Kelly Residential & Apartment Real Estate ETF
Q3 2013 Earnings Call Transcript

Published: 22 Oct 2013

[Operator:]

Good day, ladies and gentlemen. And welcome to the Altisource Residential Corporation Q3 2013 Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. (Operator Instructions) As a reminder, this conference call is being recorded. I would now like to introduce your host for today’s conference, Ken Najour, Chief Financial Officer. You may begin.

[Ken Najour:]

Thank you. Good morning, everyone, and thank you for joining us today. My name is Ken Najour and I am the Chief Financial Officer of Altisource Residential Corporation, which we refer to as Residential. Before we begin, I want to remind you that a slide presentation is available to accompany our remarks. To access the slides, please log on to our website at www.altisourceresi.com. These slides provide additional information investors may find useful. As indicated on slide one, our presentation may contain certain forward-looking statements pursuant to the Safe Harbor Provision of the Federal Securities Laws. These forward-looking statements may be identified by reference to a future period or by use of forward-looking terminology. They may involve risk and uncertainties that could cause the company’s actual results to differ materially from the results discussed in the forward-looking statements. For an elaboration of the factors that may cause such a difference, please refer to the risk disclosure statement in today’s earnings release, as well as the company’s filings with the Securities and Exchange Commission, including our year-end December 31, 2012 Form 10-K, our first and second quarter 2013 Form 10-Q’s and the third quarter 2013 Form 10-Q we will file today. If you’d like to receive news releases, SEC filings and other material via e-mail, please register on the Shareholders page of our website using the e-mail alerts button. As indicated on slide two, joining me for today’s presentation are Bill Erbey, Chairman of Residential; and Ashish Pandey, Chief Executive Officer of Residential. I would now like to turn the call over to Bill Erbey. Bill?

[Bill Erbey:]

Thank you, Ken. Good morning, everyone, and thank you for joining us today. It’s a pleasure to share with you Residential’s third quarter results. As we previously highlighted, our business model was predicated upon our ability to acquire single-family properties at attractive returns, managed properties in our rental portfolio effectively and a cost significantly below the industry and raise capital at accretive pricing. During the quarter we continue to deliver on each of these critical aspects of our business model as shown on slides three and four. First, we agree to acquire 2,966 non-performing loans, with a total of $922 million of unpaid principal balances and $790 million of underlying property value that we believe meet our return targets. With the closing of these acquisitions, our non-performing loan portfolio totals 6,300 loans with $1,560 million an unpaid principal balances, $1,270 million at market value of underlying properties and $850 million in book value. Second, we successfully completed our second accretive equity offering, raising a total of $350 million. We also added $325 million an additional borrowing capacity at attractive rates. We expect that with the equity capital available to us at our target leverage and acquisition discount. We’ll be able to acquire loans with an additional underlying property value of approximately $1 billion. And third, we met our targets for loan resolution, renovation and leasing in line with the cost, time and return assumptions we used in our business model. I'm pleased with these achievements which underscores the strength of our differentiated business model. The strength of our business model was also demonstrated by our financial performance. Slide eight highlights our financial results for the quarter. For the quarter the company earned GAAP net income of $13.7 million or $0.53 per share and taxable net income of $5 million or $0.20 per share, representing increases of 162% and 53% over second quarter GAAP and taxable income, respectively. We also declared a quarterly dividend of $0.10 per share, which was paid at the end of the third quarter. It's important to note that with the passage of time, we would expect GAAP net income to be converted into taxable net income. We believe that our differentiated acquisition strategy, a lot of us to acquire loans and properties at a meaningful discount relative to the REO market. Today we believe that we’ve been able to achieve an average discount of 17%. Based on our experience and the visibility we have into the pipeline, we currently believe that this level of discount will be sustainable into the foreseeable future. Today, we acquired or agreed to acquire loans with an aggregate underlying property value of approximately $1,270 million. As shown on slide five, using our 17% discount estimate, we believe we've added of approximately $220 million of additional value to our shareholders that is not currently reflected in our book value. If realized, this discount would add approximately $5.20 of value per share. If we fully invest the capital we have available today on the same terms, the additional value would be $7.30 per share. Please note that the $7.30 assumes that we will not raise any further equity to fund the cost required to take the loans through the foreclosure process. If we would relax this assumption, the additional value would be $7.90 per share. Based on our current target resolution timelines, we believe a significant part of this value will be realized into income within 24 months of acquisition as our loans were resolved. To summarize, I'm pleased with what we've accomplished so far and I look forward to the rest of 2013 as we continue to execute our business strategy. Ashish will provide more detail on our investment activities during the quarter and Ken will provide details on our financial performance. With that, I'll now turn the call over to Ashish. Ashish?

[Ashish Pandey:]

Thank you, Bill. Good morning and thank you again for being on today’s call. I plan to spend a few minutes discussing non-performing loan pools for which our bidding efforts were successful in the third quarter. I will also update you on the performance of our existing non-performing loan pools. In the third quarter, we agreed to acquire our non-performing loan pool comprised of 2966 first-lien mortgage loans having $922 million of unpaid principal balance and $790 million of market value of the underlying properties. We completed the acquisition of this pool in September and October for a final amount of 2,647 loans having $821 million of unpaid principal balance and $702 million of market value of the underlying properties. For these loans, we bid $474 million or approximately 68% of the market value of the underlying properties. As shown on Slide 6, the vast majority of the loans in this pool were 90 plus days delinquent or in foreclosure on the acquisition cut-off date. The top two states by unpaid principal balance are California and New Jersey, which collectively account for 46% of loans by unpaid principal balance. In addition, we completed the previously announced acquisition of HUD and SerVertis pool comprising 2,270 first lien mortgage loans and REOs with $308 million of market wide view of underlying properties. I'll now spend a few minutes updating you on the performance of our NPL portfolio. The performance update relates to the 1400 loans we acquired in the first and second quarters. We expect that fourth quarter results will reflect in part of our resolution performance on the loans acquired in the third quarter. Please turn to Slide 7 for performance highlights. As you can see as of the end of the quarter, we successfully resolved 118 loans with $29 million in unpaid principal balance. Of these loans, 43 loans were converted to REO either through foreclosure or deeds in lieu. 31 loans were released -- were resolved via sharp sales and third-party sales resulting in proceeds of $7 million representing 96% of average BPO values. 30 loans were modified and rendered current. Four loans were refinanced generating approximately $900,000 in net proceeds. Six loans were reinstated i.e. the borrower made all delinquent payments. Four loans were repaid in full by their respective borrowers. In addition at the end of third quarter, 89 loans were on trial modification plans. The gain we realized from these liquidations is almost double the amount of gain we would have realized from a loan resolution through foreclosure. Overall, we are happy with the progress we have made in resolving loans and expect to report resolution of more loans next quarter. For the fourth quarter, we continue to see a very large supply of non-performing loans in the market and we are actively reviewing these pools for acquisition when the characteristics of pools meet our investment criteria. I would now like to turn the call over to Ken. Ken?

[Ken Najour:]

Thank you, Ashish. Today, I'll provide more detail on our financial performance for the third quarter of 2013 and review our taxable income and discuss our liquidity and funding position. As you can see on Slide 8, we reported net income of $13.7 million or $0.53 per share for the quarter. Our book value per share at the end of the quarter was $16.94. Total net investment gains for the quarter were $19.6 million. This can be divided into three components. First, we realized cash gains of $1.9 million from the resolution of 55 loans. Second, we recognized $1.8 million in unrealized gains driven by material changes in loan status. During the quarter, we converted 43 loans to REO status. Upon conversion of these loans to REO, we marked these properties to the most recent market value plus selling cost in the case of REO held for sale in accordance with GAAP. Third, we accreted $15.9 million of discount and expense which were priced into the acquisition as discounts to market value and represent time value of money and servicing expense incurred as property proceeds to the foreclosure process. The judgment embedded in this item is the estimate of time it takes to foreclose on a loan in various jurisdictions. During the quarter, we recorded $6 million of expenses which includes the following three items. $2.2 million of servicing costs which includes approximately $600,000 of contractual servicing fees payable to Ocwen and $1.6 million of reimbursement of servicing event made by Ocwen on our behalf to cover insurance and other expenses, $1.3 million of reimbursable expenses to AAMC and $1 million of due diligence cost. We intend to elect and qualify to be taxed of the REIT in 2013 and quarterly dividend are intended to satisfy the requirements that our REIT must distribute at least 90% of its annual REIT taxable income to its shareholders. As you can see on Slide 9, residential’s total estimated taxable income for the third quarter is $5 million. We reconciled GAAP net income to taxable income in the following steps. First, we reversed our entire unrealized gains of $17.7 million from GAAP net income, since most of these gains are not taxable. These gains will become taxable over time as they become realized gains. Second, we have the following amounts, $3.8 million of income for gains on modified loans and $2.1 million of income from gains on conversions to loans to REO. These material changes in loan status that is converting non-performing loans to performing status or securing titles to its underlying property are considered taxable events. $1.6 million of certain advances made on behalf of borrowers that are capitalized for tax purposes and $1.5 million of interest income on advance recoveries and other items. Under GAAP, such amounts of cash collected are recorded as a reduction to our basis and loan. However, these amounts are reported as income for tax purposes. We expect the net cash flow we generate to exceed our taxable income and hence adequately cover any distributions we have to make as a REIT. As you can see on Slide 10, for the nine months ended September 30, 2013, we generated $21.6 million of cash flow from loan dispositions and repayments, and used a total of $9.7 million in operations and estimate to use $1 million for property renovations, leaving us with a net cash flow of $11 million. Residential taxable income for the first nine months of 2013 is estimated to be $6.4 million. The remaining cash flow of $4.6 million is available to be recycled into new acquisitions. I would now ask you to turn to Slide 11 where we have provided additional details on our financing arrangements. We completed two new purchase facilities and added $325 million of borrowing capacity, and have a blended advance rate of 63% and funding cost of LIBOR plus 300 basis points, which are more favorable than the 50% advance rate and the 4.5% all-in funding cost contemplated in our business plan. We expect that with the remaining equity capital available to us at our targeted leverage and acquisition discount, we will be able to acquire loans with an additional underlying property value of approximately $1 billion. At the time, we would like to open the call up for questions. Operator?

[Operator:]

(Operator Instructions) Our first question comes from the line of Dan Oppenheim with Credit Suisse. Your line is now open.

[Dan Oppenheim:]

Thanks very much. I was wondering if you can talk little bit about some of the first kind of portfolios that were acquired at the 1,400 loans. You showed the resolutions during the quarter, which was very helpful. Thinking about the remainder of loans there, is there any update in terms of how you think about the overall timing to resolution, or in terms of the mix of those loans stuffed into REO status than your converged rentals disposed at that point?

[Bill Erbey:]

Ashish? Would you take that?

[Ashish Pandey:]

Sure. Dan, Ashish here. So 1400 loans where we reported the performance, we feel pleased with what we have achieved till date. I think we are meeting our targets. On the loans that we announced that we have agreed to acquire during the second quarter, those loans were acquired in the third quarter and both of the pools as well as SerVertis boarded during the month of September with our service at Ocwen. So there has been very limited time or no time in which Ocwen could have worked on these loans. But as we go into fourth quarter, we will report performance on those particular pools also.

[Dan Oppenheim:]

Thanks. In terms of just the overall environment you talked about many pools that you are looking at, are you seeing -- how you seeing the competition in terms of pricing forward given somewhat tough environments for some of those in terms of raising capital in the environment overall? Are you seeing anything coming from this competition for at any better pricing?

[Ashish Pandey:]

Sure. So we are evaluating a pipeline in excess of $5 billion of UPB in the near term. There is a significant amount of activity from sellers to date and we expect that fourth quarter NPL trading volume will be the highest in 2013. We are optimistic that this quarter will provide us many attractive investment opportunities. Just given the sheer volume that we expect to get sold in the quarter, we think that technicals will either allow pricing to remain stable at the levels where it was in the prior quarters, or probably we can end up seeing some decrease in the price that these non-performing loan pools are sold.

[Dan Oppenheim:]

Thank you.

[Operator:]

Thank you. And our next question comes from the line of Jade Rahmani with KBW. Your line is now open.

[Jade Rahmani:]

Thanks. When I take the 6,300 of loans and the $850 million of book value, equates to an average price of $135,000 per property. Is this the value that is at a 17% discount or are they embedded costs included in that? And then secondly over the course of time, what percentage of additional costs you expect to incur including foreclosure costs and the initial CapEx on properties that you end up renovating?

[Ashish Pandey:]

Jade, Ashish here. The property -- $630 million and $850 million which you are referring to, they referred to actually 66%, that’s not 83 -- 68%, not 83% number. So that’s effectively the price that we paid there of the property value.

[Jade Rahmani:]

The $850 million in book value is the pricing that you paid?

[Ashish Pandey:]

That’s correct.

[Jade Rahmani:]

Okay. So $850 divide by 6,300 is $135,000. Right?

[Ashish Pandey:]

Right.

[Jade Rahmani:]

So is that $135,000 at a 17% discount to market value?

[Ken Najour:]

No. It’s at a 34% discount to market -- 32% discount to market value.

[Jade Rahmani:]

Okay. And then, you expect the -- essentially half of that to be cost that you incur through the foreclosure process, half of the 34% discount?

[Ken Najour:]

Well some of it -- and most of it is -- lot of it is time value of money. So it’s -- it would accrete from the 68 to 83, most …

[Jade Rahmani:]

Okay.

[Ken Najour:]

…time value of money associated with it.

[Jade Rahmani:]

So in terms of the actual cost basis of the properties that end up in your rental portfolio, what do you think of a reasonable number is to assume, is it, I think, $15,000 of CapEx added to the $135,000 plus additional costs to go through the foreclosure process?

[Ken Najour:]

Ashish.

[Ashish Pandey:]

Yeah. That would be the correct way of looking at that number.

[Jade Rahmani:]

So that would be an average price of, I think it would be about a $165,000 -- the average cost?

[Ken Najour:]

If you take the 135, right, you can divide it by 68, eighty thirds and add 15,000 to it.

[Jade Rahmani:]

Okay. And then regarding your NPL portfolio, can you talk about how far into the foreclosure process most of the loans are? I assume some of the loans are already in some stage of foreclosure. So essentially what a weighted average resolution time horizon would be?

[Ashish Pandey:]

Jade, I don’t have that number right in front of me but we can follow up on that. Most of the loans that we acquired have been in various states of foreclosure. So you will find in many instances that 30% to 40% of foreclosure has been completed except when foreclosure has not been initiated or has been put on hold.

[Jade Rahmani:]

Okay. And lastly, do you have the percentage of the NPL pools that are in Florida? I thought previously Florida was the largest state, so I think the recent acquisitions have a different geographic distribution?

[Ashish Pandey:]

Yeah. You will find that in 10-Q. I think we -- we have disclosed that in 10-Q. By geography our portfolio -- what we were disclosing here was just the pool that we acquired during the third quarter.

[Jade Rahmani:]

Okay. Great. Thanks a lot.

[Operator:]

(Operator Instructions) Our next question comes from the line of Mike Grondahl with Piper Jaffray. Your line is now open.

[Mike Grondahl:]

Yeah. Just a couple of questions, guys. Could you talk a little bit about the sources of supply? Is it banks, is it government agencies and just sort of the number of bidders and sort of the intensity of competition that you are seeing and then I just have a follow up or two?

[Bill Erbey:]

Ashish, would you like to do that?

[Ashish Pandey:]

Sure. So Mike, sellers remain large money center commercial banks, government and in certain instances certain private equity funds which are exiting the business. In terms of intensity of competition, we continue to see four to five credible competitors who compete on these large-sized pools.

[Mike Grondahl:]

Okay. And then earlier you mentioned the $5 billion UPB pipeline and I think you mentioned that you had a billion dollars of liquidity or you could purchase a billion dollars of market value or is it of UPB. Can you just kind of clarify that amount and the sources of liquidity?

[Ashish Pandey:]

Sure. So that was a billion dollar of market value for underlying properties which should translate to like $680 million of investment assuming 68% purchase price.

[Mike Grondahl:]

Okay. And what’s the source of that liquidity? I mean, I think I see about a $100 million on the balance sheet and the rest of it debt?

[Ashish Pandey:]

You don’t see the $350 million that we raised during at the end of the quarter that came -- the money came on the 1st of October. You are not seeing that $350 million in there, Mike.

[Mike Grondahl:]

Okay. So it’s -- got it, got it. And then lastly, the last slide talks about an advance rate of 63%, could you talk -- I mean, does that mean you are going to use 63% debt going forward 37% equity, can you talk about what your plan is there and sort of your comfort level with debt?

[Ashish Pandey:]

Mike, we may step up -- Mike, we may step up a bit when we are acquiring these pools and if we feel that having a couple of tens of millions will help us make a bid on a bigger pool which we would have lost otherwise or would not have made a bid. But I think in long run you should see us inching up our leverage from 55% to 60% until and unless we have a significant proportion of rental portfolio. Once we have rental portfolio which is producing income we feel more comfortable taking up more debt because we will use securitization financing at that point of time.

[Mike Grondahl:]

Okay. Thank you. Congrats on the quarter.

[Ashish Pandey:]

Thank you

[Operator:]

And our next question comes from the line of Adam Chud with Capstone Equities. Your line is now open.

[Adam Chud:]

Hi. Good morning, guys. I have a question regarding a revenue or income statement item. On the net unrealized gain on mortgage loans, it seems like most of the income from the income statement is generated from this item. Just kind of understand how that income -- how that item comes about and how we should estimate it going forward?

[Bill Erbey:]

Yeah. So a good way to look at the unrealized gain on mortgage loans is in our prepared remarks, we talked about the conversion of a material change in loan status. And so the conversion to REO properties can be taken right of the top that we know of roughly $2 million. And then if you look at the balance of loans on our balance sheet, as you go into the quarter was about $160 million. And if you take our weighted average cost of capital of about 9% or 10% against that amount, that gives you a good indication of how much of their earnings were accreting through the time value of money and by working the loans through sort of a resolution strategy.

[Adam Chud:]

If you are taking that kind of gain, how does that effect the cash flow when you turned it into an REO and then you turned it back into rental property, how does that affect your income statement?

[Bill Erbey:]

So it converts to REO that we are going to keep in our rental portfolio, then that’s not turning into a cash gain for us immediately. But on the balances of loan that we are liquidating to our other resolution strategy, that is giving us more than adequate cash flow in order to satisfy our daily requirements in our operating needs.

[Adam Chud:]

In our prepared remarks, Ken, why don’t you go through that? And that’s why we gave you the information, as to how much free cash flow we are generating over and above the dividend.

[Ken Najour:]

Yeah. Adam, we tried to illustrate that, Adam on Slide 10 of the prepared remarks, where just from mortgage loans and dispositions, here to date, we’re generating $21.6 million of cash inflow and then if we take out roughly $10 million for operating expenses and renovation expenses, it’s leaving us with $11 million to cover distribution requirements.

[Adam Chud:]

Okay. Fair enough. Thank you.

[Ken Najour:]

The unrealized gains are GAAP income. They are not taxable income. And I think one thing about this model is, it’s very elegant is that, as we began to move these loans through the whole resolution process then we do generate increases in not just taxable income, but we also generate net free cash flow that you can then reinvest back into more properties over and above.

[Adam Chud:]

As you are selling -- as you are selling loans.

[Ken Najour:]

As we are selling loans or as we are getting -- as we are selling properties and those will generate cash.

[Adam Chud:]

You resolved the 118 loans, is that correct?

[Ashish Pandey:]

That’s correct.

[Adam Chud:]

And I thought you were on target for keeping 70% of the loans and turning term into rental homes but seems like you are…

[Ken Najour:]

No. We said with 15%, would be basically converted. It would be resolved as a loan. Of the remaining 85%, 50% would go through into rental pool and 35% would be disposed off this REO.

[Adam Chud:]

Understood.

[Ken Najour:]

Adam, if you..

[Adam Chud:]

But it looks like it’s a lot less than you originally kind of guided.

[Ken Najour:]

Say that again, please?

[Adam Chud:]

No. It seems like you are resolving or selling more loans than you had originally anticipated. As far as your -- as a percentage of loans, you keep as, you plan on keeping as rental properties

[Ken Najour:]

We are doing a better job of resolving those. But keep in mind more of the resolutions occur on the front end. But we are at least making our assumptions today and that’s actually very positive because resolving the loan is virtually….

[Adam Chud:]

Is more profitable, right?

[Ken Najour:]

It’s a 100% return on equity, so if we see and resolve all these loans, we will go a slight upper.

[Ashish Pandey:]

Adam, if you were to look at the loans that do not fit your rental portfolio, you want them off your book as soon as possible to generate more value for yourself. If you want a property in the rental portfolio and there is not a resolution which is possible with borrower, you just need to go through the process of foreclosure and getting the title. So it’s much longer timeline. You can't short-circuit that timeline except attempting a deed in lieu.

[Adam Chud:]

Understood. I think that’s all my questions.

[Ken Najour:]

Thank you.

[Operator:]

(Operator Instructions) And we have a follow-up question from Jade Rahmani with KBW. Your line is now open.

[Jade Rahmani:]

Thanks. I want to find out, are there any deals that are currently in contract that were previously disclosed that have not yet closed?

[Ashish Pandey:]

No, Jade, everything that was previously announced has been closed.

[Jade Rahmani:]

Okay. Thanks very much.

[Ashish Pandey:]

You are welcome.

[Operator:]

And I’m showing no further questions at this time. I would now like to turn the call back over to management.

[Bill Erbey:]

Thank you very much for your interest and support. And everybody have a great day. Good bye.

[Operator:]

Ladies and gentlemen, thank you for participating in today’s conferences. That concludes today’s program. You may all disconnect. Have a great day, everyone.