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Apollo Residential Mortgage Inc (NYSE:AMTG)

Q1 2014 Earnings Conference Call

May 07, 2014 10:00 AM ET

Executives

Michael A. Commaroto – Chief Executive Officer

Teresa D. Covello – Chief Financial Officer, Treasurer and Secretary

Analysts

Trevor Cranston – JMP Securities

Tapfuma Chibaya – Credit Suisse

Jason Stewart – Compass Point Research

Operator

Good day ladies and gentlemen, and welcome to the Apollo Residential Mortgage Incorporated First Quarter 2014 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions) 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 incorporated and any unauthorized broadcast in any form is strictly prohibited. Information about the 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 referred to our most recent filings with the Securities and Exchange Commission 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 Incorporated.

Michael A. Commaroto

Good morning and thank you for joining us on the Apollo Residential Mortgage Inc. first quarter 2014 earnings call. Joining me in New York this morning are Teresa Covello, our Chief Financial Officer; Keith Rosenbloom, our Agency Portfolio Manager; and Paul Mangione, our Non-Agency Portfolio Manager, and (indiscernible) our Managers Treasury.

Mortgage-backed securities showed signs of stability in first quarter 2014 as market was able to absorb the tapering. Interest rates generally declined throughout the quarter as weak economic data, geopolitical terminals in Eastern Europe and instability across emerging markets developed. Despite the decline in interest rates, mortgage prepayments remain benign as mortgage rates are not following up the spot refinance activity.

In addition, while the housing markets showed some signs of slowing down with the MBA purchase index and existing home sales moderating, house price gains stood at roughly 1.5% for case shiller for the first two months of 2014 and the consensus is that the housing market is generally stable. Against this backdrop, we continue to optimize AMTG’s portfolio and migrate the company’s equity allocation towards credit, which as a result, overall leverage in portfolio to decline.

The company’s portfolio of equity allocation at March 31, 2014 was 52% non-agency RMBS, securitized mortgage loans and other credit investments, 39% Agency RMBS and 9% cash with a leverage ratio of 3.8 times as compared to 4.1 times at the end of 2013.

At March 31, 2014, AMTG’s book value per common share was $18.64, an increase of 2% over the prior quarter. The increase in book value primarily was driven by $1.03 in net unrealized mark-to-market gains across our investment portfolio, demonstrating the benefit of our diligent asset selection strategy, which resulted in a balanced and diversified portfolio.

We continue to see yield compression in non-agency market, predominantly driven by market technical as the overall pool of investable assets shrink as well as the global capital that continues to seek yield. As I mentioned on our prior call, given this rally, we believe it is important for AMTG to begin originating credit investments to complement the company’s strategy of investing in seasoned securities.

I’m pleased to report that during the first quarter, AMTG took its first steps for diversifying our credit funds and investment portfolio. The company entered into an agreement where they will provide funding to a third party to finance the acquisition and improvement of single family homes. Once the homes are improved, they will be marketed for sale with the cell providing financing to the buyer in the form of mortgage loan for bond for title contracts. This investment strategy is in its early stage.

Currently, AMTG has provided warehouse advances of $8 million to fund the acquisition and improvement of 137 properties. We expect the company will begin personally associated bond for title contracts and our mortgage loans originated through this program in the second quarter of 2014.

We expect that as home price appreciation moderates, housing demand will transition from investor demand to owner occupant demand, these investment strategy is compatible with such a market shift. In addition, we continue to explore various credit focused opportunities in the residential mortgage market as we look to expand the company’s overall mortgage credit investment strategy.

I’d like to turn the call over to Teresa who will review our financial results for the quarter. Teresa?

Teresa D. Covello

Thanks, Michael. Turning to first quarter performance, AMTG reported operating earnings of $17.1 million or $0.53 per common share and net income allocable to common stockholders and participating securities of $24.3 million or $0.76 per common share. The company’s earning release and 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 variance between GAAP net income per common share and operating earnings per common share in the first quarter primarily reflects realized net losses of $0.79 per common share and unrealized net mark-to-market gain of $1.03 per common share, which are not reflected in operating earnings.

I would also like to highlight that estimated taxable earnings in the first quarter was $0.44 per common share, a $0.09 difference from operating earnings. This variance primarily reflects differences in the method of recognizing purchase discount accretion for tax purposes.

As purchase discount on certain non-agency RMBS are currently accreting into taxable income, more slowly than under GAAP, the most significant timings difference is associated with non-agency bonds that are currently locked out from receiving principal payments.

As the amount of market discount accretion recognized tax purposes on these bonds is generally limited to cash received on them, this difference is expected to reverse over time as the bonds that are currently locked out begin receiving principal payments in the future. The company has a number of other items driving the difference between operating earnings and estimated taxable income, which will vary over time.

Keeping these differences in mind, it is important to note that when AMTG Board of Directors set each quarterly dividend, it considers several factors, including the company’s forecast for taxable income and operating earnings, liquidity needs, and our compliance with these requirements.

One other item I would like to highlight in AMTG’s financials this quarter, is this transfer of $16.6 million from credit reserve to accretable discount on the Company’s non-Agency RMBS, which is net of other than temporary impairments recognizes.

These transfers reflect the positive impact on the performance of our non-Agency RMBS from home price depreciation, as reflected by lower default levels across AMTG’s non-agency portfolio. We expect the impact of this transfer to be reflected in future interest income on AMTG’s non-Agency RMBS.

With respect to AMTG’s financing in the first quarter, access to repurchase agreements remain readily available from our counterparties for repurchase agreements collateralized by Agency and non-Agency RMBS.

A growing number of counterparties offered non-agency financing, resulting in a competitive environment across haircuts and funding rates for repurchase borrowings collateralized by non-Agency RMBS to decline.

In addition, AMTG established a repurchase borrowing facilities during the quarter through which the company will be able to finance residential mortgage loans.

The weighted average repurchase borrowing costs for the first quarter increased to 97 basis points as compared to 91 basis points in the fourth quarter of 2013, which reflects our increase in non-Agency RMBS investments and associated repurchase borrowing.

Turning our attention to AMTG’s hedging strategy, AMTG had $2.9 billion of notional interest rate derivative outstanding as of March 31, 2014. Net agency duration gap, which measures the difference in the interest rate sensitivity of the company’s agency RMBS and associated derivatives was approximately half a year as of quarter end. As we look ahead, we expect to target our agency duration gap between zero and one year, a range with which we currently feel comfortable in today’s fixed income market.

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

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from the line of Trevor Cranston with JMP Securities. Your line is open.

Trevor Cranston – JMP Securities

Hi, thanks. I was wondering if you could talk a little bit in more detail about how you see kind of the new strategy on the bond for title program. Just how do you see the capital deployment in that ramping up over the next couple of quarters, and kind of what you’re seeing as the expected returns on that today?

Michael A. Commaroto

Right now, we’re operating in five states in the Southeast, and we’ll probably roll it out on a state by state basis across another three to four states. I would say within the next quarter or two.

In terms of capital deployment, I think overtime we are doing a very thoughtful matter. So I could see our capital base. How do you across the first year, I would think, maybe 10% to 15%, and it’s going to be un-levered initially, because it’s going to be first to focus on OREOs and then over time we’ll roll from OREOs into bond for titles or into mortgages, and over time, we’ll apply leverage to that.

And then we would hold on to the positions be it refinancing and at some point for securitizing them, were positively selling them these whole loan. So really keeping our options open in terms of how we look at those to add leverage to these or realize a gain on the future.

And then the strategy is simply, as the housing market is turning, we think of this as a way to building liquidity to the housing market for either first time home buyers or for homeowners who had previously been in a home, and have their credit damage as part of the recession I just went through, and this could be worrisome to rehabilitate their credit.

I mean we’re really targeting, but I would say, our kind of lower value type of start of homes that you would see in rural areas or ex-urban areas along the lines of maybe a $30,000 home to probably around $100,000 of that.

Yields right now; we are targeting I would say high single digits to low double digits without leverage, and we are in discussions with different leverage providers as for the most efficiently to leverage on a go-forward basis.

Trevor Cranston – JMP Securities

Got it, that’s very helpful. And then on the locked-out bonds, in your when your non-agency portfolio, do you have an estimate as to kind of how long the expected remaining locked out period as before, most of that portfolio becomes kind of current pay position?

Michael A. Commaroto

Yeah. We generally have a loss replacement of it, I would tell you, I think it was in the next three years, roughly around half of the divisions districted cash flow and then the balance will kind of fall behind the next three years behind now.

Trevor Cranston – JMP Securities

Okay, perfect. Thanks very much.

Operator

Our next question comes from the line of Douglas Harter with Credit Suisse. Your line is open.

Tapfuma Chibaya – Credit Suisse

Sure. Thanks. This is actually Tapfuma for – on for Douglas. Couple of my questions have been asked, but just wondering at this point what did you take your guys to get a bit more defensive on the agency side there?

Michael A. Commaroto

A bit more defensive, how do you mean?

Tapfuma Chibaya – Credit Suisse

A bit more offensive on the agency side.

Michael A. Commaroto

A bit more offensive on the agency side.

Tapfuma Chibaya – Credit Suisse

Correct.

Michael A. Commaroto

I think we like to do our position in agencies right now. I mean in terms of defensive versus offensive, we are trying to keep a duration gap somewhere between flat to a half year, we can allow as long as a year. So really just trying to watch the market and our view is that at some point rates will start to back up especially on the long end. So I think it’s far for us to really increase our duration gap materially and we want to make a somewhat levered better on the direction of rates. So trying to be very intelligent across, which bonds we own and how we hedge those with a combination of swap, swaptions and testers?

Tapfuma Chibaya – Credit Suisse

Great. And just to follow up on core versus taxable income variance there, so is the biggest difference there that the timing difference on the loans of cash flow bonds?

Michael A. Commaroto

Yes. That is not significant Tapfuma.

Tapfuma Chibaya – Credit Suisse

Okay, great, thanks.

Operator

Our next question comes from line of Jason Stewart with Compass Point. Your line is open.

Jason Stewart – Compass Point Research

Good morning and thanks for taking the questions. Just a few follow-ups. On the direct residential real estate side there, could you provide any color on the competitive environment that you are seeing today?

Michael A. Commaroto

When you say direct residential meaning that the bonds for titles contracts that you talked about?

Jason Stewart – Compass Point Research

Yeah.

Michael A. Commaroto

I think right now, there is not a lot of competition in that space directly. It’s somewhat our chain, we like it because we transacted in it previously as different points in our prior lives. We think we’re working with intelligence very powerful partner across way to originated and feasibility and then sell the properties. We’ve seen, I would say once you build portfolios from smaller not in the regional, I’ll just call it’s more of private investors that are book to sell the paper, and we’ve done due diligence on those, and found them frankly lacking.

We don’t think that they have the same rigor around quality control, especially with respect to regulatory compliance such as we bring to this space. So, there definitely some people out there doing this – there are some people out there maybe with more than intercity focused doing it. We don’t really want to traffic in that market, we just trying to traffic in, again once again kind of starter homes or lower value homes, but not necessarily in an intercity location.

So, I don’t see there will be a lot of competition directly with we’re dealing with the scale we’re trying to put things with professionalism we’re trying to bring to it. I know there’s some knock-on products from other guys somewhat related, but not really an REO to a loan program that we’ve developed.

Jason Stewart – Compass Point Research

Okay. And just another one or two, are is there certain like capital allocation percentage you’re targeting for all. Could investments going forward, and how should we think about leverage as you continue to allocate capital toward these investments?

Michael A. Commaroto

Well, I think we are right now right around 50% of the book in credit, and I think we’ll stay around that. We can obviously increase it, so the big picture is as to watching our allocation to hold close in our compliance with those regulations. So, the leverage, I think can go down all the time. Distributors sell out to be their agencies are non-agencies, as a way of raising cash to buy properties, and buy loans on an unlevered basis, and then we can bring the leverage back up as we then apply leverage to those purchases. One thing to keep in mind is that the agency book can be levered broadly between 6 and 8 times. And could be levered lot more than that, but we can have the target a 6 times to 8 times leverage ratio for that.

And non-agencies tend to be usually 2 times to 3 times or call it right around an average of 3. And then some of these whole long strategies are probably also 1 time to 2 times leverage ratio. So leverage probably can go down, but then we’d like to think that our spread on the assets were do go up, so we should end up with probably less leverage across the entire platform, the ability to have a higher spread, and also to the extent we like the market. We feel comfortable with our rate risk and our agency position, and obviously always applied a little bit more leverage against that position to raise capital we’re putting into some of these other businesses. So it’s really a function of us really be able to maximize our ability to be across all different asset classes as a hybrid.

Jason Stewart – Compass Point Research

All right. So, we could assume you’re comfortable with what your leverage is right now.

Michael A. Commaroto

That’s correct.

Jason Stewart – Compass Point Research

Okay. Thanks for taking the question.

Operator

I’m not showing any further questions at this time, I’d like to turn the call back over to management for closing remarks.

Michael A. Commaroto

Thank you everybody for joining us this quarter. We appreciate your support and look forward to speaking with you at the end of next quarter. Thank you.

Operator

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program and you may all disconnect. Everyone have a good day.

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