Overview of Great Ajax Corp.

Great Ajax Corp. is a Maryland-based company that focuses on acquiring and managing a portfolio of re-performing and non-performing mortgage loans secured by single-family homes, as well as some multi-family and commercial properties. The company completed its initial public offering (IPO) in 2015, raising over $50 million to fund additional loan purchases.

Great Ajax is externally managed by an affiliated entity, Thetis Asset Management LLC, in which it owns a 19.8% stake. The company’s mortgage loans are serviced by another affiliated entity, Gregory Funding LLC. Great Ajax has elected to be taxed as a real estate investment trust (REIT) for U.S. federal income tax purposes starting in 2014.

Market Trends and Outlook

The company believes several key trends are shaping opportunities in the mortgage sector:

• Banks and lenders continue selling off residential mortgage assets due to high operating costs and delinquencies. This is creating a large supply of re-performing and non-performing loans available for acquisition.

• Home ownership rates have declined, increasing demand for single-family and multi-family rental properties. This is driving more need for loan modifications, non-GSE mortgage financing, and single-family rentals.

• New regulations have tightened mortgage lending standards, limiting availability of traditional mortgage loans. This leaves many borrowers unable to qualify for home purchases.

• Smaller commercial properties, like multi-family and mixed-use buildings, are an attractive investment area as larger lenders are less interested in these assets.

Overall, Great Ajax sees heightened near-term and long-term demand for single-family and smaller multi-family rental properties, as well as opportunities to acquire discounted mortgage loans.

Factors Affecting Operating Results

Acquisitions: The company’s results depend heavily on sourcing re-performing and non-performing mortgage loans. Great Ajax believes it can purchase these loans at lower prices than foreclosed properties (REO) for several reasons:

• Re-performing loans typically generate higher current yields than rental cash flows from REO properties.
• For non-performing loans, the company has various loss mitigation strategies to recover value, like loan modifications and foreclosure.
• Sellers of mortgage loans can avoid costs associated with selling real estate, allowing Great Ajax to pay lower prices.
• There is less competition in the mortgage loan market compared to the REO acquisition channels.

Financing: The company’s ability to grow depends on accessing adequate debt and equity financing. Great Ajax uses securitizations as a key financing tool, retaining subordinate securities. It also has a repurchase facility to finance mortgage loan acquisitions.

Resolution Methodologies: The company prefers to modify non-performing loans to keep borrowers in their homes, as this generates the highest economic returns. However, some loans will still result in foreclosure and conversion to rental properties.

Home Prices: Generally, rising home prices positively impact Great Ajax’s results through increased re-performance, faster refinancing, and higher recoveries. Declining prices have the opposite effect.

Interest Rates: Higher rates can reduce the value of the company’s mortgage portfolio and increase its borrowing costs, while lower rates have the opposite impact.

Critical Accounting Policies

Mortgage Loans: Great Ajax accounts for its mortgage loans under ASC 310-30, which allows pooling of loans with similar credit quality. The company estimates expected cash flows, recording interest income based on a composite rate. Impaired loans are carried at the present value of expected future cash flows.

Residential Properties: REO properties are carried at the lower of acquisition cost or fair market value. Rental properties are depreciated over their useful lives. The company evaluates properties for impairment if events indicate the carrying value may not be recoverable.

Fair Value Measurement: The company uses a fair value hierarchy to measure the fair value of financial instruments, with Level 3 inputs having the least observability.

Income Taxes: As a REIT, Great Ajax generally avoids federal income taxes by distributing at least 90% of its taxable income. Its taxable REIT subsidiary, however, is subject to corporate income taxes.

Recent Results of Operations

Great Ajax’s financial performance has improved significantly since commencing operations in 2014:

• Revenues grew from $6.3 million in 2014 to $37.5 million in 2015.
• Consolidated net income increased from $3.8 million to $25.8 million.
• Diluted earnings per share rose from $0.40 to $1.68.

The growth was driven by a larger loan portfolio, which grew from $298.6 million in UPB at the end of 2014 to $725.7 million by the end of 2015. The portfolio consisted of 85% re-performing loans and 15% non-performing loans as of December 2015.

Interest income was the primary revenue source, totaling $36.2 million in 2015 compared to $6.2 million in 2014. This included $30.9 million of non-cash interest income accretion in 2015, up from $4.1 million the prior year.

Interest expense grew from $0.8 million in 2014 to $11.5 million in 2015, reflecting increased borrowings to fund loan acquisitions. The company’s average borrowing balance rose from $64.7 million to $238.5 million over this period.

Management fees paid to the external manager increased from $1.0 million to $3.4 million, while loan servicing fees grew from $0.5 million to $4.0 million, in line with the larger loan portfolio.

Other expenses, including loan transaction costs and professional fees, also increased from $1.1 million to $4.3 million.

Overall, Great Ajax’s net book value per share rose from $14.43 at the end of 2014 to $14.92 at the end of 2015, an increase of $0.49 per share.

Liquidity and Capital Resources

Great Ajax’s primary sources of cash have been proceeds from its IPO and private placements, securitizations, repurchase agreements, and collections on its loan portfolio. The company expects these sources will be sufficient to meet its short-term and long-term liquidity needs.

As of December 2015, the company held $30.8 million in cash and cash equivalents, down from $53.1 million at the end of 2014 due to loan acquisitions. Its average daily cash balance was $44.7 million in 2015, up from $23.8 million in 2014.

Cash flows from operations were negative in both years, as increases in assets and non-cash interest income accretion offset net income. Investing activities used $321.0 million in 2015 for loan acquisitions, while financing activities provided $314.5 million from securitizations, repurchase agreements, and equity offerings.

Great Ajax has completed five securitizations since inception, retaining subordinate securities and the residual trust certificates. It also has a $200 million repurchase facility, under which it had $104.5 million outstanding at the end of 2015.

The company is not required to maintain any specific debt-to-equity ratio and believes the appropriate leverage depends on the risk of its assets. It has paid quarterly dividends since 2014, with the most recent dividend of $0.24 per share declared in February 2016.

Outlook and Conclusion

Great Ajax is well-positioned to capitalize on the significant opportunities it sees in the mortgage sector, driven by industry trends and its specialized expertise. The company’s growing portfolio of discounted mortgage loans, combined with its disciplined financing strategy and focus on loan modifications, should continue to drive strong financial performance.

While the company faces risks from changes in home prices, interest rates, and the regulatory environment, its conservative underwriting, diversified geographic footprint, and flexible financing sources provide a solid foundation for weathering market cycles. With an experienced management team and alignment of interests through its REIT structure and partial ownership of the external manager, Great Ajax appears poised for further growth and value creation for shareholders.