AG Mortgage Investment Trust Inc (MITT) 2016 Q4 法說會逐字稿

Good morning, and welcome to the AG Mortgage Investment Trust fourth-quarter 2016 earnings call. My name is Brandon and I will be your operator for today's call.

(Operator Instructions)

Please note this conference is being recorded. 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 fourth-quarter and full-year 2016 results and recent developments. Before we begin, I would 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 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, are forward-looking statements by their nature.

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 made as of today, March 1, 2017, and we disclaim any obligation to update them. We will refer to certain non-GAAP measures on this call. And for reconciliation, please refer to the earnings press release and 8-K, which are posted on our website and have been filed with the SEC. At this time, I would like to turn the call over to David Roberts.

Thank you, Karen, and good morning, everyone. I would like to share some highlights from 2016 with you today. Including retro adjustments, we produced 2016 core earnings of $1.90 per share, which matched the dividends we paid of $1.90 per share. Excluding retro, core earnings for the year were $1.92 per share.

Book value per share was almost the same at the end of the year as it was at the beginning, $17.88 per share at the start, $17.86 at the end. We began the year with at-risk leverage of 3.5 times, and over the course of the year, we reduced our leverage, particularly in the fourth quarter, ending the year at leverage of 2.9 times. Our reduced leverage was a reflection both of adding certain unlevered positions to our credit book, as well as our decision to take a more defensive posture, post-election, as rates began to rise rapidly.

Our duration gap started the year at 1.79 years and ended the year at 1.53 years, again reflecting our decision to be defensive post-election. During the year, we repurchased about 615,000 shares, or $8.7 million of common stock, at an average purchase price of $14.20 per share. That represented 2.2% of shares outstanding as of December 31, 2016.

On the capability side, we established Arc Home to serve as our residential mortgage origination affiliate. We believe Arc Home will provide us with significant opportunities to purchase mortgage-servicing rights and various whole-loan products going forward, and we are very pleased with the company's progress in its first seven months of operations.

Now, focusing on our fourth-quarter results. Book value decreased during the quarter by 3.4%, to $17.86 at quarter and year's end. The book-value decline was driven primarily by the agency portion of our portfolio as the rise in interest rates during the quarter resulted in an extension of the duration of our agency portfolio. We responded to the rate rise and the increased uncertainty post-election by adding hedges, reducing leverage, and adding to our overall liquidity.

In the fourth quarter, our core earnings was $0.57 per share, which included a positive $0.06 retrospective adjustment and a positive $0.03 adjustment for lower G&A expenses in the first three quarters of the year. Without those two adjustment factors, core EPS would have been $0.48 per share. During the quarter, we declared a dividend of $0.475 per share for the fifth quarter in a row.

As I mentioned, we ended the year with a conservative position in terms of leverage, liquidity, and duration gap. Additionally, our borrowing and hedging costs are have increased. As a result, we expect our core earnings to dip in the first quarter. That said, we are currently seeing opportunities to deploy capital, which will have a positive impact on core earnings going forward. In terms of our dividend, at this time we do not anticipate any change.

Our portfolio is composed of approximately 57% of credit investments on a fair market value basis, while approximately 75% of our equity is allocated to the credit portion of our book. We continue to see opportunities to add to our credit portfolio, subject to 1940 Act constraints, by leveraging the Angelo, Gordon platform. As an example, in the fourth quarter, we purchased a $16 million commercial real estate loan at what we believed was a very attractive yield. This loan was sourced and analyzed by Angelo, Gordon's CMBS group.

Turning to the Management Team, as announced in our 8-K filing on February 14, Jonathan Lieberman stepped down as CIO of MITT and will continue in his role as President and Board Member of MITT. In addition to my role as CEO, I have assumed the CIO role. I would like to introduce the other team members in the room: Co-Portfolio Manager and Head Trader, TJ Durkin; Co-Portfolio Manager and Head of Quantitative Research, Yong Joe; and Head Agency RMBS and Derivatives Trader, Michael Antilety. TJ and Yong have helped manage MITT's portfolio since its IPO, while Mike has been a trader in the Firm's residential and consumer debt team since 2013. With that, I will turn the call over to TJ Durkin.

Thank you, David. Good morning. The outcome of the US presidential race during the fourth quarter resulted in a repricing of a broad array of financial instruments from risk assets to risk-free benchmark rates. Pre-election credit spreads have continued a steady grind tighter, while interest rates were slowly drifting higher. Post-election, the 10-year US Treasury rate increased dramatically, ending 85 basis points higher on the quarter, and equity markets rallied on hopes of fiscal stimulus and ease in government regulations.

The US election brought a paradigm shift to the macroinvesting environment and was coupled with only the second increase in the federal funds rate since the implementation of a zero interest rate policy. Amid this backdrop, the mortgage credit markets were liquid and spreads broadly tightened during the fourth quarter. Following the election, we positioned the portfolio defensively against higher interest rates and added a mix of interest rate hedges, shortening the duration gap of the portfolio, and taking down overall leverage.

Agency MBS performed well during the post-election interest rate move on a spread and OAS basis. Much more so than during the taper tantrum of 2013, which was the last time we saw such a dramatic rate move. This is in part due to a wider or relative valuation at the onset of the rate move and also due to more stable real money buyer base in the post-QE period of domestic banks, foreign central banks, and money managers.

Spreads for the credit-risk transfer sector were relatively volatile during fourth quarter and the heavy new issue calendar weighed on the market, causing spread widening and underperformance. After the year's final CRT deal was priced in early December, spreads reversed some of its underperformance.

Persistently favorable fundamentals and a strong net demand technical continue to support positive performance in the legacy residential mortgage sectors. Fundamental collateral performance of residential mortgages continued to remain steady and in some cases improving, benefiting from continued price appreciation and credit curing. We anticipate residential mortgage credit will become more available as we expect the new administration to reduce some of the regulatory burden placed on mortgage originators. Additionally, we think the rise in interest rates points to expectations of higher economic growth and rising incomes, both of which will be supportive of home prices and fundamental collateral performance.

And we do not believe that higher rates will materially hamper housing affordability. We remain constructive on housing and believe home price stability is durable at this time. CMBS and multifamily performance in the fourth quarter also remained healthy, while CMBS spreads generally participated in the broader rally as well.

Focusing on our portfolio on slide 9 of our quarterly earnings presentation, we have laid out the investment portfolio composition for the quarter. The aggregate portfolio size decreased to approximately $2.5 billion as we took down leverage given increased uncertainty following the election results. The fair value of our agency book was approximately $1.1 billion, and the fair value of our credit book was approximately $1.4 billion.

Focusing on our agency RMBS portfolio on slide 10, the constant prepayment rate for our agency book was 12.9% for the fourth quarter. The moderate increase in prepayment speeds from the previous quarter was driven by the near all-time low in primary mortgage rates offered to the borrower during the third quarter. Prepayment speeds for our portfolio remain benign and stable, owing to the favorable characteristics of our holdings.

Moving on to our credit portfolio on slide 11, we actively managed the credit book during the quarter, selling a portion of our CRT positions and residential loans. Additionally, we purchased a commercial real estate loan, other CMBS, including Freddie K multifamily securities. An interesting credit investment that we made in the fourth quarter was partnering with a broker dealer that owned a pool of re-performing mortgage loans they were looking to securitize. Having already pre-placed the senior debt, they approached Angelo, Gordon and a small set of our competitors to sell the mezzanine and first-loss risk.

We were able to successfully structure the transaction to make the investment appealing to MITT and other Angelo, Gordon funds, which included the rate to collapse the transaction in three years. We think this could be a repeatable investment strategy as we look ahead to 2017.

On slide 14 of the quarterly earnings presentation, we lay out the duration gap of our portfolio, which decreased from the prior quarter, from 1.81 to 1.53 years. During the quarter, the agency duration of our fixed-rate book extended approximately 60%. We chose to hedge the extension of our agency RMBS portfolio by adding pay fixed swaps, selling treasury futures, and selling agency RMBS.

In response to the post-election market movements and increased uncertainty introduced, we felt it prudent to reduce our risk profiles during the quarter by reducing both leverage and duration gap. We look for rates over the next quarter or so to remain within recent trading ranges as we await details of a broader array of potential fiscal policy actions. And as we look forward into 2017, we believe MITT is well positioned to take advantage of a wide range of agency and credit market opportunities at increasingly favorable returns.

Specifically, investments we find attractive to add are commercial assets sourced by Angelo, Gordon CMBS and real estate private equity group, certain agency MBS, and newly originated residential whole loans, and MSRs. With that, I turn the call over to Brian to review our financial results.

Thanks, TJ. For the full-year 2016, we reported net income available to common stockholders of $50.2 million, or $1.80 per fully diluted share. Overall for the fourth quarter, we recorded a net loss available to common stockholders of $4.4 million, or $0.16 per fully diluted share. For the full year of 2016, we reported core earnings of $53 million, or $1.90 per fully diluted share.

Overall for the quarter, core earnings was $15.8 million, or $0.57 per fully diluted share, versus $14 million, or $0.50 per share, in the prior quarter. As a result of the rise in interest rates, we had a $0.06 retrospective adjustment in the current quarter due to the premium amortization on our agency portfolio versus a de minimus retrospective adjustment in the prior quarter. Additionally, the $0.57 of core earnings does include a one-time positive $0.03 impact of certain reduced operating expenses. At December 31, our book value was $17.86, a decrease of $0.63, or 3.4%, from last quarter due to the reasons David previously mentioned.

To give you a better sense of our current $2.5 billion portfolio, I would like to highlight a few more statistics. As described on page 6 of our presentation, the portfolio at December 31, 2016 had a net interest margin of 3.16%. This was comprised of an asset yield of 5.18% offset by repo and hedging costs of 1.72% and 0.30%, respectively, for a total cost of funds of 2.02%. The increase in yield is primarily due to the increase of interest rates and rotation into higher-yielding unlevered investments. The increase in cost of funds from the prior quarter was due to the addition of the hedges that TJ mentioned, coupled with the increased cost of financing due to the increase in overnight rates by the Fed.

As of December 31, we had 37 financing counterparties and are financing investments with 23 of those. In February, we extended the funding period for another year on what is now a $50 million facility that finances our residential mortgage loans. In the fourth quarter, we did not see any ill effects from the financing market from either the rate increase or money market reform. In general, funding continues to be plentiful with new entrants in both the credit and agency space.

Our liquidity remains strong at quarter end as we had liquidity of $137.9 million, comprised of $52 million of cash and $52 million of unlevered agency [hold-pull] securities and $33 million of unlevered agency IO securities. Additionally, at quarter end, our estimated undistributed taxable income was $1.90 per share. We continue to evaluate this on a quarterly basis to make that sure we are in compliance with our distribution requirements. As a reminder, we have until September of 2017 to distribute out our 2000 (sic) taxable income. That concludes our prepared remarks. We would now like to open the call for questions. Operator?

(Operator Instructions)

Eric Hagen, KBW.

Thanks. Good morning. Are you seeing the likelihood for a Fed increase later this month being priced into the repo market right now? And I think you touched on it in your opening comments, but how are you thinking about leverage in the portfolio based on your expectations for additional hikes this year and next year?

Hi. This is Michael. With respect to the -- in price in the repo markets, repo has been very stable relative to where -- versus LIBOR. So to the extent that we've seen three-month LIBOR push up expectations given the Dudley comments yesterday.

We have seen LIBOR obviously push up at the likelihood of a rate move increase, but those funding spreads versus LIBOR have remained very stable. We've seen, versus three-month LIBOR, actually we're trading inside of -- our agency repo funding is trading inside of that. With respect to leverage, I will turn it over to David and TJ.

Sure. I think leverage is more a function of the opportunity set we are seeing than necessarily our funding costs. So as we move forward and we see attractive investments, that would probably affect our overall leverage more so than absolute funding rates.

And I think also -- this is David -- I think also, depends on which types of opportunities we see that certain investments, such as commercial whole loans, would come typically without leverage to the extent we increased opportunistically the agency side that would come with leverage.

All right. Thank you. That's helpful. And then the yield you guys reported for some of your [Reg E] credit assets looked like it may have jumped a little more than I would have expected quarter over quarter. How much of that is just using a higher discount rate versus an actual improvement in your outlook for credit fundamentals?

It is, of course, a mixture of a lot of things. A couple of things, like I mentioned, we did buy a couple of higher-yielding, unlevered assets. Some of the commercial real estate loans is a good example where it's unlevered, so the yield is pretty high. So, that ticked it up a little bit. Some of it is because of the increase in rates, and some of it is because of improved credit underwriting and the forward cash flows that we've seen. I wouldn't say it is one of those three, but it's a combo of those three.

Right. Okay. Thanks for the color, guys, appreciate it.

Doug Harter, Credit Suisse.

Thanks. On the securitized loans or that structured securitized investment you made this quarter, can you talk about the underlying loan characteristics and what type of leverage you might be putting on the piece that you are retaining?

Sure. So they were re-performing mortgages, so, all current loans that were purchased from a money center bank. We effectively took, again, the bottom part of the capital structure. The broker/dealer had already preplaced the senior, and we are using modest repo leverage on that investment. We are really benefiting from the structural leverage of the securitization.

Got it. Can you talk about the relative -- there has been a strong bid for those types of assets from insurance companies or other asset managers that have a lower cost of capital. Can you just talk about the relative advantage that you have in acquiring those loans versus a buyer like that?

Sure. I think those buyers that you mentioned have a little bit more of a stringent credit box in terms of looking for specific durations of a current pay history that they may not want to look at assets that haven't been current for less than three or two years. We can be a little bit more flexible in our credit box and, therefore, pick up incremental yield.

Makes sense. Thank you.

Trevor Cranston, JMP Securities.

Hi. Thanks. A question on Arc Home: Can you just give us an update on what the growth strategy is going to be there, in terms of getting origination volumes to larger levels and, therefore, producing more investment opportunities in terms of MSRs and potentially non-QM loans? Thanks.

Sure. Again, as David mentioned, they are really only in their seventh month of operations. They continue to look to expand both their correspondent and wholesale channels. That's not something that happens overnight. And additionally, as we look forward to 2017, I think we've steadied the platform where we can start adding more non-agency product, which should attract sellers to their platform.

Okay, that's helpful. And then just a question on the yield on the investment portfolio, just looking at slide 6. Are you able to quantify how much of the increase in the asset yield is related to the retrospective adjustments versus other factors?

So, I have that information; it's just not with me. In the 10-K that we are going to file later today, you'll be able to see that clearer. Definitely, some of the piece of the agency was due to that. We had the big increase in rates, and there was a $0.06 retrospective adjustment.

So I don't think you can get that information from here, and I don't have it on me. So we'll have to take a look at the 10-K later, and if you would like, you can give me a call back.

Okay, that's fine. Thank you.

(Operator Instructions)

It looks like no further questions at this time. I'll turn it back to the speakers for closing remarks.

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 joining. You may now disconnect.