Q3 2019 Earnings Call

October 24, 2019

The linked to this webcast is also in the Investor Relations section of our website an archive of this webcast and a replay of this call will be available through January 29 to 2020 details of the replay are included in yesterday's release with me today as Phil Reinsch, President and Chief Executive Officer, Robert Spears, Executive Vice President and Chief Investment Officer.

And landfill as senior Vice President and Chief Financial Officer before we get started I want to remind you that some of today's comments could be considered forward looking statements pursuant to the safe Harbor provisions of the private Securities Litigation Reform Act at 1995 and are based on certain assumptions and expectations of management for a detailed list of Alderwoods factors associated with that.

Our business please refer to our filings with the SEC, which are available on our website.

The information contained in this call is current only if the data this call October 24th 2019.

Company assumes no obligation to update any statements, including any forward looking statements made during this call with that I'll turn the call over to Phil.

Thank you Lindsay after a few brief remarks last will give a retail for the quarter and then we'll open the call.

Said repo rates have been stubbornly elevated relative fed funds for some time time now representing a headwind for financing spreads and earnings.

Further lower prevailing rates and higher levels of market volatility, we've had a negative effect on portfolio and swap valuations contributing to a 3.7% decline in book value this quarter and leading us to take a cautious approach to leverage levels and the deployment of 75 million in new.

The capital raised in early August .

Despite these market conditions fed funds cuts in July mid September and perhaps the ended this month will benefit us significantly and should contribute to stronger earnings in the quarters to come.

Right.

As a result of these efforts at September Thirtyth, the fixed rate on our swap book stood at 2.04% down considerably from an average fixed rate of two point, 14% during this quarter.

Which will lead to to significantly lower hedging costs in the quarter to quarter is to come.

I want to emphasize that while the mortgage prepayment levels. We experienced this quarter were higher rate of increase at under 15% quarter over quarter was significantly less than the overall, 40% increase in agency fixed rate speeds.

Further arm speeds actually declined for October versus continued increases in the fixed rate universe.

To wrap this up we are increasingly optimistic about our earnings prospects with mortgage prepayments moderating short term interest rates declining with no small help from the fed hedging costs declining attractive returns available on agency arms and dry powder things to cautious leverage management.

And our timely equity raise with that I'll turn the call over to Lance. Thank you Phil We reported GAAP net income of 3.2 million lives for a net loss of two cents per diluted common share. Our core earnings were 14.8 million or 11 cents per diluted common.

Sure the difference between our GAAP and core results this quarter, primarily relates to the impact of lower prevailing interest rates on our interest rate swap agreements and other derivatives held for hedging purposes. We include a reconciliation of these differences on page nine of our press release.

Yields declined primarily due to the effects of higher mortgage prepayment levels for cash yields were largely unchanged.

Four basis points lower than the prior quarter the benefits of a larger decline in on hedge rates and a lower fixed rate.

Book value decreased 33 cents per share during the third quarter, Indiana $8.60 per common share, reflecting a 23 cents decline associated with our hedging activities six cents in initial dilution related to our capital issuance in August and three cents and partially related pricing <unk> portfolio.

Related pricing changes with that we will open the call up two questions.

We will now begin the question and answer session to ask a question you May Press Star then one on your Touchtone phone.

We are using a speakerphone please pick up your handset for pressing the keys to withdraw your question. Please press Star then tail.

At this time, we'll pause momentarily to assemble a roster.

Our first question comes from Eric Hagen with KBW. Please go ahead.

Hi, Thanks, Good morning at what point did you guys reduce leverage during the quarter. It looks like there was a fair amount of nominal spread widening.

Which would suggest that you might actually want that leverage to capture the return available to you in a relatively more attractive spread environment I'm, just trying to get a sense for.

The timing in and kind of the nature of reducing leverage.

Sure I mean, we made a conscious decision during the quarter to take our leverage down just given what was going on.

In the market at that point in time, obviously, we raised 75 million in capital, we didnt feel the need to completely deploy that at that point in time.

It's been running high and there was this array in the repo markets.

So we just thought there might be some better entry points and if you look at where we are now in the fourth quarter spreads haven't snap back. So we have some dry powder.

To deploy a if we see some year end selling I'm, having said that given where spreads are right. Now we can deploy that in a three quarters to 90 area and get returns are comparable to what we were getting that nine half times leveraged a few months ago as you alluded to.

Because of the spread widened so we just think it's prudent at this point in time, given what's going on in the repo markets in Prepays to keep our leverage a little low.

Okay. So the capital raise in July was not was not use directly for de lever. It. It was the de levering took place after.

You know separate no we were weaken a penny to buy bonds throughout the quarter. We just didn't buy as many as we could add because we made a conscious decision to take our leverage down irrespective of the capital that we raise.

Yeah, I guess, so a lot of the return of Ah Ah.

Some of what we experienced in the second quarter with rates dropping and market volatility picking up and in that and help inform our decision making.

Okay that makes sense I guess could you have also captured in a sense that the same goal of reducing risk on the balance sheet by buying back some of your preferred stock with.

With the common that you raised in July I guess.

The rest look somewhat high that if prepays.

You know remain somewhat elevated in your book value remains under a little bit of pressure because of pay downs that the preferred and your capital structure will just continue.

Continue to consume a larger portion of your overall equity base.

And you guys have a fairly large chunk of preferred that's costing you more than your overall return on equity.

And I guess, there's no free lunch I realize that there's the potential to you know for that to hit book value. If you were to use come into buyback preferred but I'm. Just curious how you guys thought about the option to reduce leverage but the overall business level versus just de levering the common investor.

Unsecured borrowings that has about.

Almost 20 years to run.

The overall cost of that capital is pretty reasonable.

Seven three quarters, so a little bit under that.

And and that's that's pretty tough to replace in this environment, even the perpetual preferred market today.

It is a five year fixed and floating environment.

Which from a permanent capital perspective is we don't view it as nearly as attractive as as a perpetually fixed coupon preferred.

And at the levels that are getting done out there you wouldn't refinance that preferred with a new preferred.

In terms of using common equity to reduce our preferred equity drew a redemption of some sort.

You can do that but then you're giving up the the option of having that mezzanine capital out there when your overall returns exceed that preferred cost of capital and on the margin deploying that capital and.

From run off or or from the equity raise into new securities.

That is considerably higher ROI, we then that to preferred cost of capital such that over time.

We'll be earning in excess of the preferred cost.

That's the plan and that preferred will once again be accretive to our common returns.

Okay.

Again, if you have a question. Please press Star then one.

Our next question comes from Steve Delaney with JMP Securities. Please go ahead.

Thanks, and appreciate you guys taking my questions.

Robert I was wondering we look at fed funds today 180, the GCF RMBS ready to 193, or so where does that put your 30 day repo rate to you from the dealers.

What we're seeing right now on is around to go seven.

Okay.

And Oh, the spread basis that 10 to 20 basis points more than you would've expected. If those spreads would have just remain constant so having said that if if the fed cuts why people effect at the end of October we would expect that repo rate the drop to say 185 [laughter] hobbies.

And with you know given what we saw in September and I know the Feds responded aggressively but anything different this year as you approach you're in in terms of.

You got the yeah it'd be nice to lock in now, but you also want to wait for a rate cut which you know possibly doesn't come until December .

Yeah, well, probably proactively manage repo book or will we might extend some roles and if we see advantageous rates every year end, we might not you know we.

Primarily due 30 day stuff that we see 60 or 90 day rates it look attractive to get us over year end, we'll probably do some of that trade because it's anybody's guess as to what the funding markets are going to look like at year end I mean, I think with the Fed fund has been obviously a positive but it was pretty ugly.

Mid September through the end of quarter, and so I still think Theres a question of how much.

How much of that borrowing rate that that primaries are getting through the feds reap operations, how much of that they actually passed down to there either other intermediaries are two other counterparties. So we'll we'll just kind of look at that as we go buy we will probably also positions.

Early just to make sure. We are book is in good shape your.

At the margin issue and you brought I know, you're you're not looking to actively redeploy but at the margin what type of net interest spread or would you say you're looking at today.

I'd say, we're probably looking at kind of the 90 to 95 basis point area, which as I as I mentioned, Eric earlier, even in a three quarters nine times leverage that's still throwing off 10.5% to 11% type returns.

So.

We we have some dry powder to take advantage. If there are opportunities in the fourth quarter and we are looking to do that so spreads are.

Right, you've got a little flexibility there if you saw great opportunity. So yes, and one last my last thing I've. Obviously I have we have here are some work to do on air premium amortization, you you guys beat us handily in this quarter. So so congrats.

I'm trying to rationalize the fact that you've moved to a more stabilize lifetime approach, but yet in the quarter you lost six basis points, which you attributed primarily that declined to 76 from 282, you attributed to higher pre pay so I'm I'm sort of trying to rationalize sort of.

Calculation.

I don't know what all we can tell you is you know we're amortizing.

Uh huh.

You are seeing less you're seeing a more or less.

Aggressive amortization of our premium Ben and from years ago.

I think hours, that's absolutely right that's the way it should be.

Well I would try to give a data point that would help you get their bye bye, indicating what our average fixed swap rate was a two point 14%.

Q3 2019 Earnings Call

Request a DemoDemo

FBRT

Franklin BSP Realty

Earnings