Apollo Residential Mortgage, Inc. (NYSE:AMTG)
2014 Morgan Stanley Financials Conference Call
June 11, 2014 2:25 pm ET
Teresa D. Covello - CFO, Treasurer and Secretary
Cheryl M. Pate - Morgan Stanley
Cheryl M. Pate - Morgan Stanley
For our next presentation, we have next up Apollo Residential Mortgage. AMTG is a hybrid mortgage REIT formed in 2011 that invest in both Agency MBS and credit residential mortgage assets, including non-Agency MBS and residential mortgage loans. AMTG's non-Agency MBS portfolio consists of roughly 81% subprime, 11% Alt-A and 8% option ARMs. And with us here to present today is Teresa Covello, AMTG's Chief Financial Officer, Treasurer and Secretary. With that, I'd like to welcome you, Teresa.
Teresa D. Covello
Thank you, Cheryl. Welcome. As Cheryl pointed out, we are a hybrid residential mortgage REIT, we are currently primarily invested in Agency and non-Agency RMBS, we do have about $100 million of securitized mortgage loans that we acquired in February of 2012. We trade on New York Stock Exchange under the ticker AMTG and we currently have a market cap that's just north of $700 million.
Based on our first quarter common stock dividend of $0.40 per share, our annualized dividend is currently $1.60, which is about a 9.6% return based on our closing stock price on May 27. It's fortunately moved up a little bit since then. Our portfolio at the end of the first quarter, which is really just the mortgage backed security portfolio, was $3.4 billion with the securitized mortgage loans at $3.5 million. At the end of the first quarter, we had a book value of $18.64.
We're led by a team of portfolio managers that are led by our CEO, Michael Commaroto, who has over 30 years in the credit space, and under him a couple of credit portfolio managers, and an Agency portfolio manager, Keith Rosenbloom, who also has a significant number of years in the Agency space which is our rate part of the business.
I'd like to talk a little bit about what we're seeing in the marketplace in terms of current opportunities, but before I move to that, I just would like to kind of frame that by looking a little bit at the current market dynamics in both our Agency, which is our rate space, and in the credit market for us. If you look at the first chart up here, it's just basically mapped out. We're spread between the 2-year and the 10-year notes have been basically since we came to market, and this is just an indication of the market opportunities that are available for us in the Agency space. Obviously the steeper the yield curve, the better the opportunities are for us.
Over to the right are mortgage spreads, which again have also bounced around over time. You see that one kind of blip all the way down around November, and that was the – that just marks the time period right around the announcement of QE3, and then obviously kind of went back and moved up a little bit again fortunately.
In terms of the technicals in the Agency space, production has really come down over the past couple of years. For 2012, you saw we were at $1.7 trillion, down even further in 2013 to $1.6 trillion. And then in 2014, which this is a year-to-date number, really towards like the end of May, it was about $338 billion actually through the very end of May, and currently as of yesterday it was around $350 billion of production.
And when we look at opportunities in the marketplace, we kind of have to frame that along with what are the demands in the marketplace. Right now, the Fed, it is stepping away from purchases into marketplace but it's still purchasing $20 billion per month in regular purchases and then another $16 billion per month just to replace the runoff from their existing portfolio. We expect, like everybody else I think in the marketplace, that the Fed will exit from the new purchases by the end of this year, but as long as they continue their accommodative stance, we do expect that they will continue to replace runoffs.
So again, we're seeing production is really down. What will happen when the Fed ultimately exits, remains to be seen. They are the largest, most significant buyer in the marketplace, and it depends who you speak with. Some of the economists are really expecting the 10-year to hover around 3% and possibly break that level, and if you talk with the strategists, they are saying that there's such scarcity premium, there's such a demand for yield products and with so many other things going on across the globe, that this is still a safe haven and a place that investors will still put money to work and invest in these assets, and that they believe will keep rates down.
So, there's definitely different views out there. What we'd like to do is – we have a view but what we'd like to do is not make a bet on rates, but actually just make sure that when we make an investment decision that we hedge it properly, and that what occurred around the beginning of last summer, we're protected against that better in the future because I think the market was a little bit surprised or a lot surprised about the intensity of the movement in rates when the said announcement came out around tapering.
So if we flip, in terms of our credit book, we have a couple of bar charts and line graphs here. In terms of non-current mortgages, non-current levels really peaked in 2009 and they have continued to improve. So we like this space a lot, we like the credit space, we like the fundamentals. In terms of the technicals, obviously this is an evaporating pool of assets that has really been priced up significantly over time, even since we came into the market. Obviously [anybody] (ph) was really early player in this space, got really significant discounts, 30%, 40% to par. As we came into the place in 2011 and have continued throughout, spreads have just continued, credit spreads have just continued to tighten and it's become challenging to find value in this space over time.
We have a focused a lot of our purchases in the last year as we rotated our book away from rates and more into credit. We have focused on a lot of the locked-out non-Agency bonds, and what those bonds are, are just not the top-tier at the current point but just below that, so they are not cash flowing but we like the total return profile on those. So for the investor that's patient and doesn't need cash every month from day one, we really like those opportunities. They currently comprise about half of our non-Agency book.
In terms of how we look at housing, again the fundamentals have been really strong. Housing has performed very well since we've launched. And our sense is that the biggest driver for housing going forward is really going to be employment. If the economists are right, there is pent-up demand and we're really just waiting for employment to really continue to show some traction and stay the course for housing to continue to appreciate. We have been going up pretty nicely and it's still, housing valuations are still increasing, but now they are kind of levelling off and they are not just on this straight lineup but they are definitely levelling off but they're still appreciating nonetheless, it's still in positive territory. So we're constructive on housing.
The ABX 06 Index at the bottom corner, that's probably the best proxy or the closest proxy, if not exact, again because our locked out bonds are not in this index but that's a good proxy directionally for how our non-Agency securities have performed. And if you look at it, we've already reached – really at this point so far, we've reached post-crash highs, breaking the psychologically important 80% threshold. So we're happy with the fundamentals, the technicals also support valuations but at the same time do make it challenging to go out and buy products in the credit space in non-Agency bonds.
If you look at our current positioning, around the middle of last year, we really repositioned our book. We wanted to take a lot of our interest-rate risk and start rotating it more into credit risk. So when we did that, we reallocated a lot of our equity out of the Agency space, and by doing that, we really repositioned how our equity was allocated. We were 39% in Agencies at the end of the first quarter and that number was like 59% the same time in the prior year. So we've made a really conscious effort to continue to migrate the book. We don't see it that we eliminated risk, we see that we changed our risk profile.
So the other thing when we talk about our shift in capital allocation, we do look at lots of opportunities in the marketplace, we try to find opportunities that are less trafficked in but maybe are a little bit more complex, that aren't just a straight purchase of a non-Agency bond, we look at pools of performing and re-performing mortgage loans, we've looked at MSRs, we've looked at lots of different products that have been available, and negotiated on a pool of loans back again when we really started that trade in early 2012, late 2012, and closed on it in early 2013, and we've been – that was like that's currently a 7% yield on that pool, and if you look in the current marketplaces, the yields on similar types of pools have really come down. We've actually seen some trades around a 3% unlevered yields, a return of 3%, and that's a little bit too higher priced to reach with us, price for us, and too low of the yield. So we end up – we may bid on that but that's not necessarily an asset that we are going to end up obtaining for the portfolio.
As we look ahead, in the first quarter we announced new initiatives where we are providing balance sheet to a counterparty to go out and acquire properties, whether they are OREOs or just properties that are listed on MLS or purchased off from Fannie Mae or Freddie Mac, go out, purchase these properties, perform some rehabilitation work to them, make sure that the home is structurally and functionally sound, and then they will go and sell this to a homeowner taking back a bond for title or a contract for deed agreement and put the homeowner in the house. And the idea is for that homeowner to be in a position where they're really not paying significantly more than they would be paying rent in that same marketplace.
We then purchase that and contract and hold that in our portfolio, and those are pretty nice returns. They are high – well, they are low double digits without leverage and higher double-digits with some leverage put on them. We currently don't have leverage on them yet, we're still negotiating, we are finding that banks are expanding their balance sheet and are very interested in lending on different types of mortgage assets.
So, the other thing that we're looking at – and we haven't executed on any of these transactions but things that we're talking about are non-QM loans. Again, we have to be diligent that in terms of compliance that there is Dodd-Frank and that any counterparty that we deal with, make sure that they are very aware and they are dotting the i's and crossing the t's and that the assets that we buy from them are not going to trip us off on some Dodd-Frank violation.
And then the last thing that we're looking at, which falls outside of Dodd-Frank and would not fall under the QM loans, are really loans that would go to investors who invest in properties like fix and flip type of scenarios where it's not just the post guy or the police officer or somebody else whose handy that's just buying a home, fixing it, flipping it, it's somebody who's really a real estate professional that's purchasing the assets through an LLP that really has experience, that knows how to do this, and we are providing again, we're looking to provide balance sheet to them so they can go purchase these properties, improve them, sell them to the end-user.
So I think that right now the opportunities out there are things that we're spending a lot of our time on, we're being careful about it. Everybody seems to be chasing yields. It's definitely challenging to come by. So all of the strategies that we are looking at and ultimately execute on really takes a lot of our time, but our investment professionals are really very focused on them and really put all the numbers through a lot of calculations before we do anything.
In terms of, moving to the next page, if you look at our allocation of equity, we have moved. We now have about 52% of our equity in credit, and that compares back in March of last year, we only had 47%. That is a significant move for us. In terms of the Agency RMBS, we currently have 39%. We still like this space. We like the idea of being a hybrid mortgage REIT. It allows us to kind of oscillate back and forth between credit and rate depending on what the market looks like.
Again, we target cash at 10%, we can't always keep it at 10%, sometimes it's 11%, sometimes it's 9%, kind of moves around that point, but we need to do that because we do use leverage and we do get margin calls on our borrowings on a very regular basis.
The next chart, we just map out what are our returns, and if you look at the Agency space, the asset yields there, if you look at our portfolio, we really migrate towards, we move words the higher coupon prepaid protected stories, we've always been there. I think one of the differences today versus where we were pre June 2013 is that we use significantly more hedges in the form of swaps and swaptions to mitigate against changes in interest rates that would offset changes in the valuation. So if we were to get margin calls on the mortgage-backed securities portfolio, we could also initiate a margin call on the other side to the swap or the swaption.
Again, the securitized mortgage loans, these numbers are spot rates, so they are not an indication of exactly where our yields or our spreads are going to be in the future, they are really at a point in time. Our securitized mortgage loan portfolio gave us a 7.9% return and a 12.4% effective levered asset yield. Again, those pools, we're currently seeing them at around 3% yield, so not something that we're doing right now, not something that at the present time we really feel like we can replicate.
When you look at our total asset yield, the 4.5%, if you're thinking that the math doesn't work, it kind of does, it's not in there in the column but because we keep around 10% cash, that cash effectively earned zero. So that obviously brings down the weighted average return on our assets.
The other side of our balance sheet in terms of financing, which we primarily use repurchase borrowings and in addition we had done a securitization again associated with that pool of loans that we bought. So we had a securitization that's terming out the funding on that particular pool. We sold the A piece and kept the M2 piece and that's effectively our financing.
If you look at our cost of borrowings, what we do is on our non-Agency securities, we try to go out a little bit longer. We have term funding that is, up to the year we typically do between six months and a year on our non-Agency book, shorter on our Agency book basically one to three months, and overall our total repurchase agreement had a weighted average of just a little over two months at the end of the first quarter.
So again, our funding costs may lean a little bit towards, if you're looking at the peer group, maybe they're a little bit higher, but we feel that in terms of the risk and just to ensure that we have the balance sheet there, that if there is a change in the marketplace, that if the banks decide that they don't want to start lending, that we don't have this 30-day paper with a weighted average maturity of 15 days. So we feel that it's currently worth the cost, but again that's something that we are always looking at.
We use again, I mentioned the derivative instruments, swaps and swaptions. The swaptions are really used to hedge the negative convexity in our mortgage portfolio and we just map out our swaps which we've also used. Again, these are significantly higher than they were relative to both our repo borrowings and our RMBS portfolios than they had been historically.
In terms of our operating performance, we just mapped that out along with our dividends and book value. I think the thing really that definitely stands out here is, between Q2 of 2013 and Q3, there was definitely a decline in kind of all things across, whether it was book value, operating, earnings or dividend, and really that had to do with us making a conscious decision to rebalance our book to move away from rate and to move into credit investments. And when we did that, obviously moving into credit is a lot more, takes a lot more time and diligence than just moving into rates.
You can ramp up an Agency portfolio pretty quickly just by buying a handful of bonds and leveraging them. Doing it in credit takes a lot more time, they are smaller sized securities, and as a result we ended up holding a significant amount of cash for a period of time which really had a drag on earnings. So if we look at kind of what is more of a normalized quarter, Q1 – although you can't assume that it's a run rate for the rest of the year, Q1 was something that we considered more of a normalized quarter with our existing portfolio.
Our dividends from Q2 to Q3, we did significantly cut our dividends and that was really comprised of two things. One, we came in to 2013 under-distributed. So we kind of had this money in our back pocket that we needed to distribute. And then two, we had capital gains that we had realized in the first two quarters. So our goal was to distribute them kind of on an as we go basis.
When we repositioned the book, we obviously realized a lot of losses in that portfolio. Again, the right thing to do, a little bit painful, but we cut the dividend back significantly and we really wanted to put it to a level that we felt that we would be able to sustain, at least in the near-term what we could see out a couple of quarters ahead of us, and that's what we did. So the dividend has stayed at $0.40 for the last three quarters. The Board and management spends an excessive amount of time talking about the dividend, all the different metrics that we look at in determining that, it's a fluid conversation and we look at it each and every quarter to see where we should be setting the dividend for that particular quarter.
In terms of book value, again we had gone down again in terms of what happened to the marketplace, down to $18.63, happy to say that since then we've moved generally in the right direction, that our hedges have worked well and our portfolio, both our portfolios have performed well.
So again, just to recap, we are hybrid REIT, we do like to take advantage of opportunities across the entire residential mortgage platform. We will oscillate from time to time between credit and rate. We are not advocating commitment to the Agency space, although the Agency may at some point in the future really begin to change and we'll kind of see where that goes in the future, but at the current time, it doesn't seem that Congress is getting anything done all that quickly in that area.
We do have a seasoned management team with significant credit expertise, again led by Michael Commaroto, who was with us earlier but couldn't be here today. And we have a very strong sponsorship from Apollo Global Management, and what this really does for us is it allows the company that's our size, which is really a small company, to have the opportunity to see investments that other companies that are our size would not necessarily have the opportunity to see, [indiscernible] comes across the entire Apollo Global platform.
So we may see opportunities that may not work within AMTG and they could go elsewhere or someone else may see an opportunity that is perhaps too small for one of the funds and that to come to AMTG. Then the portfolio manager spends a lot of their day every day looking at all of these opportunities and trying to be very judicious in making decisions about executing on any of these trades.
So again, our dividend yield is currently 9.6%, and for our second quarter 2014 dividend, we will be looking at that again and announcing that at some point towards later on in this month.
Cheryl M. Pate - Morgan Stanley
Great. Thank you, Teresa. I'll kick off the Q&A and then we'll open it up to the floor. So obviously we have seen a pretty pronounced shift more towards the credit side over the last several quarters and including a lot of interesting new initiatives into securitization, bond for title, et cetera. Maybe you can spend a little bit of time sort of giving us more detail on the investment decisioning process, how you think about the opportunity, [IRR hurdle] (ph) rates that you look to when making these sort of interesting [indiscernible]?
Teresa D. Covello
I think that we're still targeting – in terms of depending on the product, we're still targeting a high single digit return without leverage, and obviously looking to put on, if we're talking about the bond for title, that was a lower double-digit ROE. Currently our target on that again adding one turn of leverage, bringing us to a higher double-digit, I'm sorry I can't give you exact numbers, but it's obviously something that's very fluid and moves over time and we haven't disclosed anything else about that. But that's really where we're targeting with the bond for title and that's one of the initiatives that we have executed on. So that's a little bit easier to speak to.
In terms of the non-QM, that's something that is a higher, mid to higher single-digit return without leverage, lower double-digit returns with some leverage on it. I mean that's something that we are looking to build with a counterparty, where the counterparty would really be providing a lot of the operational platforms that we would not have to incur all that upfront G&A to build out that particular platform.
In terms of lending, really which is more a commercial type of loan, but lending to really investors who would go out and buy properties, again a higher single-digit return adding a turn of leverage on to it to get us to a lower double-digit returns, again looking to have counterparties that we work with or even possibly acquiring entering into either a joint venture or acquiring a company if that's the right opportunity to build out that platform, again with our market cap being very mindful not to do anything to saturate our G&A and to try to use to the greatest extent possible our relationships to really kind of serve as our back office for a lot of these products.
Cheryl M. Pate - Morgan Stanley
Just one more from me before I open it up. We spent a little bit of time talking about your funding strategy and particularly on the non-Agency side a little bit longer dated term funding, something interesting that's becoming more of a topic in the space has been potentially use of the Federal Loan Home Bank…
Teresa D. Covello
So definitely aware of that, that has been a conversation that we've had, the Federal Home Loan Bank have been active in going out to the REITs and in particular maybe to some of the commercial mortgage REITs as an avenue. At this point in time, we don't feel that that's something that is really the right mix for us currently. It's still there, it's still something that we continue to think about, but I think that over time as news about that and market reaction and regulatory reactions develop, I think that that will dictate the direction that we lean-in on that. I think that it's in a little bit of the early stages to make a decision to jump in, and if we were to jump in and all of a sudden that door closes, the question becomes, are you grandfathered because you were in or are you out at that point. So it's something, yes, we've definitely looked at it.
Cheryl M. Pate - Morgan Stanley
Okay, great. Any questions from the audience? Okay, one of the other things that we've obviously seen, and part of this would go to your change in strategy more towards the credit side, but leverage has come down fairly substantially. What type of environment would you need to see to be a little bit more comfortable particularly on the Agency side putting leverage up?
Teresa D. Covello
I think right now there's still a lot of uncertainty as far as where rates are going, what will be the impact when the Fed exits the space, how long will they stay accommodative, is there really pent-up demand. So I think that certainly through the rest of this year, we're being cautious and a little bit sensitive on rates and I think we would lean more towards the conservative side in terms of leverage. I think it has served us well historically. I think that in terms of the entire sector, if the sector were levered up in June the way that it had been in 2007, I think that would have been a really, really ugly outcome.
So I think being prudent around, prudent uses of leverage is definitely the side of the bar that we want to lean towards. So I think for the foreseeable future for us, we'll probably stay conservative. I mean it's nice to have the option there that we can go out and turn leverage up a little bit and get returns, but we certainly don't want to do anything that would in the long term be damaging to the Company. So we're being cautious about it.
Cheryl M. Pate - Morgan Stanley
And maybe just one last one from me. I know you spoke to the dividend a little bit and not asking for any guidance specifically but earnings have been running ahead of the dividend for the last couple of quarters, can you just talk about how you think about the dividend in relation to core earnings or taxable earnings and what sort of signpost you look for to get more comfortable with the rate [indiscernible]?
Teresa D. Covello
Good question, we do get that question a lot and have got it a lot, especially at these last couple of meetings. Yes, we started reporting in Q1 more information, so that our investors would have a better idea of some of the different items that we look at when the Board determines what the dividend is. We had $0.53 of core earnings, we did report for the first time that we had estimated taxable income of $0.44. Within that $0.44 was kind of like a special nonrecurring type of item and that was really associated with the sale of one of our non-Agency locked-out bonds. So if you discount that and say it's $0.42 and the dividend was $0.40, it's not that far off.
As a REIT, we really look to our taxable income as a driver or one of the drivers of our dividend, we look at cash to the extent that we pay out more in our dividend than cash that comes in. That's real equity that's out the door that we can no longer invest. When we look at the opportunities in the marketplace, we do want to see some dry powder for some of these opportunities because a lot of them are very capital intensive, particularly out of the gate when we're looking at the bond for title transaction, again starts out with the warehouse line, ultimately converts into loans, and then at some point we would put leverage on, but those leverage facilities are not currently set up.
So again, it's really a bit of a balancing act and we are pleased that we did have a good taxable income number per share and we'll look at it again this quarter. We don't want to get in a position where we're so far out over our [seas] (ph) that we have return of capital, we're not anywhere near there right now. So again, it's just something that we look at from quarter to quarter.
We don't want to be one of those – to be a company that has a dividend, that really doesn't have any indication of predictability, that we're kind of just up and down all over the place. We would like to generate, at least this is the goal, to generate a more stable dividend over the course of time. So again, we hear what some of the investors are saying, we understand the questions, and we'll continue to look at it.
Cheryl M. Pate - Morgan Stanley
Okay, great. Well, thanks very much for sticking with us today.
Teresa D. Covello
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