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Apollo Residential Mortgage, Inc. (NYSE:AMTG)

2014 J.P. Morgan Securitized Products Research Conference Call

March 06, 2014 02:30 PM ET

Executives

Michael A. Commaroto – Chief Executive Officer

David Finkelstein – Head of Agency MBS Trading-Annaly Capital Management, Inc.

William S. Gorin – Chief Executive Officer-MFA Financial, Inc.

Jason Marshall – Head of MBS Portfolio Management-Invesco Mortgage Capital Inc.

William Roth – Chief Investment Officer-Two Harbors Investment Corp.

Analysts

Matt J. Jozoff – JPMorgan Securities LLC

Matt J. Jozoff – JPMorgan Securities LLC

All right, great. Thanks, everybody. So, just a quick housekeeping note again, as Amy mentioned earlier this is closed to the press now from this point onwards. So we’d ask the press to respect that, please.

And I’d like to do a brief introduction of the panel the full bios are actually in the printed books on Page 137, conveniently located. But in alphabetical order, we have Mike Commaroto, he is the CEO of Apollo Residential Mortgage; David Finglestein, Head of Agency MBS Trading at Annaly; Bill Gorin, CEO of MFA Financial; Jason Marshall, Head of MBS Portfolio Management at Invesco; and Bill Roth, CIO of Two Harbors.

So, I think with that, I’d actually like each of the panelist maybe just in that order alphabetical, just to kind of give a quick one minute summary of your firm. And then we can launch into the discussion. The other thing is we’d like to have some Q&A at the end. We’ll leave decent amount of time for that at the end. So, please think of some questions and we definitely encourage you to engage our panelists. So Mike?

Michael Commarato

Matt, thank you, thanks for having us here, on today this week, I’m really happy to be here. I’m Michael Commarato, like Matt said, I run a REIT for Apollo, it’s an agency REIT, it’s a hybrid REIT. So, it’s a mix of agencies and non-agencies. We went public in 2011 in the summer. We raised $200 million in our IPO. And then, we did a couple of follow-ons, and a preferred offering, so right now we have about $700 million, $750 million of capital under management.

The genesis of the REIT was actually a private equity vehicle that we started at Apollo in 2008 that was very focused on credit distressed assets, basically home loans and RMBS. And then as the market evolved we changed that business from a private equity business to frankly a public equity business in the form of REIT.

And then in 2011 and 2012, we were very focused on agencies, with still an allocation into non-agencies. And again as the market evolved and we’ve changed our allocation from heavy agencies into more heavy credit, still with an overlay of agencies as well. As the market continues to evolve, we hope to turn the business into one that’s not just purchasing credit, of the works, and of dealers inventories, but actually originating credit opportunities of our own. So, again trying to continue to evolve the business with the market as it turns. Thank you.

David Finglestein

Good afternoon. I am David Finglestein. I am with Annaly Capital Management, where I’m responsible for agency mortgage trading. Annaly has been a public company, since 1997. We have a little over $12 billion in equity capital. We are predominantly an agency REIT however, this past year 2013 we diversified by acquiring Crexus, which is commercial real estate business. We now allocate or have the capability to allocate up to 25% of our capital into the commercial real estate space, and it complements the agency side of the business relatively well. We think that it is a good diversifier and so far it helps us manage or will help us manage interest rate cycles going forward, between that barbell, between agency and commercial real estate.

William S. Gorin

All right, thanks. I’m Bill Gorin. I’m with MFA Financial, and have been since its founding about 17 years ago. I would say, we are pretty much a pure agency REIT until when we time this right, the first quarter of 2009, where we decided to reallocate a good portion of our capital into the non-agency sector, so we invest across the residential mortgage-backed security universe. So we won’t tie our hand behind our back, and say we are only this, we are only that we’ll go where the opportunities are, in this it seems to be about $11 trillion of opportunities to pick and choose from. We are internally advised and our market cap is about $3 billion.

Jason Marshall

Jason Marshall, I’m the Portfolio Manager for Invesco Mortgage Capital. We went public in 2009. We’ve raised roughly $3 billion in book equities since that time, and we too are hybrid RIET initially primarily focused on agencies. We’ve been migrating more towards credit space over the last year, what includes legacy, non-agency MBS and CMBS. And two markets, we’ve really concentrated on really is partnering on new ways to hold on deals where we’ll buy the subordinates at IO and sell off the seniors to consolidate us back on to our balance sheet, and also in CRE as a mezzanine lender.

William Rioth

All right, good afternoon and thanks Matt for including us today. I’m Bill Rioth, Chief Investment Officer at Two Harbors. Two Harbors was formed in 2009, we are also a hybrid REIT. We have a market cap of approximately $3.8 billion. We’re externally managed by a subsidiary of Pine River Capital Management. Over the 4.5 years, that we’ve been publically delivered a little over 100%, total return to our shareholders, and actually the thing we’re proudest is that we’ve had a positive return every year that we’ve been public.

Our business is comprised of two primary strategies, a rate strategy which most recently was about 57% of allocated capital, and that includes agency assets of all shapes and forms including derivatives, mortgage servicing rights or MSR as well as any associated hedges. And then our credit strategy, which is about 43% of our capital is comprised primarily of legacy distressed RMBS, non-agency style loans as well as a conduit business to generate new credit investments for us going forward. Thank you.

Matt J. Jozoff – JPMorgan Securities LLC

All right, thanks. So I’ve got a set of questions here kind of covering the assets that REITs are looking at. What looks attractive, hedging and in some of the broader industry questions. So see how many we get through before the Q&A. But I guess on the asset side, this morning I sort of laid out our view on where we think agency MBS spreads are going and the REITs have been a big player in the market obviously, having got into as big as $400 billion at the peak. So I would turn it back to you guys as we head into 2014, what do you think of the agency MBS asset at this point. You are free to jump in.

Michael A. Commaroto

Yes, we were pretty constructive on agency MBS through, I would say early 2013. And then we evolved our book, I mean we went about $5 billion in agencies in our balance sheet down to close to like $2 billion, $2.5 billion. And it was obviously function of the back up in REIT, and we haven’t really reloaded on the agency side. We are much more focused on reloading on the credit side. I think right now, it feels like a lot of the pain has been experienced in the agency space, so to a certain degree it’s a little bit safer to get back in water now than it was 100 basis points ago in the 10 year note.

But on the other hand, I do think later on in the year, you can see some pressure on spreads and there could be little more spread widening. We tend to continue to stay in the 30 year sector. We think on a fully hedged basis we get the base rate of return for investors there. But we definitely try to keep our duration gap as close to zero as possible. Because we are concerned about the volatility in the rates market.

David Finkelstein

I would say, we are relatively optimistic on the MBS basis, but that being said we are always cautious in the current environment, we obviously have the Fed stepping away ultimately towards the latter part of this year. We do feel that the technicals over the near-term are relatively supportive of MBS, and we also believe that even beyond the Fed’s departure from being a – or from adding to their portfolio, we think that the landscape will still be favorable to MBS due to relatively low volatility the fact that we will not have a significant portion of the MBS market actively hedging their portfolio, which should reduce volatility day to day.

And we feel like that at current spread levels they are reasonability attractive in terms of growth as Matt was alluding to, I think that most people think that equity issuance may not materialize much this year, but we specifically we spend the last couple of years reducing leverage year-over-year and we are at a point now, we are at our historically low leverage levels that are around five times at the end of the year.

So we are actually comfortable in a very opportunistic fashion over the course of the next couple of quarters to actually add leverage and increase our exposure to MBS. Methodically and opportunistically, but to the extend the opportunity to materialize we will add MBS.

William S. Gorin

Nothing newsworthy here from MFA. We came into the year owning a zero 30-year agency paper, and therefore we had to May and June owning zero to the agency paper, which we are happy with. When you are competing with a non economic, non profit maximizing competitor in the space, I don’t mean the other people on the panel, I mean the federal reserve, we’ve decided not to be in that space. So we continue to focus on the lower duration portion of the agency universe, we were not direct competitor with the Fed.

Jason Marshall

We too have kind of been diversifying away from 30-year space especially but, that being said, when we think valuations, I do look and locate here, we’ve been in a trading range, and we kind of view that we will continue to be in a trading range. Although, we do have to get through the tapering, so yes, well, I do think agency MBS look relatively okay, here I think at the margin we’ll probably continue to add credit assets, as a way to continue to diversify our portfolio.

Yes, I would guess overall borrowing another short REIT price again REITs I think you certainly not going to have a year like last year, where REITs where sellers of $70 billion, $80 billion of MBS. I think if anything I think REITs will not be net sellers of agency MBS is here, yes, maybe even marginally adding MBS and that’s all.

William Roth

So I think we are a mix of what everybody has said, but we are not fans of the agency basis, if you look at our holdings, which we have a presentation on our website, from our Analyst Day you will see we are actually net short 30-year current coupons through TBAs, we’re substantially concentrated in higher coupon 30-years, but so basically short duration. We have substantial holding in Ginnie Mae HECMs, which are short duration assets as well as some arm.

So we trying to stay out of the sector that we think will widen the most going through the end of the year, the bottom line is the ROEs that we see hedging out the risk and we are not a company that takes a lot of leverage or duration risk in fact, very little if any, rate risk. It’s hard for us to make money for our shareholders right now in the sector that Feds playing in and so that’s kind of where we stand.

Matt J. Jozoff - JPMorgan Securities LLC

Great thanks, the right answer is I’m just kidding. So I guess and I think Bill Gorin actually kind of hinted this little bit the duration of mortgage is sort of one of the themes I talked about this morning, and the fact that mortgage are so long, it’s becoming a problem I think for banks and to REITs to a certain extend, so my question is again on the asset side, do you see yourselves maybe moving into some of the negative duration assets, whether its servicing or IOS or excess or any of their products like that?

Michael A. Commaroto

Yes, I would say all the above to the extend we could right now, we have added more IO as hedges in our duration assets to just help hedge the 30-year duration we have in our pass throughs. I think I do like the MSR trade. We spend a lot of time looking at that. There are lot of barriers to entry with respect to that trade, regarding licensing and approvals of the counter party. We’ve looked at it more in a joint venture basis with an entity that wouldn’t necessarily be part of the Apollo family and that’s what makes it tough. So I think we will continue to look at that as a potential way to add more make of the duration of assets or excess servicing in MSRs, but right now we’ve definitely used IO as a way to just help it negative duration to the book.

Unidentified Company Representative

I agree, first of all to Billy’s point about the carry on lower coupon MBS and the fact that it is at times an attractive short vehicle, we agree with that discount 30 years or when you look at the duration just been carried that is an area that is far inferior to hire up the coupon stacks in most of our 30-year exposure and new purchases or tend to be in higher coupons 4s and 4.5.

So we absolutely agree with what Billy said as far as IO MSRs, we’ve been an player in the IO market for quite sometime. We look at MSRs very regulatory to Mike’s point in terms of barriers to entry that, that’s certainly the case and also to get that ideal negative duration positive yielding exposure, IOs do offer an attractive substitute. The difference between IOs and MSRs are two fold; number one is with the MSRs your servicer, you have the liability and the obligation to go along with that, which is a complex business; and number 2 is, liquidity IOs and excess IO do tend to be relatively better more liquid than in instrument or an asset like an MSR.

So we do realize that the yield on MSRs can be a little bit higher, but when you consider the quality associated with IO and excess IO, that’s a favorable attribute that we tend to value. That being said, again we do look at MSRs on a regular basis. We have the infrastructure and the capability to go into that sector. We just have not, as of yet, found the appropriate entry point.

Unidentified Company Representative

So for the last number of years we’ve been saying, we built a real good shop focusing on credit and I think it’s a little easier to predict credit, because all pretty clear for next three years. Home prices should trend up somewhat, loan-to-values should trend down, the credit should look good. If you’re buying IOs or mortgage servicing rights – while there are great strategic partnerships involved, ways to recapture prepays, you probably need to have a good model about how long the assets are going to be there and that’s predicting prepayments over one year, two year, three years, which we find a little more difficult to predict in credit. So we haven’t owned any of those assets yet and we try to control our hedges by the interest rate risk we take on with buyer assets.

Unidentified Company Representative

I’d say somewhat similar. I mean, we do hedge most of our book through our swap and swaption book. We do have a small structured agency IO book and we also own some 2.0 non-Agency IO. We haven’t pursued getting set up to be a servicer. It’s something we look at and always keep in mind. In near-term we’ve kind of focused on trying to find about negative duration, trying to originate floating rate, mezzanine, commercial real estate assets and participating in some of the GSE we’re sharing. So we haven’t taken that step yet into the MSRs, but we do periodically buy IO and we’ve been looking at the margin to have floating rate assets.

Unidentified Company Representative

So my comments on this will be a little different, two harbors, we actually own a servicer. We don’t actually service loans directly. We subcontract that out. We have a couple of very strong partnerships, one with Flagstar whom we purchased about 40 some odd billion notional last year and one with PHH where we have a two-year flow agreement. So we’re very active in the MSR space and that’s a business that we’re looking to expand. We think the asset is a perfect fit for our book and so we’re comfortable managing the interest rate risk and the prepayment risk as we have that expertise in terms of managing prepays, IOs, duration et cetera, just from our natural business. So that’s a business we’re very active in and we’re looking to grow.

And I would just add one more comment. There’s a couple of comments about barriers to entry. They are extraordinarily high and in fact, even if you get into the game every transaction has to be approved by Fannie, Freddie or Ginnie as well. So, just because you’re in doesn’t necessarily mean that you get to do trades or transactions. So it’s very complicated. It takes a substantial infrastructure to process that.

Unidentified Analyst

So I guess also on the asset side, maybe on the credit dimension, I had a slide this morning that kind of compared the repo haircuts for, let’s say, REITs or hedge funds on various assets relative to the bank capital requirements. And basically sort of the conclusion was that the high credit quality asset should be going to banks. That’s where the capital is less than haircuts. So when it comes to credit, it goes the other way. And in particular, when you look at something like stack or any of the risk transfer deals, it seems like the banks really are not going to be competitive. So my question to you guys is kind of two-part. In general, how do you see your allocation shifting to an agency in credit or are non-agency? And then, secondly in terms of risk transfer, how does that asset look to you in terms of stack et cetera?

Unidentified Company Representative

Sure. I think, as I mentioned before, we already moved a fair amount of our capital out of agencies into credit in June of last year as we saw rates backing up. So we saw that and we still subscribe to that. We’re much more constructive on credit, non-housing then really trying to figure out the path of interest rates here. And then, even with the spreads and agency given the FED is in its taper [ph] mode. So I think our mix, and again my sense of where the industry is, is definitely shifting more from rates into credit. And then, with respect to stack, I mean we participated in risk transfer trades. The spreads have been a lot on those from first one or two, but still are attractive.

And then haircut are definitely, I think, more attractive to REITs than, say, bank capital charges are bank some assets like stack or even a lot of the bonds that we traffic in. On the credit side we tend to traffic in a lot of seasoned subprime, 2006, 2007 vintage, but even a lot of stuff that’s probably earlier than that. So we have our books probably fairly of vintage, but a lot of it is non-investment grade. Some new pieces even are non-investment grade. So the haircuts began on that and this is something new to me that I heard, but it’s not like clear to me. Then I think U.S banks or FINRA maybe has down and said they have a certain haircut of 25% and maybe that’s the case. I don’t think all the banks necessarily follow that rule.

I don’t know. I think JPMorgan might be on the other side of the 25%, might be my sense of it. But then a lot of the foreign banks are inside that and to the extend they’re inside of that things like stack around, things like seasoned sub primers or season non-agency, then I think we definitely have an advantage versus bank. But the important thing just to mention to is we are not out. We’re not cowboys. We’re not using the leverage to try and chase returns, especially in something that is somewhat less liquid in terms of credit bonds, non-agency bonds, private label securities. So we still try to have our maximum leverage in that side of the business between two and three times of leverage.

Unidentified Company Representative

First of all, with respect to credit risk sharing, because the cash flows from those instruments do not come directly from the real estate asset, we actually do not view them as good REIT asset, which would mean that in our view we can allocate up to 5% of our assets toward that sector. And when you have a narrow slice to which you could invest in we think there is better opportunities in credit. For example, as I was saying earlier, commercial real estate is the area in which we’re gravitating more into.

Our asset base right now is approximately – or at year end was about $1.6 billion in commercial real estate. That’s currently unlevered, although we do have the opportunity if we choose to do so to lever that through borrowing or through securitizations.

Unidentified Company Representative

So, Dave, explained something, which is always complex, but these mid-term deals are not qualifying real estate asset. So there is a natural limit for companies such as our own to be major players. On the other hand probably the majority of the people in this room were major players and most were sharing transactions. So I don’t think it is very high value added for us to say it is a big part of our strategy. I mean it’s okay. I think we all agree 450 sounds good, but there is other niches that we tend to focus on.

Unidentified Company Representative

We participated in, I think, almost all of the deals and if anyone has looked at it, demand has been spectacular for – on the deals.

So it’s hard to get a lot of allocation on them, but we have participated and I think we will continue to. And I’ve just given the credit profile of the positive income, the floating rate nature of the asset. It’s a tracker to us of course subject to some of the REIT rolls, as you guys matching there is a limit as to how much you can do, but we continue to participate in that market and I think we’ll continue to do so and do issue as well.

Unidentified Company Representative

We have a substantial position in mortgage credit. We have over $3 billion market value as of the end of the year, which is about 43% of our capital allocation. The bulk of that is in season, non-agency, primarily subprime paper, typically AAA 4M1 [ph] bonds. And we think that the optionality from faster prepays or better bar performance is still compelling. I think the points about qualifying REIT assets actually strikes at the heart of GSE reform and private label securitization.

If you think about how much the government would like to reduce their footprint and then these end up in private label securities, those do not qualify as to meet the whole approval test or the whole mortgage interest test.

So distributing this kind of the volumes that might come out, we’re an ideal holder for credit, but we get capped out on how much capital can be allocated. So that’s something that we’re hoping that the folks down in D.C. make some headway on to allow, not ourselves but other panels and other companies allocate more to mortgage credit going forward, because I think Matt as you point out, we’re good holders of this risk, but we do need a little help to be able to commit the kind of capital that will be meaningful.

Matt J. Jozoff – JPMorgan Securities LLC

Okay. Switching gears a little bit and talking about maybe the business model and hedging, to the hedging side of things, I mean over the last seven, eight years we’ve seen the overall leverage of REITs drop from, let’s say, 12 times to five or six times. So big drop in leverage, but over the long-term we’ve seen in certain cases extension in the duration gap, and so those are kind of two dimensions that REITs can take in terms of risk to generate net interest margin.

So how do you think about the leverage versus duration gap trade-off and where do you stand in that? And I think David kind of addressed this a little bit earlier, but…

David Finkelstein

I would say in 2011 and 2012, we probably had a longer duration gap than we have now. And we probably had a little bit more leverage, again just because of fixing our book with more agencies and non-agencies. I think we view the market presently in a more defensive manner. So we’ve actually taken our duration gap back pretty close to zero. It’s between half year and a year end. And same thing with respect to our leverage, I think the overall book is down from five times of leverage to closer to four times of leverage, again a function of going from agencies to credit with the capital allocation.

I’ve seen that research you’ve done, Matt, I think it’s a pretty nice research actually and it shows that, to me the way I look at it, if you were to try and chase returns by adding duration gap versus adding leverage you tend to have, I think, a lot more risk as you tend to add duration to the portfolio.

Again, just given the nature of the fact that it’s a levered portfolio you don’t need a lot of moves in rates to really start to drive returns, and if they move against you it can get pretty painful. So I think the prudent way if you want and try to add return we try to add more return at this point. We’d probably be add more leverage rather than to, at the not, again incredible amounts of leverage. We’re still well below where we’ve been historically, but rather would add it with leverage and adding it through duration gap.

Unidentified Company Representative

So how we view it, we take a look at the three major components of risk in a portfolio, particularly a levered portfolio, interest rate risk, basis risk and convexity risk, we think of interest rate risk is determining our wiliness to take increase our duration gap obviously and with respect to leverage, basis risk as well as funding risk, but basis risk informs that, and convexity actually overlays both of those.

First taking a look at convexity the more negatively convex the market or our portfolio the less tolerance for both interest rate risk and leverage risk we are willing to take because that can magnify performance based on or under performance based on adverse market. So we overlay convexity to the decision of how we feel about interest rates, which informs our duration gap, and then we also overlay convexity on to our appetite for the basis. If we are optimistic on the basis we’ll increase leverage, if we’re optimistic on the level of interest rates, we will take on more duration gap.

With respect to convexity again, we are in a very, or a better convexity environment like right now, given the fact that the vast majority of the mortgage universe is out of the money in terms of refinancability. We think that the reduction in the amount of convexity risk in the market and in the portfolio enables us to look to those two other pockets of risk and return and gives us a little more opportunity to increase either duration or leverage. In the current environment where rates are still at relatively historic low levels in spite of the fact that we’re 100 basis point higher than we were a year ago.

We are cautious on the level of interest rates, so we keep our duration gap relatively low. However with respect to leverage we are as I said before at the low end of our leverage range, and we think that spreads are reasonable here, so we are a little more comfortable adding leverage.

Unidentified Company Representative

So Matt, we take the Fed at their word and everything they say. It actually works out because it simplifies our way, so where interest rates are going to go based on Fed actions or data depended, and that is true. So they don’t necessarily know the voting members don’t know where rates are going to be at the next meeting, so I certainly don’t.

We mentioned we started the year with zero percent exposure in 30 year and we are still there. We started the year with leverage of three times and again, we are still there. Your question was, how do you lok at duration relative to leverage. And it’s a simple formula duration times your leverage is how much equity you have at risk and our equity exposure has remained fairly constant throughout the year.

Fortunately, because we have a large credit exposure and we think these assets are lot less depended on movements of interest rate and a lot more depended on credit. We’ve been able to maintain a constant duration and constant leverage while still generating good ROEs, so that’s how we look at those two trade-offs.

Unidentified Company Representative

And we are going to be there, I mean we were running historically at our low end of duration gap and leverage and basically we take MBS spread duration residential and commercial spread risk and that’s how we have money for our investors and right now, we just view the spread risk in credit and residential and commercial credit is more attractive of risk as the duration or MBS spread risk. So we are going to continue to run our GAAP probably one or inside of one on a model basis, and hope that empirically that we get some benefit from correlations between those assets in a gradually rising rate environment we would expect credit to do well, so empirically we think gap is probably closer to zero.

Unidentified Company Representative

Yes, we think of the world in terms of equity value at risk. So I think getting back to duration and leverage, we typically have had the philosophy of taking very, very low level of risk in those regards. We view ourselves as extractors of relative value in the mortgage space. Someone is going to take a bunch of leverage or rate risk to drive a certain return.

So if you look back historically, we’ve typically run very close to no interest rate risk. And additionally, our leverage has historically been on the very low end of the range. So more recently it’s in the low 3s on an aggregate basis. So I guess you put us in the low risk camp.

Matt J. Jozoff – JPMorgan Securities LLC

Great. Maybe I’ll just throw out one more question before we open it to the audience. I guess just very bigger picture. In terms of the industry, what do you think are the biggest threats to growth for the REITs right now? Do you see any regulatory pressures coming up? How big of an issue is price-to-book ratios right now? Kind of where do you see the industry going?

Michael A. Commaroto

I think the biggest risk is, more than anything, market risk in terms of trying to grow. I think we’ve really seen a lot of regulatory risk. I do think some of our bigger peers in the industry have potentially been looked at as are they CPs or not, systemically important financial institutions and I think that they can wait in doing that. To me right now the industry is relatively unregulated. There was some worries three years ago from the SEC around amounts of leverage and the application of the 40 [ph] Company Act. So I think that – I only view regulation as a big overhang for us. I think regulation has overhang for the mortgage industry, definitely has repercussions on our business. Things like securitization 2.0, what’s going to happen with the footprint of Fannie and Freddie and then risk transference, step warrant and how that kind of plays itself out in the next round of securitizations.

So I think that the mortgage industry is frankly overly regulated and since we rely on the mortgage industry for our asset base and for our returns and regulation does impact us, but it’s more of a second order event, I think, with respect to us. And I think with respect to price to book, I mean it’s a function of market. So right now I think the REITs are definitely cyclical industry with the point in the cycle where a lot of guys touch lows. That’s included of 80% in terms of price to book. We’ve come back to kind of mid-90s. I think most of the peer group is in the mid-90s.

So it’s kind of just a function of how the market thinks about the sector, the business model and forward path of rates and obviously spreads. And I think that that will always put, I won’t say, pressure on the business, but it just makes it cyclical in terms when can you raise capital, but it’s an industry that has to raise capital to grow, because the capital that you earn has to be distributed to your shareholders.

Unidentified Company Representative

I certainly agree with Mike and so far the work that’s been done by the Fed, FSOC, et cetera, has been ongoing. It’s been a number of years and we face the same set of discussion points that other participants in the mortgage industry as well as in financial markets in general face. So there’s always the possibility of regulatory changes, but we do feel like we’ve been through a lot the discussion thus far and in spite of the work being or continuing, we do feel like we’re in a better place in terms of being able to explain our industry the fact that the capital is private equity capital, the role we play in housing finance in terms of our positive impact and in helping borrowers achieve loans, et cetera.

So we feel like we’ve made a good statement to the people who evaluate this industry and we continue to have those discussions as one of the larger participants in the REIT sector. We’re often in a position to provide insight to people in D.C. et cetera. So we do feel like we’ve gotten through a lot of the work and there’s always the possibility of some regulatory changes, but we’re not as concerned about it as maybe at times in the past.

With respect to GSE reform et cetera, one of the things that we do think about as a very large agency player, we do have an upwards of $80 billion in agency MBS assets. One of the concerns long-term with respect to possible changes in housing finance is the availability of securities for us to invest in. We are concerned about liquidity, the functioning of the TBA market and things like that. So we do attempt to inform policy makers as much as possible with respect to the importance of that TBA mechanism and a fungible market that creates strong liquidity.

Unidentified Company Representative

So, I don’t know what will come tomorrow, but as we’ve mentioned this is private capital. We do face regulations. But probably a lot less so than banks and insurance companies. So to some extent the regulatory environment is a competitive advantage. Michael’s statement when he spoke you made a point that we sort of our essential thesis, the government took on all the residential mortgage credit risk, and we’ve been paid enough to do it.

So we know we don’t want to take as much risk and if they do they want to get paid more. So I think people like ourselves with permanent capital will get paid more to absorb the residential mortgage credit risk. That ways residential mortgage credit risk always exits and is trillions of dollars.

Now, if the industry doesn’t grow because there’s no premium to book for years, so what we’ll – all make a lot of money on the way. The key was to get – you going to get to critical size. So you’re important to your counterparties so that you’re not too small for opportunities, but once you’re there whether you grow incrementally or not if you just band your earnings and stay in a place, it’s a prime time and actually very comfortable because when large institutions do get concerned about change in interest rates, maybe there is less incremental buyers of mortgage REITs to the extent we did shrink our share base as a industry as a whole. Maybe we’re in the good supply demand equilibrium now, so I’m pretty happy where we are.

Unidentified Company Representative

And I would agree. There is additional regulations always there, but right now there is an advantage for REIT entities and I think they’ll be dynamic and be a part of housing fiancé performed. However, that ends up looking, I think Matt said at intro, 1.8 rates on $400 billion of agency MBS, which is 10% of the universe. That’s a significant amount. So I think we as an some industry. We’ll play an important role in how housing finance evolves and of course, the more you grow, I guess the more regulation could become there, but as for now I think it is an advantage that we have relative to some of the others in the market.

Unidentified Company Representative

Yes, I’m going to try not to be repetitive. There’s been a lot of good comments made. I just have a couple of points. First of all, the fact that the REITs have own a lot less mortgage, agency mortgages today is actually, I think a testament to the folks sitting up here as well, some of our other peers because when your stock is trading at a substantial discount to book value and you can sell your agency mortgages at where they’re marked that’s a very good trade for our shareholders.

So we bought stock back last year. I know a number of companies here did and I think that’s a very good discipline for the market, when that opportunity exists.

The other thing I would say is in terms of raising new capital, we’ve been fortunate to be able to raise capital numerous times since 2009, and in every case we had something really good to do with the money. And the thing about equity investors, they are actually pretty smart crowd, if you just have something really good to do with the money then they think will make their money they are willing to give you the capital to do it. So I think as the winds blow back and forth and opportunities present themselves to read industry, I think we will have no problem raising capital when those opportunities are there.

Matt J. Jozoff - JPMorgan Securities LLC

All right great, thanks. So with that I think with the time we got left. Why don’t we open up to the audience if there are any questions? There is one down here, you have a mic coming, okay?

Question-and-Answer Session

Unidentified Analyst

Hello, this is going to sound like a little bit of smart ally questions, really not meant to be that way. I worked at a big money manager on the securitized side and often times our equity guys come down into my office, and they try to figure out what you guys do and how your business works and obviously they look to me to try to explain it to them, and if you look over the past year with your equity returns being negative anywhere from 13% to 27%, with the SMP up 22%, and at the same time the Feds giving all the agency mortgage business and the non-agency and CMBS credit market reasonable people disagree, but it’s probably in the sixth or seventh ending as far as tightening goes.

And mean while you guys seem to be looking to do different things instead of agency going into CMBS or non-agency. I struggle with telling our equity guys, why I think your business model makes a lot of sense unless you want just time it, buy at the bottom of the cycle and hold your nose and hope it does well. So I’m not trying to justify your – have you guys justified your existence, I just want how you would look at it given where we are in the cycle right now. Bill said if things look good that equity guys will give you a lot of capital do things look that good for you right now and do you think it makes sense for the equity market to be giving you capital?

Unidentified Company Representative

I think I’m the Bill, you are refereeing to?

Unidentified Analyst

That’s right.

William S. Gorin

So yes, so we said publically in the past and say again today that ROEs out there in the market that we see or not that interesting, certainly in the agency space, and if you are involved in that space. I’m sure you read some of the research that shows you the same thing. You are looking at the same numbers, you go back to a couple of years, and expected ROEs were in the mid teens plus or minus. And so we are well below 10%, so its very hard for us to raise own hand and say, hey Mr. Equity guy, this is a good time and in fact, as I mentioned we not only we net short current coupons, but our basis exposure overall is probably as low as it’s ever been.

So we are happy to wait until spreads normalize and depending on whose research, sure JPMorgan obviously has some great write-ups on that about where they might go. We’ll be the first to say that that’s the way we see it. We are spending a lot of time developing our MSR platform, which we think it provides very attractive returns for us as well as the conduit business to generate our MBS 2.0 credit bonds and IOs et cetera. And we think that, well, the market is going to have opportunities from time to time today as you point out spreads are not nearly what they were. But at the same time the question is, I don’t know what the REIT index average yield is, but I know it’s over 10%. The question is, is that an adequate return given – assuming guys are well hedged and at low leverage, is that an adequate return? Some folks will say yes and some will say no.

David Finkelstein

Could I just add to what Billy mentioned? I think to your point about being in the 6 or seventh inning of tightening, I would disagree with given the fact that the Fed is actually still easing to the tune of 60 billion a month roughly and that will continue through the fall at which point they’ll remain neutral for some period of time while they reinvest the run off of their portfolio and it’s likely 18 months away from actual tightening to occur. So when we look at the shape of the curve, the cost of funding et cetera, over the near-term it’s certainly still a reasonably good carry environment for the MBS spaces.

Unidentified Company Representative

Well, just one thing I’ll add to that, unless much more time we have. But I think to David’s point, I think you can definitely get paid to weight if you look at the ROEs or the dividend yields on the guys up here as well as the rest of the peer group. And I think you’ve also heard from the team up here as well that everybody here to a certainly degree has a hybrid trade on and someway should perform, right, between credit and rate. And then everybody has evolved as the markets evolve –we’ve evolved. So I’ll just speak from our experience, I mean we were great in credit, but heavily weighted towards rates and then we were now more heavily weighted towards credit, but again opportunities that we buy in the secondary market primarily.

And as you look where the market is going, we’re trying to evolve one more time to an entity not just buys credit, but manufactures its own credit periodically along the lines of some of the stuff that were offset. We’re looking at it from a slightly different perspective rather than just a jumbo conduit or kind of the current conduit, but looking at more ways to originate credit sensitive loans. And that could be a big market if you talk to some people and other people would say it’s not a very big market. So I was at a conference that – again, one of your competitors through couple of weeks ago and the team of people that were up there were talking about the jumbo market, which were essentially bank originators.

Their view was that the credit is sensitive to loan market in terms of a new issue market, won’t be very big at all. But then some of the guys who are on the REIT panel, I think those on that panel and I think that those guys had a view that that market guy should be very big on go-forward basis.

So you’re right. Some of these markets are in the six, seven, eight, maybe the ninth inning, but then there are other markets that did not even kind of do [indiscernible] and ideally we can turn our business into and a business that takes advantage of that and at the same time given the business model, because it can be high grade and you can get paid to wait to a certain grade.

Unidentified Company Representative

All right. Let’s take care of maybe one more question. Is there any? Yes, I think there’s one over there. We can run our mike over there. Raise your hand. There you go, over there. Here it is.

Unidentified Analyst

[indiscernible] this morning, talks about private label securities market as being critical to the next round of residential finance in this country. To date that hasn’t really taken whole to a large degree. What do you guys think is really holding that back today?

Unidentified Company Representative

I spoke. Bill, you want to go?

Bill Gorin

I think there is lot of referral warrant issues, but mainly on the large originators, real banks and right now it’s a very attractive portfolio asset for them and I think it will be for several years. So until you get banks an active pull on market where banks are willing to sell those assets, it’s going to be tough. There are a lot of conduit and small origination programs, but you do have then the referral warrant issues when you look at those securitizations. I mean, they are getting done, but at a rather anemic pace, but I do think the main thing holding it back it it’s just an attractive organic asset for the banks right now.

Unidentified Company Representative

Yes, I’ll just add. We’re in that business and we have a long list of hurdles or impediments. What Jason said is probably one of the biggest ones. Lack of supply of deals creates a lack of demand. It’s very hard for large investors to care when there’s no volume. At the same time there are a whole host of other issues repo warrant is one, sunset, existence with second liens, I mean the list kind of goes on and on. I will tell you that some of the industry groups have formed groups to work on. There needs to be consensus and sort of certainty to see large buyers of the AAA come back. And until we get that I think it’s going to be slow.

Matt J. Jozoff – JPMorgan Securities LLC

Okay. Well, I think we’re out of time. But thanks so much panelists; Mike, David, Bill, Jason and Bill. Thanks for participating and sharing your thoughts and I’ll encourage the audience to get more questions.

Michael A. Commaroto

Thank you.

Teresa D. Covello

You can approach them afterwards. Thanks.

Michael A. Commaroto

Thank you, guys.

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