AG Mortgage Investment Trust Inc (MITT) 2013 Q2 法說會逐字稿

Welcome to the AG Mortgage Investment Trust second-quarter 2013 earnings call. My name is John and I'll 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 this conference is being recorded. I will now turn the call over to Ms. Lisa Yahr. Ms. Yahr, you may begin.

Thanks, John. Good morning, everyone. We appreciate you joining us for today's conference call to review AG Mortgage Investment Trust second-quarter 2013 results and recent developments. 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 you 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 by the Reform Act. Statements regarding the following subjects are forward-looking statements by their nature. Our business and investment strategy; market trends and risks; assumptions regarding adjust rates and prepayments; changes in the yield curve and changes in government programs or regulations affecting our business. The Company's actual results may differ materially from those projected due to the 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 August 7, 2013.

Please note that information reported on today's call speaks only as of today and therefore you are advised that time-sensitive information may no longer be accurate as of the time of any replay listening or transcript reading. Additional information concerning the factors that could cause actual results to differ materially from those contained in the forward-looking statement are included in the risk factor section of the Company's periodic reports filed with the Securities and Exchange Commission. Copies 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.

Good morning, everyone. The second quarter was a difficult one for AG Mortgage Investment Trust and many other fixed income investors. Toward the end of the quarter there was a sharp rise in interest rates and an even sharper selloff in agency mortgage-back securities, leading to a widening in the mortgage basis. With this selloff came a greatly heightened level of volatility in the asset classes that comprise our portfolio. Our portfolio was positioned for a continued slow growth economic environment and therefore we had set up our portfolio to protect against both prepayment risk and modestly rising rates. As a result of our positioning and what happened to markets during the quarter, our book value per share declined approximately 14.6% to end the quarter at $19.77 per share. We have determined that the increased volatility and potentially higher interest rate environment we have seen is not compatible with the portfolio we have had in the past. Therefore, we have reduced the size of our portfolio and increased the amount of interest rate hedges we have.

While we expect these moves will provide our portfolio with more protection in a rising rate environment, we also expect that they will lower our core earnings. On last quarter's call I said, quote -- in terms of our dividend, based on current conditions and everything we see today, we do not anticipate a change in our dividend rate through the remainder of calendar 2013 -- end of quote. Conditions have definitely changed and we did not foresee the events I just discussed at the beginning of my comments this morning. The future level of our dividend will depend upon our core earnings, our undistributed earnings and our general outlook. We have always planned for AG Mortgage Investment Trust to increase the percentage of our assets represented by residential and commercial whole loans, which are the asset classes we believe can maximize the value add to be derived from the Angelo Gordon platform. We believe the opportunities in these asset classes for an investment manager with the skills and resources of Angelo Gordon will to prove to have superior risk reward characteristics, particularly in periods of volatility. Therefore, subject to finding the right opportunities and consistent with prudent portfolio management, we plan to accelerate the rotation of the portfolio into whole loans. We continue to add personnel and other resources to assist us with our whole loan strategies and are very excited about the opportunities in the whole loan markets that we are seeing.

Now Jonathan Lieberman will give more details on our current portfolio and our outlook and then finally, Frank Stadelmaier will go through the numbers for the quarter.

Thank you, David. Before I begin I just want to let you know that my prepared comments and remarks will be briefer than previous quarters, as we thought it made sense to leave more time for questions. As David mentioned, we've always indicated our economic and monetary outlook has been one of the fundamental building blocks for our portfolio construction process. My comments on prior calls reflects -- reflected our expectation for ongoing tepid US economic growth, economic weakness in Europe and the emerging markets, as well as, we believe that the fed would remain supportive of the housing markets by keeping its foot planted on the QE pedal and eventually choreographing a more orderly transition to a taper and ultimately an increase in fed funds. Like most market participants, therefore, we did not anticipate commentary from the FOMC depicting a more robust outlook for growth and an earlier start of tapering of future asset purchases. We could sit and we could debate whether that growth will ultimately come through in the second half of this year and into 2014, but we must accept at least the views put forth by the FOMC.

While an improved economy is good news for our credit portfolio, the increased uncertainty around future central bank monetary policy led to a sharp rise in interest rates and a widening of credit spreads for most fixed income products. No like most market participants, we were not positioned for such a sharp rise and sudden volatility in rates and an even sharper and dramatic widening of the mortgage basis. I mention and emphasize many market participants because I think it's important to realize how much of what went on was due to positioning and the result of unwinding of levered carry trades. As a consequence, just among some of the sectors, treasuries, agencies and municipals all experienced this orderly market.

Our agency MBS portfolio was constructed, as David mentioned, to provide prepayment protection and therefore was positioned substantially in qual-protected, lower-coupon mortgages. These mortgages would have done exceptionally well in a tepid economic environment, more of the same, but would have underperformed in a rising interest rate stronger economic environment. We constructed our portfolio with a view that the fed was more concerned about US deflation, home prices, unemployment, the deep recession in the European core, a depression in the European periphery, Japanese deflation and slowing Chinese economic activity. We also believed that Dr. Bernanke would error on the side of too much QE3 versus curtailing monetary stimulus. Clearly, insufficient weight was given to the fed's view of the frothy fixed income markets, the expansive growth in mortgage REIT equities and the absolute size of the feds QE balance sheet.

Notwithstanding our views on QE and consistent with our portfolio management approach, we had materially increased our hedge ratio over the prior two quarters, so from 53% to the book at the end of September 2012 to 83% of our agency repo book at the end of the first quarter of this year. Our hedge policy, as we've always stated, was not designed to fully insulate the portfolio from interest rate risk, or to protect book value completely. Rather it was designed to manage the portfolio performance with a ban -- within a band of economic and interest rate scenarios. In addition, we've always stated that we were inherently long in the mortgage basis. As we have reassessed the predictability of the markets and the magnitude of the market moves over the last few months, we decided to reposition into a smaller portfolio, which we believe will be better able and capable to withstand longer periods of both higher volatility and limited market liquidity. This more balanced portfolio should be able to tolerate the current interest rate environment, higher volatility and higher or modestly lower interest rates.

Unlike the portfolio we have historically run, we expect this portfolio to have greater sensitivity to higher mortgage prepayment rates. This more defensive positioning will also negatively impact our earnings, as David mentioned. Though the markets have retraced a portion of the selloff and are today functioning more smoothly, we believe these measures are still prudent. Today's calmer market environment may prove to be [afimal], bond outflows have continued at a slower pace, many hedge funds have suffered from negative performance, and as we approach the fall we may see redemptions from these hedge funds, as well as we're approaching the September fed meeting. Rates may experience another bout of volatility. REITs and other market participants may elect to sell assets to reduce their exposure and to curtail their leverage.

While Frank will go to our numbers in more thorough detail in a moment, I'd like to highlight a few of the metrics that reflect the action we took, both during the second quarter and in the month of July. First, during the quarter we reduced the size of the portfolio by 10% from roughly $5.1 billion to $4.5 billion. We have since further reduced the portfolio by approximately 15% as of July 31st. Our leverage now stands at approximate range of 4.7 to 4.8 times our equity. Our current NIM is roughly in the same range as our NIM at the quarter end. In addition, we've added hedges in very meaning -- in a very meaningful fashion, going from 83% hedge ratio at the end of the first quarter to 134% hedge ratio as a percent of agency repo at the end of the second quarter. The average maturity profile, or hedges, is also expended in a meaningful fashion, moving from 4.61 years at the end of Q1 to closer to 5.4 years at the end of June 30th. The additional hedges in the book are primarily the factor driving up our overall cost of funds to 1.84% at quarter end versus 1.32% at the end of the first quarter. When taking into account our entire repo book, including our credit portfolio, our hedge ratio stood at 95% as of the quarter end.

The rise in interest rates negatively impacted credit spreads and the broader fixed income markets. Accordingly, we thought it was prudent to layer in additional hedges. These additional hedges reflect the priority we place on risk management. As the events of the last few months unfold we remain focused on managing the portfolio through market turbulence. As I mentioned earlier, we believe more volatility is likely ahead of us and in accordance with our risk management philosophy we will continue to prioritize risk management and liquidity management and book value preservation, even if it comes at an expense of earnings. At the end of the quarter we were [wanting] a negative -- slight negative gap of 0.05 years on our duration. This represents a meaningful departure from the gaps we've won in prior quarters and again is reflective of our focus on risk management. On our earnings call last quarter I talked about how we had reduced our gap from 1.6 years to 1.3 years at the end of March. As I indicated earlier, we want the portfolio to be positioned to withstand a greater range of interest rates market movements and therefore, until we have clear visibility into what the new interest rate regime or range will look like we expect to maintain a very tight gap. We may open up this gap as we get more comfortable with the liquidity and profile of the interest rate market. Once we believe the transition path is clear, we will adjust accordingly.

Finally, in the latter bottom part of the quarter we began a process of portfolio rotation within our agency book. After initially moving to substantially neutralized the existing portfolio from further shocks of higher interest rates, we've embarked upon the repositioning of the book. Near term we envision a book that runs with more modest duration on the agency side, so you should expect to see us carry less 30-year MBS than we have in the past several quarters, and diversify into some shorter-duration agency's, including hybrid arms. Yields in the agency MBS market are generally more attractive than they were in prior quarters and we'll be able to rotate our positions to better improve our duration and yield profiles. The credit book will continue to be a very important piece to the portfolio. We've spent a lot of time the last few calls talking about our plans in the whole loan space. As David mentioned in his introductory remarks, it's our intention to accelerate our move from agency MBS into loans, both residential and commercial, and we've been actively bidding and working to source assets. We continue to believe that MITT's shareholders will benefit from the Angelo Gordon credit platform, including our ability to identify the most compelling assets on a risk-adjusted relative return basis. Angelo Gordon's investment professionals remain engaged in the markets on a daily basis and we are focused on identifying the best credit assets for MITT as we continue to build our presence in the whole loan markets. With that I'll turn the call over to Frank.

Good morning. For the quarter we reported core earnings of $23.3 million, or $0.83 per share, versus $20.5 million, or $0.75 per share in the prior quarter. The increase in core earnings was primarily the result of increased asset yields partially offset by higher cost of funds. Yield earned on assets during the quarter increased to 3.84% from 3.45% during the prior quarter. This was driven by two factors; the increase in our credit portfolio where yields are higher and the effect of higher rates. As a percentage of total assets our credit portfolio increased from 26.5% to 31.8%. Also, the yield on our agency portfolio increased from 2.84% to 3.02%. This was primarily the result of higher rates. We record revenue using a retrospective level yield methodology that considers a lifetime prepayment assumption. When rates rise prepayments tend to slow, which results in a higher yield -- effective yield for premium bonds. These higher yields also resulted in a positive $0.06 per share retrospective adjustment during the quarter, which is included in core earnings.

The higher yields earned on our portfolio were partially offset by higher funding costs. As Jonathan mentioned earlier, the higher funding costs were primarily attributable to higher swap costs. During the quarter we added approximately $1 billion notional of interest rate swaps, which increase the weighted average cost of our swaps from 0.49% to 0.62%. Additionally, the borrowings on our credit assets cost more than on agency assets so this increase in size of the credit portfolio also increased funding costs. These factors contributed to an increase in our total funding cost from 1.27% last quarter to 1.46% this quarter. Finally, the weighted average leverage used during the quarter was 5.47 times. Many of the steps we took around the portfolio and hedging occurred close to quarter [and/or] post quarter, therefore the effects are not fully included in this quarter's earnings.

To give you a better sense of our current portfolio I'd like to highlight a few more statistics. The portfolio at June 30th had a net interest margin of 1.96%, the asset yield was 3.8% offset by repo and swap cost of 0.82% and 1.02% respectively, for a total cost of funds of 1.84%. Portfolio leverage was 5.4 times at 6/30, and as Jonathan mentioned earlier, at 7/31 stands between 4.7 times and 4.8 times. Moving onto net income. For the quarter we reported a net loss to common shareholders of $74.6 million, or $2.66 per share. In addition to the $0.83 of core earnings, our GAAP net income includes realized and unrealized losses of $3.49 per share. This loss was made up of $4.79 per share of losses on our agency portfolio, $0.89 on our credit portfolio, offset by $2.19 of gains on our derivative portfolio. Finally, we maintain undistributed earnings, which as David mentioned earlier impact our dividend decisions. At quarter end the amount stood at $1.78 per share. That concludes our prepared remarks and we'd now like to open the call for questions.

Thank you.

(Operator Instructions)

Trevor Cranston, JMP Securities.

I guess first I just wanted to follow up on your comment that there had been further asset sales since the end of the quarter. Does that imply that the duration gap you show, which is close to zero at June 30 -- has that gotten more negative if you've sold more assets and haven't changed your hedge position materially?

I would say it's probably just a little bit more negative. We have reduced by maybe about $300 million, $400 million our hedges, but it's really been in commensurate with asset sales. But we have definitely brought the duration down, rotating out of 30's into shorter-duration paper, and at the same time we've taken off some of the hedges.

Got it. Do those numbers assume positive duration on your non-agency RMBS portfolio, or do you think there is a significant positive duration in that portfolio?

The duration gap we're showing does not show a positive duration for the credit assets. We undertook sales of assets that had the most positive duration in the credit book. We would attribute some positive duration to some credit assets to the portfolio, but we've not included those in the numbers.

Got it. I guess, in terms of the whole loan opportunities you're seeing as you accelerate your transition, can you just talk about -- a little bit specifically about what you're seeing, both in the resi and the commercial space currently?

On the residential side, we've seen a material increase in sales of assets, and we see, from a relative value point of view, greater yield in whole loans versus non-agency securities. We see a pickup of a couple hundred basis points in our relative value basis. On the commercial side, we really have a bolt-on strategy to our brick-and-mortar business, and there, if our brick-and-mortar team will see buildings that they would like to own, cannot own, but we are able to lend to owners in either stretch-first, repositioning first lien paper mezzanine credit that we think we can get very, very attractive risk-adjusted yields in the high-single digits, low-double digits.

Okay, got it. Thanks for the color.

Joel Houck, Wells Fargo.

Just a question on the strategy, how -- it sounds like it's more driven by the uncertainty and volatility in the current environment, given that rates have moved and the basis is already widened through July would seem to imply that you guys remain cautious, concerned, whatever adjective you want to insert, between now and the year end. What exactly are you looking for, or more directly, what would it take to get more net duration in the portfolio, and maybe more exposed to a [tire] basis?

I highlighted in my prepared comments that positioning of other fixed income investors was a big component of the selloff and the sharp widening in the basis, the sharp widening in -- or increase in interest rates. So I think we are looking and monitoring, and would like greater visibility into the positioning or possible behavior of other fixed income investors, including other REITs. So that's a big component.

And then, I think we're also looking for visibility into how the fed may mix or change the composition of their bond purchase program, and which we'll hope that we may have visibility in September. It appears that the markets have priced in largely a taper occurring in September, but there's still quite a bit of uncertainty whether they will continue to keep the same proportions of treasury purchases to agency purchases. They did mention that they are apprehensive about misallocation of credit, and so I think we need greater visibility to allow us to understand how much additional risk we should allow into the portfolio.

Okay. And then on the undistributed earnings, $1.78 per share, that would seem to -- obviously, you're going to have a lower core earnings power as long as you maintain this defensive positioning. But is it -- should we assume that that is going to be used for the balance of the year to support the dividend, and then we'll reassess going into next year based on the different portfolio positioning as we get through the taper and a new fed Chairman?

I think -- it's David Roberts. We don't view that as supporting the dividend, but just basically we're looking at the undistributed earnings, and complying with what we have to do in terms of distributing it. And that can be somewhat of a moving target depending upon what happens in the portfolio over time.

Okay, and what's the timeframe for when it has to be distributed? I appreciate that it can change.

It has to be out by September 15 of next year.

Okay, thanks, guys.

Mike Widner, KBW.

Let me just follow up on Joel's question there. Different companies have different ways of thinking about that undisr -- the requirements around the undistributed taxable with some having a preference for doing one-time dividends versus others demonstrating a preference that they'd rather spread it out over the horizon. How do you guys think about those two choices?

I think we've spread it out historically in the past, and we'd continue to do so. We still view it as a somewhat cheap source of capital, and I don't think that that changes for us.

And so this is -- I guess -- I don't know, I guess this thing I wrestle with here is if I take the $1.78 and it has to be out -- let's say you've got four, maybe five, quarters to spread it out over, that's a pretty healthy chunk of change, which is $0.45-ish or a little bit lower per quarter, which tells me you could cut the portfolio even more than you have, and still support $0.80 if you really wanted to. I guess that's what -- one of the things I wrestle with, or we wrestle with, and any thoughts on that, or is my math -- am I missing something in the math?

I think the math is -- it's about $0.35 over the five quarters, maybe a little bit higher than that, but I think that that's right. It depends on really what happens in the next two quarters, also. You have the next two quarters' earnings, as well, to factor in, and the size of the portfolio will be one of the main factors in how much it generates.

I really appreciate it that you guys have done our jobs for us, a little more than most, but if I take the guidance you gave and what you said, you're telling me you're 4.7, 4.8 times leverage now, and I think in your slide presentation and your verbal comments you laid out the net interest spread and all of that, and it pretty clearly points us to something around a 10%-ish ROE, and I -- again, am I missing something there, or have you done my job for me?

We would never say that we would do your job for you.

(laughter) I wish you would. I guess the final question I have then is -- and I think you answered this -- but philosophically, for all the reasons you laid out, we've gone from an environment where I think a lot of the market had a little more conviction about what was going to happen with regard to rates, as well as fed policy, to one where I would say it is a complete wild card at this point. We don't really have any idea who the fed Chairman's going to be, let alone whether that person feels any obligation to coax rates lower versus let them run higher. And I'm just not sure that that has any prospect of changing in the second half of the year, given timing on Bernanke's departure and all of that.

There's two ways you can hedge away that risk, and I think you guys seem to be doing a little bit of both of them. But one is to get yourself to basically, on paper, a duration-neutral position that may or may not be effective. Last quarter it wouldn't have been terribly effective because of basis widening and duration extension and blah, blah, blah. And the other is obviously if you go to all cash, then you don't have any book value risk at all, so delevering and selling assets is another way to protect your book value. How do you think about evolve -- again, you guys have sort of taken both of those approaches right now, you've pointed out that that has a negative impact on earnings, but how do you wrestle with it? You think you're comfortable now at this level, and with the portfolio, given the likely evolution, and what might make you think one way or the other as we look at it over the next six months?

Yes, I think there's a third component there that we have really voiced even stronger our preference to move into whole loans or self-originated opportunities that we think will be more insulated from fed action potentially and, most importantly, the positioning of other participants in the markets. So I think -- I will say that we will probably be very uncomfortable for the foreseeable future. We've been uncomfortable for several months. We've taken a series of actions. Even when we had conviction, we increased our hedge ratio in the first and the second -- first quarter, and even the fourth quarter, and we had quite a bit of conviction.

Now I think we have a great deal of discomfort with the structure of the markets and the uncertainty out of Washington. I think we have taken, as you said, steps to basically shrink the portfolio; we've taken steps on the interest rate side. We're not going to be able to escape the basis, but we can at least push more capital into assets that hopefully are away from the basis, and we can insulate from rates and maybe insulate a little more from other market participants.

Let me ask you about one other asset class you haven't mentioned, which is investing capital in buying back your own stock, which at the moment is trading somewhere right around 87% of book.

We look at everything all the time.

So, it's a contemplation, but it sounds like you're not terribly committed. Some have been more vocal about saying -- look, we like the opportunity to buy back our own stock when we're trading at substantial discount to book. I'm not sure I'm hearing that, which I think is fine, but just looking for a comment?

I think you got the comment.

I got all the comment I'm going to get.

You got the comment. It's certainly something we're aware of, and we look at it, and we -- everything that we do, we try to think not only about the immediate effect but also long-term value creation, as well.

Look, we also think about when to issue stock, and so you did not see us do an offering in the first half of this year.

Yes, which was perplexing because you guys were trading above book for a while longer than a lot of guys. I think that was -- I don't know, that's where I think book was, but that was good discipline then. And I guess, I appreciate the comments, and I think you probably said all you need to about share repurchases.

Merrill Ross, Wunderlich Securities.

At the end of the year, you announced that you hired a managing director and a head of residential whole loan platform. Is there any update as to how that business is progressing or any intention of creating flow relationships that would generate [a pools of loans] on the residential side?

That business is progressing per plan. We have added another individual to work with Jason Biegel. We anticipate that there will be future hires, hopefully in the near term. We do anticipate at some point entering into flow arrangements, but the opportunity set that's immediately upon us is legacy mortgages.

Thank you.

We have no further questions at this time.

Well, thank you, everyone, for participating, and we look forward to our next quarter's call. Thank you.

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