AG Mortgage Investment Trust Inc (MITT) 2016 Q3 法說會逐字稿

Welcome to the AG Mortgage Investment Trust third-quarter 2016 earnings call. My name is Sylvia and I will be your operator for today's call. (Operator Instructions). Please note that this conference is being recorded. I will now turn the call over to Karen Werbel. Karen, you may begin.

Thanks, Sylvia. Good morning, everyone. We appreciate you joining us for today's conference call to review AG Mortgage Investment Trust's third-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 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 the slide presentation are based on our beliefs and expectations as of today, November 4, 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.

Thank you, Karen and good morning, everyone. Our book value per share increased during the quarter by 6.1% to $18.49 at quarter's end. The increase in book value was driven primarily by the credit portion of our portfolio as strong demand drove credit spreads to the tightest levels in over a year. Additionally, a Re-REMIC securitization and residential loan sales contributed to the book value increase. Our core earnings for the quarter was $0.50 per share inclusive of a de minimis retro adjustment. We declared a dividend of $0.475 per share for the fourth quarter in a row.

To date, we have funded initial capital of $13.4 million to our mortgage origination affiliate, Arc Home. We are very pleased with the progress Arc Home has made thus far. Arc Home is originating mortgages in 44 states through both the retail and correspondent channels. In addition to retaining mortgage servicing rights on its originated production, Arc Home purchased mortgage servicing rights on $2.4 billion of notional principal balance during the quarter. We expect that a substantial portion of Arc Home's capital will continue to be deployed to purchase and retain MSRs. Arc Home anticipates launching its retention strategy with respect to its MSR portfolios in the fourth quarter of 2016 and then beginning in 2017, we anticipate that AG Mortgage Investment Trust will be acquiring mortgage-related products originated and sourced by Arc Home.

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

Thank you, David. Good morning, all. During the third quarter, mortgage credit spreads benefited from both a rally in the broader credit markets, as well as continued strong demand for non-agency MBS. Specifically, we saw spreads tighten in credit risk transferred securities, legacy non-agency securities and NPL and RPL-backed securities.

Capital markets during the third quarter were characterized by relatively low volatility as there was no BRIC exit type event and risk markets were generally firm across the board. Net demand in the third quarter was particularly unique because RMBS investors also received approximately $8 billion from cash distributions relating to the Bank of America-Countrywide settlement. We think this was largely reinvested back in our residential space. Further, we also believe a significant amount of underinvested capital remains on the sidelines waiting for a dislocation or interesting investment opportunities at this time.

Despite the overall increase in prepayments during the quarter in response to July lows in benchmark yields, spreads on the agency RMBS performed better than expected and finished the quarter on a strong note given higher benchmark interest rates and continued strong market technicals.

Domestic banks increased their already robust purchasing activity during the quarter; overseas investors continue to deploy capital into our products; money managers increase their allocation to the agency sector; and the Fed's reinvestment activity rose in response to larger pay downs of existing holdings.

While historically low, interest rates did retrace some of their post-BRIC exit rally during the quarter as global economic conditions and the outlook improved marginally and the efficacy of sustained use of accommodative monetary policy has been called into question. We do not believe, however, that the retracement is the start of a longer-term trend. Accordingly, we continue to maintain a benign outlook on interest rates and the duration of our book over the coming quarters. We do anticipate that the Fed will raise Fed funds by 25 basis points probably in December and also anticipate an additional one or two movements of rates in 2017.

Moving to the fundamental side, fundamental collateral performance of legacy mortgages continues to remain steady and in some cases is improving. This is due to the continued stability of the job market, continued home price appreciation in parts of our country and credit [cure]. Housing affordability, including first-time homebuyers, remains above historical averages; consumer confidence is pretty stable to approaching highs. We remain constructive generally on housing, although it is much more market-specific and believe home price stability is durable at this time.

Furthermore, we see favorable net supply technicals and strong reinvestment demand supporting price outperformance of RMBS, non-agency RMBS versus other spread asset classes.

As David previously mentioned, in the third quarter, Arc Home purchased MSRs backed by $2.4 billion notional principal balances and retained servicing also on $213 million of notional principal balances on loans originated by the platform. Arc is actively building infrastructure and hiring mortgage banking professionals to permit further investments by MITT and AG Private Funds. The investment team is very pleased with the progress Arc has made and remains focused on capitalizing on the current interest rate environment to increase origination volume at Arc going forward.

For the quarter, as David mentioned, MITT reported net income of $1.54 per diluted share and core earnings of $0.50 per diluted share. The increase in net income from last quarter was supported primarily by our credit side of our portfolio. Book value increased to $18.49, which represents an increase of $1.07 inclusive of the impact of our dividend paid to shareholders on October 31. The aggregate portfolio size decreased modestly to approximately $2.7 billion; at-risk leverage decreased to 3.2 from 3.4X last quarter. Quarter-end net interest margin decreased to 2.97%.

Changes in our NIM were primarily due to portfolio yield declines attributable to monetizations for paydowns of several higher-yielding investments. We do anticipate recycling monetized equity capital during the fourth quarter and following the conclusion of US national elections.

On slide 9 of our quarterly earnings presentation, we laid out the investment portfolio composition for the quarter. The fair value of our agency book was approximately $1.2 billion, and the fair value of our credit book was approximately $1.5 billion.

Focusing first on our agency portfolio, the constant prepayment rate for our agency book was 11.7% for the third quarter. Prepayment speed for our portfolio remained benign and stable, notwithstanding the recent interest rate rally for the retracement in the last several weeks, owing to favorable prepayment characteristics of our holdings. We did adjust our agency asset mix on the margin by monetizing [Rich Hall]-protected specified holdings in higher coupons versus buying lower coupons, new production MBS at minimal premiums to TBA. This was done to help reduce losses associated with premium amortization during a period of elevated prepayments on all MBS.

During the third quarter, we further diversified our credit portfolio and increased our allocation to floating rate and short duration fixed rate securities. We continue to participate in floating rate tranches and new-issue transactions, including credit risk transfer deals where we believe historically tight underwriting standards provide superior loss protection.

In legacy mortgage credit, we opportunistically added securities, as well as rotated out of asset-backed and legacy non-agency securities that we believe had reached intrinsic value. Specifically, we did purchase non-agency RMBS, Freddie Mac K-series CMBS, CMBS IO and then legacy CMBS securities as detailed on slide 6.

Turning to slide 13, we provided an update on our finances. We currently have 38 financing counterparties and are financing investments with 22 of these counterparties. In general, funding continues to be robust, plentiful and stable for the Company.

On slide 15, we lay out hedging tables. We continue to adjust our hedge positions in responses to changes in our portfolio, US economic conditions, the elections, interest rates and potential normalization of US monetary policy. The overall duration gap of the portfolio increased modestly from the prior quarter from 1.63 to 1.81 years primarily due to the unwinding of Eurodollar hedges we added in the second quarter. These hedges were put in place in response to market overreaction during the BRIC exit vote and were removed as the market's implied probability of Fed tightening of monetary policy by year-end reached more reasonable levels during the third quarter.

Put another way, it was a very opportunistic trade on the interest rate side that we put in place in the second quarter that we monetized during the third quarter. Our swap position also declined as we unwound the majority of our long swap spread positions as swap spreads widened further. Despite marginally higher rates at quarter-end, the impact of our positive duration gap on book value was minimal due to our short positioning at the front end of the yield curve and a tightening of agency RMBS versus the swap basis.

We believe that through the rest of 2016 and into 2017, MITT will be well-positioned to take advantage of a wider range of credit market opportunities at increasingly favorable returns. MITT is well-positioned to capitalize on any post-election dislocation or any year-end buying opportunities. With that, I will turn the call over to Brian to walk through our financial results.

Thanks, Jonathan. Overall, for the third quarter, we recorded net income available to common stockholders of $42.8 million, or $1.54 per fully diluted share. Core earnings for the quarter were $14 million, or $0.50 per fully diluted share, versus $11.9 million, or $0.43 per share in the prior quarter. We had a de minimis retrospective adjustment in the current quarter versus a negative $0.03 retrospective adjustment in the prior quarter to our premium amortization on our agency portfolio.

The $0.50 of core was coupled with $0.97 of net realized and unrealized gains related to our credit portfolio and $0.07 of net realized and unrealized gains related to the agency and derivatives portfolio. Core earnings includes $0.01 attributable to Arc Home and includes a $0.01 one-time nonrecurring item related to increased fees we received on one of our residential mortgage loan pools.

At September 30, our book value was $18.49, an increase of $1.07, or 6.1% from last quarter. This increase is mostly attributable to the gains I previously mentioned. Additionally, we repurchased 181,000 shares, or $3 million of common stock during the quarter for net accretion to book value after the repurchases of $0.01 per share.

To give you a better sense of our current $2.7 billion portfolio, I would like to highlight a few more statistics. As described on page 5 of our presentation, the portfolio at September 30 had a net interest margin of 2.97%. This was comprised of an asset yield of 4.73% offset by repo and hedging costs of 1.55% and 0.21% respectively for a total cost of funds of 1.76%. The decline in yield this quarter was primarily due to the monetization of some of our higher-yielding investments.

Our liquidity remains strong at quarter-end as we had total liquidity of $143 million comprised of $46 million of cash, $66 million of unlevered agency [holdco] securities and $31 million of unlevered agency IO securities. Our liquidity included $10 million from the payoff of a large commercial real estate loan in the quarter.

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

Thank you. (Operator Instructions). Joel Houck, Wells Fargo.

Thanks, everyone and good morning. So I guess the question is, if you had to rank order the opportunity set on the credit side, what would that look like on a risk/reward basis as we head into 2017?

Currently, I think subordinated CMBS is one of the most interesting spaces, but it is -- once again, it's not a beta type of investment environment today. It's really a trade by trade, asset by asset type of analysis, which is really well-suited toward the Angelo Gordon platform. Non-QM MSR would follow behind.

So CRT and legacy RMBS would necessarily be behind those two?

I would say that specific non-agency securities are interesting. It's case-by-case and we will see potentially some sales. We've seen some sales this week and we anticipate that there may be some additional sales for the balance of the year. CRT has tightened in pretty materially throughout this year following the first quarter and I think we are in a wait-and-see. Since that asset class tends to trade more consistent with the market and so you have to have a view potentially on the election to have a vision of whether it's right now cheap or expensive.

Okay. One other, if I may. So when you look at -- the composition of the book value increase in the third quarter was primarily credit; that's understandable. On the agency side, you mentioned here in your commentary that the hedge book was positioned to benefit from higher short-term rate. We have seen the expectation of higher short-term rates creep up, but we've also seen longer-term rates move up here early in the fourth quarter. So I'm kind of wondering what your commentary or view is in terms of how the agency book is faring in this environment where the curve seems to be steepening a bit here at least early in the fourth quarter.

Good question. I think we've been pleased with the agency book has performed in the last week or so. Certainly there is a little bit of noise associated with pushback on the efficacy of monetary policy. Some of this also may be seasonality. We still are holding to the view that economic growth, although favorable, is not going to accelerate dramatically and that we really wish not to overreact in either direction to a slowdown in growth and/or potentially to an acceleration here for a very short period of time.

We still hold to the thesis that basically we are pretty much rangebound here, we are part of a global economy and that it would be very difficult for potentially -- for the Fed to really move rates up dramatically here, that it just certainly would not be warranted.

Okay. Great. Thanks for the commentary. Appreciate it.

Eric Hagen, KBW.

Thanks. Good morning, guys and well done on a solid quarter. I want to confirm that the nickel and equity method earnings over the quarter was a penny from Arc and the remainder was from the existing equity method investments that had been in the portfolio before.

Yes, and what we do with our security equity method for core, we look through and we back out the unrealized mark-to-market or realized gains to come up with a core earnings that's similar to the rest of the portfolio. So, out of the $0.50 of core, $0.01 was -- Arc Home was positive $0.01. Last quarter, and I think we had talked about it, it was negative $0.01, so that was about a $0.02 tickup from last quarter. Away from that, there really wasn't much change in the composition of our equity investments. Typically, the other equity investments are really just JV structures with other AG Funds that hold regular way credit securities and there wasn't much change on any of those. So it was really more the $0.02 or about $500,000, $600,000 pickup in swing of Arc Home from negative to positive.

Got it. Thanks, Brian. And regarding the MSR that you are looking at for next quarter, how quickly do you think you can bring that into the portfolio? What should we expect for either a run rate or a comfortable portfolio size on that segment of the portfolio?

Yes, we really can't give you sufficient guidance at this moment in time. We are building infrastructure. We are hiring staffing, testing pipes effectively and we are going to do it in a disciplined and prudent manner and then we will ramp the MSR side of the portfolio, but we do not have a number in mind and we don't presuppose a number until we are really ready if we see an opportunity set.

So you are not comfortable giving a number right now, or you simply don't have a number (multiple speakers)?

Simply not comfortable giving a number at this point for your modeling purposes. I think you can see what we've been originating. We gave you an origination number from the Company where they are retaining MSR. Theoretically, that's available to transfer over to either the funds or to MITT at some point in time should we choose to do so, or it stays in Arc Home, but third-party acquisition will really be subject to a combination of market conditions, although there is ample MSR available for sale and it will be subject to that we are comfortable with the infrastructure is in place, including retention capability.

Okay. Well, on the origination front for Arc, I assume that you definitely have a number there and curious if you would be willing to share that. This is a material part of your business, a major investment of yours. I assume that you have to have some estimate for what the portfolio can do on the origination front?

We are just not in the practice of giving forward guidance. So you can see what we've originated. As Jonathan said, the plan is to increase over time based on market conditions and based on ensuring that we feel we have the sufficient infrastructure in place.

I would direct you to page 7 of our slide presentation, which lays out the originations for approximately $250 million for the quarter and also the MSR acquisitions during the quarter and that's as far as we can take it given our general approach to being more conservative in terms of expectation management.

All right. That's fair. My last question, if you don't mind, I think I will probably expand on some of Joel's questions. If we do get into the next year and the market's expectations for both inflation and Fed tightening get walked back a bit similar to what they did this past year, would you say that you are well-prepared to take advantage of that now and is there something you could do specifically to double down so to speak if that gets realized, or if it looks like it's going to get realized?

If they have to walk back in [placement] and rates, was that the practice?

Yes, I think in your commentary you said that the market is currently expecting one to two increases next year and if that gets walked back to one increase or to zero potentially, would you say that you are well-positioned to take advantage of that now and is there something you could do to double down so to speak?

Look, I think that we are -- the portfolio is very well-positioned should they choose not to increase in 2017. The portfolio -- the market has already priced in to a large extent a December increase, but any sort of walking down of potential rate rises will benefit the current positioning and the current duration of the book, both on the credit side, as well as on the agency side. The agency side will certainly benefit very materially.

In terms of doubling down, we are very materially invested, so it's not like there's -- there's not the ability to theoretically even double down. We do have a good deal of capital because of the gap in monetization events and paydowns of several investments. We have several investments in pipeline and we are really, really well-situated in the event that there was a dislocation in connection with the election or in connection with year-end events or following a monetary event potentially in December. We certainly have capacity to take advantage of any opportunity. Plus we have I think some very good securities that we could rotate as well.

Got you. Thanks, guys. I appreciate it.

Douglas Harter, Credit Suisse.

Thanks. You talked about hoping to be able to add some non-QM loans from Arc next year. Can you just talk about where Arc is in that process and what else needs to be done for those loans to start showing up?

We are certainly very early in the process of rolling out non-QM products at Arc. The prioritization has been to focus on retail correspondent and then add in wholesale on the acquisition channels. I'm certainly focused on conforming product initially then moving to MSR and then non-QM is behind that, but we do anticipate that by the first quarter, we will start to layer in non-agency-oriented products into their menu or suite of products at the Company.

Got it. Thank you. As you start taking delivery of MSRs, can you talk about what changes you might make to your hedge portfolio as those come in?

We will certainly look at our IO strips that are in the portfolio, our agency IOs, as well as our swap book and determine what we think is the optimal mix between MSR and the two existing types of positions that are in the portfolio, as well as the balance of fixed and floating securities in the portfolio and then determine some combination of those positions along with cash movement on a mark-to-market basis of the assets to optimize returns.

Great. Thank you.

Trevor Cranston, JMP Securities.

Thanks. A follow-up question on the non-QM opportunity at Arc Home. Do you have an idea at this point what the non-agency non-QM products are going to look like when they are rolled out next year? And then a second part, when those loans are originated, can you say if Arc Home will have the ability to sell those to any investor, or does the REIT have a first right to look at them and buy them? Thanks.

So answering the second question first, Arc Home has the ability to sell all mortgage products to third-party investors if they find an attractive alternative outlet for the product. There is no in-place rights of first refusal by any vehicle currently in place with respect to the mortgage company.

With respect to what the product would look like, the investment team both in Angelo as well as Arc are working on appropriate guidelines, procedures, policies, controls. There are several non-QM products in the marketplace today. You should probably anticipate or envision that the product will not deviate materially from existing products that are in the marketplace that have demonstrated liquidity, as well as market acceptance from the borrowers.

Great. Okay, that's helpful. Thank you.

We have no further questions at this time.

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

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