AG Mortgage Investment Trust Inc (MITT) 2017 Q4 法說會逐字稿

Welcome to the AG Management Investment Trust Fourth Quarter 2017 Earnings Call. My name is Vanessa, and I will be your operator for today's call. (Operator Instructions) Please note that this conference is being recorded. And I will now turn the call over to Karen Werbel, Head of Investor Relations.

Thanks, Vanessa. Good morning, everyone. We appreciate you joining us for today's conference call to review AG Mortgage Investment Trust's fourth quarter 2017 results and recent developments.

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 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 slide presentation are made as of today, February 28, 2018, 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 to everyone. I'd like to share some highlights of our 2017 financial results with you today. Our core earnings for the year were $1.90 per share, and we paid regular common dividends also of $1.90 per share. We also paid a special cash dividend of $0.10 per share. Excluding retro adjustments for the year, core earnings for the year were $1.92. Book value per share increased during 2017, starting the year at the $17.86 per share, and ending the year at $19.62 per share, resulting in an economic return on equity overall of 21.1%. We typically do not comment on any post quarter and financial metrics. However, given the market increase in rate since year end, we feel it's appropriate to provide a rough sense of current book value, which we currently estimate is slightly lower since year end in a range of 1% to 2% decline.

During the year, we increased the portfolio's allocation of agencies based on the review of the agency sector as offering compelling risk-adjusted returns. We increased our equity allocation Agency RMBS to 39.2% at year-end from 28.9% at the start of the year. This rotation led to an increase in our overall portfolio size to $3.8 billion from $2.5 billion, as well as an increase in our leverage to 4.4x from 2.9x. During the year, we actively managed our duration gap to reduce our interest rate exposure, ending the year with a duration gap of 1.15 years, down from 1.53 years at the start of the year.

Now focusing on our fourth quarter results. Book value increased during the quarter by 1.4%, primarily driven by the credit portion of our portfolio. Our core earnings for the quarter were $0.50 per share, including a de minimis retrospective adjustment and $0.02 per share from dollar roll income associated with our net TBA position.

During the quarter, we declared a regular common dividend of $0.475 per share for the 9th quarter in a row. We also would like to update you on Arc Home, our residential mortgage origination affiliate. During 2017, Arc Home originated $1.1 billion of government and agency loans through its 4 channels of origination and retained the originated Mortgage Servicing Rights on its balance sheet. In conjunction with AG Mortgage Investment Trust and other Angelo, Gordon funds, Arc Home purchased approximately $2.4 billion, notional of Fannie Mae, Freddie Mac and Ginnie Mae Mortgage Servicing Rights from third parties during the year. We believe Arc Home will provide us with more opportunities to invest in excess MSRs nonqualified mortgages and other assets that Arc Home originates going forward.

We are continuing to see opportunities to add to our Credit portfolio, subject to our '40 Act constraints by leveraging the Angelo, Gordon platform. As always, we remain opportunistic and evaluate investment opportunities on a relative value basis.

With that, I will turn the call over to TJ Durkin.

Thank you, David. Good morning, everyone. The fed in its December meeting raised the federal fund rates by 25 basis points, and continued to reduce its holdings of Agency MBS by curtailing its monthly reinvestment of paid outs. Progress continues to be made with respect to the Fed's dual mandate of full employment and price stability, as unemployment remains below 5% and transitory factors set the present inflation earlier in the year appear to have faded.

During the fourth quarter, the yield curve flattened, led by steadily rising short-term and well-anchored long-term interest rates. Agency MBS spreads to benchmark rates were stable to tighter during the quarter, supported by range-bound long-term interest rates, subdued volatility and modest supply.

As the Fed continues to wind down its balance sheet in 2018, it will require investors to absorb an increasing share of gross issuance, and this may exert some upward pressure on spreads over time. However, we believe the already occurring defensive market positioning in the sector and tight valuations of competing spread product should help to mitigate the risk of a sudden and sharp widening of Agency MBS spreads.

Spreads for most mortgage-backed credit sectors were moderately tighter during the fourth quarter, with continued support from strong demand and stable fundamentals. Robust new issue activity of RBS and ABS propelled both sectors to their highest new issued volumes since 2007. Additionally, CRT securities outperformed in the fourth quarter, as concerns surrounding the 2017 hurricanes in Florida and Texas began to diminish early in the quarter.

In late November, the first performance REIT has confirmed that early delinquencies were within expectations. The reduced concerns surrounding expected losses related to hurricanes and strong demand drove spreads tighter for the sector, and nearly all CRT securities finished the fourth quarter at or near all-time tights.

In the CMBS market, the quarter began with a slight widening in new issued CMBS spreads, partially driven by supply concerns, as several issuers try to come to market at once. However, this weakness was short-lived, as demand for securities more than offset CMBS spreads, tightened for the seventh consecutive quarter.

Our interest rate outlook for 2018 has not been materially altered. We continue to anticipate interest rates at the front-end of the curve to lead the way higher, and we expect the fed to increase the federal funds rate 3x this year. The longer-term rates have become more volatile to start the year. We ultimately expect further moves to higher rates to moderate and pace the magnitude, as significant global demand for longer maturity fixed income product persists.

Additionally, we think any material rise in interest rates points to expectations of higher economic growth and rising incomes, both of which would be supportive of home prices and fundamental collateral performance. We do not expect higher interest rates to materially hamper housing affordability. We remain constructive on housing, and believe home price stability is durable at this time.

We think it is important to note that unlike many other asset classes within credit, where we have seen underwriting standards loosen, residential mortgage lending has remained extremely conservative since the crisis. Given that backdrop, we would like to highlight 2 things. While spreads may be tighter in the past, we are comfortable in the strength of the fundamentals on the residential credits that we currently own. I would expect their pricing to hold in better than other asset classes in the face of broader market volatility. Secondly, and looking ahead, we do expect to see mortgage credit begin to open at the margin, as housing fundamentals remain strong and household balance sheets continued to improve. Furthermore, for the first time post crisis, the regulatory environment is starting to show signs of relaxing under the new administration.

Focusing on Slide 6 of our quarterly earnings presentation, we outlined the fourth quarter activity. We actively managed the Agency and credit book, increasing our investments in both categories by total net equity of $105.7 million. During the quarter, we continue to increase our sector locations in Agency MBS on a hedge basis. And on the credit side, MITT, along with -- alongside another Angelo, Gordon fund, purchased a pool of primarily nonperforming residential mortgage loans. Additionally, MITT purchased a large portfolio of prime jumbo 2.0 subordinate funds, and we also led a refinancing of the credit card backed ABS bridge securitization that we purchased in the second quarter of 2017.

On Slide 10, we've laid out the investment portfolio composition for the quarter. The fair value of the aggregate portfolio increased to approximately $3.8 billion from $3.5 billion in the prior quarter. The fair value of our Agency book was approximately $2.4 billion, and the fair value of our credit book was approximately $1.4 billion.

Focusing on our Agency portfolio on Slide 11, you will see a breakdown of our current exposure by product type. The constant prepayment rate for our Agency book was 7.8% for the fourth quarter. Given the size of our Agency portfolio, relative to the overall market, the investment team was able to be disciplined and selective when adding Agency risk into the portfolio. Because of this, we expect prepayments speeds for our portfolio to generally outperform the overall universe of Agency collateral, owing to the favorable characteristics of our holdings.

On Slide 12 and 13, we'd like to highlight that 46% of our residential credit Investments and 68% of our commercial or ABS investments are floating rate in nature, and are directly benefiting from the recent increases in the fed funds rate.

Moving ahead to Slide 15. We lay out the duration gap of our portfolio, which declined this quarter to 1.15 years versus 1.36 years in the prior quarter. The duration gap of our Agency MBS book, the more interest rate sensitive portion of our portfolio, declined from 0.5 years to 0.18 years. During the quarter, we reduced our duration gap in response to improved underlying economic fundamentals. We also took advantage of historically low levels of implied volatility by adding $270 million notional payers options to help protect the portfolio from a potential rise in volatility.

As David mentioned earlier, we have provided Arc Home update on Slide 17. Arc Home has now completed its first fiscal year of mortgage origination. After demonstrating sufficient risk controls in originating and delivering, conforming and government paper throughout the year, Arc Home expanded its product offerings in the fourth quarter by launching its non-QM program. Additionally, over the course of the year, Arc Home, in conjunction with MITT and other Angelo, Gordon funds was successful in purchasing MSR pools that were originated by third-party sellers.

As we look ahead into 2018, we are confident that MITT is well positioned to deliver attractive returns to our investors, while protecting book value. Our asset allocation and modest use of leverage are 4.4 turns as of quarter end, give us the flexibility to take advantage of opportunities that may arise out of any increased spread volatility in the future. We seek to deploy capital into investments that we find attractive in more liquid sectors, such as Agency MBS and other residential or commercial Credit Investments, and into larger opportunities in less liquid forms presented to us through the larger Angelo, Gordon platform.

With that, I will turn the call over to Brian to review our financial results.

Thanks, TJ. For the full year 2017, we reported net income available to common stockholders of $105 million or $3.77 per fully diluted share. Overall, for the fourth quarter, we reported net income available to common stockholders of $20.9 million or $0.74 per fully diluted share. For the full year 2017, we reported core earnings of $52.9 million or $1.90 per fully diluted share. Core earnings in the fourth quarter was $14.2 million or $0.50 per share. There was a de minimis retrospective adjustment in the fourth quarter due to the premium amortization on our Agency portfolio.

At December 31, our book value was $19.62, an increase of $0.27 or 1.4% from last quarter, due to the reasons David previously mentioned. To give you a better sense of our current $3.8 billion portfolio, I'd like to highlight a few more statistics. As described on Page 5 of our presentation, the portfolio at December 31, 2017, had a net interest margin of 2.38%. This was comprised of an asset yield of 4.64%, offset by financing and hedging cost of 1.98% and 0.28%, respectively, for a total cost of fund of 2.26%. Net interest margin decreased from the prior quarter, primarily due to increased cost of financing due to increase in overnight rate [fund fed].

As of December 31, we had 39 financing house parties and are financing investments with 27 of those. In the fourth quarter, we do not see any ill effects in the financing market from the rate increase, and in general, funding continues to be practical with new interest in both the credit and Agency space.

At quarter end, we have liquidity of $135.3 million, comprised of $15.2 million of cash, $99.3 million of unlevered Agency hold pool securities and $20.8 million of unlevered Agency idle securities. Additionally, at quarter end, our estimated undistributable -- undistributed taxable income was $1.54 per share, and we continue to evaluate this on a quarterly basis to make sure that we are compliant with our distribution requirements. We also utilized our aftermarket equity offering program during 2017. For the year, we issued the 461,000 shares of common stock for net proceeds of approximately $9 million through this program.

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

(Operator Instructions) And we have our first question from Doug Harter with Crédit Suisse.

TJ, I was hoping we could talk a little bit about the duration gap you show, especially in light of the commentary you made about first quarter book value performance. I guess, how does the credit piece of that performed in this up rate environment? And should we really be looking at that duration gap of just the Agency portfolio?

Thanks, Doug. So I do think we should focus really more on the Agency part of the portfolio in terms of moderating the interest rate gap. We mentioned earlier, a large percentage of our credit is floating rate, which obviously, doesn't have the interest rate duration issues. And then secondly, I would say some of our Credit Investments are typically lower in the capital structure, and just aren't as sensitive to the daily interest rate volatility that we would see on something like the Agency book. So net-net, the credit book has performed well through the first 2 months of, call it, interest rate volatility.

All right. Makes sense. And then, I guess, if you could just talk about your plans for the undistributed taxable earnings and sort of the ability to sort of continue to roll that over versus other alternatives?

Sure. I think that in last year, we had that one big event, actually the 2016 event, that kind of jumped the taxables' undistributed amount a little higher than we were used to carrying. So if you look at 12/31, as I mentioned, it's $1.54 per share. We have until September of 2018 to pay that out. So the normal course at our current dividend rate of $0.475, common, plus the preferred, works out to be about $0.11, $0.12. That's $0.58 a quarter that we're paying out. So through the first 3 quarters, we would easily exceed the $1.54. So I think as of now, to the extent that we're going to pay it out in the normal course, then the one time $0.10 from last summer is what we kind of thought it would be, which is one time. These are still based on estimates. We won't know the exact taxable income numbers until we file our returns in September. But I think that should give you kind of good guidance on what we're thinking.

Our next question comes from Eric Hagen with KBW.

Just given your outlook for both rates and volatility from the opening remarks, can you just discuss the relative attractiveness between adding more Agency MBS versus credit right now?

Sure. I think like we mentioned, we are generally comfortable that Agency spreads don't have material widening ahead of them, given the competing products, whether it be other structured credit or corporates. They're all generally fairly tight. We like -- we do like the liquidity that the Agency portion of the book provides us versus some of the other credits that we look at which are just generally tighter than they were, say, a year ago. So I think we would wait for either something more off the run in the credit space or for spreads to probably be a touch wider on the more liquid things in credit to redeploy capital there.

Great. I mean, what was -- can you just give us the yield that you put on the new acquisitions for in the residential credit that you acquired over a little last quarter?

Are you referring to the home loans in particular or...

The home loans would be great. But if you just have -- I think it was $92 million, if you have sort of a rough yield on where those were at, that would be great.

Yes, I think on the home loan side, I think we would say unlevered yields are probably in the, call it, 6 to 7 range. I think the CRT space is fairly transparent. Those were the bigger things that I can think of. And the other, I think, more interesting thing would be to purchase subordinate securities off of jumbo post-crisis deals, and they were -- depending where we were in the capital structure, probably 4.5 to probably 6, if you were to go down to the first loss pieces. So it's a little bit all over the map, depending on which space we are talking about specifically.

(Operator Instructions) And our next question comes from Trevor Cranston with JMP Securities.

A follow up on the question about duration and how you guys are thinking about that for the overall portfolio. Can you comment on how you've managed that as rates have increase so far this year? And if you've made any meaningful changes to the Agency portfolio or the hedge book to kind of try and keep duration right where it was at the end of the year?

Yes. So I think just at a high level on the duration side, the Agency book has largely extended based off of -- of where rates are and where the coupon on our Agency portfolio is versus where current coupon is in the market. So in terms of rates moving another 5, 10 basis points higher in the back end, our duration doesn't really nominally extend much anymore. So that's, I would say, under control. And we have -- we are running a fairly tight GAAP on just isolating the Agency part of the book, both in Q4 to end the year, and as well as throughout the first 2 months of this year. So we're generally comfortable with where we are. And if anything, the risks are probably to a big decrease in rates in terms of convexity and having to reallocate hedges or the asset side of the book on the Agency side, and credits have been largely immune from the volatility on the rate side so far this year.

Got it, okay. And then a question about the prime jumbo subordinate bonds you guys bought in the fourth quarter. I was curious if you guys are finding more opportunities to buy subordinate bonds off new issued deals or if you guys have even considered buying pools and executing your own securitizations to retain the subordinates on your balance sheet.

Yes. I'd say that there was a healthy pick up in jumbo securitizations in 2017. We looked at all the kind of market offerings, and did bids on the ones that we find attractive. We were able to pick up this one nonnew issue, but post-crisis portfolio bonds from a seller in the middle of the quarter. We would expect securitization volume to continue to be healthy in 2018, and we'll continue to look at the different offerings from the issuers. We're always looking at co-loans, whether it be jumbo, non-QM or RPL, NPL and really trying to figure out the relative value between all 4 sectors, and we have executed securitizations in the past on RPLs and NPLs, and we're exploring doing on some of the new origination products as well.

And thank you. I see no further questions in queue at this time. I will now turn the call back over to Karen Werbel for closing remarks.

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

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