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Edited Transcript of RESI earnings conference call or presentation 8-May-19 12:30pm GMT

Q1 2019 Front Yard Residential Corp Earnings Call

Frederiksted May 23, 2019 (Thomson StreetEvents) -- Edited Transcript of Front Yard Residential Corp earnings conference call or presentation Wednesday, May 8, 2019 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Alysia Cherry

Front Yard Residential Corporation - Head of IR

* George G. Ellison

Front Yard Residential Corporation - CEO & Director

* Miles Adams

Front Yard Residential Corporation - SVP of Property Operations

* Robin Neil Lowe

Front Yard Residential Corporation - CFO

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Conference Call Participants

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* Douglas Michael Harter

Crédit Suisse AG, Research Division - Director

* Jade Joseph Rahmani

Keefe, Bruyette, & Woods, Inc., Research Division - Director

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Presentation

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Operator [1]

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Good afternoon, ladies and gentlemen, and welcome to the Front Yard Residential Corporation's First Quarter Conference Call. (Operator Instructions)

I would now like to turn the conference over to your host, Ms. Alysia Cherry, Head of Investor Relations.

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Alysia Cherry, Front Yard Residential Corporation - Head of IR [2]

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Thank you, Joy. Good morning, and thank you for joining us for Front Yard's First Quarter 2019 Earnings Conference Call. Joining me on today's call is George Ellison, Chief Executive Officer; Robin Lowe, Chief Financial Officer; and Miles Adams, Senior Vice President of Property Operations. I'd like to guide everyone to the first quarter earnings slide presentation available through the Investors section of our website at www.frontyardresidential.com. These slides were created to accompany the company's remarks and provide additional information investors may find useful.

I'd also like to inform you that our comments today may contain forward-looking statements relating to the future performance of our business, the company's financial results, capital allocations and other nonhistorical information. These statements may involve risks and uncertainties that could cause the company's actual results to differ materially from those discussed in the forward-looking statements. We describe some of these risks and potential differences in our earnings release as well as the company's filings with the SEC, including the Form 10-Q we filed today.

We may also discuss certain non-GAAP financial measures. You can find additional information on these measures, including a reconciliation to GAAP, within our earnings release and earnings presentation located in the Investors section of our website.

I'll now turn the call over to George Ellison, Chief Executive Officer. George?

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George G. Ellison, Front Yard Residential Corporation - CEO & Director [3]

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Thanks, Alysia, and good morning, everyone. It's been another very productive quarter at Front Yard Residential. The financial and operational results have continued to improve this quarter as projected when we spoke in February. The transition of our homes onto our host platform is effectively complete months ahead of schedule, and we're pleased to announce today that another of our main strategic goals has been achieved.

Front Yard Residential and Altisource Asset Management have agreed to a new contract. We'll cover the details later, but the bottom line is that we've created a much simpler straightforward contract, one that controls G&A costs as we grow and drives key expense ratios to industry standards. Controlling G&A costs along with transparency and simplicity were key goals of this new deal. In addition to managing expenses, the 2 sides worked together to build a fair termination option into the contract. This feature along with just about every other component of the deal was vetted by Board and outside advisers to match or exceed industry conventions and to ensure that the new arrangement was a market deal. I think you'll find, as we walk through it, it compares very well to other externally managed REIT contracts.

We promised to unlock shareholder value by building the largest public single-family rental REIT focused on workforce housing, and that's now done. Internalizing the REIT property management, done. And now simplify the relationship with the manager and the REIT, and that's done.

If you please turn to Page 4, we can run through the first quarter results. Rental revenue of $52.6 million. Stabilized rental core NOI margin, 62.7%. Core FFO, $0.07 per share. Blended rental increases, 4.3%. 95.7% of stabilized rentals released at quarter end. Turnover for the stabilized portfolio, 6.1%. Over 14,000 homes are now internally managed, and 92% of funding was fixed or capped and had a weighted average maturity of 5.5 years.

As mentioned on our last call, we saw the portfolio of about 450 noncore rental homes in the quarter along with over 100 homes across several markets that had subpar metrics. Rob will go over the numbers and show the positive financial results of these sales, which continue to amplify and underscore the unrecognized value that is embedded in our portfolio of homes.

If you please turn to Page 5, we show some important company data over the last several quarters. The percentage of stabilized rentals that are leased took a strong jump this quarter, which sets us up very well for the second quarter. Core rental revenue keeps going up. And as you see, turnover remains very low.

I'll now turn it over to Rob.

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Robin Neil Lowe, Front Yard Residential Corporation - CFO [4]

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Thank you, George. Today, we're reporting a GAAP net loss of $18.5 million for the quarter, a 46% improvement over the prior quarter driven by improving operational metrics and strong gains from property sales.

Revenues were marginally down sequentially mainly due to the sale of 576 homes in the quarter, and expenses reduced by 10% compared to the prior quarter primarily driven by lower interest expense and a significant reduction in acquisition and integration costs.

Interest expense was approximately $3 million lower than the prior quarter as we saw the benefit of the fourth quarter loan refinance with Morgan Stanley and also lower average borrowing as we used proceeds from home sales to pay down debts.

Acquisition and integration costs reduced to $2.2 million compared to $7.6 million last quarter and are expected to drop very significantly next quarter now that the transition of our homes to our internal platform is complete.

G&A expenses this quarter included about $2 million of non-ordinary course legal and professional expenses related to the AMA negotiation, property contest and litigation.

Core NOI margin of 62.7% was 0.2% higher than last quarter as we continue to see elevated turn costs due to continued accelerated efforts to maximize the number of properties available for rent as we start the leasing season. Results so far have been very encouraging. We ended the quarter with occupancy at 95.7%.

Core FFO for the quarter was $0.07, a 28% increase as the last quarters. We believe we remain on track to achieve the targets for the end of 2019 shown on Slide 15.

Regarding our balance sheet, approximately 92% of our debt is now fixed rate or capped with a weighted average maturity of 5.5 years. In April, we successfully negotiated a 70 basis point reduction in interest rate spread for rental properties on both our Nomura and Crédit Suisse lines from 3% to 2.3% as well as some other improvements to the fee structures.

Finally, during the quarter, we sold 576 noncore homes that did not fit our rental criteria, 444 of the homes was a block sale that we previously announced. Net sales proceeds were approximately $102 million giving a $4.6 million gain of a GAAP carrying value.

Additionally, we sold a further 132 homes in the first quarter. So our proceeds were approximately $23 million giving a $2.9 million gain of a GAAP carrying value. We believe these gains are further evidence of the value embedded in our portfolio.

Once again, on Slides 19 and 20, we are providing details of investment cost and home price appreciation by key markets that we believe provide support for a baseline valuation of our portfolio.

I'll now turn the call over to Miles.

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Miles Adams, Front Yard Residential Corporation - SVP of Property Operations [5]

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Thank you, Rob, and good morning, everyone. This quarter for the operations team was very similar to the prior quarter in terms of focused areas and objectives. Our first objective was to successfully transition all of the MSR homes onto our management company platform. Next, to complete the expansion of our footprint into a similar team capable of operating 15,000 properties at best-in-class metrics. Finally, we challenged our teams to improve occupancy levels.

As a reminder, during Q4 of 2018, we transitioned all the approximately 4,000 homes from ASPS onto our internal platform and had a total of 7,300 homes under management at December 31, 2018. I'm pleased to report that as of the end of Q1 2019, we've completed the transition of rental homes onto our internal platform well ahead of schedule.

During the first quarter of 2019, we transferred approximately 7,300 homes from MSR. After the sale of approximately 600 homes during the quarter, we are currently managing over 14,000 homes. This was no small feat and is a testament to the dedication and skill of our great team. After completing the property transitions, our operating footprint now spans from Miami to Minneapolis, Charlotte to Kansas City. Our portfolio is located in approximately 25 MSAs, which we have divided into 7 distinct geographical regions. Within those regions, we have strategically located offices and people to service our residents and homes. Our local teams are well versed with the resident demands and jurisdictional requirements of their markets.

When we began the transition process, our management company was comprised of approximately 80 people. This team has been expanded to include approximately 185 team members as of today, and the team is now largely complete. We have assembled an experienced team of professionals to deliver best-in-class service and operating performance. We are in the middle of a rigorous training program to optimize the performance of the talent that has joined our company, and we are truly excited about our new team members.

Our primary focus during this transition was to maintain high-quality service for our existing residents, which we believe was accomplished. We also challenged ourselves with turning and leasing homes to improve our portfolio occupancy level of 94.2% at December 31, 2018. As a result of our team's focused efforts, our portfolio's stabilized lease percentage at March 31 was 95.7%. This represents a significant improvement of 150 basis points from December 31, 2018, and sets us up very well for the rest of the year.

In addition to improving occupancy, we were able to maintain a stabilized blended rental growth rate of 4.3% consistent with the prior quarter. This growth rate was comprised of renewal rent growth of 4.2% and re-lease rent growth of 4.4%. The Q1 renewal rate of 79% represents an improvement of 800 basis points over the 71% rate of Q4 2018. The Q1 turnover rate of 6.1% represents a 50 basis point improvement over Q4's turnover rate of 6.6%.

We certainly expect lower retention rates and higher turnover during the seasonal summer months, but we're very pleased with the rates achieved this quarter and during Q4, particularly as we all boarded over 7,000 homes and doubled the size of our team at the same time. Residents have many different options for they may choose to live. We are honored that they have chosen our company and continue to demonstrate their approval of our service by renewing their leases with us.

For Q2 and the remainder of the year, our primary goal is to further improve our operating margins while keeping service levels high. Continued growth in revenue combined with a reduction in turn costs and repairs and maintenance expense is required to unlock cash flow commensurate with our expectations. I am confident our team is focused on these objectives and will achieve our goals.

In summary, it was another very successful quarter. We completed the build-out of our property management team. We completed the transition from external property management onto our platform, and we improved our occupancy significantly. The property transition process we just completed provided a unique opportunity to gain experience with the steps necessary to onboard a large number of homes. Many of these requirements are the same or similar to those associated with a major acquisition of homes. This experience combined with the depth and reach of our platform uniquely positions our company to take advantage of a wide array of market opportunities. We are focused on improving margins within our existing portfolio. However, we are eager to take on new challenges that are sure to come our way.

I will now turn the call back over to George.

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George G. Ellison, Front Yard Residential Corporation - CEO & Director [6]

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Thanks, Miles, and great job. If you please turn to Page 6, we can see the highlights of the new asset management agreement. And as I stated, the need for simplicity, clarity and transparency were overarching goals during the construction of this deal as well as creating a deal that was shareholder-friendly.

One of the features of the last contract that held back growth at RESI was that, as RESI grew, the AAMC management team would disproportionally increase RESI's G&A. The structure of the new contract allows for a gradual increase in the fees paid to AAMC, but only after the quarterly AFFO of $0.15 is reached. We wanted to ensure that the dividend was covered. After this target is hit, the additional AFFO will be split 50/50, but only up to a cap. So let's cover that again. The stated goal of $0.15 of AFFO per share will not be impacting, only after this target is reached will AAMC share the anticipated growth of RESI's AFFO, but that sharing is capped. This important feature allows RESI's dividend to be covered and then grow. As RESI continues to grow, the fees earned by AAMC grow as well, but at a descending rate, and that makes sense. G&A must decline as a ratio of real estate assets as the portfolio grows.

If you look at the chart on Page 6, we've modeled how the G&A ratio will decline over time. The chart shows the declining fees as well as the cap that governs them. This is parallel. So regardless of internal or external issues, our competitors managed to and openly discussed this ratio, and we're holding ourselves to that same high standard.

Incentive fees can also be earned by AAMC, but again, they're capped. The control of G&A and its growth over time are really what's at the heart of this contract. We think we've come up with an excellent solution, which will enable us to manage expense growth within industry standards as we grow.

The second important feature that we thought needed to be addressed in the contract was to add a clear, simple, quantifiable termination mechanism. The existing contract only allowed Front Yard and AAMC to separate other than for cause in a change of control situation. There were no other options under RESI's control. The 2 boards studied dozens of contracts in our marketplace and industry and found a fair, frequently used market convention that allows external managers to be terminated for a reasonable, visible, multiple (inaudible) fees. This new deal allows the RESI to terminate AAMC for 3x the average of 3 trailing years of fees. This termination is one of convenience and is available to RESI at its sole discretion. As stated, dozens of structures were reviewed, and the average multiple of annual fees paid to terminate was 3, just as in our deal. We were asked to make termination quantifiable, available and simple. That is now done.

These are just the key terms to the agreement. Obviously, the details can be reviewed in full, and we filed that today. But the bottom line is that there's now a clear path to grow Front Yard Residential with tight expense controls and a mechanism for the 2 companies to separate has been installed, one that mirrors best industry practice.

Page 7 recaps our performance on several stated initiatives. We've completed the internalization of property management. We continue to drive our operating efficiency, increasing occupancy rates, strong rental growth, low turnover to name just a few metrics. We continue to prune our portfolio of existing homes in nontarget markets with excellent financial results. We continue to improve our earnings and maintain our goal of hitting $0.13 to $0.16 per share of AFFO by the end of the year, and now we have delivered on a new shareholder-friendly asset management agreement.

These accomplishments position us to continue our great growth story for our shareholders. Macro trends provide an opportunity to grow our revenue and improve our operating margins. We continue to focus on leverage, bringing it down if and when the time is right. But I would remind you that some of our larger competitors in the sector ram leverage high when they were in their growth mode, and some private competitors have higher leverage as well.

To wrap up, financially and operationally, it's clear that Front Yard Residential is turning the corner. All the key metrics are improving and should continue to improve each quarter, NOI, occupancy, rent increases, FFO. We're continuing to push revenue growth even inside of our current portfolio. Now with property management internalization complete, we now have greater clarity into and better control over our expenses.

Tonight, we're starting a 2-day operational deep dive here at our headquarters with all of our senior leaders to review and finalize several expense control strategies as we map out our next 3 years. The business is on solid ground, which continue to produce better and better results just as we have this quarter. And now the last remaining structural impediment, the existing asset management agreement has also been addressed. We're thrilled to have this last building block in place. I would like to thank both boards of RESI and AAMC for having the vision, courage and patience to bring resolution to this difficult and complicated negotiation while finding the right balance for shareholders. Today, Front Yard stands as one of the best ways to play the largest segment of a single-family rental market, workforce housing. We have a world-class management team, deep experience in acquisitions and a market footprint that gives us first-mover advantages in our industry.

I'll now turn the call back to the operator to open up for Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of Douglas Harter of Crédit Suisse.

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Douglas Michael Harter, Crédit Suisse AG, Research Division - Director [2]

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George or Robin, can you talk about, under the new management agreement, how fees or G&A will look kind of in the short term at the current size?

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George G. Ellison, Front Yard Residential Corporation - CEO & Director [3]

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Yes, Doug. So obviously the first thing to say is that the fees don't go up at all until RESI covers the $0.15 quarterly AFFO. So that's the first thing. Once we get past that level, there's a 50/50 sharing until AAMC fees hit the cap at the current level of gross rental assets, which is $21 million. By that stage, if you work through the math and I know you will have seen this, so you need some time to work through, but that's like $0.82 AFFO a year. So in the short term, the AAMC fee, it's not going to go up at all until that fee is -- the $0.15 a quarter is covered.

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Douglas Michael Harter, Crédit Suisse AG, Research Division - Director [4]

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Okay. And then you guys mentioned that now that the internalization is mostly complete, you would expect to see some expense benefits from that. Can you quantify kind of what the extra costs that you kind of incurred during the quarter and what type of benefit you would expect to receive going forward?

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George G. Ellison, Front Yard Residential Corporation - CEO & Director [5]

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Yes. I'll start, and then I'll hand over to Miles. So as I mentioned in my prepared remarks, one of the things we're still seeing is the accelerated turn costs as we on-boarded all those new homes. So we've on-boarded, right, basically 11,000 homes over the last 2 quarters, which is now being fee. We have tried to accelerate turn cost both last quarter and this quarter. So there's easily, I think, a 1% of NOI just embedded in that. And then now that we've done that and focused on occupancy and driven that up, our entire focus now is on operational efficiency as we fully integrate the HavenBrook platform, and we'll let Miles talk a bit more about this. But I think there's a lot of opportunity here to really focus and reduce cost.

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Miles Adams, Front Yard Residential Corporation - SVP of Property Operations [6]

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Yes. So over time, we want to unlock another couple of hundred basis points in the R&M categories, and that's going to happen primarily by utilization of our internal resources and through improved use of technology in the R&M space. Those are what we think are the greatest opportunities. And then in addition to that, we still have some room to grow the top line beyond where we're at when we end in March 31. On an average occupied basis, we can certainly be up another 100 or 150 basis points from where we are currently and very comfortably. Both of those things would contribute very nicely to an NOI margin above where we are today.

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Operator [7]

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And your next question comes from the line of Jade Rahmani of KBW.

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Jade Joseph Rahmani, Keefe, Bruyette, & Woods, Inc., Research Division - Director [8]

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Just looking at the NOI margin, 62.7%, I think you have a target of 66%. What are -- are you still sticking to that 66% target? And what are the main drivers to get there?

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Robin Neil Lowe, Front Yard Residential Corporation - CFO [9]

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Yes. As we just said in response to Doug's question, Jade, I think -- as I said, we saw accelerated turn cost this quarter again. That was probably $0.5 million of those left. That's 1% right there on NOI, which will go away going forward. And then as Miles alluded to, I think we have a lot of opportunity in R&M over the next few months. So we feel shooting for 66%. We still think that's achievable by the end of the year.

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Jade Joseph Rahmani, Keefe, Bruyette, & Woods, Inc., Research Division - Director [10]

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And just separately on the internalization -- I mean, sorry, on the revised management agreement. Did the Boards consider and contemplate potential internalization and then just put the entire external structure behind the company?

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George G. Ellison, Front Yard Residential Corporation - CEO & Director [11]

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I mean, we -- this was a negotiation by both Boards who took probably 6 to 7 months of pretty much everything was discussed. I think the real thrust of what we're trying to deliver to shareholders was maximum flexibility and maximum optionality. And so internalizing or putting the all together right now, I don't think was necessary. But getting control of costs as the external manager went forward was critical, and we've all talked about that. So I think what this does is that option can happen now. There's a lot of opaqueness and confusion around how the 2 work and what strategic things could happen. So now that option that you're discussing could happen, but all types of options could happen now. Everything's on the table. It's very clear, very clean, very quantifiable and very simple.

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Operator [12]

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(Operator Instructions) Yes, there are no more questions at this time. I will now turn it back over to the speakers for any further comments.

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Miles Adams, Front Yard Residential Corporation - SVP of Property Operations [13]

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We would like to thank everybody for joining today, and have a great day. Thank you very much.

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George G. Ellison, Front Yard Residential Corporation - CEO & Director [14]

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Thank you.

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Operator [15]

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Ladies and gentlemen, this concludes today's conference. Thank you for your participation. Have a wonderful day. You may all disconnect.