AJX - Great Ajax: An Otherwise Unimpressive High-Yielding mREIT Poised For Recovery

2023-06-16 06:55:07 ET

Summary

• Great Ajax Corp. specializes in purchasing of poor-quality mortgage loans and making them perform - a strategy that may perform well during an economic recovery.
• AJX’s earnings are most likely to recover due to favorable economic environment, strong mortgage pipeline, and an anticipated dip in funding cost.
• I'm expecting AJX to report earnings growth in another 12 to 18 months and continue to offer a double-digit yield along with a steady quarterly pay-out.
• With declining NAV, there lies a possibility of AJX defaulting or liquidating, especially under an environment of rising interest rate and looming recession.

~ by Snehasish Chaudhuri, MBA (Finance)

Great Ajax Corp. (AJX) is an externally managed mortgage real estate investment trust with a quite low market value of $140 million and a short interest of 0.36 percent. It became public in February 2015 and has been paying consistent quarterly dividends for the past 32 quarters. Annual average yield generated since 2018 has been 10.03 percent. Yield has been exceptionally high during 2022 and 2023, primarily due to the price loss of AJX in the equity market. However, otherwise too, its yield was comparatively high, ranging between 8 percent to 10 percent. Despite all these, AJX's track record as a public company has been unimpressive. Its net asset value has declined for a good 18 months (from November 8, 2021 to May 17, 2023), and currently AJX trades much lower than ( less than half ) of its 2015 IPO price.

Great Ajax Corp.'s Loan Portfolio Consists Primarily of Single-family Home Loans

Great Ajax Corp. operates mainly by three channels a) through acquisition of re-performing and non-performing loans b) through originating small balance commercial mortgage loans that are secured by multi-family residential and commercial mixed-use retail/residential properties; and c) through investing in single-family and smaller commercial properties. AJX's loan portfolio consists primarily of single-family home loans, and a very small proportion of small commercial property loans. When a loan is foreclosed upon, AJX either rents out the foreclosed property or sells it. In the event of selling out the foreclosed property, Great Ajax also provides mortgage financing to the new purchaser.

AJX Specializes in Purchasing Poor-Quality Mortgage Loans on a Discount

AJX's management believes that its custom approach to each (foreclosure) acquired property will generate strong returns for its investors over the long term. Great Ajax Corp. also purchases re-performing mortgage loans at a discount, adding yield to its portfolio. Intuitively, this seems like a difficult and risky business as debtors that miss payments are more likely to miss payments again in the future. Perhaps, however, non-payments are less of an issue when there is sufficient loan volume, the majority of which has been purchased at a discount. AJX also has a small portfolio of small commercial loans, primarily offered to multi-family and mixed retail/residential properties.

AJX Suffered Huge Price Loss, but Didn't Slash Pay-out and has Started Recovering

AJX's risk level is usually high due to its business model of acquiring poor quality mortgage loans at a discount and fixing them. In addition to these, the series of interest rate hikes adversely affected this mortgage REIT. We can witness the impact on AJX's share price as the price gradually decreased from a level of $14.7 on November 8, 2021 to $5.3 on May 17, 2023. That's a drop of 64 percent within a period of 18 months. Such a drop is surely to scare the short-term investors. However, Great Ajax Corp. didn't disappoint with respect to pay-out as the average quarterly payment remained higher than $0.25. In fact, the pay-out increased from a pandemic period average quarterly payout of $0.165. So, that's a positive sign for the investors. Moreover, AJX also recorded exceptionally high price growth of 11.44 percent during the past one month. Price return for S&P500 during the same period was only 6.03 percent.

AJX's Strategy May Work During Economic Recovery and Reduce the Cost of Funds

AJX specializes in the business of purchasing poor-quality mortgage loans with payment issues and then fixing them. This business strategy should perform well in an economic recovery. As the economy improves, the debt servicing ability of the struggling borrowers will automatically recover even without much managerial effort. AJX also acquired several re-performing and small-balance commercial property loans. Further, the mREIT was under contract to close other re-performing and non-performing mortgage loan acquisitions. All these acquisitions and investments in poor quality mortgage loans are expected to deliver strong benefits in terms of reducing the cost of funds. However, all these are dependent on a steady economic recovery.

Net Interest Income Set to Increase Considerably During the Coming Period

On the other hand, heightened prepayments will likely pressurize total revenue. The company expects higher prepayments to continue because of low mortgage rates. Prepayments will not only affect the outstanding volumes of loan, but also the margin earned on such loans. AJX will need to reinvest the prepaid amount at lower rates, which will pressurize the net interest margin. However, as discussed earlier, its cost of funds will likely come down in case the poor-quality mortgage loans purchased at a discount start performing. Considering the factors mentioned above, I'm expecting the net interest income to increase considerably this year, and am really looking forward to the next 12 to 18 months. This will be a make-or-break period for Great Ajax Corp.

AJX May Report Strong Earnings Growth and Continue to Offer a Double-Digit Yield

It is worth watching whether management's capital allocation decisions result in increased operating cash flow going forward. With the Company's net asset value declining there lies a possibility of this mREIT defaulting or liquidating, especially under an environment of rising interest rate, rising unemployment and looming recession. If we are willing to absorb that default risk, we may find a decent investment option in AJX. Its earnings will most likely recover in the coming period due to favorable economic environment, strong mortgage pipeline, and an anticipated dip in funding cost. Overall, I'm expecting Great Ajax Corp. to report an earnings growth and continue to offer a double-digit yield. It will be a wise decision to hold onto this mREIT for another 12 months.

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