AG Mortgage Investment Trust Inc (MITT) 2016 Q2 法說會逐字稿

Good morning and welcome to the AG Mortgage Investment Trust second-quarter 2016 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. Karen, 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 second 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 Private Securities Litigation Reform Act of 1995. All such statements are intended to be subject to the Safe Harbor 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 these factors and others beyond its control. All forward-looking statements included in this conference call and slide presentation are based on our beliefs and expectations as of today, August 5, 2016. We disclaim any obligation to update our forward-looking statements unless required by law. 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 company's periodic reports filed with the SEC. Copies of the reports are available on the SEC's website at www.SEC.gov.

At this time, I would like to turn the call over to David Roberts.

Thanks, Karen, and good morning everyone.

Our book value increased during the quarter by 1.2% to $17.42 per share at quarter's end. The value of the agency portion of our portfolio increased primarily due to the positive portfolio duration gap in place and given the rally in rates. Our core earnings for the quarter were $0.46 per share before a negative retro adjustment of $0.03 per share. We declared a dividend of $0.475 cents per share for the second quarter, consistent with the dividend rate we used for the past two quarters.

During the quarter we rotated into 30-year agency RMBS on a hedged basis. We also purchased assets for the credit portfolio, which Jonathan will get into in more detail. We are pleased to announce that in June our mortgage origination affiliate, Arc Home, closed on the acquisition of a Fannie Mae, Freddie Mac and Ginnie Mae mortgage originator. Arc Home has commenced originating mortgages in 44 states through retail and [correspondent] channels. Arc Home will continue to pursue licenses in the remaining states and expects to receive most of the remaining approvals by the end of this calendar year.

We are excited about increasing origination volumes at Arc Home and deploying capital to purchase and retain mortgage servicing rights, which will create investment opportunities for AG Mortgage Investment Trust. Finally, last year our Board authorized a $25 million share buyback program to give us the potential means to increase book value per share. To date we have repurchased approximately 560,000 shares of common stock for a cost of approximately $7.5 million, which has led to a total net accretion to book value of $0.07 per share.

With that, I will turn the call over to our President, Jonathan Lieberman.

Thank you, David. Good morning, all.

During the second quarter of 2016 the volatility and the price risk assets globally from the prior quarter largely subsided. Mortgage and consumer credit regained most if not all of the mark-to-market losses suffered in the prior two quarters. The market rebound only momentarily paused in response to the surprised outcome of the June 23 United Kingdom referendum on European Union membership. Despite this momentary uncertainty, risk assets, particularly US dollar-based assets, held up very well. Legacy mortgage assets proved to be especially resilient during this, due to support of technicals and stable underlying fundamentals. Most asset classes priced at or near their best levels of the year as of the end of the second quarter.

The Fed, in its June 15, 2016, meeting, further tempered its expectations for policy action both in the near and long term in response to stubbornly low inflation and a growing belief within the Fed that the neutral level of Fed funds is lower than they had previously thought. Beyond 2016, the Feds forecasts the pace of upward inflation, interest rate adjustments be more gradual, with a reduction in the median number of increases in both 2017 and 2018. Even as the Fed has reduced its forecast we continue to subscribe to the view that the risk of a slower pace of rate normalization is greater than that of a faster rate. This, combined with global demand for fixed income product that overwhelms available supply, shifts our benign, medium-term outlook on interest rates.

Continuing the theme that began in Q1, agency MBS technicals remained strong during the second quarter. The scarcity of absolute yields available globally, with liquidity, especially from overseas investors looking for attractive yields relative to their global benchmarks, remains intact. There is strong sponsorship from banks, money managers, as well as the overseas accounts. The favorable yield and liquidity and credit profile of agency MBS has tightened valuations despite increased prepayments and supply concerns.

Swap spreads were also stable during the quarter, and as a result proved to be an effective hedge. In fact, the gradually widening swap spreads have enabled us to unwind a large portion of our long position in swap spreads that we entered into during the fourth quarter of 2015 and the first quarter of 2016 at favorable economic outcomes.

Mortgage credit spreads took part in the second quarter broader market rally that commenced at the end of the first quarter. The rally was broad-based across several RMBS subsectors. CMBS continues to trail amidst lower global sovereign rates, the hunt for yields has been a driving factor in tightening spreads. As a result we are pleased with performance for the credit book this quarter.

Fundamental collateral performance of legacy mortgages continues to remain steady and in some cases is improving, benefiting from continued home price appreciation and credit curing. Housing affordability included in first-time homebuyers remains above historical averages and consumer confidence stands near postrecession highs. We remain constructive on housing and believe home price stability is durable at this time. Favorable net supply technicals and strong reinvestment demand support pricing outperformance of RMBS for other spread asset classes.

As David previously mentioned, in the second quarter Arc Home closed on the acquisition of a Fannie Mae, Freddie Mac, and Ginnie Mae mortgage originator. Beyond this transaction, Arc Home was successful in other achievements during the quarter, including commencing mortgage originations and launching a car [sponsored] origination channel. The investment team is very pleased with the progress Arc Home has made and remains focused on capitalizing on the current interest rate environment to increase origination volumes at Arc Home. Additionally, Arc Home plans to introduce new mortgage products and expand its investment activities for mortgage servicing rights as well as launch wholesale originations and portfolio retention strategies in the third quarter of 2016.

For the quarter, MITT reported net income of $0.63 per diluted share and core earnings of $0.43. The increase in net income from last quarter was supported by our agency book. Core earnings without retro remained relatively flat quarter over quarter. Book value increased to $17.42, which represents an increase of $0.20 inclusive of the impact of our dividend paid to shareholders on July 29. The aggregate portfolio size increased modestly to approximately $2.8 billion. At-risk leverage increased slightly to 3.3, 8 times from 3.36 times last quarter. Quarter-ending net interest margin increased modestly to 3.06 into higher yields on the credit book.

On slide 9 of our quarterly earnings presentation, we have 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 approximately $1.5 billion. Focusing first on our agency MBS portfolio, the constant prepayment rate for our agency book was 9.9% for the second quarter. Prepayment speeds for our portfolio remain benign and stable, notwithstanding the recent interest rate rally, owing to the favorable prepayment characteristics of our holdings.

During the quarter, we increased the allocation to agency RMBS 30-year product on a hedged basis at attractive ROEs. Specifically, we purchased face value of $100 million of TBA on a hedged basis. We also rotated holdings by selling $65.6 million at face value of agency pools and replacing them with $82.2 million of pools that would better insulate us from expected near-term increases in the overall market prepayment rates.

During the second quarter, for the credit book we purchased nonagency MBS Freddie Mac K-Series securities, CMBS IO, and ABS. Specifically, we purchased face value of $19.5 million of prime and Alt A securities and sold face value of $23.5 million prime securities. We purchased face value of $35.8 million of Freddie Mac K-Series securities and $580.6 million of CMBS IOs were $29.6 million of fair value. On the ABS side we purchased face value of approximately $12.5 million in securities. The credit book did perform nicely during the second quarter. But it performed even better and appreciated more during the month of July. A portion of that price depreciation may be attributable to delayed price movement during the June period.

Turning to slide 13, we provide update on our financing. We currently have 38 financing counterparties and our financing and investments are 22 of the counterparties. In general, funding continues to be plentiful and stable for the company.

Our hedge tables are (inaudible) laid out on slide 15. We continue to adjust our hedge positions in responses to changes in our portfolio, US economic conditions, interest rates, and potential normalization of US monetary policy. Specifically, the rally in interest rates from the quarter put downward pressure on our duration gap. In response we added duration that limited the shrinkage of our gap (inaudible) agency to credit of 1.94 years to 1.63 years.

So in closing, we believe that, as 2016 unfolds, MITT was well-solutioned to take advantage of wider ranges of credit market opportunities and an increasingly favorable [report]. With that, I will turn the call over to Brian to review our financial results.

Thanks, Jonathan.

In the second quarter we reported core earnings of $11.9 million or $0.43 per fully diluted share versus $11.3 million or $0.40 per share in the prior quarter. As of June 30 we had a negative $0.03 (inaudible) our agency portfolio. Overall for the quarter we recorded net income level common stock [holdings] of $7.7 million or $0.63 per fully diluted share. In the second quarter the $0.43 (inaudible) was coupled with $0.22 of net realized and unrealized gains on the agency and derivatives portfolio. At June 30th our book value was $17.42, an increase of about $0.20, [up 22%] from last quarter. This increase is mostly attributable to the gains I previously mentioned. Additionally we repurchased 313,000 shares for $4.3 million common stock during the quarter and that accretion to book value after repurchase of $0.03 per share.

To give you a better sense of our current $2.8 billion portfolio, I would like to highlight a few more statistics. As described on page 5 of our presentation, the portfolio at June 30, 2016, had a net interest margin of 3.06%. This is (inaudible) active yield of [4.6%], offset by rehabilitation costs of 1.52 and (inaudible) respectively of 1.76%. Additionally, our cost of hedging increased modestly at the end of the quarter due to the removal of (inaudible) and coupled with increased financing costs (inaudible). We saw a little bit of a slide at the quarter end, although this was offset by the (inaudible) swap, which we will see the benefits in the future.

During the quarter we received a net equity of $9.69 from the payoff at maturity of one of our commercial loans. We also redeemed the majority of our FHLB stock (inaudible) $8 million. Additionally, we received net equity of $3.2 million on some of our Countrywide bonds as a result of the settlement by Bank of America with RMBS investors related to mortgages sold by the Countrywide unit. All these factors contributed to our (inaudible), which at quarter end was $166.3 million, comprised of $42 million of cash, $80 million of unlevered agency [hopeful] securities, and $44 million of unlevered agency IO securities.

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

Thank you. We will now begin the question-and-answer session.

(Operator Instructions)

Joel Houck, Wells Fargo.

Thanks, guys, and good morning. Just a really solid quarter. I think that's the overall theme that we are seeing from most of the companies. I'm curious on the movement toward agency.

Is that -- would you characterize that as more opportunistic given what has happened or is it more of kind of a -- more of a core holding, you are more amenable to holding agency given the lower rate volatility, and as you mentioned, I think the hedging costs are more favorable or at least the swaps are cooperating with respect to being more of an appropriate hedge.

Good morning. I would characterize it as more opportunistic a moment in time where we felt that we should and could add agency effectively on a hedged basis. And part of a rotation of portfolio, just modest rotation, on the agency side into a little bit lower coupon and just an adjustment for just the interest rate environment and really prepayment protection.

Okay. And I guess the next question is more macro related. We see strong jobs report this morning on the heels of a previous good report. Yet the bond markets rates are taking it with stride. Do you still kind of maintain lower for longer stands? That's one of the themes we have heard on many conference calls, so despite the strong jobs report there is still kind of an income problem, if you will, globally. Are you worried that -- if this jobs strength continues that rates may move systemically higher?

I think we've stated that we believe in lower for longer in the medium-term. I think we ultimately need to see real sustained growth and some income growth and more aggregate demand. If you look at tax receipts in the last couple of months, they have certainly come down and we are seeing lower economic activity at many companies. Earnings in many companies have disappointed this quarter [and] prior quarter.

So you couple that with some of the other big macro themes that are dominating the bond market, we are not implying that we are going through a recession, we just think that basically growth is really pegged at a low number, and the Fed is really contained an their ability to push rates up or even the markets are really contained in their ability to push the bond yields higher because of just the worldwide demand for yield.

Okay. Very good. Thank you very much for the comments.

Douglas Harter, Credit Suisse.

Thanks. You talked about Arc Homes starting to deliver credit products in the third quarter. Can you talk about the competition there and what we could expect around pacing of new investments added?

I think we are trying to guide you to just a slow buildup of Arc Homes. We're not trying to push an agenda that Arc Home is going to deliver products at too rapid a pace this year. I think the first product that we would expect would be MSR off of traditional agency product and then over time we envision basically expanding the menu of products to include more credit oriented products including non-QM. But it will be really I think a 2017 story on some of these incremental products.

We are very, very pleased with the management team and the small retail originators that we acquired that came with licenses. The management team, led by Barry Bier, an experienced mortgage banker with over 25 years experience and he has the ability and capability of putting together a business very, very rapidly, and we will say that he is ahead of plan. But we are only several months into this. So we look forward to being able to add more credit product. But initially, the first product that will be added is MSR into the portfolio.

How should we think about the overhead cost or the cost of running that business in light of the slow ramp up, as you have seen others, I know a different business, but other of your mortgage REIT peers closing their conduit businesses as they cannot generate enough volume to support the costs.

I think I will take the first part of that. It is really the costs at the mortgage company which MITT only owns 45% of. So to the extent there are costs to bare down there, MITT only picks up the 45% of that.

I think we started it from scratch as opposed to going out and really buying a larger one that was in place in order to build this up the right way with partners that we think can do a great job scaling it. And yet, for sure, we have talked about the first year or so there being some start-up costs. I think have given estimates of maybe about $0.01 or so a quarter to the MITT book. But at the operator level, we are very happy with what we see in terms of how they are scaling up and we think we have chosen the right partners that it is not going to get to the point of where some of our other competitors are. And then for the second part, David?

It is David Roberts speaking. I think we think said at the beginning that the management team and we were very focused on making this as much of a variable cost business as possible, and it is the expertise and the experience of the management team that allows them to really build it up that way. So we are very conscious of the risk of growing too quickly and building up too much infrastructure and then getting on a treadmill that can be negative. So we are building the business plan specifically to avoid those circumstances.

And then just a clarification. You own 45% of the mortgage company. Are you guys taking the -- do you get 45% of the MSR investment that comes out, or are you getting the pro rata investments as well or how does that allocation work?

The allocation of MSR is an arm's-length transaction between the mortgage company and any of the vehicles, including the REIT. So the management team is incentivized to sell the MSR to the best execution counterparty. So if the REIT has appetite but gets certainly the benefit of a counterparty that can protect us legally and has the appropriate licenses, it is potential that they could get 100% of the allocation of the MSR. In other cases they may share it with other private funds. But those private funds will pay the same price that MITT would pay for that asset.

And it will be allocated, again, based on the appropriateness of whatever the asset is to the various vehicles and so that is the way that we run Angelo Gordon and that we run MITT.

Got it. Makes sense.

Eric Hagen, KBW.

Thanks. Good morning. A few of my questions were the same as -- or very similar to Doug's. I guess I will go in a different direction. How much of your asset yield was due to discount accretion this past quarter?

You know, I don't have it on me. We give more detail in the Q, which we'll be filing later today, but the discount accretion action on the credit is typically right around what the amortization of the premium is on the agency book. That's not a perfect science, but they are roughly in line. So net-net we end up really coming close to actually the yield being close enough to what the true coupon is.

Got it.

That is the only information I have on me.

So going forward, it is kind of safe to assume that we can neutralize -- we can really just run with the coupon in the portfolio.

Yes. Pretty close to that. We do give all of the coupons. We do give all of the yields. You can definitely work through it from our book and the information that we would put in the presentation in the Q, but it is close, actually, to offsetting just given that we buy the agency at premiums and the credit at discounts.

Great. Thanks. And you alluded to it in your opening comments, but want to get a better sense for what you are predicting for speeds on the agency book this quarter in 3Q. We saw the print come in last night. It was a little bit lower, and I assume you agree with, I guess, my opinion that doesn't reflect the post Brexit activity. Would you say that is on par?

I would agree in concept. But I would say that Mike [Angeletti] who trades our agency book has done a good job of positioning us in some New York, some Northeast type of product, and we did rotate and add a little bit of I believe 3% coupon product to the portfolio.

So I think that we are very comfortable with the speeds, and then the other thing I would say is that -- and you have to take into account the day count as well for this period. But I would say we certainly know that speeds for the next one, two, three months will pick up as the post Brexit euphoria of the bond market really comes through, and then we have moved up in yield once again on the 10-year side. And in often cases, we've seen some of the originators really expand their market.

So you are not seeing nearly the volumes that you have historically seen that a lot of originators had curtailed their origination capacity and they're really using this as an opportunity to pick up profitability to make up for negative performance on their MSR side.

Great. That's helpful, Jonathan. Thanks.

(Operator Instructions)

We are standing by for any additional questions. We have no further questions. Karen, we will turn it back to you for final remarks.

Thank you, everyone, and we look forward to speaking with you next quarter.

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