Apollo Residential Mortgage CEO Discusses Q2 2012 Results - Earnings Call Transcript

| About: Apollo Residential (AMTG)

Apollo Residential Mortgage Inc (NYSE:AMTG)

Q22012 Earnings Call

August 8, 2012 8:30 am ET

Executives

Michael Commaroto - Chief Executive Officer

Stuart Rothstein - Chief Financial Officer

Analysts

Douglas Harter - Credit Suisse

Rick Shane - JP Morgan

Trevor Cranston - JMP Securities

Operator

I would like to remind everyone that today's call and webcast are being recorded. Please note that they are the property of Apollo Residential Mortgage 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 cautionary safe harbor disclosure in our press release regarding forward looking statements. Today's conference call and webcast may include forward looking statements and projections and we ask that you refer to our most recent filing with the SEC for important factors that could cause actual results to differ materially from these statements and projections.

We do not undertake to update our forward looking statements or projections unless required by law. To obtain copies of our latest SEC filings, please visit our website at www.apolloresidentialmortgage.com or call us at 212-822-0600.

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

Michael Commaroto

Good morning and thank you for joining us on the Apollo Residential Mortgage Inc. second quarter 2012 earnings call. Joining me in New York this morning are Stuart Rothstein, our Chief Financial Officer, Keith Rosenbloom, our Agency Portfolio Manager and Teresa Covello, the Controller of our Management.

Before I turn the call over to Stuart to discuss the financial results, I would like to discuss our investment strategy in the second quarter as well as provide some color on opportunities we are seeing in the marketplace currently.

The company reported operating earnings of $14.1 million, or $0.66 per share for the second quarter ended June 30, 2012, driven by the performance of our well constructed $3 billion RMBS portfolio which generated a 2.7% blended net interest spread and 18.7% levered asset yield.

AMTG's asset selection and financing strategies were guided by macro trends witnessed in the markets throughout the second quarter. In April, when we completed an equity raise, the markets were relatively calm, we were able to redeploy the proceeds at net interest spreads substantially similar to our first quarter investment. Initially, we deployed equity with a heavier allocation towards Agency RMBS and opportunistically rotated our portfolio into Non-Agency RMBS as the quarter progressed.

Following our capital deployment, elevated volatility associated with the continuing soft index prices in Europe led to a flight to quality and strong demand for the U.S. treasury. Historically, Agency RMBS spreads have widened in this environment. However, a greater likelihood for another round of quantitative using and continued benign prepayments took valuations firm throughout the quarter. At the beginning of the quarter, the spread using a two-year and 10-year treasury notes was 180 basis points as compared to 134 basis points at the end of June.

Against this backdrop, we maintained a disciplined approach towards investing the Agency RMBS where we source potential agency investments, use a granular approach to identify loans with specific characteristics such as low loan balance or loans that have already been through the HARP program which we believe will serve to mitigate prepayments.

In general, we found that new production collateral with these features offers the best relative value within the sector with direct investment supporting. This is evidenced by the low fee payment rates we witnessed in our portfolio which exhibited one month CPRs of 3.7% on average over the quarter.

In addition, as market interest rates moved lower, we continued to execute our down investment strategy and sold approximately $612 million, primarily comprised of high coupon securities realizing net gains of $11.5 million or $0.55 per share. We then reinvested the proceeds into lower coupon Agency RMBS as well as Non-Agency RMBS.

Non-Agency prices rallied throughout the second quarter as well as investors seeking yields increased their capital allocations to the Non-Agency sector. We continued to utilize our proprietary investing models to identify attractive risk adjusted investments for our Non-Agency portfolio. During the three months ended June 30, 2012 the company purchased Non-Agency RMBS at a weighted average purchase price of 62.7% of par value.

While our focus primarily remains on sub-prime, we did ship the portion of our Non-Agency portfolio into Alt-A and pay-option adjustable mortgages where we found interesting opportunities. As a result, our advance rates from our repurchase facility providers improved slightly for our Non-Agency investments.

As of June 30, 2012, the equity allocation of our portfolio is comprised of 50% Agency, 23% Non-Agency and 19% cash. Based upon the current market climate, we expect to ship this allocation more towards on agencies to continue to see spread tightening in the Agency sector. Our hybrid restructure enables us to reallocate our equity in a manner that we believe will maximize returns to our stockholders and allow us to take advantage of opportunities across a broad spectrum of the residential mortgage market.

In addition to Agency and Non-Agency RMBS investment, we have begun to explore other residential mortgage investments in order to expand the scope of our portfolio. While we believe there are ample opportunities in our core investment, we believe it is important to explore ways to expand our platform utilizing investment experience of our management team and to broaden the asset class in which we are invested.

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

Stuart Rothstein

Thanks, Michael. As Michael mentioned and as is highlighted in our earnings release for the quarter ended June 30, 2012, the company had operating earnings of $0.66 per share which was in line with our expectations.

As we indicated on our call last quarter, our operating earnings in the second quarter would be slightly below our expected quarterly run rate as we had a one month ramp up period during which we invested the capital we raised in April. We believe our operating earnings this quarter are indicative of our portfolio's ability to produce attractive net interest margins and risk adjusted returns on equity.

Our earnings release and the supplemental information package both of which are available in the Investor Relations section of our website contain a detailed reconciliation of GAAP net income to operating earnings.

In reviewing the reconciliation, you will note that for the quarter, GAAP net income per share was $1.24, substantially higher than operating earnings per share. This primarily is due to realized gains of $0.55 per share from the sale of RMBS in addition to unrealized mark-to-market gains on our RMBS and unrealized losses on our swaps which net to $0.04 per share.

Our interest rate swaps had a total notional amount of $995 million at quarter end and were in an unrealized loss position which totaled $17 million. As we evaluate the company's economic hedge positions throughout the remainder of the year, we expect that we will likely roll a portion of our existing swaps to take advantage of lower nominal pay rates and as a result may realize a portion of the associated unrealized losses during the third and fourth quarters.

With respect to our financing, at quarter end the company had 19 lending relationships representing approximately $7.1 billion of liquidity of which $2.6 billion was drawn down from 17 of these relationships. Regarding repurchase agreements, we carefully manage our exposure with respect to both concentration as well as credit risk of the counter party. We added a slide to our supplemental financial package this quarter outlining our counter party exposure which illustrates that our borrowings are broadly diversified.

In addition, we retain a meaningful amount of cash to meet margin calls. At quarter end, we had $101 million of cash on our balance sheet. We continue to implement our stringent risk controls which are designed to create a conservative balance sheet able to weather short term price shock and promote stability for our portfolio.

Finally, subsequent to quarter end, we closed an additional term financing facility with another global investment bank for our Non-Agency investments, our second to date. This financing facility provides us with added diversity in funding sources as well as extending the term of our Non-Agency borrowings.

Operator, we will now open the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Douglas Harter with Credit Suisse.

Douglas Harter - Credit Suisse

Thanks. Michael, I was hoping you could expand a little bit more on some of the other residential investments that you guys are exploring.

Michael Commaroto

Well, right now it's totally exploratory. We looked at a bunch of different things that are going on in this space. We spent a lot of time, obviously I think, as people know, doing home loans, both prior to Apollo and then with (inaudible) and we stay very close to that market, especially what I recall season legacy collateral versus pure jumbo that has been originated today.

There has also been a lot of interest in MSRs. We have seen some of the other competitors in the space involved in that. So based on that we are taking close look in seeing if that makes sense given our corporate structure.

Douglas Harter - Credit Suisse

Great, thanks, and then, Stuart, I was wondering if you could talk about where tax go and come through the first six months stands relative to the dividend or core income?

Stuart Rothstein

Broadly speaking, taxable income has been running slightly behind core income, though I think as we mentioned in previous calls with respect to the dividend, obviously we are trying to run a balance between what we generate on the book side and then what we are wired to pay out for tax purposes.

We would expect that we will give further guidance on that when we announce the next dividend in mid-September.

Douglas Harter - Credit Suisse

Great, can you just clarify that a little bit? I would have guessed that the realized gains that you have had for the first half of the year would have helped taxable income more than that.

Stuart Rothstein

Yes. I am looking at it more from a core perspective. Yes, the realized gains have certainly through taxable income but as we look out through the end of the year, I think you should reflect back on the comments I made in the prepared remarks vis-à-vis realizing some losses on the swaps as well that are currently sitting in an unrealized position.

So my comments were reflective of where I think we will be at the end of the year.

Douglas Harter - Credit Suisse

Got it, thank you.

Operator

The next question comes from the line of Rick Shane with JP Morgan.

Rick Shane - JP Morgan

Thanks, guys, for taking my question. One of the things we have seen in the third quarter is a pretty significant rally in Non-Agency markets. Are you continuing to deploy capital there at this point? Are you status quo and will you continue to shift your portfolio in that direction in the current environment?

Stuart Rothstein

Right now we are pretty fully invested based upon our last capital raise. I think we would like to get a slightly higher allocation in the Non-Agency space so we continue to watch the space carefully. We will bid on everything that comes into the market. We will work with our inventories but we have tended really take a slow grow approach with respect to that and we continue to do it.

If stuff just seems too rich we are not going to buy at these levels and with respect to agencies, to the extent that we see trades that make sense in terms of rebalancing that book, then we will take advantage of that.

Rick Shane - JP Morgan

Got it. So it is fair to say, look, you have a lot of embedded gains in the agency book. You can realize some gains there but at least for now, maybe the migration with the run-in on agency is going to slow a little bit?

Stuart Rothstein

To me, it's really a day at a time.

Rick Shane - JP Morgan

Okay.

Stuart Rothstein

If we find them cheap, and we find them. From time to time, it's just us being very dogged and looking at everything that comes out and trying to be creative about how we think about risk.

Rick Shane - JP Morgan

Terrific. Thanks, guys.

Operator

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

Trevor Cranston - JMP Securities

Hi, thanks. I just wanted to clarify on your comment on the swap book. I think your intention is to add some, maybe, longer duration swaps in the current rate environment but it also sounded like maybe you are thinking of doing that by terminating some of the existing shorter duration loans, I guess. Am I understanding that correctly?

Stuart Rothstein

No, we are not necessarily going to increase our duration of the swap book. Of course, we will look at it in the context of our overall hedge position. So I think what we have looked at is, some of our pay rates are above the market at this point. So we are thinking we want to rebalance that book into lower pay rates.

Obviously, striking swaps at today's rates versus whether we struck over time as we build the book up. So it really is just rebalancing the existing books to the extent that we think we need to add duration to it, we will do that.

Trevor Cranston - JMP Securities

I see. That’s helpful. Thanks. Staying on hedging for a second. Do you guys see any value in adding anything like swaptions or increasing the size of your book in the current environment?

Stuart Rothstein

Yes, we always continue to look at that. We have run a couple of different scenarios with adding swaptions. We are really just trying to take our right entry point. So we will definitely add to the book at some point. It is just a question of when. But we definitely think there is value there.

Trevor Cranston - JMP Securities

Okay, thank you.

Operator

(Operator Instructions) At this time, there are no questions. I would like to turn the call over to management for any closing remarks.

Michael Commaroto

We just like to thank everybody for their continued attention and interest and support of the company and look forward to speaking to you next quarter. Thank you.

Operator

This concludes today's conference call. You may now disconnect.

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