AG Mortgage Investment Trust Inc (MITT) 2014 Q2 法說會逐字稿

Welcome to the AG Mortgage Investment Trust second quarter 2014 earnings call. My name is Christine and I will be the operator for today's call. (Operator Instructions) Please note that this conference is being recorded. I will now turn the call over to Mr. Allan Krinsman. You may begin.

Thanks, Christine. Good morning, everyone. We appreciate you joining us for today's conference call to review AG Mortgage Investment Trust's second 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'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 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 based on our beliefs and expectations as of today, August 6, 2014. 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 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 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, Alan, and good morning, everyone. AG Mortgage Investment Trust had solid and positive performance on all fronts in the second quarter of 2014. Similar to the first quarter, our core earnings were approximately equal to our $0.60 per share dividend and we made additional progress in increasing our portfolio's allocation to value-added credit assets.

In both the residential and commercial whole loan sectors, our deal flow and our capabilities continued to increase. AG Mortgage Investment Trust's investment team continues to work hard and well at balancing risk, book value, and current earnings. With that introduction, I'll turn things over to Jonathan Lieberman, President and Chief Investment Officer of MITT.

Thank you, David. Good morning, all. In sharp contrast to last summer's temper tantrum, fixed income capital markets during the first half of 2014 have been favorable, uncharacteristically calm, and notable for their lack of volatility. The sea of tranquility is occurring despite tapering of the Federal Reserve's Quantitative Easing Program and modest softness in high-yield unsecured securities, as well as some geopolitical issues.

Mortgage investments with strong interest income attributes continue to outperform under these market conditions. Accordingly, we're very pleased with MITT's portfolio of performance, as well as our investment team's executive on several strategic initiatives. With respect to MITT's asset and financial performance, we distributed our fourth consecutive quarterly dividend of $0.60.

MITT has paid cumulative dividends of $2.40 to our shareholders over the past 12 months. We continue to retain $1.91 of undistributed taxable income for potential future distributions. The investment team continued to execute 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 allocations.

During the second quarter, Angelo, Gordon sourced and made new investments on behalf of MITT in both residential and commercial real estate loans. Our asset manager, Angelo, Gordon, continues to add talented investment professionals, which will benefit MITT shareholders in the future. As I noted in our prior quarters' earnings call, we have specific investment and return objectives for 2014.

The key observable metrics were continued rotation of capital into credit assets, new investments in residential and CRE loans, 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 and very high quality earnings, may I add, cash earnings, new residential and CRE loan investments, growing book value per share, and continuing our ongoing migration into credit assets.

During the quarter, we closed several investments in residential and commercial loans and we are very excited about the future investment opportunities we have seen today to deploy additional capital in both markets. More specifically, MITT earned $1.33 of net income during Q2. $0.63 was attributable to core earnings before a negative $0.03 retrospective adjustment for projected future agency prepayments.

Book value rose to $20.26, netted for the impact for our dividend paid to shareholders on July 28. The portfolio size remained roughly the same as prior quarter at approximately $3.8 billion. Our hedge ratio stood at 106% of our agency MBS portfolio and 65% of our total repo notional. Prepayment speeds for our agency book remained well-channeled and contained at 7.6% CPR.

Leverage of 4.25 times was modestly lower than the prior quarter due to our rotation of capital into unlevered CRE loans from higher levered agency securities. We expect leverage to rise modestly back to a ratio consistent with Q1 once we complete our new CRE funding facility. Net interest margin rose by 8 basis points to 2.7% from the first quarter. NIM benefited from a better mix of higher-yielding assets.

During the quarter, we made investments of approximately $122 million in legacy residential mortgage loans held in security form and deployed $62 million of equity into to two senior commercial real estate loans. Before turning to more details on the portfolio, I'd like to share just a few brief thoughts on our 2014 outlook, which we've outlined on slide 5. During the second quarter, technicals and fundamentals remained favorable for both housing and the mortgage market.

Although recent economic data hasn't recovered as strongly as anticipated following a unusually harsh winter, we fully expect the Fed to stay the course and wind down QE3-related Treasury and agency purchases by November. With respect to the economy, the US economic recovery continues to make steady and stable progress. Steady growth with little inflation pressure looks reasonable for the balance of 2014 and the first half of 2015.

A gradual pickup in nominal wages can be viewed as constructive for future consumer consumption and housing. While housing will not repeat its 2013 gains, we do believe home price appreciation will continue slower and at different levels across different geographies. With regard to interest rates, we believe short-term rates will remain relatively benign for the next year, given the high levels of worldwide liquidity and challenges in different economic zones.

As to the interest rate curve, we would not be surprised to see ongoing volatility in both short and long-term rates stemming from geopolitical issues, economic data, and monetary policy spin doctoring. Market participants will continue to seek and use new information to sway an interest rate market. We've 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 worldwide interest rate markets. Our portfolio outlook and positioning reflects our objectives, vigilance, and neutral interest rate posture. We anticipate accelerating our rotation of capital into credit securities, residential, and commercial real estate loans. Overall, the portfolio and liquidity positioning is structured to withstand a wider range of interest rate agency spreads, and credit market movements than in 2013.

Moving on to our portfolio, slide 6 details some of the top-level senior metrics for the quarter. The fair value of our agency and credit book was approximately $2.2 billion and $1.6 billion, respectively. Focusing first on our agency book, we reduced the size of our agency portfolio by roughly $130 million of fair value quarter-over-quarter. As the pie chart on the bottom of the slide 7 shows, hybrid adjustable rate mortgages represent approximately 20% of our agency pool exposure and over 68% of our fixed-rate pools have some form of [call-protected] characteristics.

From a prepayment perspective, our pools continue to perform in line with expectations with Q2 CPR of 7.6% and June CPR of 7.7%. Turning to the credit side of our business, we grew our credit book by approximately $185 million, a fair value during the quarter, with the increase predominantly attributable to residential whole loans and CRE investments.

As I discussed earlier, we're pleased to report we deployed $62 million of equity in two commercial real estate first lien loans secured by a hotel and office building, respectively. Upon completion of a new CRE lending facility, we expect to generate a gross levered return in excess of 15%. In the residential segment of the business, we invested approximately $122 million of fair value or $30 million of equity capital in legacy residential whole loans at an attractive risk-adjusted yield.

As we have noted on several calls, we believe that Angelo, Gordon is well-positioned to source and originate attractive investment opportunities in the loan space, both commercial and residential, and our investment teams are busy underwriting numerous investments currently. Now turning to slide 9, we provided an update on our financing and duration gap. We currently have 33 financing counterparties, funding conditions for MITT are favorable, and we continue to benefit from attractive cost of funds and better financing terms in the marketplace.

MITT's duration gap declined from 0.29 years to 0.16 years quarter-over-quarter. If we our agencies whole pools as TBAs, our reported gap would narrow to roughly zero. Given the strength of the credit book and the agency basis throughout the second quarter, we elected to minimize our interest rate risk and to allow our interest rate gap to contract. Interest rate swaps positioning currently overweights the belly and the back end of the interest rate curve.

The belly of the curve has experienced the most severe widening and volatility in response to potential Fed monetary policy changes. Looking forward, we should be able to improve our earnings capacity by allowing this gap to widen out to a more normalized positioning in future quarters. Our hedging and interest rate sensitivity tables are 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 the portfolio was a year ago. I'd like to wrap up by saying that we believe our current portfolio is appropriately sized and positioned in today's market environment and we're excited by the flow of investment opportunities we're seeing in both the bond and loan markets. With that, I'll turn the call over to Brian to review our financial results.

Thanks, Jonathan. In the second quarter, we reported core earnings of $17 million or $0.60 per fully diluted share versus $17.7 million or $0.62 per share in the prior quarter. At June 30, we had a negative $0.03 retrospective adjustment to our premium amortization in our agency portfolio. Stripping this out, core would have been $0.63 per share.

We're pleased with this result and it marks the third quarter in a row where our core has met or exceeded our common dividend. Overall, for the quarter, we reported net income available to common shareholders of $37.8 million or $1.33 per fully diluted share. In addition to the $0.60 of core earnings, our net income included realized and unrealized gains of $0.73 per share. The $0.73 gain was primarily due to $0.59 of net unrealized gains in our securities and derivatives portfolio.

Additionally, we had $0.06 of realized gains on our securities and derivatives portfolios, including gains in our equity and earnings line item and another $0.08 of net gains on our linked transactions. At June 30, our book value was $20.26, an increase of $0.73 or 4% from last year. This increase was primarily a result of the total $0.73 net gain on our security and derivative a portfolio as I described above.

To give you a better sense of our current $3.8 billion portfolio, I'd like to highlight a few more statistics. As described on page 3 and 4 of our presentation, the portfolio at June 30, 2014 had a net interest margin of 2.7%. This was composed of an asset yield of 4.4%, offset by repo and costs of 0.93% and 0.78%, respectively, for a total cost of funds of 1.71%.

We are pleased that are net interest margin continues to trend higher as the increase was driven by an increase in our weighted average yield with a rotation into higher-yielding credit investments from lower yielding agency securities, as well as the improved underlying performance of our securities. Our funding costs was up slightly quarter-over-quarter with a continued rotation to credit investments, which come with higher funding costs than agency securities.

On the derivative side, we do not have any forward-starting swaps and therefore, our swap costs reflect the true cost of our swaps. Our liquidity remains strong and at quarter end, we had a total liquidity of $147 million composed of $11 million of cash, $107 million of unlevered agency whole polled securities, and $29 million of unlevered agency IO securities. In addition to the liquidity that I just mentioned, we have funded the two senior commercial mortgages with cash on hand; both of which we expect to finance in the near-term, which will increase our cash position.

On the funding side, we continue to be active and as was previously mentioned, in April, we extended the maturity of our one-year facility that finances non-agency securities. This facility was extended for another year and as a part of the renewal, we increased its size to $165 million, while also lowering the borrowing rate, as well as lowering certain bond-specific haircuts. We currently have signed a term sheet for a commercial loan facility that we expect to finalize in the upcoming weeks.

This facility will initially finance the two senior commercial loans that we made in the quarter and will give us additional capacity for future commercial whole loan investments. In addition, we continue to explore ways to extend our maturities and lower our costs on our existing liabilities. That concludes our prepared remarks and we would now like to open the call for questions.

(Operator Instructions) Trevor Cranston, JMP Securities.

The first thing, on the residential loan investments in the quarter, can you go into a little bit more detail about the structure of those? I know they're in security form. Are those investments where you're buying bonds off of RPL or loan pools that other people have securitized? If that's the case, can you talk about kind of where in the capital stack you're buying?

We have purchased loans in security format collapsed structures to basically be left with, in some cases, whole loans, which then we put into a trust and then we take back trust certificates so that we are permitted to hold those assets. That's part of the investment and then part of the investment is where we are buying residual interests or other securities that we will be able to collapse in the future.

Then, the third way that we buy whole loans is we're actually buying a pool of unsecuritized whole loans and then once again, we're putting them into a trust. For technical reasons, we must put them into that trust and then take back certificates, and so they will show up in the line, in basically our disclosure as securities held for investment.

Got it. That's helpful. There's been some talk among other market participants about a lot of competition in that market. Can you guys just kind of give some color on what you're seeing in terms of price levels and expected returns?

I would agree that there is certainly heightened competition, but the market is a very sizable one. It can be opaque at times and there are situations where you can get exclusive looks at collateral. So in the a broad kind of HUD-style auctions, you saw, at least in this past quarter, very material heightened competition. In other cases and similar time periods, we've been able to enter into bilateral agreements to acquire assets that have been materially cheaper than basically those broadly-marketed processes.

We also benefit from counterparties that are looking for certainty of execution and have kind of what I would call non-standard situations and we can work with them. We've been able to procure loans in the high single-digit unlevered cases and with leverage to achieve what we could would consider attractive mid-teen type of returns.

Got it. Last thing then, when you look at the opportunities on the resi side and the commercial side, would you characterize either opportunity as having a more substantial pipeline right now? How should we think about kind of the near-term outlook for opportunity to put capital into each of those categories?

Each of the investment teams are seeing strong opportunities given their sourcing capacity and their relationships. Each team has a material pipeline of opportunities that they're engaged in and seeking to close and it will be choppy in terms of timing. These deals are unpredictable in terms of documentation, diligence, but as I said, we see equal opportunities on both sides of the business and look forward to deploying capital on both sides of the business.

Jason Stewart, Compass Point.

On the two commercial real estate loans, could you give us a little bit more information about the structure, maybe LTV of those loans you made in the second quarter?

It's David Roberts. I think we don't really want to set the precedent of going loan by loan, but what I will tell you is that the process by which we go through is we have a team that looks at a lot of difference transactions, working closely with Jonathan and myself, Brian, of course our long-established equity real estate team. We're looking for assets that are typically in some sort of a transition, some sort of value add where it makes sense for the borrower to look to someone like us to come in, really understand the asset, understand what the plan is to stabilize it, and we expect them to get taken out sometimes earlier than our saved maturity.

We try to negotiate make-wholes to increase the yield, which is what happened, if you recall, with our first loan. But I don't think it would be appropriate for us to go loan by loan as we expect this to assemble a meaningful portfolio, both in terms of size and in terms of diversity.

That's fair. I guess my takeaway would be generally lower LTV loans rather than, say, taking an initial higher LTV and retaining a MES after doing some other permanent financing. That would be the strategy that you're going down is the transitional. I mean, you're not going back and forth between the two different types of products here.

I think the takeaway should be that if there's an opportunity to finance a 100% leased Manhattan office building, we're not going to be competitive unless there's a huge tenant that's going to be moving out and we have to underwrite what the market is and a lot of the traditional lenders will stay away because they just don't want any sort of transitional asset. I wouldn't take my comments to indicate a particular loan-to-value range because that's going to differ depending upon all the factors that go into our assessment of the risk of whatever the transition is.

Okay. When you look at these properties, what would the -- and this is for modeling purposes, a typical average life be? When should start factoring in takeouts?

A typical loan might be a three-year maturity with two one-year extensions or it might be two-year maturity with three one-year extensions, but these are, I would say, they generally will be more transitional in nature. You had asked about, once again, whether we should think about this as MES or tranche first lien, we're putting in place the funding facility that will give us the flexibility to evaluate whether we should sell off a first lien if banks are very, very aggressive or alternatively, to have option of putting that same loan on the line at an attractive funding level.

Okay. Are you at the point where you can share your expectation for leverage on that facility?

We can't share, but it would be typical, I think, to some of our comps, which is between [65 and 75.]

One more question on the RPL/NPL purchases. It sort of sounded like, as you were describing the answer to the previous question, these were almost deals that have been factored down and you were purchasing almost a cleanup call. Am I thinking about that? Is that part of what you're looking at or is that a completely different opportunity set?

That is part of the opportunity set. Buying, basically, legacy cleanup calls or legacy subordinate securities is one part of where we are acquiring whole loans. These are loans, in some cases, that are six to 10 years old, strong performance characteristics, and we think it's an attractive investment opportunity to collapse the structure and then to basically improve the service and quality going forward. In other cases, it's an outright purchase of legacy whole loans.

On the cleanup calls, I mean there's certainly been a couple of other servicers/investors who've pursued a similar strategy. Have you found one or two primary partners to do this with or is this on an opportunistic basis when you find somebody, you're willing to go in with and service the loans? Are these something that you're going to service yourself?

Both Angelo, Gordon and MITT do not control the servicer. We use third parties in all cases, who we basically oversee actively. These are active managed servicers and we basically put the assets with a servicer that we think is best suited to service a distinct type of collateral.

Merrill Ross, Wunderlich Securities.

The equity and earnings from the affiliate, that $3.3 million in the quarter, can you give us a little color on that one?

Sure. We co-invested in some typical CMBS securities as a part of JV with other Angelo, Gordon funds. The JV entities sold those securities as part of a resecuritization and there was a pretty large gain on that sale, as opposed to flowing out just through securities because it was a JV investment, it flows through as a JV investment in equity earnings.

So that's not likely to recur?

Not the gain. At part core -- that's not part of core. As part of core, any NIM through that JV is part of core and the gains are stripped out.

Looking back at slide 10, the market has been relatively tranquil, low volatility certainly compared to last year. I'm finding that modeling earnings is very, very sensitive to how you construct these hedges. Maybe you can give us a little bit of theory about where you might lighten up or double down as you roll forward your hedges?

We expected some degree of volatility in rates and if you did not have the geopolitical issues in the marketplace, as well some weakness in Europe, potentially the 10-year would be maybe 20, 25 basis points higher and maybe the front-end would be another 10 or 15 basis points higher. The way we're currently positioned, when we saw a sell-off last week of, I think, 10 or 15 basis points, roughly, it really did not move valuation of our portfolio. The hedges pretty much moved in sync with the current portfolio, give or take maybe $250,000 to $500,000 and one direction or another, which we think is pretty good symmetry of movement given that it's a $3.8 billion book.

In the event that rates were to gravitate higher in the back end to, let's say, from 2.44% we think they were this morning to closer to 2.75%, we would potentially with some hedges in the long end of the curve, the tens. If the market started to price in fully, maybe a first quarter move in the Fed funds or additional reverse repos from the Fed; potentially we would lighten up in the fours and five portion of the curve.

(Operator Instructions) We have no further questions at this time.

Thank you very much, everybody. Look forward to speaking to you next quarter.

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