AG Mortgage Investment Trust Inc (MITT) 2012 Q4 法說會逐字稿

Welcome to the AG Mortgage Investment Trust fourth-quarter 2012 earnings call. My name is Dawn, and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note that the conference is being recorded.

I will now turn the call over to Lisa Yahr. Lisa, you may begin.

Thanks, Dawn. Good morning, everyone, and welcome to the AG Mortgage Trust fourth-quarter 2012 earnings conference call. Joining me on today's call are David Roberts, our Chief Executive Officer; Jonathan Lieberman, our Chief Investment Officer; and Frank Stadelmaier, our Chief Financial Officer.

Before we begin, I'd like to review our Safe Harbor statement. Today's conference call and corresponding slide presentation contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All such statements are intended to be subject to the protection provided the Reform Act. The Company's actual results may differ materially from those projected due to impact of many factors beyond its control. All forward-looking statements included in this conference call and the slide presentation are based on our beliefs and expectations as of today, March 6, 2013. Additional information concerning the factors that could cause actual results to differ materially from those contained in the forward-looking statements are included in the risk factors section of the Company's periodic reports filed with the Securities and Exchange Commission. Copy of the reports are available on the SEC's website at www.sec.gov. Finally, we disclaim any obligation to update our forward-looking statements unless required by law.

With that, I'll turn the call over to David Roberts.

Thank you, Lisa, and good morning to everyone.

MITT ended 2012 with another strong quarter. Our fourth-quarter core earnings were $0.85 per share. We are pleased to declare our first-quarter 2013 dividend of $0.80 per share, consistent with our 2012 fourth-quarter dividend. One of the highlights since our last call was the addition to MITT's portfolio two proprietary transactions sourced through the Angelo, Gordon platform. One was commercial real estate loan that closed in January of this year and the other a legacy portfolio of residential whole loans that closed in December. In 2012, our success in expanding MITT's capital base from around $200 million to around $800 million in turn has expanded MITT's scale, and thus, with the expansion of that scale, and thus our ability to invest in these types of transactions. We expect that these transactions, these proprietary transactions, to be an increasingly significant factor for MITT this year and in future years.

I want to take a few minutes to discuss the Angelo, Gordon platform and how it benefits MITT and its shareholders. Angelo, Gordon is a firm with $25 billion in assets under management, specializing in real estate and credit. Many of our investment areas, like RMBS and CMBS and residential and commercial and real estate whole loans, stand at the intersection of both credit and real estate, and these disciplines and areas benefit from the combination of our expertise in both credit and real estate. We have over 100 investment professionals in these areas. The commercial real estate loan MITT invested in, in January was sourced and analyzed by Angelo, Gordon's private equity real estate group. The legacy whole loan portfolio that MITT invested in, in December was sourced through relationships that Angelo, Gordon had developed over many years, predating the formation of MITT, and this transaction was analyzed using the resources of the RMBS group.

We have continued to add resources to the Angelo, Gordon platform, which we expect will benefit MITT. In February, we hired Jason Biegel to lead our efforts in the residential whole loan area. Our plan is for Jason to add significantly to our resources in this area, which we believe will provide MITT with differentiated, attractive, and sizeable investment opportunities. Similarly, we plan to add resources to commercial real estate lending. We believe our deep expertise in the great networks we have developed as a buyer of properties over the past 20 years will give us an edge in sourcing and analyzing opportunities. Here I'm talking about Angelo, Gordon's private equity real estate group. In summary, as we have said ever since we formed MITT, our goal is to bring the considerable resources of Angelo, Gordon to create for our MITT shareholders the best, risk-adjusted, most diverse, and robust portfolio in our industry.

With that, I will turn it over to Jonathan Lieberman to talk about our quarter's investments.

Thank you, David.

We are very pleased with our accomplishments and the maturation of the Company. As we look ahead to this year, we are excited about our existing portfolio, the scale of the platform, and the outlook for continuing to deliver value to our shareholders. To begin, I'd like to touch on a few highlights for the full year. This is set out on page 3 of our presentation that's on our website. First, we generated total annual shareholder returns of over 31%, including paying close to $3 per share in dividends. Second, we completed a strategic capital raise in mid-December. This equity raise for approximately $90 million was done in anticipation of the two new investment opportunities that David mentioned earlier. Third, we grew our overall portfolio from $1.4 billion to $4.9 billion, and our gross allocation to credit assets was 22.2% at year-end, up from 9% a year earlier. Finally, I'll discuss in greater detail MITT's participation in a legacy whole-owned trade that was procured by AG just prior to year-end. The investment team is very excited about this facet of our business.

On slide 4, we share top-line performance details, along with several portfolio metrics. I'll spend more time discussing many of these metrics later, but I'd like to discuss a few important performance attributes. For the quarter, we generated $0.85 of core earnings and also increased our un-distributable taxable income by close to $1, from $1.19 to $2.15 per share. The investment team is actively rotating assets that reach terminal value, basically that they've peaked in valuation and we believe that at this point we should realize the gains, monetize our gains, and basically redeploy that capital in much more attractive opportunities. Retention of undistributed income accomplishes two strategic objectives for the Company. First, it enhances valuation by providing the investment team with our cheapest source of capital, which Frank will address in more detail. And secondly, we can maintain a more durable and sustainable dividend level for the future.

Book value increased $2.95 from $20.52 as of December 31, 2011. For Q4 2012, book value modestly declined from $23.71 to $23.47. This decline was predominantly attributable to moving agency MBS prices quarter-over-quarter, not completely offset by our credit book, and warrant exercise activity. With respect to leverage, as of December 31, leverage declined to approximately 5.26 times. This decrease in leverage partially reflected the delay in closing our two proprietary transactions, the residential deal, which closed on December 31, and the commercial deal that closed in the middle of January. Leverage also reflects our prudent management of capital during Washington's fiscal cliff negotiations. I know this is kind of ancient history, but you will recall for a time there was concern that potentially Washington would take us over the cliff. Our NIM decline quarter-over-quarter is due in part to a typical year-end increase in repo cost of funds, greater interest rate hedging, and the delayed credit capital deployment.

On slide 5, the foundation for portfolio allocation decisions is our economic outlook, and then granular asset level analysis by the portfolio teams. Despite some marginal improvements, the global macro environment continues to be challenging. In the US economy, despite signs of recovery and a broadening of base of activity, still faces challenges. Housing and commercial real estate remain among the brightest spots in the US economy. In the case of housing, it has gone through six grueling years of price declines and declining home ownership. The US housing market seems to have finally bottomed in 2012. We are much more optimistic at this point, and construction activity is now a net contributed to GDP growth. Home price appreciation is further healing the balance sheets of both households and intermediaries.

For the year, we expect housing to be an important engine of growth for the US economy and project US home prices will increase approximately 5% to 6%, with a meaningful positive impact on real personal consumption expenditures as a result. Our constructive view on housing is driven by supply and demand considerations, the REO rental buyers coming into the market in force, record low interest rates, and the anticipation of a relaxation in credit standards for underwater borrowers refinancing their homes and new purchase money mortgages. Labor market conditions, we believe, will continue to heal, with contributions from energy, construction, housing-related occupations, and some service industries. Job reductions by the defense industry, government, financial services, will cause a drag on employment. Our belief is that both the unemployment rate and non-foreign payrolls should be able to keep up with natural growth rates in a working-age population.

Consumer spending is at risk of decline due to a combination of the expiring payroll tax cuts in January, elevated energy costs, and a higher taxes from both upper-income wage earnings and also on investment earnings. Median income remains stagnant. As you've seen recently in the press, students remain encumbered by significant debt, which is impeding their ability to basically purchase houses. With respect to Europe, the poor economic situation remains chronic despite the concerted accommodative policy stance and accompanying low interest rates in the periphery countries. As the world's largest economic zone, Europe's fiscal woe's will have a global impact that stands to potentially impede any type of meaningful growth in other parts of the world.

Now moving to page 6 of the slides of our presentation, we have a snapshot highlighting quarter-over-quarter changes in rates and credit markets. Credit markets rallied on the heels of ongoing -- on the ongoing reach for yield by investors, improving fundamentals, and the resolution of the fiscal cliff. While long-term rates and agency MBS sold off, trading volumes in credit remain robust, even in the typical quiet year-end. Our team was able to continue sourcing attractive credit investments for the portfolio during the fourth quarter. And I'd also like to note that the investment environment in February and March continues to improve from what we've seen in January, and we're seeing a steady stream of potential attractive investments across the entire platform.

On slide 7, as of year-end, we held just under $4.9 billion in securities, roughly unchanged from the end of Q3. The size of our agency portfolio decreased slightly, and we did undertake some optimization of the agency book. As you will recall from prior calls, our focus since inception has been on growing our credit portfolio by taking advantage of Angelo, Gordon's credit platform and expertise. On a gross asset basis, we crossed the 20% mark in the fourth quarter, with the credit book increasing from 19.7% to 22.2% of the overall portfolio. Equity capital allocation to credit assets was approximately 35% at year-end, so significantly higher than the gross exposure.

On slide 8, returning to our agency portfolio, we invest in a diversified portfolio of 15-, 20- and 30-year specified [whole loans] guaranteed by Fannie and Freddie. We continue to invest in bonds that we believe will exhibit prepayment behavior. These stories continue to include lower loan balance, which accounts for roughly one-third of our agency portfolio, as well as HARP pools and newer production current coupon bonds. Our aggregate CPRs, constant prepayment rates, have remain muted, with the book printing at 7.8% CPR for the fourth quarter and 6.4% CPR for the full year. We are selecting agency pools with the expectation that interest rates will remain relatively low, but with periodic bouts of volatility for the foreseeable future. We also believe origination capacity constraints will continue to ease, resulting in a tightening of the primary and secondary spreads and ultimately an increase in organic refinance activity. Continuing home price appreciation should translate into higher future prepayment's as borrowers emerge from negative equity positions and the credit box eases over time. We therefore continue to believe the right positioning for our portfolio is involves bonds that will exhibit favorable prepayment behavior in this changing environment.

Now turning to the credit side of our portfolio on slide 9, you'll see that we continue to deploy capital into credit throughout the quarter. Of note, we more than quadrupled the size of our Alt A exposure from $51 million of fair value to over $212 million. As we mentioned repeatedly, the depth/breadth of the AG platform continues to see and source robust sets of opportunities. Our entry into the whole loan space in December exemplifies our opportunistic approach to investing and where we are taking the business. This opportunity was sourced in an extremely limited competition fashion and was among the largest, and we believe most attractive, whole loan trades in 2012.

MITT participated in the acquisition of 1,898 legacy whole loans, which were financed in a securitization on the closing date, December 31. So we managed to ruin Hanukkah, Christmas, and almost New Year's to get this closed. The total equity capital committed to this investment was approximately $29 million after financing. We continue to increase AG's resources, as David mentioned, and we believe that the hiring of Jason Biegel will give us a competitive advantage in building out our whole loan business. Subsequent to quarter-end, MITT did close on a mezzanine loan investment backed by a commercial, retail, and office property located in the island of Manhattan. This loan was originated by Angelo, Gordon's private equity real estate group and the investment team is continuing to dedicate significant resources to source additional opportunities for MITT.

Now turning to slide 11, the overall portfolio leverage decreased from 6.06 times as of September 30 to 5.26 times at year-end. This decrease stems from our higher credit allocation, our desire for greater cash balances pending the resolution of the fiscal cliff negotiations, and then the timing of the closing of our whole-loan trade on the last day of the year, and the delayed closing of the -- our first originated commercial loan until early January. Overall, leverage is within our target range and allows us flexibility to respond to any attractive opportunity. At quarter-end, excess liquidity was greater than $315 million.

On slide 12, we lay out our funding. On the funding side, weighted average original maturity of our repo book was extended to 87 days from 79 days as of the prior quarter-end. As is typical, agency repo rates did increase during the fourth quarter by approximately 4 basis points. Since the beginning of 2013, we have seen those basis points come down. We've seen roughly a 4% decline in funding costs on the agency side, and we believe this trend will continue. We also expect that our term financing rates for the credit side will also decline. We now have 30 counter-parties and are actively engaged in several conversations and negotiations regarding longer counter-financing facilities for the platform. Given the size of the portfolio, we believe that we have adequate financing at our disposal for any opportunistic trades that would arise.

On page 13, our hedging summary lays out that we had approximately 65% of our total agency repo notional hedged. Our hedged percentage rose from 53% as of September 30, with the addition of over $300 million of notional paid fixed swaps. As we have previously discussed on prior earnings calls, we do not seek to fully hedge out rate and market value risk. Consistent with our views of interest rates and first-quarter market volatility, we did shift the bands of hedges from the previous range of 40% to 60% to 50% to 75% of our total notional repo exposure to agencies. As this shift demonstrates, we are not wed to a specific target. It is meant to be dynamic and flexible in response to both our views of the future path of interest rate changes, as well as the composition of our portfolio. In line with prior quarters, we are employing both swaps and MBS derivatives as hedges.

To finish off, on slide 14, as you can observe, our duration gap at quarter-end was approximately 1.6 years. This represents a decline from the third quarter. Given the composition of our portfolio and its actual prepayment experience, we are comfortable with the current level of interest rate exposure retained by the Company.

With that, I'll now turn the call over to Frank Stadelmaier, who will discuss our financial performance in greater detail.

Thank you, Jonathan. Good morning.

I'd now like to highlight a few of the financial metrics in more detail. For the quarter, the yield on our interest-earning assets decreased from 3.48% to 3.37%. During the quarter, we sold approximately $400 million of securities and recognized $0.56 per share in gains and replaced them with securities that we believe have a better relative yield but a lower yield than those that which we sold. This was partially offset by the increase in the size of our credit portfolio relative to agency, where yields are typically higher. Additionally, at December 31, the capital rates that we did late December had not been fully deployed, and therefore, the yield at December 31 does not include the effects of all the credit assets that we purchased subsequent to year-end.

During the quarter, our cost of funds increased from 98 basis points last quarter to 1.11% this quarter. Our cost of funds include the amount we pay on borrowings, as well as the cost of our interest rate derivatives. Cost of borrowings under repurchase agreements during the quarter increased to 75 basis points from 67. Borrowing costs are higher on our credit assets, and as we increase the size of our credit portfolio during the quarter, our borrowings also increased --the cost of borrowings also increased. Additionally, during the quarter, we extended the maturity profile of our repo's. Consistent with prior years, repo rates for borrowings that will cross year-end tick up in the fourth quarter and then come back down after year-end. During the quarter, our cost of swaps increased from 31 basis points to 35. This increase came from the additional $300 million notional interest rate swaps Jonathan described earlier.

Our G&A as a percentage of equity during the quarter decreased from 1.4% to 1.26%. As we have significantly grown the equity base during the year, we are now starting to see efficiencies by spreading our G&A costs over a bigger capital base. The business is at a point where it will continue to scale better with continued growth, and continued growth should bring down G&A as a percentage of equity. During the quarter, our taxable income increased by $0.96 per share to $2.15. The increase in taxable income was driven primarily by the gains on sales of securities. Additionally, our core earnings continue to exceed our dividend, and this excess amounts adds to our undistributed taxable income as well. The increase in undistributed earnings is also what caused the increase in excise tax period-over-period. This undistributed earnings continues to provide us with flexibility when considering future dividends.

I'd now like to open the line for questions.

Thank you. We will now begin the question-and-answer session.

(Operator Instructions)

Trevor Cranston, JMP Securities.

Hi, thanks. Congratulations on a good quarter. I was wondering if you could expand a little bit on the build-out of the residential loan platform. At least for the near term, if that is something you envision being primarily focused on acquiring legacy assets, or you're also thinking of originating new prime jumbo loans and retaining MSRs or something like that?

I think it is a case of all of the above subject to the right price point, right yield for the portfolio. But we're in the market, and we're going to build this. We have the skill set for all three types of assets. We're now putting in place the infrastructure that we think is important for each of those distinct asset classes.

In the case of jumbos, it is making sure the credit box is appropriate, building the appropriate diligence controls around the credit, and then controlling legal risks associated with jumbos and the financing of jumbos. In the case of legacy, it's a lot of the up-front diligence and then basically managing the risk once you have it on board. In the case of MSRs, a lot of the value is in retention of the MSRs, no matter which way interest rates go, and no matter which way housing prices go. We can buy MSRs every day of the year, but we don't think that that's prudent without having the ability to recapture or protect the MSR at this point in time.

Okay. That makes sense. On the acquisitions of the whole loan opportunities, such as the two recent ones you completed, can you just give us a sense of where you see targeted returns on those types of investments right now?

We expect that the investment that we made will probably be in the upper teens for the recent acquisition of the residential whole loans. Then the commercial, it's a high single-digit type of return. Then it's a function of the permanent leverage that we'll put in place that we think elevate the return. We're working through that currently.

Okay. Thank you.

Jason Stewart, Compass Point.

Hi, thank you. Drilling down into the focus on the residential platform and MSRs, are you looking at making investments in excess MSRs in addition to creating them through either the origination platform or purchasing securities?

We have in the past had in the portfolio excess servicing, excess MSRs that were previously securetized. We have not recently added any excess. There have been some recent transactions, I think out of Wells Fargo in particular. But once again, it's a -- we think that there's other assets that may provide similar benefits to the portfolio that don't have the prepayment profile of excess.

Okay. Taking that and looking at that as both an investment and a potential hedge, and comparing it to an IO or looking at your book and taking MSRs, the credit book, and your hedge portfolio altogether, and thinking about the duration gap, how should we be looking at all of those together? Because it seems like credit is going up as a percentage, hedges are going up as a percentage, and there might be an opportunity to lower that cost to hedge through some other investments.

That's very fair. We have been, as I said, we have looked at, we have made investments in IOs, that provide positive carry hedges to the portfolio, similarly with excess. The agency assets also provide a nice hedge to the agency book and it certainly [adds] the percentage and depends upon the dollar price of the asset. Basically, it's a relationship to rates, as well as it's a relationship to home prices. It integrates really, really well with the agency side. I would say that you come back to the agency side for a moment, we do look at that both in the context of the overall portfolio, but we also look at that as a portfolio unto itself.

In the fourth quarter and in the first quarter, we have taken the view that there was going to be more volatility in rates and potentially higher short-term rates. You typically --or sometimes you'll have a little bit of a growth scare in the first quarter. You certainly have seen a much more vigorous debate between the doves and the hawks on the fed and the size of their balance sheet. We felt that it would be prudent for us to basically add additional hedges here to the portfolio that could protect book value. We've shown that we are not wed to one specific hedge ratio and that we'll move opportunistically. I think it's transpired very much the way we foresaw.

Okay. That's good color. Shifting gears, one follow-up question on the question on the question of loan origination. When you're looking at that space, is there a price point or yield or part of the capital structure or even a sector that you're focusing on, or is it really just opportunistic?

It's David. It really is opportunistic. We've a lot of resources here that look at all sorts of different real estate product types, whether it's office or retail, multi-family hotels, and it's very geographically diversified. We're one of the longest-standing, and probably the most prolific, in terms of all the markets that we cover in terms of opportunistic real estate players. So we see a lot of different product from the equity side, and we're just looking and being opportunistic to see what where on the lending side we can add value. Like everything else, it is a competitive market. We're going to be very choosy and about what we want to participate in. It is really going to be a bottom-up approach as opposed to saying X% of the portfolio should be in this. It really is going to depend upon how we're able to use the network to uncover great risk/reward opportunities. We're very happy with the transaction that closed in January and hope there are others like that.

Great. Thanks for taking the questions.

Boris Pialloux, National Securities.

Hi, good morning, and thanks for taking my questions. Most of my questions regarding CMBS. One, I'd like to understand your views on the CMBS because there was a recent article of Bloomberg saying that the spreads actually were going up. Second, as the CMBS market is having difficulties, does that mean that what you're doing like originating or participating in the organization of direct loans would actually seal the gap?

It's David. I think that, again, we're going to be opportunistic in terms of when you look at the CMBS market overall, there are plenty of different places, different tranches, different opportunities, different vintage years to look at. We're constantly looking at all of those to see where we think there's compelling risk/reward. We would view our effort to buy commercial real estate loans, whole loans, as really being a corollary and complementary to looking at legacy CMBS assets. We don't see it as necessarily a conflict. Some areas of the CMBS market have tightened, and there may be other areas that we -- where we can opportunistically make good purchases.

Lastly, regarding your -- the hiring of Jason, long term, if you were originating loans to or going into the jumbo loan, do you have the sense that you would end up with doing securitization or having a securitization platform?

I think long term, you have to have a method of placing leverage on jumbo mortgages, or most mortgages, given the low yield. You have to have a way of basically putting some amount of term leverage in place and potentially mitigating interest rate exposure. It could be bank facilities. Securitization is an off-balance-sheet kind of terminology and segregation of assets. I think we have some thoughts around it. I think it's still evolving, what the format for financing jumbos long term will be. We're kind of open to all of them and also maybe blazing our own path.

Okay. Thank you.

(Operator Instructions)

Ken Bruce, Bank of America/Merrill Lynch.

Thanks, good morning. I just want to make sure I understand what your intentions are in the whole loan market. Is this an area that you envision setting up a platform, or do you see yourself being more just opportunistic in terms of acquiring bulk whole loans just as they become available? How are you looking at that business? There's been obviously some very high-profile platform development initiatives from some others. I'm trying to understand where you're seeing yourself fit into this ecosystem.

Okay. We are always going to be an opportunistic investor. That is the basic DNA of Angelo, Gordon and the Company MITT, that it will always have an opportunistic aspect, that if we see source, are shown opportunities that we think are attractive, or we can [de-engineer] in a way that makes them attractive and use our intellect, we're certainly going to be continuing that for the foreseeable future of the Company. In addition, we are in the typically in the flows of markets on a daily basis, so with all of our funds. We have built businesses over long term. Take our brick and mortar commercial business, the business has been in existence since 1994. It has a history of financing and acquiring and redeveloping buildings. We have a triple-net lease business. We have other businesses here that have been, once again, in existence for years.

We would expect that we will find a way to incorporate the expertise of our private equity group that has quite a bit of expertise in specialty finance, the RMBS group that has quite a bit of expertise with whole loans. And if we feel that branding a MITT, quote, shelf or acquisition platform is the best way to achieve our objectives, which is to produce good, risk-adjusted returns for our shareholders, we'll do so. I think we're developing that, and I think when the time is right, we'll kind of more fully play that out. But I think you can see that we are beginning to put in place the human capital, not only for opportunistic trades but for more long-term businesses within -- for the REIT to invest in.

Okay, thank you. Are you envisioning participating in the risk transfer initiatives that the agencies are discussing? I'm sorry if I missed that in your prepared remarks.

No, you didn't miss it. We are in Washington quite a bit. I sit on the Board of the Association of Mortgage Investors. We're in regular dialogue with regulators, as well as the agencies. We look forward to seeing opportunities from the agencies, both in the near term and in the future. When opportunities do present themselves for risk transference, we certainly hope that we are among the first investors.

This might be premature, but is there any price talk around what those returns in that structure will look like? Is there any way to sense that? There has already been some capital-raising that is done with the understanding that that's part of the target asset class. I'm trying to maybe better understand what the economics are looking like for yourself.

None that I'm aware of. I'm not aware of any pricing, but you can see where mortgages are being originated, the levels. You can see what credit losses are. You can see what the cost of funds, and you can back into -- some of the first-loss pieces have to be in the teens to basically be reasonable, risk-adjusted returns given the duration, given the interest rates, and the illiquidity of those assets. There is a bunch of things to be determined, whether what the tax treatment of those assets, whether you can get comfortable with the loss severity, given the periodic intervention of government in foreclosure activities, and whether you will have to hold 5% of the capital structure for the life of the deal, which makes a REIT or a vehicle that has permanent equity an ideal buyer of this risk.

Right. Last question, is there any -- did you have any kind of upper bound in terms of how much portfolio turnover you're willing to accept within the portfolio, whether it be across asset mix, or just in terms of optimizing within a particular part of the portfolio?

We do not have a governor on what percentage of the portfolio we're willing to turn over. If the assets have appreciated to terminal value and we think that we can better deploy the capital in a new asset, or even in cash, we will certainly take that approach. We are mindful of basically making sure that the integrity of the portfolio holds together and that we're not introducing new risks to one portion of the portfolio by selling off another portion.

Okay. Thank you very much for your comments this morning.

Thank you. At this time, we have no further questions. Do you have any closing remarks?

Just to thank everyone for attending the call, and we look forward to speaking with you next quarter. Thank you very much.

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.