Apollo Residential's (AMTG) CEO Michael Commaroto on Q2 2014 Results - Earnings Call Transcript

| About: Apollo Residential (AMTG)

Apollo Residential Mortgage (NYSE:AMTG)

Q2 2014 Earnings Conference Call

August 06, 2014, 10:00 AM ET

Executives

Michael Commaroto - Chief Executive Officer

Teresa Covello - Chief Financial Officer, Treasurer and Secretary

Keith Rosenbloom - Agency Portfolio Manager

Paul Mangione - Non-Agency Portfolio Manager

Joy Margolies - ARM Manager Treasurer

Analysts

Trevor Cranston - JMP Securities

Jason Stewart - Compass Point

Presentation

Operator

Good day, ladies and gentlemen, and welcome to the Apollo Residential Mortgage Incorporated second quarter 2014 earnings call. (Operator Instructions)

I would like to remind everyone that today's call and webcast are being recorded. Please note that they are property of Apollo Residential Mortgage Incorporated and any unauthorized broadcast in any form is strictly prohibited.

Information about audio replay of this call is available in our earnings press release. I would also like to call your attention to the customary Safe Harbor disclosure in our press release regarding forward-looking statement.

Today's conference call and webcast may include forward-looking statements and projections and we ask that you refer to our most recent filings with the 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 212-822-0600212-822-0600.

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

Michael Commaroto

Good morning, and thank you for joining us on the Apollo Residential Mortgage, Inc. second quarter 2014 earnings call. Joining me in New York this morning are Teresa Covello, our Chief Financial Officer; Keith Rosenbloom, our Agency Portfolio Manager; Paul Mangione, our Non-Agency Portfolio Manager; and Joy Margolies, who oversees our Portfolio Financing.

Mortgage-backed securities continue to show signs of stability in the second quarter of 2014, as market continue to absorb the Fed tapering and the gross mortgage supply continues to decrease. Interest rates declined throughout most of the quarter, driven by geopolitical turbulence in the Middle East and Eastern Europe and stagnant economic data.

Additionally, mortgage spread tightened significantly, leading to considerable price appreciation on agency and non-agency securities as compared to similar duration treasury securities and swaps. Mortgage prepayments remain benign throughout the quarter, as mortgage rates had not fallen enough to spark refinance activity.

In addition, the housing market showed ongoing signs of stability. While prices across the 20 metro areas tracked by the S&P/Case-Shiller indices rose by 9.3% year-over-year in May, which was slower than expected, but market seems to be reaching a more sustainable growth rate, which would result in a positive price outlook for the longer-term.

The stability in the market led to a strong quarter for AMTG. We are pleased to report the company's book value per share increased 4.6% from Q1. The growth in book value primarily was driven by $1.67 in net unrealized mark-to-market gains across the investment portfolio, demonstrating the benefit of the company's diligent approach to asset selection.

AMTG's strategic focus remained on increasing our exposure to credit investments. And the company's equity allocation to non-Agency RMBS, securitized mortgage loans and other credit investments was 54% at quarter end as compared to 31% at the end of Q2 2013, which is when the company began its efforts to reallocate the portfolio.

The company's overall leverage was 3.8x at quarter end, which was the same at the end of the first quarter of 2014, and reflects the low use of leverage for AMTG's existing credit focused asset mix. We rebuilt a well-balanced investment portfolio that was producing a steady stream of operating earnings. As a result, our Board of Directors increased our dividend per common share by 5% in the second quarter.

With respect to the company's Agency RMBS portfolio, AMTG continue to focus its investment on prepayment protected 30-year bonds, which on the price perspective outperformed 15-year RMBS during the second quarter. CPRs in the agency portfolio remained low, averaging 6.7% for the quarter ended June 30, 2014. Taking advantage of the low volatility environment during the quarter, the company added to its swaption position, as we believe the pricing for swaptions was attractive.

Shifting to our non-agency portfolio, AMTG continues to focus on seasoned subprime floating rate bonds. We continue to see yield compression in the non-agency market, predominantly driven by market technicals, we selectively added new bonds to AMTG's portfolio, which ended the quarter with an estimated fair value of $1.4 billion, more than double the size of the non-agency portfolio at the end of Q2 2013. The company's non-Agency RMBS performed well over the second quarter of 2014, with stable voluntary prepayments and loss severities, and continued decreases in defaults.

With respect to the company's bond-for-title program, whereby AMTG provides funding to a third party to finance the acquisition and improvement of single-family homes, during the quarter, the company advanced $10.4 million on a warehouse line to fund the acquisition and rehabilitation of single-family homes in the Southeastern U.S. At the end of the first quarter, the warehouse line had $30 million outstanding, which was used to fund the acquisition and improvement of 220 properties to make earnest money deposit on 29 properties.

We view this program, which is in its early stages as an additional way to gain exposure, rising real estate values outside of acquiring non-Agency RMBS. In addition to this program, we continue to explore various credit-focused opportunities in the residential mortgage market, as we look to expand the company's overall mortgage credit investing strategy.

I would now like to turn the call over to Teresa, who will review our financial results for the quarter. Teresa?

Teresa Covello

Thanks, Michael. Turning to second quarter performance, AMTG reported operating earnings of $16.5 million or $0.52 per common share and net income allocable to common stockholders and participating securities of $40.5 million or $1.26 per basic common share.

For the six months ended June 30, 2014, AMTG reported operating earnings of $33.6 million or $1.05 per common share and net income allocable to common stockholders and participating securities of $65 million or $2.02 per basic common share. The company's earning release and the supplemental information package, both of which are available in the Investor Relations section of our website contain a detailed reconciliation of GAAP net income to operating earnings.

As detailed in the reconciliation, the variance between GAAP net income per common share and operating earnings per common share in the second quarter, primarily reflects unrealized net mark-to-market gain of $1.22 per common share and realized net losses of $0.46 per common share, which are not reflected in operating earnings.

I will also like to highlight that estimated taxable income in the second quarter was $0.42 per common share, a $0.10 difference from operating earnings. This variance primarily continues to reflect the 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 for receiving principal payment.

As the amount of market discount recognized on these bonds for tax purposes is generally limited to the 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.

One other item I'd like to highlight in AMTG's financials this quarter is the transfer of $1.8 million from credit reserve to accretable discount on the company's non-Agency RMBS, which is net of other than temporary impairments recognized.

These transfers reflect the positive impact on the actual and expected future performance of our non-Agency RMBS from home price appreciation, 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 second quarter, we continue to focus on extending the term of our non-agency repurchase agreement. And at June 30, the weighted average remaining maturity for our non-agency borrowings was 174 days. The weighted average repurchase borrowing costs at the end of the second quarter was 94 basis points, remaining relatively constant as compared to 97 basis points at the end of the first quarter of 2014.

Turning our attention to AMTG's hedging strategy. AMTG has $3 billion of notional interest rate derivative outstanding as of June 30, 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 zero 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 todays fixed income market.

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

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Trevor Cranston with JMP Securities.

Trevor Cranston - JMP Securities

I guess the first thing, the warehouse line that you guys are using in connection with the bond-for-title program and that increased a small amount this quarter. Can you give us an update on the outlook for kind of how you view the size of that opportunity? And how you'd expect it to ramp in the near-term?

Michael Commaroto

We still continue to like the opportunity a great deal. We're just being very judicious as to how we ramp it out or ramp up. We're hoping to have more bulk purchases of homes versus buying them on a one-off basis. And we're not seeing as many bulk opportunities, so that why we're just being very selective in terms of how we buy them and being obviously careful around them, the renovation and rehabilitation process.

So at this point, I'm not sure we can give much guidance in terms of how it will ramp up. We can tell you, we like the opportunity a lot. We like the yields that we're seeing on the bond-for-title that we've originated. And we will continue to stay involved in the process. But it's just that the bulk opportunity just doesn't seem to be there right now.

Trevor Cranston - JMP Securities

And you also mentioned kind of evaluating other credit opportunities, and we've seen some peers talk about opportunities to buy senior pieces in non-performing loan or reperforming loan securitizations. And it also seems like the issuance of prime jumbos has started to pickup a little bit again. Can you just comment on how you view those types of opportunities kind of versus the legacy non-agency space right now?

Michael Commaroto

With respect to legacy assets, we've participated in some of the NPL deals that are out there. We obviously issued our own RPL deal that was out there, when we could buy RPL whole loans at levels that we thought were attractive. We continue to look at both the performing market -- we also look at the NPL market periodically, but neither one of those seem to provide a good entry point in terms of whole loans for us presently.

We're looking at maybe there could be opportunities to accumulate smaller pools of whole loans away from some of the bigger auctions, where stuff tends to trade, we think at pretty rich levels. So we continue to try and source paper there, but we haven't seen much traction.

And with respect to legacy bonds, again, we like the legacy bonds probably best at this points. Other credit opportunities, I think we'd be more focused on, I would call it, non-conforming assets, but non-conforming assets from a credit perspective, less with respect to just pure jumbo.

Trevor Cranston - JMP Securities

And, last thing, just a detail. On Slide 8, where you show the asset yield on the non-agency assets, it looks like it went down from 6.9% at the end of last quarter to 6.1%. Is that just related to kind of the forward curve you used for modeling purposes or is there anything else going on there

Teresa Covello

This is Teresa. It really reflects the incremental purchases that we have made. Our older or our legacy non-agency bonds have higher yields as those have appreciated in the marketplace. Obviously, we're buying them at higher prices and lower yields. So you're seeing the return on those securities come down.

Operator

And our next call comes from the line of Jason Stewart with Compass Point.

Jason Stewart - Compass Point

Could you remind us how often you review the portfolio for the appropriateness of the credit reserve, and then the potential for transfers to accretable discount?

Teresa Covello

Right. We look at the portfolio on a continuous basis, for anything that's really an outlier or any unusual activity. But on a quarterly basis, we re-project our cash flows on the entire portfolio. So I would say, quarterly is the formal analysis.

Jason Stewart - Compass Point

So presumably, this quarter, there was a handful or a group of outliers.

Teresa Covello

Well, in terms of outliers -- no, I would not say that they were outliers. I think that, overall, there was some improvement on an overall basis in the portfolio, such that we ended up reallocating $1.8 million from credit reserve to accretable reserve.

Jason Stewart - Compass Point

I guess, what I'm asking is, it's very specific type of bond or sub-segment of the portfolio that looked like it was outperforming expectations and led to this transfer?

Teresa Covello

There are none that come to mind. I think that, overall, when you're taking $1.8 million in transfers on a portfolio of our size, I don't think that any one, any select group of the bonds led to that.

Jason Stewart - Compass Point

And then in terms of pricing on the non-Agency RMBS market, was there any bifurcation between the real locked-out cash flows and some of the performance of the current cash flow buckets? Maybe if you could compare 2Q to 3Q, now that it seems like home price expectations have changed a little bit. Have those two types of securities performed differently?

Michael Commaroto

Just to be clear, you want us to compare current-pay and locked-out from Q2 to today or from Q2, Q1.

Jason Stewart - Compass Point

Well, I would love to hear what's been happening in 3Q more than what has happened in 1Q, so 2Q to 3Q, if you could.

Michael Commaroto

Sure. Paul, why don't you take that?

Paul Mangione

Yes. In terms of current-pay cash flows versus locked-out cash flows, on a very general basis, I didn't see anything specific about current-pay selling off or rallying more than locked-out cash flow. Each has its own specific investor base. I would say, in general, the current-pays probably haven't sold off in any significant way versus the locked-out, that there maybe a little less interest just because they're locked-out cash flows versus current-pay. But compared to maybe other assets types, other markets, non-agency paper, I think non-agency paper has not really sold off very much in the last Q2 to Q3 that we have seen so far.

Michael Commaroto

Yes. One observation I would make just generally, I think to Paul's comment, I think we've seen some -- obviously in some of the credit retention bonds, that the cash and the stack, like those have obviously widened and we have a small exposure in those. But I would say, legacy subprime, which is where most of our exposure is, and plus some legacy Alt-A and pay-option ARMS, those have pretty much hung in through Q3, as far as you can tell.

I mean there maybe a little bit of softening, but I could put it on the order of like a handful of basis points. There was a little bit of maybe wideness in the new issue print that we saw, that maybe should have come at 350, and it came around like 360. But generally, I would say the legacy subprime bonds and legacy RMBS, in general, seem to be holding up pretty well versus other credit or fixed rated assets over the past couple of months or six weeks.

Operator

(Operator instructions) And I am not showing any further questions at this time. I'd like to turn the call back over to management for closing remarks.

Michael Commaroto

Thank you very much. We continue to focus on attention on our business. We will talk to you in next quarter. Thanks. Bye.

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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