AG Mortgage Investment Trust Inc (MITT) 2015 Q4 法說會逐字稿

Good morning and welcome to the AG Mortgage Investment Trust fourth quarter and full year 2015 earnings call. My name is Brandon, and I will be your operator for today.

(Operator Instructions)

Please note, this conference is being recorded. And I will now turn it over to Karen Werbel. You may begin.

Thanks, Brandon. Good morning, everyone. We appreciate you joining us for today's conference call to review AG Mortgage Investment Trust's fourth quarter and full year 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 contains forward-looking statements within the meaning of the Safe Harbor provisions 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. Including changes in interest rates, the availability and terms of financing, prepayment rates, changes in the market value of our assets, economic and market conditions, and legislative and regulatory changes that could adversely affect the business of the Company. All forward-looking statements included in this conference call and the slide presentation are based on our beliefs and expectations as of today, February 26, 2016.

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. Including its most recent annual report on Form 10-K and subsequent filings. 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.

Thank you, Karen, and good morning, everyone.

In many ways, the fourth quarter for MITT was similar to our third quarter, as we saw elevated market volatility persisting. Credit spreads across fixed income asset classes widened materially during the fourth quarter, including CMBS and credit risk transfer securities.

Into the first quarter, this widening continued, creating an environment that should provide good buying opportunities this calendar year. However, the widening and credit spreads impacted our credit portfolio.

Turning to the agency part of our portfolio. The mortgage basis underperformed in the fourth quarter as it did in the third quarter, due in part to swap spreads tightening. This also impacted our agency portfolio. Accordingly, our book value per share declined quarter to quarter by about 3% to end to the fourth quarter at $17.88 per share.

Our core earnings for the fourth quarter were $0.55 per share, after a positive retro adjustment of $0.01 per share. We declared a dividend of $0.475 per share for the fourth quarter, reflecting our best estimate of the most likely range of our core earnings going forward given the current market environment.

As of year and, our credit assets, as opposed to agency assets, represented 56% of our portfolio, up from 45% a year ago. This has been a key component of our strategy, as we believe our opportunities in credit play to the strengths of our management team.

Further to this strategy, we announced in December that MITT alongside other AG private funds had formed a mortgage banking platform named Arc Home LLC to buy and originate an increased array of credit assets, including mortgage servicing rights and whole loans. Importantly, Arc Home brings with it not legacy assets, and a first-class management team with a wealth of mortgage experience.

Arc Home recently entered into a definitive agreement to acquire a Fannie, Freddie and Ginnie mortgage originator, and this occurred in January. The closing of the transaction is subject to securing approvals from the various federal agencies and state licensing authorities. We believe Arc Home will begin to have the opportunity to buy assets in the second half of this year.

Our Board approved a $25 million fair repurchase program last quarter to give us a potential means to increase book value per share. During the fourth quarter, we repurchased approximately 127,000 shares or $1.7 million of common stock at an average purchase price of $13.19 per share, resulting in $0.08 per share of book value accretions.

With that summary, I will turn the call over to CIO and President, Jonathan Lieberman.

Thank you, David. Good morning, all.

So as David mentioned, it was a difficult fourth quarter for credit markets, and a disappointing second half of the year for CMBS, RMBS and ABS assets. As many of you know, as the headlines from Greece mostly faded, China negative sovereign interest rates and the price of oil began to dominate business news. Credit concerns, underperformance and lack of liquidity in other credit markets eventually overwhelmed the mortgage and asset backspace.

MBS and ABS credit spreads leaked wider during the fourth quarter, as fears of global slowdown accelerated, the price of oil continued to slide, and the lack of liquidity spread across from other capital markets. By November/December, most of our participants in the CMBS, RMBS and ABS world went to sidelines, went on vacation, and began to contemplate better days in 2016.

Many of us on the buy side as well as the sell side were hoping that this dislocation resembled the short volatility of July 2013, which was a momentary dip with a temper tantrum in the RMBS markets. Unfortunately, market conditions in January and February shattered all hopes with short and modest dislocation in our specific markets. Instead, CMBS, RMBS and ABS joined the broader capital markets in repricing credit risk.

Primary issuance remains anemic. Many issuers have been forced to postpone new issue deals or widen their pricing levels considerably until market demand really improves. Broker dealers also remain relatively on the sidelines, with scant interest in positioning securities or making markets.

Additionally, in December, the Federal Reserve raised rates for the first time since 2006. However, together with increasingly negative economic data reported to date in 2016, many market participants are increasingly skeptical of much in the way of further federal fund increases for the foreseeable future.

For the most part, agency AMBS collateral has performed in line with prepayment expectations. One area of stress has been the interest rate derivative market, as David mentioned.

Similar to the third quarter, interest rate swaps by most mortgage and ABS investors relative outperformed relative to their MBS and credit positions. Capital flight from emerging markets and broker dealers hedging their ballooning balance sheets may be among the primary suspects for swap spread outperformance.

Historically, swap spreads also tightened during the fourth quarter when bank balance sheets capacity also constrained. We've not yet seen that reversal. We haven't seen pressure on swaps decline potentially also due to global dollar funding pressure.

So moving to Q1 2016, financial market volatility continued into January and February, as the markets continue to grapple with the possibility of a US economic recession. That is the great debate among market participants at this point. In mid-February, spreads widened materially across most fixed income asset classes, such as Fannie Freddie risk transfer trades, the CMBX index, and high-yield credit indexes.

On the fundamental collateral side, legacy mortgages continue to remain steady and in some cases are continuing to see improvement from home price appreciation and credit curing. Housing affordability, including first-time home buyers, remains well above historical averages, and consumer confidence continues to hang in there. Favorable net supply technicals and strong reinvestment demands support price outperformance for RMBS for other spread asset classes.

Additionally, as David mentioned earlier, we continue an increase resources and capital to sourcing organic investment opportunities in consumer, commercial, and residential finance markets. Consistent with this mandate, we announced the formation of Arc Home to originate conforming, FHA, jumbo and non-QM residential mortgages, as well as to invest in MSR.

We're pleased to announce that Arc Home has entered into a definitive agreement to acquire a Fannie, Freddie and Ginnie mortgage originator in January, and we are working on securing the appropriate approvals both at a federal and state level. A portion of the approximately $30 million of capital committed to this platform will be utilized to purchase the mortgage originator.

Now moving to the quarter at hand. MITT reported a loss of $0.14, and core earnings of $0.55. The decrease in net income from last quarter was attributable to go to the agency MBS and credit segments of the investments portfolio.

From a credit perspective, the credit segment of the investments portfolio generally performed in line with expectations. Core earnings mainly increased due to a reversal of retro from negative $0.04 to positive $0.01. Book value declined $17.88, which represents a decrease of $0.59 inclusive of the impact of our dividend paid to shareholders on January 29.

The aggregate portfolio size decreased to approximately $2.9 billion, as a result of the sale of agency MBS securities, the continued rotation to less levered credit assets, and the organic amortization of our agency assets. At December 31, our hedge ratio including TBA was approximately 65% of our agency financing, and 32% of total financing. At the end of January, the hedge ratio was lower at 54% of agency financing and 26% of total financing.

The cost in prepayment rate for our agency book was 8.6% for the fourth quarter. The prepayment speeds for our portfolio remain benign and stable, notwithstanding the recent interest rate rally. Leverage including TBA declined to 3.53 times, down from 3.58 times last quarter. Quarter-ending net interest margin increased modestly to 3.05%.

On slide 10 of our quarterly earnings presentation, we laid out the investment portfolio composition for the quarter. The fair value of our agency book was approximately $1.3 billion, and the fair value of our credit book was approximatey $1.6 billion.

Now focusing first on our agency MBS portfolio, capital allocated to agency MBS declined as we exited our agency 20-year MBS positions, and reduced materially our allocation to inverse IOs, ARMS and select 30-year MBS. This is consistent with our previously stated objective to reduce our overall agency exposure to ship capital to more attractive credit positions.

As I mentioned, from a prepayment perspective, our pools continue to perform in line with our expectations with Q4 CPR of 8.6. The team has done a very good job of moving into spec pools with good prepayment protection. As previously mentioned, the agency segment did underperform in the quarter, primarily due to a combination of higher funding costs, swap spread tightening, and some mortgage basis [widening].

Now on the credit side of the book, which comprises now the majority of our portfolio, we had $1.6 billion of fair value at quarter end. Performance of our credit book continues to be generally in line with our investment underwriting. Valuations for credit RMBS and CMBS were weaker, unlimited trading volume during the fourth quarter and due to broader capital markets repricing and volatility.

However, as many participants in legacy RMBS often like to say, our markets are pretty resilient. And despite the broader sell off, our assets have held in reasonably well. And there is a number of factors for that, that includes stronger fundamental performance and favorable technicals.

Now during the fourth quarter, we selectively purchased some non-agency MBS, a little bit of credit risk transfer securities, some non-performing and reperforming front pay securities, and some selective CMBS. Specifically, we invested in current face value of $129 million of prime securities, including $94.3 million of new issued prime jumbo. Additionally, we purchased $4.7 million of all-day securities, $12.3 million of front-pay short-duration NPL securities, and $11.2 million of CRT securities, these are the risk transfer securities.

We're also purchased current face value of approximately $2.5 million of Freddie Mac K series CMBS, and $1.5 million of CMBS outright, and then $1.1 billion notional of CMBS IO. This quarter, we did significantly expand our credit metrics disclosures on slides 12 and 13, to highlight these investments and give you greater transparency into the credit portfolio.

Now turning to slide 14, we provide an update on our financing. We are pleased, we have 38 financing counterparties and are financing investments with currently with 21 counterparties. In general, funding continues to be plentiful and stable for the Company.

With respect to the duration gap for the portfolio, agency and credit duration gap increased from 1.29 to 1.79. The wider gap resulted from lower interest rate hedging, modest increase in interest rates and then portfolio rotation.

Our hedging and interest rate sensitivities are laid out on the next slide. We continue to adjust our hedge positions in responses to changes in the portfolio, overall US economic conditions and potential normalization of US monetary policy. Our hedge book continues to be set up to be modestly defensive to protect against the flattening of interest rates, which we believe will perform favorably should the fed begin to tighten further.

In closing, we believe that as 2016 unfolds, MITT will be well positioned to take advantage of a wider range of credit assets, and opportunities that present themselves at increasingly favorable returns. With that, I will turn the call over to Brian to review our financial results.

Thanks, Jonathan.

For the full year 2015, we reported core earnings of $65.3 million or $2.30 per fully diluted shares, versus $69.8 million or $2.45 per fully diluted shares in the prior year. In the fourth quarter, we reported core earnings of $15.7 million or $0.55 per fully diluted share, versus $13 million or $0.46 per share in the prior quarter. At December 31, we had a positive -- in the fourth quarter I should say, we had a positive $0.01 retrospective adjustment term premium amortization on our agency portfolio.

For the full year 2015, we reported net income available to common stockholders of $300,000 or $0.01 per fully diluted share. Overall for the quarter, we reported a net loss of available to common stockholders of $3.9 million or $0.14 per fully diluted share.

In the fourth quarter, the $0.55 of core earnings was offset by net realized and unrealized losses of $0.69 per share. The $0.69 loss was primarily due to $0.36 of net realized and unrealized losses on our agency securities and derivatives portfolio, and $0.33 of net realized and unrealized losses on the credit portfolio. The $0.55 of core earnings does include a one-time positive $0.03 impact from certain reduced operating expenses, and does not include the one-time $0.03 write off of deferred financing fees on our commercial real estate loan facility that we had booked last quarter.

At December 31, our book value was $17.88, a decrease of $0.59 or 3.2% from last quarter. This decrease is most attributable to the losses I previously mentioned. Additionally, we repurchased 127,000 shares or $1.7 million of common stock during the quarter, which was accretive to the book value by $0.08 per share.

To give you a better sense of our current $2.9 billion portfolio, I'd like to highlight a few more statistics. As described on page 6 of our presentation, the portfolio at December 31 had a net interest margin of 3.05%. This was composed of an asset yield of 4.86%, offset by a total cost of funds of 1.81%. We are pleased that our net interest margin continues to trend higher due to our increased allocation to higher-yielding credit securities.

Subsequent to quarter end, our FHLB advances were reduced to reflect the provisions of the FHFA's final rule issued on January 12, 2016, which does terminate MITT's captive insurance subsidiary membership in February of 2017. MITT had approximately $285 million outstanding with the FHLB as of mid-Feb, down from approximately $400 million at December 31, 2015. The eventual loss of the FHLB access is not expected to materially affect our liquidity position.

Our liquidity does remain strong, and at quarter end we had a total liquidity of $134 million, composed of $46 million of cash, $42 million of unlevered agency hopeful securities, $26 million of unlevered agency IO securities, and $20 million of the US Treasury 1 series that had not been pledged as collateral under any of our financing agreements.

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

Thank you.

(Operator Instructions)

Credit Suisse, Douglas Harter.

Thanks. Can you tell me how you're thinking about the overhead costs and the cost of running the business versus the magnitude of opportunities you expect to see in the coming 12, 24 months?

I would just say, and maybe this is more for David and Jonathan to talk about the AG benefits and the size of the team comparable to the size of MITT. But we did have some savings in Q4, some of that is going to be recurring as we go forward. A normalized run rate of the G&A expenses is probably more in line with an average of Q3 and Q4, and that is the numbers-wise.

I'm sorry, Brian, I don't think I was -- I meant to ask about the mortgage platform that you guys are buying.

Or you're talking about the overhead of the mortgage of Arc Home. Is that it?

As you think about the return, obviously, and in an environment where opportunities are more limited, that overhead could eat into the delivered return. And how you balance that of having the platform versus the extra costs of owning a platform.

So look, I think there is a couple of things that I think we have done to really try to balance the cost versus the opportunity set that may be presented to us. First, we have spread ownership among a much larger capital base than just MITT, so the G&A from that platform is spread with private funds.

And there is a much broader or much larger pool of capital available to take advantage of credit or opportunities that are going to hopefully be organically created by that platform. Then simply, MITT supporting that vehicle by itself.

Secondly, if you think about MSR, you think you mortgages in much lower interest rate environment which is one of the possible vectors that the economy could go into. MITT is a very -- well Arc Home is a very good hedge on the rest of our business. Should rates materially lower, many parts of the world are negative in terms of interest rates, that vehicle should be able to originate and create some great assets and create some great probability for us and it would hedge out other parts of the existing portfolio.

At the same time, we think that there are many opportunities that we have been unwilling to buy currently for the REIT because of a lack of hands-on control at the credit creation level. So even in a rising interest rate environment, we think tat there will be opportunity for that management team, which has thrived in both environments, up rates, down rate, to create credit that we can get ourselves comfortable with and create the right incentives around rather than just buying secondary risk. There will be some drag, and maybe Brian can elaborate a little bit more on the cost of what we think it's going to take to get Arc Home up to a breakeven level.

Yes, and I think what we were thinking is probably in the first two quarters is where we would see the drag and it would probably be from mid about $0.01 or so of G&A. And then we think by Q3 that starts to come down to break even, and then by the end of the year hopefully they're making money. And we are seeing the benefits, not just on the platform, and then in addition to obviously he assets that we could potentially see from the platform.

It is David. I would just add also that this management team, as Jonathan mentioned, is very experienced. Has been through a lot of different cycles, and we are totally on the same page with them about creating as variable a model as possible.

And we are all well aware of the pitfall of building something that constantly needs to be fed, and all of the incentives are aligned for profitability. So we have seen that movie, so to speak, before, and we in the management team are intent on avoiding it.

And then just on the license that you guys are just requiring and waiting approval on. Is there anything legacy that comes along with that, or is that a pretty clean license that you are requiring?

We have looked at any legacy issues associate with the licenses. We are pretty comfortable that the licenses were from a small entity which only did high-quality product, and we do not anticipate that there is any trailing liability.

Great. Thank you.

Wells Fargo, Joe Houck.

Thanks and good morning. On the Arc Home, forgive me if you guys have party disclosed this. But can you talk about how the economics work between MITT and Angelo, Gordon? Is their revenue [expensioning] or is all the economics going to MITT?

Arc Home is owned by MITT and by funds, private funds. There are no economics should with the management company of Angelo, Gordon.

It is all pari passu among all of the Angelo, Gordon entities.

Of the private funds, okay, I'm sorry, you're right, you did put that in. So given that you made a 50% or MITT made a 50% capital contribution, can we assume that 50% of the economics going to flow to MITT?

Yes.

Okay. Great. Now the second question I had was more conceptual.

So one of the things we've seen in the residential mortgage REIT space is people are pulling more and more capital away from agency MBS, and you guys have been doing that for quite some time. What are your thoughts about the ability to create alpha, which I define as book value growth plus dividends, [retainably] as an agency strategy? Is that dead, or is there something cyclical that will happen, it could come back is we get into a more normalized rate environment?

And I ask that question because we have seen -- not (inaudible) that you guys [out], but we have seen a steady drip, or if you will, a decline in book value related to the agency strategy for everybody in the space now for a couple of years, with a few quarterly exceptions. So I'm curious as to your thoughts about if it can be created, if there's something more structural that you're just going to have to continue to pare back exposure just that you can and focus on credit strategies as well as these operating businesses that you're building?

Well I think the capital markets have not been very favorable for agency for the past 18 months. If you add in the macro, you add in monetary policy changes, and I think once maybe there was normalization whatever that is going to be and structural determination for the market, we would be in a better position to assess and take advantage of that.

I think we are feeling more comfortable that agency in January/February you're starting to see some level of stability. But a lot of it is going to be determined by the direction of monetary policy, where we ultimately settle in on in an interest rate range. And then our ability to adjust hedges and the asset selection for the prepayment environment.

So I think we're -- to put it succinctly, we are in transition. We have been in transition for a period of time. And as the market gets comfortable and settles in, I think there will be an opportunity for that sector to then generate some positive returns.

Are you saying we'd need to see normalization of monetary policy for that to happen? Or are you just making a broader comment about -- when you say settle down, I'm not sure what you mean by that.

Well, I think agencies typically benefit from some directionality on interest rates. They benefit from a range -- a trading range.

You set your hedges up for a certain range in the bell curve. And at the TALs, it's very, very difficult, and then you have to reset your portfolio. And I would say that if we are in transitioning to whatever that median is or equilibrium level in the market is.

Right now, when we see swings in interest rates of 10, 20, 30, basis points in a week or 2 weeks, it is very, very difficult for many market participants on a levered basis to make money and get a fair return on capital. But if we settle into a range here of slow economic growth, maybe one additional increase in the fed funds, I think at that point there might be a very, very strong run by the agency mortgage rates. But there is just a lot of headwinds at this moment against many asset classes and fixed income.

Okay. Thank you for the answer.

(Operator Instructions)

Bose George, KBW.

Good morning, guys. Eric Hagan for Bose on this morning. I'm sure you noticed that this morning, one of your peers was acquired at a pretty significant premium to their book value.

I'm curious if you have any general thoughts on that directionally for the sector? And if you want to comment on your own stock, that would be helpful as well with the entire sector trading at what seems like a sustained level of discount to book. Thanks.

Did you say sustained or disdained? That was a joke.

It feels somewhat disdained for the last year and a half.

So we have all seen the announcement. We follow closely developments with our competitors as you would expect. We haven't cited it.

We think it's interesting to see what competitors are doing. But clearly, we are just focused on what we are doing, and hope to continue to provide a level of core earnings and book value and sustained alpha, to use a word someone used, particularly on our credit side and our new initiatives that will in the long term be rewarded by investors. So we will certainly look into the details more closely, and see if we can glean any learnings from it.

So do you see your own book value correcting back to something closer to -- maybe your stock price correcting somewhere close to 1 times book value in the near future?

That would be for investors to decide.

Okay. And then can you remind us what makes up the line item that you account for with the equity method in the income statement? I apologize if you've said this on an earnings call before.

Yes. It is no problem. It is some joint investments that we've made with some of the other private funds. Actually the new Arc Home investment will go to that line item as well since we're not consolidated it.

So some of those joint investments have been in residential non-performing mortgage loan pools, as well as mult Freddie K, multi family investments that we've made with other private funds and some other partners. And it is actually -- it hasn't really changed much in the past couple of quarters.

It is been pretty steady, and the amount of income that it's generated to core has been pretty flat over the past two quarters. And mark-to-market volatility, there's obviously a little bit there. But that's what we back that out, and then what we've been adding back to core has been NIM from the underlying investment has been pretty steady.

And you would expect it to remain fairly study at the current level going forward? Give or take a little bit?

Yes. To the extent that the investments remain there, I think we would. Obviously, if we sold down those positions or we added new positions that would, but from the current positions it is pretty steady.

It is very similar to if we had consolidated it. You have interest income and you have interest expense, and then have the net interest margin that flows through core. I will say, like I mentioned earlier, there will be a little bit of drag that will flow through that line item from the Arc Home investment, but like we said, we think it's pretty immaterial maybe $0.01 and change for the next quarter or two.

Got it. Thanks, guys.

No problem.

And we have no further questions at this time.

Thank you. We look forward to speaking with you next quarter.

Thanks, everyone.

Ladies and gentlemen, this concludes today's conference. Thank you for joining. You may now disconnect.