taking over a general partner of the underlying real estate partnership, or facilitating transfer of the general partner interest and a default property partnership to a third party. I will now turn the call back over to Mike. Mike?

[Michael L. Falcone:]

Thanks Gary. Consistent with the message shared with you in early April, we are at a point where our primary focus has moved from maintaining the viability of the company, to focusing on ways to increase shareholder value. Our efforts to create value, fall into three broad categories; first, through confident asset management, we will continue to look for opportunities to improve credit quality, and thereby bond in asset values. Next, while much of our debt restructuring is behind us, we will continue to pursue ways to reduce our financing costs; and finally, we are looking at new business opportunities, and ways to grow shareholder value, particularly in IHS. While we remain cautiously optimistic that these three activities will generate shareholder value, there can of course be no assurances given. In addition to growing shareholder value, we are also evaluating ways to mitigate our most significant business risk, which is the interest rate risk inherent in our bond portfolio in related financings. We thank our investors for their continued patience as we move forward. Before opening up the call for questions, I wanted to mention that we filed our proxy at the end of last month, and as a reminder for those on the call, as outlined in our proxy, we will hold our annual shareholder meeting next month, on Tuesday, June 18 at 1 p.m. at the office of Gallagher Evelius & Jones, here in Baltimore, Maryland. We will now open up the call to questions. Operator?

[Operator:]

Thank you, sir. We will now begin the question-and-answer session. [Operator Instructions]. Our first question comes from Mike Leconey of Bishop Rosen. Please go ahead.

[Michael Leconey:]

Thanks very much guys. Mike, thank you very much for your closing comments, it was exactly the question I wanted to ask. The opportunity number three of other businesses, because you've done quite a fine job with the asset management, and reducing financing cost. You're not going to look at opportunities, that's what struck myself and my colleagues here. The first thing that came to mind with us, aside from IHS, was you guys have a lot of -- you got a couple of big pieces of real estate rolled in, I guess, and you also have the opportunity to foreclose on a number of these underperforming properties, and I guess what I am really going at, when I look at your data, your financial data before 2008, your portfolio was producing around $0.30 a share of cash flow a year, and the other business was producing about $0.30, the real estate development and what have you, and of course that's sort of drawn free carefully, pretty closely, I mean, if you finish up just the debt retirement, you will have book value of $44, if you make 15% of that, $0.60 is a pretty good number. I guess in terms of that, without circling that number, which is to your respect, sort of worked out. I mean, you did make some -- can you start making money out of the real estate development business again?

[Michael L. Falcone:]

Well, we were in the development finance business previously, more than we were in the real estate development business per se. But you have identified that we do have several land assets, three come immediately to mind. The largest two of which are in Phoenix, London, Phoenix, and one is in Savannah. We are starting to see recovery in those markets, and we are starting to explore ways to maximize value there. But those are sort of long term -- realistically, those are longer term opportunities, and since we don't want to do, is sort of jump out of those too early. But we are spending a lot more -- with a lot of the sort of immediate financing concerns cleared away, we are able, as a sort of senior team, to focus more time on asset management. I have visited some properties that we financed recently, that are struggling or we have taken back, and they are all doing that today. So we are turning more attention to those areas of the business again, and we look forward to creating opportunities as a result of that.

[Michael Leconey:]

Okay. I mean, that's what I was thinking. You never pay attention too much with these troubled properties?

[Michael L. Falcone:]

Well there was a market function and then there was a sort of opportunity function. The market was a question of were these deals ready, in any way, shape or form [we've heard about]. And our first conclusion was, two instances I just described, no, and therefore we made those lower priorities. We are now going back and reassessing where we think those markets might be, certainly, good anecdotal evidence of recovery in Phoenix, and so we are trying to understand what that property could -- what we could do with that property over the intermediate term.

[Michael Leconey:]

All right, and I felt this is something -- you actually pointed out that it was time to start looking at other opportunities, wanted to begin the -- start a dialog. It will be interesting to, sort of thing I'd like to talk more about on the future conference calls. But sounds interesting. Thanks very much and congratulations on a hell of a job, so far this year.

[Michael L. Falcone:]

Thank you. And we will make a note to try to spend some time on some of those other assets that we haven't discussed much on this call.

[Michael Leconey:]

Right. I think people would enjoy that and find that very helpful. Terrific. Thanks Mike.

[Michael L. Falcone:]

Thank you.

[Operator:]

[Operator Instructions]. The next question we have comes from Clark Johnston, Investor.

[Unidentified Analyst:]

Yes sir. I was just curious if you might tell me, if you are anticipating distribution to shareholders of any kind?

[Michael L. Falcone:]

No we are not. It's the Board's responsibility to declare dividends and we do not -- the Board is of the view that we are not yet in a position, where we can afford to declare a dividend. So we don't see that in the -- foreseeable future, I think is the word we use in our disclosure document. But that's sort of where that stands.

[Unidentified Analyst:]

Okay. Thank you very much sir.

[Michael L. Falcone:]

Sure.

[Operator:]

Next, we have Greg Bennett, investor.

[Unidentified Analyst:]

Hi, how are you all doing today?

[Michael L. Falcone:]

Doing well. Thank you. How are you today, Greg?

[Unidentified Analyst:]

Good thanks. On the bond portfolio of the nonperforming bonds, they increased to, I think its $120 million if I am not mistaken, that's past due? Also -- in the bonds that are available for prepayment without restrictions of penalties at the end of March was almost $60 million? Are you familiar with that?

[Michael L. Falcone:]

Yes.

[Unidentified Analyst:]

All right. So the bonds that aren't working, that aren't default, the $122 million, are any of those included in the ones that could have been prepaid?

[Gary A. Mentesana:]

There may be a couple, but I would generally say no.

[Unidentified Analyst:]

So the bad bonds are bonds that didn't have the ability to -- I guess, what I am trying to get at is, of the $60 million that could be paid off as of March 31, and then April through December, that's another $40 million, have any of those paid off, after the quarter?

[Michael L. Falcone:]

No.

[Unidentified Analyst:]

None of them have, but those are performing bonds?

[Gary A. Mentesana:]

We are checking that fax. Generally, that's right.

[Unidentified Analyst:]

Okay. You all haven't been proactive as far as taking back properties yet? It seems like the idea of actually taking them back and managing them, when the developer -- I guess, when the developer gives up on cheating the negative cash flow of the property. Is that something that's going to change later this year?

[Michael L. Falcone:]

What we tend to do is take a deed and move a foreclosure and we view that for fairly complicated tax reasons, but in general what we want to do, is preserve the taxes and bonds in the way that we foreclose. So we have taken control through appointment of a property manager or other kind of steps like that, of a fair number of properties, and that we have -- lastly, the regional developer in place is really an awfully good reason for that. He or she is somehow supporting the property, even if it is in the fall, would be a prime example of that. So maybe, the shortfall is $40,000 a month, and then $20,000 or something. So we may keep them around in that sort of (inaudible). But each deal is looked at on its own merits, and each developer partner is looked at on their own merits, and we decide how to act.

[Unidentified Analyst:]

The bonds are attached to debt, if I am correct, the trend in that is just getting worse over the last year or two, am I right about that?

[Michael L. Falcone:]

It has gotten worse over the last year or so. There are sort of two reasons for that, one is deals that were -- particularly in Atlanta, we have had developers who supported the deals over the long term, just sort of ran out of gas, I guess, would be the most appropriate term, for supporting the deals and they left them in default. The other thing that's going on is, we are not -- in the past we would often sell the underlying real estate, or in a defaulted deal. And at this point frankly, within the bond sub, basically all we can do is invest in tax exempt bonds. There aren't a ton of great alternative investments, we have $50 million of cash in that entity right now. So there is no real need for cash. So often, the best investment we can make, is to sort of hold on to the bond, get control of the property, fix it up a little bit, do proactive asset management, but leave the bond in the soft, and not sort of flush it through the system in any way.

[Unidentified Analyst:]

In the -- it's the TEI subsidiary that has the subordinated bonds. Is there any cash down there, if you wanted to buyback bonds?

[Lisa Roberts:]

When you say the subordinate --

[Unidentified Analyst:]

The bonds that have been -- that started. You retired some bonds in this quarter I would discount, that materialized in the --

[Lisa Roberts:]

That's the subordinate debt. The borrower on that is not TEI.

[Gary A. Mentesana:]

The debt that was issued by another subsidiary, that is held by third parties.

[Unidentified Analyst:]

My question, do you have any cash available, if one of them wanted -- if somebody else wanted to do another deal, and sell their bonds back or retire their bonds, $0.50 or $1 or whatever?

[Michael L. Falcone:]

In general, right now, we do not have a significant amount of cash available for that. We have cash in PE bonds, which seem to be invested basically in tax exempt bonds. This debt is debt of our C Corp and is taxable, and we have various restrictions on getting cash out of PE bond sub. So we are limited in our ability to move cash out of PE bond sub to purchase debt. So the only cash that we have to purchase debt, is the cash that's generated out of PE bond sub, to return on capital as opposed to return of capital in PE bond sub. So sitting here today, as a practical matter, we don't have a meaningful amount of cash to buy in additional subordinated debt. Not to say that's not something we will try to look at and understand and figure out ways to get more cash to do that. But we also don't have willing sellers on the other side right now. So that's an ongoing discussion.

[Unidentified Analyst:]

Okay. Thank you all very much. Appreciate it.

[Operator:]

[Operator Instructions]. Well at this time, there appear to be no further questions. We will go ahead and conclude our question-and-answer session. I would now like to turn the conference back over to management for any closing remarks. Ladies and gentlemen?

[Michael L. Falcone:]

Great. Thanks operator. I just want to say, if you were to look at the numbers, you were to sort of obviously, probably conclude that the first quarter was a great quarter. In fact, the first quarter was really the culmination of -- but a culmination of years of hard work in terms of our process of buying the subordinate debt, it was sort of the last piece of debt that we were able to buy. There has been a lot of employees, who have worked very hard for an extended period of time, and we saw the benefit of that effort in the first quarter, and I just want to take the opportunity to thank them for their hard work, and thank you for your patience, as we have gone through this process of recovery, and we are going to continue to work hard to try to improve share price for you over the coming years. Thanks and have a good night.

[Operator:]

And we thank you sir and the rest of the management for your time. The conference call has now concluded, we thank you all for attending today's presentation. At this time, you may disconnect your lines. Thank you and have a great day.