Apollo Residential Mortgage's CEO Discusses Q1 2013 Results - Earnings Call Transcript

| About: Apollo Residential (AMTG)

Apollo Residential Mortgage, Inc. (NYSE:AMTG)

Q1 2013 Earnings Conference Call

May 7, 2013 10:00 AM ET

Executives

Michael A. Commaroto – CEO

Stuart Rothstein - Treasurer and CFO

Keith Rosenbloom - Agency Portfolio Manager

Analysts

Mike Widner - KBW

Trevor Cranston - JMP Securities

Richard Shane - JPMorgan

Operator

I would like to remind everyone that today's call and webcast are being recorded. Please note that they are the property of Apollo Residential Mortgage, Inc. and any unauthorized broadcast in any form is strictly prohibited. Information about audio replay of this call is available in our earnings press release.

I would also like to call your attention to the customary Safe Harbor disclosure in our press release regarding forward-looking statements. Today's conference call and webcast may include forward-looking statements and projections, and we ask that you refer to our most recent filings with the SEC for important factors that could cause actual results to differ materially from these statements and projections. We do not undertake to update our forward-looking statements or projections unless required by law. To obtain copies of our latest SEC filings, please visit our website at www.apolloresidentialmortgage.com or call us at 212-822-0600.

At this time, I would like to turn the call over to Michael Commaroto, Chief Executive Officer of Apollo Residential Mortgage.

Michael A. Commaroto

Good morning, and thank you for joining us on the Apollo Residential Mortgage Inc. First Quarter 2013 Earnings Call. Joining me in New York this morning are Stuart Rothstein, our Chief Financial Officer; Keith Rosenbloom, our Agency Portfolio Manager; Paul Mangione, our Non-Agency Portfolio Manager; and Teresa Covello, the Controller of our Manager.

AMTG had another solid quarter of financial and operating results set against the backdrop of volatility in the mortgage market. At March 31, our $4.9 billion residential mortgage backed securities portfolio consisted of agency RMBS with an estimated fair value of $4.3 billion, and on agency RMBS with an estimated fair value of $595.8 million.

Portfolio growth in the quarter was accomplished through the completion of a common stock offering in March, during which AMTG issued 7.82 million shares resulting in net cash proceeds of $171.5 million. In addition, during the quarter, the company completed its first purchase and securitization of a whole loan pool, which diversified our asset base and revenue streams, and was an important first step towards broadening our investment platform.

The combined RMBS and securitized mortgage loan portfolio had a blended net interest spread of 2.8% and a levered asset yield of 17.7%. At March 31, 2013, the equity allocation of our portfolio was comprised of 59% agency RMBS, 21% non-agency RMBS, 4% securitized mortgage loans, and 16% cash. Our hybrid REIT structure enables us to reallocate our equity in a manner that we believe will maximize returns to our stockholders and allow us to take advantage of opportunities across a broad spectrum of the residential mortgage market. We expect AMTG will continue to diversify in 2013, as we optimize our portfolio based upon market conditions.

During the first quarter, mortgage spreads widened through early March, driven by higher interest rate expectations, a steeper yield curve, and the rebalancing of fixed income investors' portfolio allocations. In addition, premiums on specified agency RMBS contracted as investors focused more on extension risk rather than on prepayment risk. These factors contributed to the declining value of our agency RMBS, which resulted in a decrease in our book value per share.

However, March's disappointing employment data, which was released in early April reversed this trend, and rates began to retrace their recent upward move. Therefore, we believe that some of the decline in value on our agency RMBS portfolio was erased and our book value per share has trended positively since quarter end.

One positive factor from the spread widening was the timing of our capital raise in March. We were able to take advantage of the wider spreads and had new agency RMBS at attractive incremental net interest spreads. AMTG's agency investment strategy has consistently been based upon identifying prepayment protective stories and our recent CPR experience is testament to our ability to execute on this strategy.

During the first quarter, our agency RMBS portfolio experienced prepayments at an average one-month CPR over the quarter of 6.8%, and 7% when including our agency interest-only and agency inverse interest-only securities as compared to 25.5% for all Fannie Mae fixed rate RMBS.

Throughout the quarter, we continued to optimize our agency portfolio by selling our 15 and 20 year agency pass-through securities in favor of 30-year pass-through securities, as the steeper yield curve created less extensive valuations for longer duration assets.

Shifting to the credit side of our portfolio; the rally in non-agency prices slowed in the first quarter and prices remained relatively stable. There was a significant reduction in the amount of non-agency RMBS being sold through bid lists throughout the quarter as there were less alternative investments, in which sellers could redeploy capital.

Underlying fundamentals of seasoned non-agency RMBS continued to improve, bolstered by a strong housing market. S&P's Case-Shiller Index of home prices in 20 cities showed an annual gain of 9.3% in February as the housing market continues its recovery. In addition, we've seen improvements in the key metrics in our non-agency portfolio, as defaults and severity levels declined through the end of March.

During the quarter, we sold some of our non-agency RMBS, where we believe valuations will maximize. As a result of these sales, as well as the sales of some of our agency securities, we generated net realized gains of $15.8 million in the quarter or $0.61 per share.

As we mentioned on last quarter's call in February, AMTG purchased a pool of 755 residential mortgage loans with an unpaid principal balance of approximately $155 million and simultaneously completed securitization transaction collateralized by these mortgage loans. As part of the securitization, we sold through a private placement, an aggregate of approximately $50 million principal value non-agency RMBS at par, which effectively financed a portion of the transaction with non-recourse debt with a stated fixed rate of approximately 4%.

In addition, we financed a portion of the non-agency RMBS created through the securitization using borrowings under repurchase agreements. AMTG is earning an attractive double-digit return on equity for this transaction.

Capitalizing our experience in the credit markets as well as key Apollo relationships within the financial sector, we continue to explore transactions similar to the whole loan securitization as well as additional residential mortgage investments such as new production mortgage loans and excess mortgage servicing rights.

We believe there continues to be compelling value in investments throughout the residential mortgage sector. Accordingly, the strength of our team and our hybrid structure should enable us to expand our platform and take advantage of these opportunities.

At this point, I would like to turn the call over to Stuart Rothstein, who will review our financial results for the quarter. Stuart?

Stuart Rothstein

Thanks Michael. Turning to our first quarter performance, AMTG reported operating earnings of $19.1 million or $0.74 per common share, and net income eligible to common stockholders of $1.9 million or $0.07 per share. Our earnings release and the supplemental information package, both of which are available in the Investor Relations section of our website, contain a detailed reconciliation of GAAP net income to operating earnings.

As detailed in the reconciliation, the significant variance between GAAP net income per common share and operating earnings per common share was due to realized gains of $0.61 per common share from the sale of certain RMBS, offset by unrealized mark-to-market losses on our RMBS and our derivative instruments, which totaled $1.35 per share.

I would also like to highlight that operating earnings for the first quarter benefitted from an update in our agency RMBS CPR assumptions, which positively impacted our interest income. Our premium amortization on agency RMBS decreased by $3.2 million to $8.9 million for the quarter ended March 31, 2013 as compared to $12.2 million for the quarter ended December 31, 2012. Changes in expectations about prepayment rates, which reflect market fundamentals at the time of assessment, may cause future premium amortization on our agency RMBS to vary from quarter to quarter.

With respect to our financing, at quarter end, the company had $4.3 billion of outstanding borrowings with 18 counterparties. Our cost for repo financing for our agency RMBS declined slightly from the fourth quarter, and remains flat for our non-agency securities.

Our weighted average borrowing rate was 60 basis points at March 31, 2013, as compared to 65 basis points at December 31, 2012. Financing continues to be readily available for both agency and non-agency securities, and we continue to work with our repo providers to extend the terms of our financing. Subsequent to quarter end, we renewed one of our term non-agency facilities and extended the term from 12 months to 18 months, while keeping pricing stable.

Turning our attention to our hedging strategy; we had $2.2 billion of notional derivative instruments outstanding as of March 31, 2013. The substantial majority of our derivative instruments are five or 10 year interest rate swaps. From the first quarter, in anticipation of rising interest rates, the company continued to enter into interest rate swaptions, as of March 31, 2013, the company had swaptions with a total notional amount of $225 million. We are confident that our existing hedging strategy has the company well positioned for a steepening yield curve.

At this point, we will open the line for questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions]. Our first question comes from Mike Widner of KBW.

Mike Widner - KBW

Hey guys. Just wondering if you could talk a little bit more about the securitization you did and maybe give us some details there on things like the effective yield cost of funds, net spread, etcetera, and then just maybe talk a little bit more about what you see the opportunities there for you guys going forward?

Michael A. Commaroto

Certainly, we securitized the top 32.5% of the collateral in the senior bond that we sold at a 4% yield. We then retained an M1 bond and an M2 bond and a residual, and we financed the M1 bond, which was also 32.5% of the collateral, and we held the M2 and residual with equity, and our overall expected yield on that in terms of ROE, we think it's going to be roughly in the low-double digits.

Mike Widner - KBW

Great, and I mean, where do you think the opportunities there are for you guys? I mean, is this going to be a growing part of the business, and what’s your plans as far as sourcing loans and originations and types, jumbo, or are you looking at -- thinking about other things?

Michael A. Commaroto

We definitely want the whole loan business to be a growing part of the business. That transaction is a transaction that we undertook in the fourth quarter of 2012, and it was a really long-tailed transaction to settle and securitize. So from when we committed to that transaction in the fourth quarter to when we actually funded the trade, which was more like February of this year, the market moved tremendously. So, we continue to look for opportunities like that. We have not seen similar opportunities in the seasoned collateral space. We could get the same type of levered return on equity that we got in that transaction. So, we have actually brought our yield expectations down a little bit on some of the new loan packages we are bidding on consistent to where we are seeing bonds trade in the non-agency space. So, we are trying to buy stuff at a little bit, what I'd call it a discount, with respect to creation value versus whether actually trading already, and we are still not finding opportunities as exciting as the one that we just did.

We will continue to look for seasoned collateral like that. We are also in discussions with people about current coupon jumbo to see if that's something that we want to purchase. But we will spend more of our time on seasoned collateral, continue to kick tires on current coupon jumbo, and even look at maybe more of a credit story type of loan on a go forward basis.

Mike Widner - KBW

So, you talked about liking what you saw there in that deal, and kind of low-double digit ROEs there. I mean, how do that compare, and I guess maybe the fact that you are not doing more of them answers to the question, but I mean, how does that compare to what you see is the opportunities in the RMBS space today?

Michael A. Commaroto

RMBS -- in the seasoned RMBS space, I would say are after leverage returns on equity are probably more of what I'd call the higher-single digits. So we are still seeing attractive returns in the seasoned RMBS space, but in terms of trying to find collateral -- seasoned collateral that we like after factoring in the expenses of doing the transaction, the risks associated with the transaction, some of the spread risks between when you commit to buy a whole loan and then sell the bonds on a forward basis, we can replicate those types of yields. So, right now, we have been finding more opportunities in the seasoned RMBS space than in the seasoned whole loan space.

Mike Widner - KBW

Okay. So bottom line, as far as like projecting results out, I mean, it sounds like you are going to continue to move in the buy and securitize direction, but we shouldn't expect a massive allocation shift, if you will, over at least if spreads stay where they are today?

Michael A. Commaroto

I'd say not at this point in time. But to the extent there are more sellers, there is more collateral, we would definitely be involved in the market.

Mike Widner - KBW

Great. Appreciate it and congrats on the solid quarter.

Michael A. Commaroto

Thank you. Appreciate it.

Operator

Thank you. Our next question comes from Trevor Cranston of JMP Securities.

Trevor Cranston - JMP Securities

Thanks. Just to follow-up a little bit on the comments you made about kind of where returns are on the credit side right now. Can you talk about kind of the returns you are seeing in the agency market, and if you are still favoring 30 years, like you were in the first quarter, given the moving rates so far in 2Q?

Stuart Rothstein

We are still favoring 30 years in that space, and our returns in that space tends to still be, I would say, kind of like low double-digit yields after leverage, and maybe Keith wants to add a couple of points about some bond he likes.

Keith Rosenbloom

Yeah, hey, Keith Rosenbloom here. One thing we look at is, where our yield is after hedging and financing, and currently evaluating the 15-year trade versus the 30 year trade, and given the rates in yields on [net restructures], (inaudible) aren't very attractive at all. We think that, equity financing hedge, anything you could buy in that space with prepaid protection, you are getting out -- coming after yields, roughly 1%. Whereas you are in the 170, 180 area when you look at the same evaluation with a 30 year trade that we have on.

Trevor Cranston - JMP Securities

Okay. And so would it be reasonable to assume if you continue to drift more towards 30 years with the hedge book in terms of the swaps, whole length and in duration also?

Keith Rosenbloom

Yeah, absolutely. As Michael said, we started to increase our exposure to swaptions, most of which restructured, [75 basis points] side of the money. So nearly a convexity hedge against the big moves than if they steepen the run rates. And when you look at what's available in the 30-year sector, it's really limited to coupons, 3% to 4%. So generally speaking, in the backdrop, you are taking on more duration. So in that case, we have moved our allocation in hedging, a little bit deeper in sort of the 10 year swap area, versus where we were at the last year and a half.

Trevor Cranston - JMP Securities

Okay. That's helpful. Then, in terms of kind of moves in prices since quarter end, you commented that agencies have kind of gained back some of what they gave up in the first quarter, can you talk a little bit about what you are seeing in the non-agency markets since the end of the quarter?

Michael A. Commaroto

I think in the non-agency market, the market continues to rally pretty aggressively. There has been a little bit more activity in terms of recent switch. But it just feels like, there continues to be a rush towards people looking for opportunities in that space, pushing unlevered yields lower.

Trevor Cranston - JMP Securities

Okay, thanks for the comments.

Michael A. Commaroto

You're welcome. Thank you.

Operator

Thank you. Our next question comes from Rick Shane of JPMorgan.

Richard Shane - JPMorgan

Thanks for taking my question. I just want to follow-up on the last question a little bit. When we look at it, our sort of analysis suggests that, the value of specified pools have basically regained about two-thirds of the loss that you saw during the first quarter. When we look at our NAV on a quarter-over-quarter basis, you basically said look, we think on a mark-to-mark basis, it's up from first quarter levels. Do you think that we are sort of basically back, maybe recovered three quarters of the decline during the first quarter, based on that move, and what you're seeing in the non-agency space as well?

Michael A. Commaroto

Yeah, this is something Keith and I talked about a lot, in terms of price action on specifieds. So Keith, will you give a little bit color on just what we have seen, regarding the bonds we own?

Keith Rosenbloom

I don't want to get that specific in the (inaudible). But just keep in mind, that there are other moving parts, like shape of the curve and how our swaps are doing and how spreads, in absolute terms are doing. But yeah, I think it's fair to say that from where it seems we are trading in specified space, and in the bonds that we own, that it regroups somewhere in the area of two-thirds to three quarters of the premium on a [dollar price] basis.

Richard Shane - JPMorgan

Great. Thank you. I know it's a very specific question. I appreciate you guys addressing it. Thank you.

Keith Rosenbloom

You're welcome.

Operator

Thank you. [Operator Instructions]. At this time, there are no further questions.

Michael A. Commaroto

Okay. Thank you ladies and gentlemen for participating in our call. We look forward to speaking to you next quarter. Thank you.

Operator

Thank you, participants. This concludes today's conference call. You may now disconnect.

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