AG Mortgage Investment Trust Inc (MITT) 2016 Q1 法說會逐字稿

Welcome to AG Mortgage Investment Trust first-quarter 2016 earnings call. My name is Christine and I will be the operator for today's call.

(Operator Instructions)

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

Good morning, everyone. We appreciate you joining us for today's conference call to review AG Mortgage Investment Trust's first-quarter 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 the corresponding slide presentation contain 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 on 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, May 6, 2016.

Please note that the 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. Now David Roberts, I'll turn it to you.

Thanks, Karen. Good morning. Credit spreads across fixed income asset classes widened materially during January and February. Since this dislocation, we've seen a rebound in March and April from the February loads.

Our book value declined during the quarter by 3.7% to $17.22 per share at quarter's end. This was entirely due to the credit portion of our portfolio, which declined due to credit spreads widening.

On the Agency side, the larger portfolio duration gap that we had in place since the middle of the fourth quarter more than offset the modest basis widening experienced given the substantial rally in rates, which positively impacted the book value, but certainly not enough to make up for the credit spread widening. Our core earnings for the quarter were $0.45 per share before a negative retro adjustment of $0.05 per share.

The decline in core earnings was due to the decline in interest income from last quarter, and that was primarily due to lower yields and also lower leverage and thus a smaller portfolio. We declared a dividend of $0.475 per share for the first quarter, reflecting our best estimate of the most likely range of our core earnings going forward given the current market environment.

During the quarter, we continued our strategic objective of rotation and reallocation to credit investments, with credit assets representing 56.9% and agency assets representing 43.1% of our portfolio at the end of the quarter. In this current quarter, we have continue to see -- the second quarter we have continued to see opportunities to add to our credit portfolio.

As we discussed on the last call, our mortgage banking ability at Arc Home entered into a definitive agreement to acquire a Fannie Mae, Freddie Mac, and Ginnie Mae mortgage originator. The necessary licenses and approvals are ahead of schedule, and we hope to receive the requisite consents to complete the acquisition sometime this quarter.

Arc Home's model is to create a highly variable and diversified mortgage origination business which itself can be profitable. And at the same time, provide MITT and other AG affiliates with value-added mortgage and mortgage servicing rights investment opportunities.

Last year, our Board authorized a $25 million share buyback program to give us the potential means to increase book value per share. During the first quarter, we repurchased 119,506 shares, or about $1.5 million of common stock, at an average share price of $12.86. This resulted in $0.07 of book value accretion.

With that, I will turn the call over to our Chief Investment Officer, Jonathan Lieberman.

Thank you, David. Good morning all. The first quarter of this year was certainly one of the most challenging quarters to navigate credit markets since the post-recession period. The weakness in the energy sector and fears of an increasing global slowdown and growth slowdown in China that began in the fourth quarter of last year, mutated into fears of a global recession during the first part of this year.

Mortgage credit and asset backed securities experienced their most severe dislocation since 2011. Unlike the 2007 to 2009 credit dislocation, the epicenter initially occurred in energy, CCC high yield, then spread to levered loans, CLOs, CMBS before finally hitting the RMBS and ABS markets hard in January and February.

RMBS and ABS credit spreads leaped wider as the price of oil continued to slide and as the lack of liquidity spread across most capital markets. However, from late February through quarter end, there was a recovery in risk assets which was helped in large part by the Fed tempering its forecast for the trajectory and ultimate resting place for short-term policy rates.

The Fed, in its March meeting, sent a strong message that while there is reason to be optimistic about economic improvement, uncertainties about the sustainability of the increase in inflation, US dollar strength, and the international growth landscape will cause the Fed to have an increasingly patient attitude in normalizing monetary policy. We have asserted for some time that the Fed will find it both difficult and inappropriate to run a divergent path for monetary policy that is counter to the direction of other global central banks.

We have been skeptical of their ability to raise policy rates more than one or two times this year, and both the Fed themselves and other market participants have finally begun to revise their expectations for a further policy move lower. Against this benign interest rate backdrop, we are optimistic about the future of the REIT sector.

For the most part, agency MBS collateral performed in line with prepayment expectations. During the quarter, agency RMBS spreads were well supported by investors seeking greater liquidity and avoidance of the turmoil taking place in the credit sector.

As a result, spread widening of agency RMBS was more than contained compared to other credit spread or other spread products. Swap spreads did exhibit some amount of volatility during the quarter, but finished the quarter roughly flat to where they began the quarter, and as a result swaps proved to be a more stable hedge than in the prior two quarters.

Given our economic outlook, we have increased our duration gap during the fourth quarter of 2015, and this served us well during Q1. As the rates market rallied in the quarter and the duration of our assets shortened in response to faster projected prepayment speeds, we maintained our duration gap and actually increased it marginally by unwinding swaps and adding Treasury positions.

In response to the recent whitening in swap spreads, we have begun to collapse our pay fixed swaps versus long Treasury positions at a favorable economic outcome post quarter end. Fundamental collateral performance of legacy mortgages continues to remain steady and in some case improved, benefiting from continued home price appreciation and credit curing.

Housing affordability, including first-time home buyers, remains still above historical averages, and consumer confidence stands reasonably high. Favorable net supply technicals and strong reinvestment demands support price performance of RMBS versus other spread asset classes.

It's important to emphasize that many of the assets held by MITT perform better than the broader hedge fund community because they were higher up in the capital structure and had better carry characteristics. Additionally, we increased resources to our sourcing organic investment opportunities in consumer, commercial, residential finance markets. Consistent with the mandate January, Arc Home entered into a definitive agreement to acquire a Fannie Mae, Freddie Mac, and Ginnie Mae mortgage originator, and we hope to receive, as David mentioned, the requisite consents to complete this acquisition by the second quarter of 2016.

For the quarter, MITT reported a loss of $0.21 net and core earnings of $0.40. Unlike past periods, the decrease in net income from last quarter was primarily attributable to the credit segment of the investment portfolio. Core earnings mainly decreased due to the reversal of retro from positive $0.01 to negative $0.05, as well as due to lower yields and a smaller overall portfolio.

Book value declined to $17.22, which represents decrease of $0.66 inclusive of the impact of our dividend paid to shareholders on April 29. Book value came under pressure during the quarter because of credit spread widening led by CMBS, non-agency, and ABS.

We've seen some rebound in the credit markets in March and April, and is our belief that should the capital markets heal and stabilize, there will be some recovery on the credit side. The aggregate portfolio size decreased to approximately $2.7 billion as a result of the continued rotation into less levered credit assets and the organic amortization of our agency assets.

At March 31, our hedge ratio was 47% of our agency financing and 22% of total financing. At the end of April, the hedge ratio was lower at 34% of agency financing, or 16% of total financing.

Leverage declined modestly to 3.36 times, down from 3.53 times last quarter. Quarter-ending net interest margin decreased slightly to 3.02%.

On slide 10 of our quarterly earnings presentation, we laid out the investment portfolio composition for the quarter. The fair value our agency book was approximately $1.2 billion, and the fair value of our credit book was approximately $1.6 billion. Focusing first on our agency MBS portfolio, the constant prepayment rate for our agency book was 8.1% for the first quarter.

Prepayment speeds for our portfolio remain benign and stable and notwithstanding the recent interest rate rally, owing to the favorable prepayment characteristics of our holdings, as shown on the pie chart listed on slide 11. Capital allocation to agency MBS declined slightly due to organic runoff. Our aggregate credit book, which comprises the majority of our portfolio at this time, was approximately $1.6 billion fair value at quarter end.

Performance of our credit book continues to be generally in line with our investment underwrite. During the first quarter, we selectively took advantage of the dislocation to purchase additional non-agency MBS, Credit Risk Transfer securities, ABS, CMBS IO, and to originate a commercial real estate loan.

Specifically, we invested in current face value of $3.7 million of prime securities, $1.3 million of securitized whole loans, $5.6 million of CRT Securities. We also purchased current face value of approximately $4.4 million of CMBS IO and originated a $12 million commercial loan, of which $1.8 million was transferred to a third party at fair value. Additionally we purchased current face value of approximately $11.2 million of ABS.

Now turning to slide 14, we provide an update on our financing. We currently have 37 financing counterparties, excluding the FHLB and our financing investments with 21 of the counterparties. In general, funding continues to be plentiful and stable for the Company.

The portfolio's duration gap, inclusive of agency and credit, increased from 1.79 to 1.94 years. The wider gap resulted from a reduction in hedges in response to a more favorable outlook on interest rates.

Our hedging and interest rates sensitivities are laid out on the next slide. We continue to adjust our hedge positions in responses to changes in our portfolio, US economic conditions, and the potential normalization of US monetary policy.

Before I turn this call over to Brian, I'd like to comment on the attractiveness of our equity and investment opportunities. During the first quarter in the midst of extreme volatility, with tactically invested available cash flow in our share repurchase program, CRT Securities, CMBS, and ABS.

With the rebound in credit in March and April, the attractiveness of buying back equity looks increasingly attractive, given the sizable discount to book value at which MITT trades. Next, we believe that keeping some dry powder available should we see an increase in volatility, should be prudent and appropriate given liquidity conditions.

And finally, we will continue to identify attractive credit on a trade-by-trade basis with appropriate stress testing and liquidity analysis. We believe that in 2016 as it unfolds, we have MITT well positioned to take advantage of the wider range of credit market opportunities that are increasingly available to us today at favorable returns. With that, I turn the call over to Brian to review our financial results.

Thanks, Jonathan. In the first quarter we reported core earnings of $11.3 million, or $0.40 per fully diluted share, versus $15.7 million, or $0.55 per share in the prior quarter. At March 31, we did have a negative $0.05 retrospective adjustment to our premium amortization on our agency portfolios.

The decrease in core earnings from last quarter was due to a number of factors, and more in line with where we set our dividend. The largest driver of the decrease was in our portfolio earnings as well as some quarter-over-quarter change in G&A expenses.

Overall for the quarter, we reported a net loss available to common stockholders of $5.8 million, or $0.21 per fully diluted share. In the first quarter, the $0.40 of core was offset by net realized and unrealized losses of $0.60 per share.

The $0.60 loss was primarily due to $0.71 of net realized and unrealized losses on the credit portfolio, offset by $0.11 of net realized and unrealized gains on our agency securities and derivatives portfolio. As part of these net realized and unrealized losses, $0.33 was considered other than temporary impairment for OTTI and certain securities.

We record OTTI when there is a decrease in our projected cash flows where the fair value of the security is less than its carrying amount. The decrease in cash flows can result from lower expected principle or interest collection.

As a result of the decrease in long-term rates this quarter, we did see a decrease to our projected future interest collection, our agency IO, and floating rate credit book, which contributed $0.17 of the OTTI. At March 31, our book value was $17.22, a decrease of $0.66 or 3.7% from last quarter.

This decrease is mostly attributable to the losses I previously mentioned. Additionally, we repurchased 120,000 shares, or $1.5 million of common stock during the quarter, which was accretive to book value by $0.07 per share. To give you a better sense of the current portfolio, I'd like to highlight a few more statistics.

As described on page 6 of our presentation, the portfolio at March 31 had a net interest margin of 3.02%. This was composed of an asset yield of 4.75%, offset by repo and hedging costs of 1.53% and 0.2% respectively, for a total cost of fund of 1.73%. Our cost of hedging did decrease this quarter due to the addition of Treasury long conditions.

Additionally, during the quarter we repaid our FHLB financing as a result of the FHFA's final rule issued on January 12, 2016, which terminates MITT's captive insurance subsidiary membership in February of 2017. We're easily able to finance these access with our current banking relationships, and continue to have ample sources of funding available to us. Our liquidity remains strong, and at quarter end we had a total liquidity of $138 million, which was composed of $49 million of cash, $49 million of unlevered agency hopeful securities, and $49 million of unlevered agency IO securities.

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

(Operator Instructions)

Samuel Cho, Credit Suisse.

I am filling in for Doug Harter today. I was wondering if you could give us an update as to when the mortgage banking platform will be fully operational? I think you mentioned in the prior call that Arc Home will breakeven around 3Q. Does that still hold?

I actually said that, it's Brian, on the last call. And given the timing that David and Jonathan says, which we do think we will get the final approvals this quarter and therefore complete the transaction this quarter, it is going in line with projections.

Got it. Given current -- the current environment with the rates remaining lower for longer, do you have a general sense as to what the additive impact will be from Arc Homes as you ramp up that business?

I think that we believe that it should be accretive to the Company in a relatively short period of time. The cost structure is quite variable.

The lower interest rate environment, and if it potentially even goes down lower, might act as a very nice hedge on basically asset attrition through prepayments. There's -- we believe that the Company will be in a position with a book of business that should day one be very helpful in amortizing cost structure.

Got it.

I would also add, this is David Roberts, I'd add that one of the key attractions to us doing the Arc Home transaction was the management. They have been through a lot of different cycles, they are very entrepreneurial, very opportunistic, and I think we believe that in just about every cycle they are going to find some interesting opportunities to make money for Arc Home and to provide portfolio opportunities for us.

Okay. Thank you so much.

Joel Houck, Wells Fargo.

So given the spread volatility on the credit side in the first quarter, no surprise at the book value move. However, intra-quarter one way to imagine it that the mark, had there been one, would've been even greater.

Have you -- and in conjunction with that, we also see that your allocation of credit is the highest ever -- it's ever been. Have you given pause to -- or is there some limit as to how much capital you are going to allocate to credit?

One of your competitors who had been going down the same track in terms of credit allocation, backtracked yesterday and talked about increasing more to agency exposure, because relative returns there were starting to look better. I'm just curious as to how you weight the relative attractiveness of agency versus credit given the volatility that we saw in Q1, and the possibility that that may be with us for a while.

Great question. I would first start to say that there -- within credit there are different levels of volatility. We saw distinct differences in the way different parts of our book and different parts of the market behaved.

The greatest volatility occurred in anything that was more corporate oriented, so CLO for instance. You saw CMBS, which had a lot more volatility and has not fully recovered from the declines of the first two months, but has made some steady progress back.

The least impacted were your senior non-agency RMBS securities with great carry characteristics, where there is very good sponsorship, the technicals are favorable because there's really no net new issuance, and the fundamentals are really stable. So, yes, did yields come off a little bit? Yes, but they really -- there is a shortage of good bonds there.

Then you move down and go to the sector of the non-agency side that really what took the biggest beating was sub-prime mezzanine securities with low carry characteristics. And floating rate assets, where unfortunately you're just not going to see the benefit of a policy rate increase.

And so I think we were very cognizant of what our allocation is in the deeper credit. We are very cognizant of our allocation to floaters, which the offset there is you don't have to worry about hedging, but the further offset is you just may not ever see the income from -- projected toward LIBOR show up that you hopefully envisioned.

I would say that given 1940-Act considerations and just portfolio construction, we're approaching really almost the limits of what we can do with credit bonds. We really would need to have more 1940-Act eligible assets if we were going to allocate additionally to credit.

We thought the loan that we made on the commercial real estate side was excellent and will be very attractive. Some of the stuff we've done on the Freddie K side, really great assets, long duration, stable. We think those are great. But agency will continue to have a place in the portfolio, and I think where we are now situated, we have a lot of optionality to move one way or another.

Okay. If I could have a follow up, that's good color. The duration gap of 1.94 at the end of March, presumably that's even higher given that you disclosed that your hedge ratios were lower in April.

Is another way to think about that, Jonathan, that in a weaker environment presumably where rates rally, as you point out in your disclosures you get a 4.2% pick up in book equity with a 50-basis point decline presumably in long rates, that that would largely offset any marks on the credit book? Or are you thinking about that roughly equally, or is there still some net exposure in the credit book that can't really be solved by having a higher duration gap?

I would say that there is some net exposure on the credit side. Because it's not just a one for one type of movement. We didn't see that in the first quarter and I would not expect that.

We are not sizing it with necessarily that one-for-one movement. We do pick up some benefit, and the agency book certainly performed very well in the first quarter. But once again, if rates decline too dramatically, at some point the assets stop appreciating on us, and we Cap out.

Is it fair to say that the increased duration gap I think too is relatively high in the space, that that is a reflection that you think rates are limited in terms of their ability to go up from here? Not the short end, but the long end.

I think it's very, very difficult for the Fed to raise rates more than once or twice. It's very difficult for long-term rates to go up in a world where at least 25% of all sovereigns I believe are negative at this point in time.

Yes.

I also think that look, it's prudent for us if we have a risk off situation like January and February, a major flight to quality, that we have an appropriate hedge in place with the agency book so that we're not having a repeat performance of 2013, a temper tantrum where basically you have both the credit and rate exposure simultaneously hitting you.

Great. Thanks, Jonathan. That's good color.

Eric Hagen, KBW.

Joel's question was very similar to my first question, and I think you did a good job of answering that. I guess I will switch to the RPL securitizations that you have done.

Have your assumptions changed about the losses or severities that you're going to see in those deals? And on a similar note, do you think there's any additional opportunities to obtain nonrecourse financing in the portfolio going forward?

So our basic assumptions have not changed. So the terminal delinquency, or loss rates for those two positions, those two securitizations have not changed, but we certainly are seeing some uptick in delinquencies at this point in the transaction's life, and the timing maybe different.

We continue to evaluate those securities. We continue to monitor them, work with the counterparties on those transactions, but we have not added additional exposure since those two transactions. Can you repeat the second part of your question?

Sure. It was do you think there's any additional opportunities to obtain nonrecourse financing going forward?

With respect to what asset class?

To any asset class.

I think if there is -- there is a possibility depending upon LPV level and price or cost of funds to achieve some level of nonrecourse financing.

It's Brian. I think we always look at that because we're very cognizant of it. But given the ample funding sources and really leverage of the portfolio and the mix of the assets, we're very comfortable with where we are at.

On the whole loan side, we have done as a part of Angelo Gordon a number of securitizations, which we've talked about, I think we did our last one with MITT involved that we just closed in Q4. And that is also something that we continue to evaluate.

But the securitized debt on the balance sheet is all the two GCAT deals and only the two deals?

It's that and we also did a Re-REMIC back -- we did a Re-REMIC I think back in 2014. And that was something that we took advantage of a specific time period where those were getting done very favorably. And we were -- we did get accounting treatment as kind of a sale. So it came up as a grossed up trade with a securitized piece of financing.

Got it. And then last question, just the duration on those treasury securities in the portfolio now? Are you able to give tenor of the treasury securities?

I think we can follow up with you on that.

Okay. Thanks.

(Operator Instructions)

We have no further questions. I would now like to turn the call back over to Management for closing comments.

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

Thank you very much.

Thank you.

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