AG Mortgage Investment Trust Inc (MITT) 2014 Q1 法說會逐字稿

Welcome to the AG Mortgage Investment Trust first-quarter 2014 earnings call. My name is Lorraine and I will be your operator for today's call. (Operator Instructions) 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, Lorraine, and good morning, everyone. We appreciate you joining us for today's conference call to review AG Mortgage Investment Trust's first-quarter 2014 results and recent developments.

Joining me on today's call are David Roberts, our Chief Executive Officer; Jonathan Lieberman, our Chief Investment Officer and Brian Sigman, our Chief Financial Officer.

Before we begin I would 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 risk; assumptions regarding interest 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 May 7, 2014. Please note that information reported on today's call speaks only as of today; and therefore we advise 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 statements are included in the Risk Factors 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 will turn the call over to David Roberts.

Thank you, Lisa, and good morning to everyone. MITT had solid and positive performance on all fronts in the first quarter of 2014. We were pleased with our $0.62 per share core earnings, particularly given our continued conservative portfolio positioning.

We were also pleased to have made progress in increasing our portfolio's allocation to value-add credit assets. With regard to these types of assets Angelo, Gordon continues to add personnel to our residential and commercial whole loan teams who source, analyze, and structure these investments.

With that very short introduction, I will turn things over to Jonathan Lieberman, Chief Investment Officer of MITT.

Thank you, David. Good morning all. I appreciate you getting up early for us.

During 2013 we navigated fixed income markets characterized by very low interest rates, variable prepayment speeds, uncertain economic conditions, and a frothy, overbought Agency MBS sector, and a volatile midyear market reaction to anticipated paper under the Federal Reserve's quantitative easing program.

Despite these challenges we are pleased that MITT distributed cash dividends of $3.00 during calendar-year 2013 to our shareholders. We executed on several key metrics, such as yield on interest-earning assets, net interest rate spread, debt-to-equity ratio, asset liability gap, and the ratio of credit assets relative to our Agency MBS allocation.

Our asset manager as David mentioned, Angelo, Gordon, continues to hire several and many talented investment and financial professionals and continues to invest in technology and portfolios systems which will benefit MITT's shareholders in 2014 and future years.

During the first quarter, technicals and fundamentals were favorable for both the housing and mortgage markets. On our last earnings call I set out several investment objectives for 2014. The key observable metrics were continued rotation of capital into credit assets, protection of book value, and restoration of optimal risk-adjusted earnings capacity for the Company.

The investment team executed on all key objectives for MITT, including core earnings covering our quarterly dividend, growing book value per share, and continuing our ongoing migration into credit assets. During the quarter we closed investments in both residential and commercial loans, and we are very excited about the investment opportunities we are seeing today through the AG platform to deploy additional capital in both markets.

More specifically, MITT earned $0.98 of net income during Q1. $0.62 was attributable to core earnings, as noted in our presentation. Book value rose to $19.53, netted for the impact of our dividend paid to our shareholders on April 28.

Undistributable taxable income rose to $1.88. Portfolio size was roughly the same as the prior quarter at roughly $3.8 billion.

Our hedge ratio stood at 106% of our Agency MBS portfolio and 69% of our total repo notional. Prepayment speeds for our Agency book remained well channeled and contained at 6 CPR.

Leverage at 4.36 times was modestly lower than last quarter due to our rotation of capital into credit assets from higher leverage Agency securities. Net interest margin rose by approximately 15 basis points to 2.61% from fourth quarter. NIM benefited from a better mix of higher-yielding assets, lower hedging costs, and improved funding costs.

During the quarter we acquired approximately $59 million of face in legacy residential mortgage loans and deployed $10 million of capital into a mezzanine commercial real estate investment.

Now on to book value and earnings trends for Q2. As of April 30, they have continued to be favorable. We are cautiously optimistic on our portfolio, housing, and the mortgage market. We are vigilantly monitoring market conditions and the risk to the Company, and we are pleased with the high quality of earnings and the portfolio composition as it stands today.

Before turning to more details on the portfolio, I would like to share a few brief thoughts on our 2014 outlook, which we outline on slide 5. Although the unusually harsh winter negatively impacted recent economic data, we fully expect the Fed to stay its course and wind down QE3-related Treasury and Agency MBS purchases by November. Though on a historical basis the pace and strength of the US economy recovery is sluggish, we do believe the US economy is firmly experiencing the new norm of modest growth.

While housing will not repeat its 2013 gains, we believe home price appreciation will continue slower and at different levels across different geographies and regions.

With regard to interest rates, we believe LIBOR should remain anchored for the next year, given high levels of worldwide liquidity. As to the interest-rate curve, we would not be surprised to see ongoing volatility in both the short- and long-term rates, stemming from economic data and geopolitical issues.

Market participants will seek to use any new information to sway an interest-rate market. We have seen rate markets for the past several months chop back and forth.

Foreign exchange flows may also be influencing the Treasury and interest-rate markets. We remain vigilant, and don't want to read too much into distorted worldwide rate markets.

Our portfolio outlook reflects our objectives and our vigilance. We anticipate a further rotation of capital into credit securities, residential and commercial real estate loans. The portfolio and liquidity position is structured to withstand a wider range of interest rate, Agency spreads, and credit market movements than in early 2013.

Now moving on to our portfolio, slide 6 details some of the top level sector metrics from the quarter. The fair value of our Agency and credit book was approximately $2.3 billion and $1.5 billion, respectively. Focusing first on our Agency book, we reduced the size of our Agency portfolio by roughly $90 million of fair value quarter-over-quarter, with most of the reduction occurring through sales of lower coupon MBS.

As the pie chart on the bottom of slide 7 shows, hybrid adjustable-rate mortgages represent approximately 22% of our Agency portfolio exposure. And over 50% of our fixed-rate pools have some call protected characteristics. From a prepayment perspective our pools continue to perform in line with expectations, with Q1 CPR of approximately 6%.

Now moving to the credit side, we grew our credit book by approximately $150 million of fair value during the quarter, with the increase coming across loans, non-Agency securities, ABS, and CMBS. As I discussed earlier, we are pleased to report deployment of $10 million of equity into a commercial real estate investment on a hotel property in New York City, which bears a current interest rate of LIBOR plus 12.25%.

We also acquired approximately $59 million of face of legacy residential whole loans at an attractive risk-adjusted yield. As we have noted on several calls we believe Angelo, Gordon is well positioned to source and originate active investment opportunities in the loan space, both commercial and residential. And our investment teams are busy underwriting numerous investments as we speak.

Now turning to our financing and duration gap, we currently have 30 financing counterparties. During the quarter we renewed our one-year facility with Wells Fargo for non-Agency MBS, and we also executed a committed whole loan facility with Wells for residential whole loans.

Funding conditions for MITT are favorable, and we continue to benefit from lower cost of funds and better financing terms.

On the duration gap side, our duration gap declined from 0.69 years to 0.29 years quarter-over-quarter. If we treat our Agency hold pools as TBAs, our reported gap would narrow to roughly zero. Given the strength of the credit book and the Agency basis throughout the Q1 period, we elected to minimize our interest-rate risk by allowing our interest-rate gap to decline.

Interest-rate swaps positioning is overweight the front-end and the belly of the interest-rate curve. These areas of the rate curve have experienced the most severe widening and the greatest volatility in response to Fed monetary policy changes. Looking forward we will be able to improve our earnings capacity by allowing the gap to widen out to a more normalized position in the future.

Our hedging and interest-rate sensitivity tables are on the next slide. We continue to optimize our hedge book for the current portfolio and believe additional expense savings is achievable. Given the construct of our assets and hedges, we believe our portfolio today should be better able to withstand a wider range of interest-rate market movements than our portfolio was over a year ago.

I would like to wrap up by saying we believe our portfolio is appropriately sized and positioned for today's market environment, and we are excited about the flow of investment opportunities we are seeing in both the bond and loan market. With that I will turn the call over to Brian to review our financial results.

Thanks, Jonathan. In the first quarter we reported core earnings of $17.7 million or $0.62 per fully diluted share, versus $19.1 million or $0.67 per share in the prior quarter. As we pointed out on the last call, our Q4 earnings included a large fee from commercial loan payoff. Stripping out the fee, Q1's core earnings would have been higher than the prior quarter; and more importantly, they again exceeded our $0.60 common dividend. This increases primarily due to an increase in the yield we earn on our assets due to the rotation into credit investments as well as better underlying asset performance.

Overall for the quarter we reported net income available to common stockholders of $27.8 million or $0.98 per fully diluted share. In addition to the $0.62 of core earnings, our net income included realized and unrealized gains of $0.36 per share.

The $0.36 net gain was primarily due to $0.35 of net unrealized gains on our securities and derivatives portfolio. Additionally we had $0.04 of realized gains on our securities and derivatives portfolio that was offset by $0.03 of realized losses upon the recognition of other than temporary impairment and the unlinking of linked transactions.

To give you a better sense of our current $3.8 billion portfolio, I would like to highlight a few more statistics. As described on page 4 of our presentation, the portfolio at March 31, 2014, had a net interest margin of 2.62%. This was comprised of an asset yield of 4.27%, offset by repo and swap costs of 0.86% and 0.79%, respectively, for a total cost of funds of 1.65%.

We are pleased that our net interest margin continues to trend higher as the increase is driven by an increase in our weighted average yield, with the rotation into the higher-yielding credit investments, away from lower-yielding agency securities, as well as the improved underlying performance of our portfolio. Our funding costs remained flat quarter-over-quarter as the increase due to the continued rotation to credit investments, which come with a higher funding cost than Agency securities, was offset by lower overall funding cost throughout the portfolio.

In January we exited out of our only forward starting swap; and our swap costs reflected the true cost of our swaps.

At March 31, our book value was $19.53, an increase of $0.39 or 2% from last quarter end. This increase was primarily the result of a total $0.36 gain on our securities and derivatives portfolio, as I described before, as well as core earnings exceeding the common dividend by $0.02. Our undistributed taxable income was $1.88 per share at 3/31. And as you can see from our roll-forward in our supplement, we had a one-time adjustment resulting from a re-class on an expected capital gain to ordinary income.

Our liquidity remains strong, and at quarter end we had a total liquidity of $199.3 million, which was comprised of $33 million of cash, $84 million of unlevered Agency whole loan securities, and $82 million of Agency IO securities.

On the funding side we continued to be active and, as previously mentioned, we entered into a $100 million facility with a two-year term to facilitate investing in nonperforming and re-performing residential loans. In April we extended the maturity of our one-year facility that finances some of our non-Agency securities. This facility was extended for another year and, as part of the renewal, we increased its size to $165 million while also lowering the borrowing rate as well as certain bond-specific haircuts.

We are in discussions with some banks on other types of facilities for both loans and securities in both the residential and commercial sectors. And in addition we continue to explore ways to extend our maturities and lower our costs on our existing investments.

That concludes our prepared remarks, and we would now like to open the call for questions. Operator?

(Operator Instructions) Douglas Harter, Credit Suisse.

Thanks. I was hoping you guys could give a little color as to where you might see the duration gap trending in the next couple quarters.

I think we would like to see the generation gap slightly over a half of a year, somewhere between a half a year and one year. But it is dependent upon what we see in the interest-rate market as well as we see on the policy side.

At this time, as I mentioned, we elected to allow the gap to narrow. When we were basically selling off Agency securities and rotating into some of the credit assets, we adjusted minimally in respect of that.

And we elected to basically keep our hedges in place, which were predominantly -- they are overweight, they're not predominantly. They are overweight at the front end of the curve as well as the belly of the curve. And so they have performed very, very well with recent volatility.

So is that something we should expect in the near term? Or would you like to see rates move higher first, before you would be comfortable to let that duration gap move out?

I think it's -- I would probably say over the next six months. We would like to see a movement in rates that is sustained before we would potentially basically reduce some of the hedges at the front end.

Then shifting to the residential and commercial loan opportunities, can you talk about the pipeline to continue the activity that you had there in the first quarter?

Sure. Starting with the residential whole loan side we saw several pools in the first quarter. Activity was a little bit more subdued than anticipated. Several of the potential sellers that we expected to market ran into some operational difficulties, and we fully expect that over the next several months, three, four months, there will be material supply that will be hitting the market.

We were quite disciplined in the first quarter, and several of the pools traded at levels that we felt were not as attractive as assets we have typically acquired. But we do anticipate that there will be more supply in the balance of this year, and we are not prepared to basically deploy capital for the sake of just simply deploying it.

On the commercial side we added Peter Gordon last summer. Peter Gordon is adding staffing, and he has several transactions in the pipeline. So not to get ahead of ourselves, but I think that we will have some favorable developments to report next quarter.

Great. Thank you.

Trevor Cranston, JMP Securities.

Thanks. To follow-up on the comments about how you are thinking about the duration gap, can you share your thoughts on how you are thinking about the Agency basis over the next few quarters, and how your thoughts on that impact how you are managing the duration gap and the portfolio overall?

Sure. The Agency basis has had favorable performance for the last several months. There was quite a bit of concern about the Agency basis earlier this year. There was obviously quite a bit of volatility last year, midyear, in the basis.

At this point in time we have -- we are very much more constructive on the Agency basis. Many investors are underweight Agencies. Supply is quite constrained and reduced.

You are not seeing the same level of mortgage production. You combine that with just vast underinvestment in the space and the lack of a lot of duration out there, and you have many, many people who were less constructive on the basis who shorted the basis. The result is that the basis continues to outperform.

Now we have said we are more constructive on the basis today than we had been last year. But we also at the same time mitigated some of our basis risk by running a much more diversified Agency book and a smaller Agency book.

So as we noted, I think 22% of the portfolio is hybrids. We have a mix of 30s, 15s, and 20s in the portfolio; a mix of different coupons in the stack. We moved up in coupon, all once again in the pursuit of mitigating some of the basis exposure.

In terms of the duration gap, we are constructive on basically expanding that gap. Right now it is not optimal in our opinion to be running a zero gap.

But we see if rates were to potentially rise, especially at the front end or the belly of the curve, we would perform very, very well under that scenario. And so we would like to see if potentially economic activity was to pick up, potentially there would be more volatility, and potentially further increases in interest rates at the front end of the curve; and we would potentially benefit from that. And at that point we would be able to cut back our hedge ratio.

Okay, that is helpful. On the funding side, some of your peers have announced that they have formed subsidiaries that have become members of the Federal Home Loan Bank system. Can you comment on if that is something you guys have looked at, and if you think you would be able to utilize FHLB borrowings on any of your existing portfolio?

Yes, it's Brian. We have been in talks with some. We looked at it pretty hard, and right now we haven't chosen to set one up or else we would have announced it.

But if ever does become something that we think would benefit the Company and the shareholders, it's definitely something we would pursue.

Okay, great. Thank you.

Joel Houck, Wells Fargo.

Thank you and good morning. I am wondering if you could maybe help us out or talk about directionally how much capital, within a certain range, you had planned to allocate, your credit strategy, which obviously may include residential and commercial. Obviously there is a floor on how much of the whole pools you have to own.

But it sounds like you are more defensive on the Agency side, just given rates are unpredictable, and you are putting more capital and more I guess the intellectual bet on the credit side of the house.

I would say, look, the Angelo, Gordon platform has a lot of value on the credit side. And we have the ability to directly originate credit assets and leverage off of over 60 different investment professionals. That is a value-add.

And so we are certainly going to increase the amount of capital allocated as the pipeline develops and as the opportunities set comes into existence.

With respect to Agencies, the Agency portfolio as well as the credit portfolio has performed very well over the past four months. We like our positioning. We like the returns that we are earning on the Agency portfolio.

I would say that we had the luxury of being able to maintain a very high hedge ratio and being correctly positioned with our interest-rate swaps for the volatility that has occurred over the last 60 to 90 days. I think that we have the luxury, given how well we are performing and the earnings capacity off the credit book as well as the Agency book, to basically spend a few insurance dollars from current earnings to protect book value very, very extensively and potentially take advantage of a rise in short-term rates.

It's David Roberts. I would just add that on the credit side, particularly on the origination and the whole loan side, it's an episodic type of activity. So you could easily see quarters where there are a few deals; you could see quarters where there are no deals. It's obviously a lot lumpier.

So I just think it's important for everyone to keep that in mind. If we want to increase the part of the portfolio dedicated to those assets, that is dependent upon finding deals that we really like. And that is -- we can be very vigilant and urgent about looking for deals, but there has to be a match between a borrower and us, or a pool and us.

Yes. I would say that we will continue to be very, very disciplined in this environment. We will -- we do have capital available to push into distinct direct originated opportunities. And then we also have the ability to trade out of existing credit assets into higher-yielding direct originated assets.

So we have a lot of flexibility. And we look forward to in the next several months really seeing if we can push the NIM further up and further enhance the profitability of the Company.

Appreciate the color. If I could maybe just ask a philosophical question, we have the 10-year on the back of what was, at least on paper, a strong jobs report sitting at 2.60%; a huge bond market rally. Are you guys surprised that the bond market, which is always forward-looking obviously, seems to be suggesting a much more subdued economic growth the rest of the year, but yet we still have this notion from investors that a rise in rates is just around the corner? I guess the question is, are you surprised that the bond market did not sell off on the heel of the jobs report?

Not particularly. I think 2.60% may not be reflective of where the back end ultimately transitions. You also have to keep in mind that, once again, our portfolios I think have roughly a 3.9 asset duration. So we are -- we do focus on the back end; but we are really more susceptible and more interested in where the belly of the curve is.

But right now I would say first Ukraine and geopolitical may be weighing on the markets. And we have seen where the back end will jump up 5 to 10 basis points for an hour or two; and then a headline will hit on Ukraine and then we will come right back down to 2.60%. So that is one aspect.

I think there's questions of whether the Chinese or some other international offshore accounts -- I shouldn't mention their name particularly -- is buying the back end because of ForEx. And I mentioned that in my introductory remarks, that foreign exchange rates may be impacting our interest-rate curve and causing distortion especially right now at the back end.

And then finally you have seen this debate raging lately by economists on whether we have some sort of stagnation, notwithstanding what the jobs number reflects. There is a focus on participation rate; there is a focus on demographics; and then there is a focus on wage growth.

So it's, I think, very difficult to really draw too many conclusions by looking at that one number of 2.60%. And you will see that once again in the way that we have positioned our hedges, which are certainly overweight at the front end of the curve and the belly of the curve, and that has been very appropriate positioning for the past four months.

All right. Thank you guys very much.

Jason Stewart, Compass Point.

Good morning. Thank you. On the commercial real estate side, could you give us an idea for what returns look like at different parts of the capital structure? For example, should we expect you to focus on mezz opportunities going forward?

And then, is LIBOR plus the 12.5% the right area for us to think about in terms of return there?

I think there is the commodity market and then there is the direct market, so I will focus on our direct origination, which is the predominant source of assets that we seek to add. The coupon for the loan that we made is LIBOR 12.25%; but when you include all of the other incidental fees, expenses, potential early payoff, we see returns for that asset potentially exceeding 15%.

So we see a pretty good risk-adjusted return for the LTV and the attachment point. And I think that is -- for mezzanine type of investment we certainly wish to be in the mid to high teens.

For more of the unit tranche transitional type of assets, there you are looking at first lien maybe up to let's call it somewhere between a 70 and 80 LTV. There you are somewhere between LIBOR 550 to 750. And there are you are going to utilize some form of term leverage, and you will be able to achieve greater than let's say a 17% type of return potentially on a gross basis with 2.5 to 3 turns of leverage.

If you are dropping down to more of a traditional first mortgage, there you are going to be inside of L plus 500.

So would it be fair to say that your focus and your core DNA is more suited for that mezzanine product and not part of the capital structure?

Yes. That part or the unit tranche with some sort of transitional nature to the property, so that we are paid for that risk.

Okay. When you think about that as a direct lending opportunity, versus some sort of direct opportunity in resi, how do you think about the two differently? Is there a meaningful return difference? Does leverage play a factor, or your ability to source assets?

Can you give us just a sense for where you think the opportunity more suits the Angelo, Gordon platform?

The benefit of the Angelo, Gordon platform is you get both. And both opportunities are apples and oranges. You have the returns -- the gross returns are typically lower for the residential side; there you are talking midteens, low teens.

But you have a lot more optionality. There are a lot of potential outcomes, vectors, that can arise. That basically in one-third of the case we may see an upside case that produces returns greater than 20%.

So it could be an acceleration of economic activity that leads to higher prepayments because people are moving out of their houses faster than we anticipated. It can be lower default rates than once again were modeled.

Whereas on the mezz side or the unit tranche side you're ultimately capped at par, getting your capital back, and an accelerated yield recapture.

It is useful to keep in mind that one, being the resi or discount assets, and commercial as Jonathan said is essentially par less whatever discount and other transaction benefits that you're able to negotiate.

Okay, that is helpful. Thank you.

(Operator Instructions) At this time I am showing no further questions.

Thank you, everyone. Have a great day. We look forward to speaking to you next quarter.

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