AG Mortgage Investment Trust Inc (MITT) 2015 Q3 法說會逐字稿

Welcome to the AG Mortgage Investment Trust third quarter 2015 earnings call. My name is Ethan. 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 this conference is being recorded.

I would now like to turn the call over to Karen Werbel, Head of Investor Relations. Karen, you may begin.

Thanks, Ethan. Good morning everyone. We appreciate you joining us for today's conference call to review AG Mortgage Investment Trust's third quarter 2015 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 are based on our beliefs and expectations as of today, November 5th, 2015. 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 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.

Thank you, Karen. It's David Roberts. And good morning, everyone. The third quarter was a tough one for both credit and for Agency RMBS. Most credit spreads widened during the quarter, including MBS and EBS.

Additionally, swap spreads tightened materially during the quarter, which lowered the value of our interest rate hedges.

As a result of all of these factors, our book value declined during the quarter by about 4%, to $18.47 per share at quarter's end.

During the quarter, we continued a defensive stance in today's lower yielding environment. We carried lower leverage, therefore, decreasing the size of our investment portfolio.

In addition to our lower leverage, we also adjusted the risk profile of the portfolio by rotating out of certain agency derivatives.

In this quarter, we had a negative retro adjustment of $0.04 per share, compared to a positive retro adjustment of $0.04 per share last quarter, an $0.08 negative swing, $0.08 per share negative swing.

As well, in this quarter we had no drop income from TBAs, compared to TBA drop income of $0.03 per share last quarter. All of the above factors led to a decline in core earnings to $0.46 per share, after the $0.04-per-share retro adjustment, and $0.50 per share before the retro adjustment.

Based on current conditions, we would expect core earnings going forward to be more consistent with this quarter's performance than previous quarters. We have said before that our dividend policy is to track the general direction of core earnings.

Accordingly, we now expect our fourth-quarter dividend to decline from $0.60 per share, and our dividend will reflect our view of the core earnings run rate at the time of the Board's dividend decision.

Additionally, we created the share buyback option to give us a potential means to increase book value per share. Our decision whether to use the share buyback will take into account the impact to core earnings and the liquidity of our investment portfolio at the time.

We are also working hard to accelerate our transition from Agency RMBS to credit and, in particular, to value add organically originated assets. To that end, we are assessing a transaction that would provide a platform for us to buy and originate an increased array of credit assets, including mortgage servicing rights and whole loans.

With that, I will turn it over to Jonathan Lieberman.

Good morning. Thank you, David. During the third quarter we experienced macro volatility, elevated correlations across most markets, confusion over fed monetary policy and fragile market structure.

We also saw another chapter in the multiyear Greek and European debt tragedy. Meanwhile, China sought to distance its monetary policy from potential fed action, and attempted to decouple its currency to some degree from the strengthening U.S. dollar.

Further clouding the investment environment was the continued collapse of oil and commodity prices, which impacted equities, high yield, bank debt, capital flows, currencies, and geopolitical relationships, among other things.

All of these headwinds weighed on bond prices and credit spreads for both non-risk and risk assets. In August, capital market volatility dry-rated and liquidity evaporated in most markets, including Treasuries and Agency MBS.

Despite worldwide markets experiencing their worst bout of instability and losses since August of 2011, the U.S. consumer continued to judiciously spend.

And while U.S. manufacturing and commodity-related employment contracted, the service sector in the U.S. continues to add employees to the overall workforce at a reasonable pace.

With respect to structured credit markets, historically the summer months are slower periods of activity with more limited liquidity, staffing, and risk-taking. Turmoil in the energy and EM sectors, as well as U.S. and Asian equity markets, further constrained activity and appears to have caused structured credit and agency spreads to re-price.

As is typical in periods of high volatility, the mortgage basis often widens and causes Agency MBS to underperform.

Further compounding underperformance during September was a decoupling of swap spreads from benchmark U.S. Treasury Securities. The decline in U.S. swap spreads has accelerated in the last two weeks.

Agency MBS did perform better if coupled with Treasury hedges. With respect to Non-Agency RMBS and ABS, spreads were wider across most subsectors. The least impacted securities were senior high cash flow Non-Agency MBS. The most severely impacted sectors were long-duration blocked out sub-prime, mezzanine, RMBS, and second-tier ABS subordinates.

During August and September, primary issuance and secondary trading was anemic and bid offer gapped out. Similarly, CMBS experienced a material spread widening due to a combination of very heavy new issuance, perceived weak secondary liquidity, and credit quality concerns.

Actual cash trading activity for structured credit was quite subdued, as sellers of securities remained reluctant to transact and concede largely to technical factors impacting the market. Broker/dealers remained on the sideline with little to no interest in positioning securities or making markets.

On the other hand, while the market activity stood still, fundamental mortgage credit continued its pattern of stable to modest improvement in borrower performance.

Home prices also continue to modestly rise, and inventory levels remain light in many major markets. Consumer appetite for housing continues to remain firm, with expanding mortgage credit availability taking hold in many markets.

Away from securities, as David mentioned, MITT's investment team has steadily increased resources dedicated to sourcing organic investment opportunities in the consumer, commercial, and residential finance markets.

The management team is actively assessing and evaluating credit creation opportunities, which may include platforms which enable MITT to invest in CRE lending, MSRs, and new residential mortgage products.

MITT continues to benefit from Angelo, Gordon's multi-discipline platform, adding, sourcing investment capacity in Non-Agency RMBS, ABS, and CMBS. For example, MITT was able to leverage the AG platform to participate alongside other AG funds in two term securitizations of nonperforming mortgage loans in July and October.

These securitizations permitted the funding of nonperforming loans with senior fixed-rate debt, which is non-mark to market.

Now turning to our earnings, MITT reported a negative $0.13 of net income and core earnings of $0.46. The decrease in net income from last quarter was primarily attributable to the Agency MBS segment of the investment portfolio. Mortgage basis widening, delta hedging, and swap hedge underperformance were responsible for the majority of this disappointing performance.

Notwithstanding a difficult environment, the credit segment of the investment portfolio generally held up and performed in line with expectations.

Core earnings also declined due to a decrease in overall leverage, higher cost of funds for certain segments of the portfolio, and the aggregate size of the overall investment portfolio.

Additionally, we had a negative $0.04 retrospective adjustment this quarter due to quarter-over-quarter decreases in interest rates and no TBA drop income during the reported period.

Book value declined to $18.47, which represents a decrease of $0.74 netting for the impact of our dividend paid to shareholders on October 30th.

As I previously mentioned, the largest component of our decrease in book value was the decline in market value of our interest rate swaps.

The aggregate portfolio size decreased to approximately $3.1 billion as a result of the sale of agency securities, the continued rotation into less levered credit assets, and organic amortization of our agency assets.

As of September 30th, our hedge ratio stood at 73% of our financing secured by Agency RMBS, and 39% of our overall financing. At the end of October, the hedge ratio was approximately 62% of our financing secured by Agency RMBS, or 31% of our overall financing.

Turning now to the prepayment speeds, the constant prepayment rate for our agency book was 10.5% for the third quarter. Leverage declined modestly to 3.58 times, down from 3.64 times last quarter. And quarter ending net interest margin increased modestly to 3.01%.

Slide 7 sets out our 2015 outlook. The relatively healthy domestic labor market, low energy costs, and steadily improving home prices continue to bolster the consumers' balance sheet and to keep the U.S. economy afloat, despite persistent weakness in manufacturing and renewed weakness in the oil industry and energy industry.

Fed Chairwoman Yellen's message that the economy's making slow but steady progress, and, if sustained, will be ready for a gentle policy rate adjustment in the fourth quarter of 2015 or the first quarter of 2016 sets the tone. Whether the fed opts to lift rates in December or sometime in 2016, we ultimately expect fed funds to remain below 2% over the next several years.

As the front-end inches higher, we see few signs, at the moment, of runaway inflation, and have positioned the portfolio and our hedges to maintain that bias towards a flattener, in the coming years.

Moving on to our portfolio, slide 8 shows details of some of our top-level metrics for the quarter. The fair value of our agency and credible book were both approximately $1.5 billion each.

Focusing first on our Agency MBS portfolio, capital allocated to Agency MBS declined as we reduced Agency 20-year MBS and derivative positions and allowed organic amortization of our overall agency whole loan pools. This is consistent with our previously stated objective to reduce overall agency exposure and shift capital to more attractive credits positions.

From a prepayment perspective, our pools continue to perform in line with our expectations, with a Q3 CPR of 10.5 and October CPR of approximately 12.2.

The agency segment of our portfolio continues to impact MITT's returns due to the combination of higher funding costs, hedge underperformance, and mortgage basis widening.

Agency whole pools remain a material component of the overall portfolio that allows MITT to satisfy its 1940 Act compliance requirements.

We believe that conditions in early 2016, after a potential fed action, may provide a better investment environment for Agency MBS.

After the reduction in capital allocated to Agency MBS, credit investments now comprise the majority of our overall portfolio. Our aggregate credit book stood at approximately $1.5 billion fair value at quarter end. Performance from our credit book continues to be in line with our investment underwrite. Valuations from credit RMBS and CMBS did weaken on limited trading volume, and potentially affected by broader capital markets volatility during the third quarter.

However, participants in the legacy RMBS market often refer to our market as resilient. And despite the broader market selloff, mortgage credit far outperformed other domestic equity and corporate credit markets during the quarter.

During the third quarter, we purchased additional positions in Non-Agency MBS, GSE risk transfer securities, CMBS, and ABS. Specifically, we invested in current face securities of approximately $38 million of prime securities, $17 million of sub-prime securities, $21 million of front pay, short duration NPL securities.

We also invested in current face value of approximately $50 million of CMBS and $235 million of CMBS IO, and $1 million of ABS.

Turning to slide 11, we provide an update on our financing. We currently have 38 financing counter parties. Funding continues to be plentiful and stable for the Company.

With the acceptance of our wholly-owned subsidiary into the FHLB of Cincinnati, we have additional, stable, and flexible financing from a really reliable counter party, and began to borrow for our Agency MBS during the quarter, borrowing approximately $400 million during the month of October.

Turning to slide 12, we now show our duration gap, inclusive of agency and credit securities. We previously had not done so.

As the effective duration on our credit investments has become a more meaningful metric in light of our shift to higher dollar priced credit investments, the gap, inclusive of agency and credit, decreased from 1.64 to 1.29 years, mostly due to a decrease in interest rates and our portfolio rotation from June 30th to September 30th.

Net interest margin during the quarter was approximately 2.65%.

Our hedging and interest rate sensitivities are laid out in the next slide. We continue to adjust our hedge position in response to changes in our portfolio, U.S. economic conditions, and potential normalization of U.S. monetary policy.

Our hedge book continues to have a bias [towards] a flattener, and we believe will perform better as the fed begins to tighten and as we get into the first quarter of next year.

I'd like to wrap up by saying that this was a challenging quarter for fixed income investors in a very difficult investment environment. We believe that the portfolio will ultimately produce favorable returns once the markets transition and re-price from structural changes and global economic conditions.

With that, I'll turn the call over to Brian to review our financial results.

Thanks, Jonathan. In the third quarter, we reported core earnings of $13 million or $0.46 per fully diluted share, versus $18.6 million or $0.65 per share in the prior quarter.

At September 30th, we had a negative $0.04 retrospective adjustment to our premium amortization on our agency portfolio. Stripping this out, core would have been $0.50 per share.

Overall for the quarter, we reported a net loss available to common stockholders of $3.7 million or $0.13 per fully diluted share. The $0.46 of core earnings was offset by net realized and unrealized losses of $0.60 per share. The $06.60 loss was primarily due to $0.50 of net realized and unrealized losses on our agency securities and derivative portfolio, and $0.10 of net realized and unrealized losses on the credit portfolio.

At September 30th, our book value was $18.47, decrease of $0.74 at 3.9% from last quarter. This decrease is mostly attributable to the losses I previously mentioned, as well as core earnings being below our dividend.

To give you a better sense of our current $3.1 billion, I'd like to highlight a few more statistics.

As described on page 4 and 5 of our presentation, the portfolio at September 30th, 2015, had a net interest margin of 3.01%. This was composed of an asset yield of 4.7%, offset by financing hedging costs of 1.18% and 0.51% respectively, for a total cost of funds 1.69%.

Our net interest margin increased, mostly as a result of the addition of Treasury long positions and the removal of some Treasury short positions, which decreased our total cost of hedging.

We do not have any forward-starting swaps, and, therefore, our swap costs reflect the true cost of our swaps.

On the funding side, we continue to be active. We were pleased to announce that as of the end of October, MITT has borrowed approximately $400 million of financing from the FHLB of Cincinnati.

While the overall financing costs did increase during the quarter, we are pleased that MITT benefited from lower agency financing rates with the FHLB.

Additionally during the quarter, we did recognize a one-time $0.03 write-off of deferred financing fees on our commercial real estate loan facility.

Our liquidity currently remains strong, and at quarter end we had total liquidity of $173 million, composed of $40 million of cash and $102 million of unlevered agency whole pool securities and $23 million of unlevered agency IO securities.

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

We will now begin the question-and-answer session. (Operator Instructions) There will be a delay before the first question is announced. (Operator Instructions) Trevor Cranston from JMP Securities.

I guess on the platform you guys mentioned that you're looking at potentially bringing on, can you maybe expand a little bit on the specific strategies you'd be interested in pursuing there, if it would be maybe prime jumbo loan, securitization, or something more like non-QM loans for the balance sheet? Thanks.

I think initially we would envision it being qualified mortgages, then, over time, it would gravitate potentially to jumbo mortgage servicing rights. And at the appropriate time if we think that there's an opportunity non-QM or consumer, the platform would have those capabilities.

Okay. So would it be something where we could expect some agency originations in the mix where you'd be retaining the MSRs and there'd be some gain on sale income? Or would it be more purely kind of the jumbo side for the balance sheet?

It could potentially be MSR off of agency. The characterization of how income would roll through our balance sheet, I think that we would have to kind of reserve comment until the time when we're active in the space.

Got it. And then, I appreciate the comments on core earnings and the dividend at the beginning of the call.

Can you maybe give us an idea of kind of throughout the quarter when the portfolio changes you made took place, just to help give us some idea of kind of where the run rate, core earnings, might be going forward versus where 3Q three came in? Thanks.

Well, organic pay downs have been occurring on a monthly basis throughout the quarter. We have not been reinvesting in the agency book.

And then, I believe it was towards the latter part of the quarter that we exited out of 20-year. We also were, I think exiting over a course of several months out of some of the inverse IO positions.

Okay. Thank you.

(Operator Instructions) Eric Hagen from KBW.

We've heard from some of the other companies in the sector that they're taking, I guess a little more cautious approach, deploying capital in a more deliberate way as spreads have widened.

Would you say you're equally kind of cautious or would you characterize your outlook us a little more aggressive right now?

I would say that we're consistent with some of the other REITs that you've mentioned. On a more conservative side, we certainly are -- we are making opportunistic investments on the credit side where we see some opportunity.

But with respect to the agency market, consistent with our approach and really trying to reduce overall exposure, it would really require something extraordinary for us to add additional exposure there.

Yes. Maybe drilling down into that characterization of extraordinary. Where would spreads have to be to get you guys really excited about the environment right now? Because I agree that it's very cautious and the clarity is lacking generally.

Look, I think we would have to be able to really lock down funding costs and really lock down hedging, which has been, it's been very, very challenging the last two weeks with the continued decoupling of the swap curve.

I think we've seen some opportunities on the risk transfer trades, CRT. We thought they were attractive. And we've seen a few opportunities in some short duration, non-agency. And there we will put capital that's somewhere between 50 and 100 basis points wider of where the market was maybe pre-August.

That's helpful. And then on the credit risk transfer space, what do you think about the non-stacker and [cash] yield, some of the other risk transfer strategies [that you have used]?

I think you're probably referring to like, I think it's Madison Avenue and --

Yes.

I think they've renamed it. So we have participated in some limited form. Generally, we have been a very small participant in the overall CRT space, and we've been opportunistic buying it and then exiting it at times.

So we've been quite pleased with how we've approached it. And if there's opportunities there and those securities come at attractive levels, we generally may consider adding.

Got it. Thanks, guys. Appreciate it.

And it appears we have no further questions at this time.

Okay. Thank you. And we look forward to speaking with you all next quarter.

Thank you.

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