AG Mortgage Investment Trust's (MITT) CEO David Roberts on Q2 2016 Results - Earnings Call Transcript

| About: AG Mortgage (MITT)
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AG Mortgage Investment Trust, Inc. (NYSE:MITT) Q2 2016 Earnings Conference Call August 5, 2016 9:30 AM ET


Karen Werbel - IR

David Roberts - CEO

Jonathan Lieberman - President and Chief Investment Officer

Brian Sigman - CFO


Joel Houck - Wells Fargo

Douglas Harter - Credit Suisse

Eric Hagen - KBW


Good morning, and welcome to the AG Mortgage Investment Trust Second Quarter 2016 Earnings Call. My name is Brandon, and I'll be your operator for today. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note this conference is being recorded.

And I will now turn it over to Karen Werbel. Karen, you may begin.

Karen Werbel

Thanks, Brandon. Good morning everyone. We appreciate you joining us for today's conference call to review AG Mortgage Investment Trust's second quarter results and recent developments. Joining me on today's call are David Roberts, our Chief Executive Officer; Jonathan Lieberman, our Chief Investment Officer; and Brian Sigman, our Chief Financial Officer.

Before we begin, I'd like to review our Safe Harbor statements. Today's conference call and the corresponding slide presentations contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All such statements are intended to be subject to the safe harbor protection provided by the Reform Act. Statements regarding the following subjects are forward-looking statements by their nature. Our business and investment strategy, market trends and risks, assumptions regarding interest rates and prepayments, changes in the yield curve, and changes in government programs or regulations affecting our business. The company's actual results may differ materially from those projected due to the impact of these factors and others beyond its control.

All forward-looking statements included in this conference call and slide presentation are based on our beliefs and expectations as of today, August 5, 2016. We disclaim any obligation to update our forward-looking statements unless required by law. Additional information concerning the factors that could cause actual results to differ materially from those contained in the forward-looking statements are included in the company's periodic reports filed with the SEC. Copies of the reports are available on SEC's Web site at

At this time, I would like to turn the call over to David Roberts.

David Roberts

Thanks, Karen, and good morning everyone. Our book value increased during the quarter by 1.2% to $17.42 per share at quarter's end. The value of the agency portion of our portfolio increased primarily due to the positive portfolio duration gap in place, and given the rally in rates.

Our core earnings for the quarter were $0.46 per share before a negative retro-adjustment of $0.03 per share. We declared a dividend of $0.475 per share for the second quarter. During the quarter, we rotated into 30-year agency RMBS on a hedged basis. We also purchased assets for a credit portfolio, which Jonathan will get into in more detail.

We are pleased to announce that in June our mortgage origination affiliate, Arc Home closed on the acquisition of a Fannie Mae, Freddie Mac, and Ginnie Mae mortgage originator. Arc Home has commenced originating mortgages in 44 states to retail and corresponded channels. Arc Home will continue to pursue licenses in the remaining states, and expects to receive most of the remaining approvals by the end of this calendar year.

We are excited about increasing origination volumes at Arc Home and deploying capital to purchase and retain mortgage servicing rights, which will create investment opportunities for AG Mortgage Investment Trust.

Finally, last year our Board authorized $25 million share buyback program to give us the potential means to increase book value per share. To-date, we have repurchased approximately 560,000 shares of common stock for cost of approximately $7.5 million, which has led to a total net accretion to book value of $0.07 per share.

With that, I will turn the call over to our President, Jonathan Lieberman.

Jonathan Lieberman

Thank you, David. Good morning all. During the second quarter of 2016, the volatility in the prices of risk assets globally from the prior quarter largely subsided. Mortgage and consumer credit regained most, if not all, the mark-to-market losses suffered in the prior two quarters.

The market rebound only momentarily paused in response to the surprised outcome of the June 23 United Kingdom Referendum on European Union membership. Despite this momentary uncertainty, risk assets, particularly U.S. dollar-based assets held-up very well. Legacy mortgage assets proved to be especially resilient during this, due to support of technicals and stable underlying fundamentals; most asset classes quite at or near their best levels of the year as of the end of the second quarter.

The Fed in it's June 15, 2016, meeting further tempered it's expectations for policy action both in the near and long-term in response to stubbornly low inflation and in growing belief within the Fed that the neutral level of Fed funds is lower than they have previously thought.

Beyond 2016, the Fed's forecast with pace of upward inflation, interest rate adjustments to be more gradual with a reduction in the median number of increases in both 2017 and 2018. Even as the Fed has reduced its forecast, we continue to subscribe to the view that the risk of a slower pace of rate normalization is greater than that of a faster rate.

This combined with global demand for fixed income product that overwhelms available supply, shapes our benign medium-term outlook on interest rates. Continuing the theme that began in Q1, Agency MBS technicals remain strong during the second quarter. The scarcity of absolute yields available globally with liquidity, especially from overseas investors looking for attractive yields relative to their global benchmarks remains intact. There is strong sponsorship from banks, money managers, as well as the overseas accounts.

The favorable yield, and liquidity, and credit profile of Agency MBS has tightened valuations despite increased prepayments and supply concerns. Swap spreads were also stable during the quarter, and as a result, proved to be an effective hedge. In fact, the gradually-widening swap spreads have enabled us to unwind a large portion of our loan position and swap spreads that we entered into during the fourth quarter of 2015 and the first quarter of 2016 at favorable economic outcomes.

Mortgage credit spreads took part in the second quarter broader market rally that commenced at the end of the first quarter. The rally was broad based across several of RMBS sub-sectors. CMBS continues to trail [ph]. Amidst lower global sovereign rates, the hunt for yields has been a driving factor in tightening spreads. As a result, we are pleased with performance of the credit book this quarter.

Fundamental collateral performance of legacy mortgages continues to remain steady and in some cases is improving, benefiting from continued home price appreciation and credit curing. Housing affordability, including first time homebuyers remains above historical averages and consumer confidence stands near post-recession highs. We remain constructive on housing and believe home price stability is durable at this time; favorable net supply technicals, and strong reinvestment demand, support, pricing, outperformance of R&D versus other spread asset classes.

As David previously mentioned, in the second quarter Arc Home closed on the acquisition of a Fannie Mae, Freddie Mac and Ginnie Mae mortgage originator. Beyond this transaction, Arc Home was successfully in achieving -- in other achievements during the quarter, including commencing mortgage originations and launching a correspondent origination channel. The investment team is very pleased with the progress Arc Home has made, and remains focused on capitalizing on the credit interest rate environment to increase originations volume at Arc Home. Additionally, Arc Home plans to introduce new mortgage products and expand its investment activities to mortgage servicing rights as well as launch wholesale originations and portfolio retention strategies in the third quarter of 2016.

For the quarter, MITT reported net income of $0.63 per diluted share and core earnings of $0.43. The increase in net income from last quarter was supported by our agency book. Core earnings without retro remained relatively flat quarter-over-quarter. Book value increased to $17.42, which represents an increase of $0.20 inclusive of the impact of our dividend paid to shareholders on July 29. The aggregate portfolio size increased modestly to approximately 2.8 billion, at risk leverage increased slightly to 3.38 times from 3.36 times last quarter.

The quarter ending net interest margin increased modestly to 3.06 due to higher yields on the credit book. On slide nine of our quarterly earnings presentation we laid out the investment portfolio composition for the quarter, the fair value of our agency book was approximately 1.3 billion and the fair value of our credit book was approximately 1.5 billion. Focusing first on our agency MBS portfolio the constant prepayment rate for our agency book was 9.9% for the second quarter. Prepayment speeds for our portfolio remained benign and stable notwithstanding the recent interest rate rally owing to the favorable prepayment characteristics of our holdings.

During the quarter, we increased the allocation to Agency RMBS 30-year product on a hedge basis at attractive ROEs. Specifically we purchased face value of $100 million in PBA on a hedge basis. We also rotated holdings by selling 65.6 million of face value of agency pools and replacing them with 82.2 million of pools that would be better insulate us from expected near term increases in the overall market prepayment rates.

During the second quarter for the credit book we purchased non agency MBS, Freddie Mac K- Series securities, CMBS IO and ABS specifically, we purchased face value of 19.5 million of Prime and Alt A securities and sold face value of 23.5 million of Prime securities.

We purchased face value of 35.8 million of Freddie Mac K-Series securities and 580.6 million of CMBS IOs or 29.6 million of fair value. On the ABS side, we purchased face value of approximately $12.5 million of securities. The credit book did performed nicely during the second quarter but it even performed even better and appreciated more during the month of July, a portion of that price appreciation maybe attributable to delay price movements during the June period.

Turning to slide 13, we provide update on our financing; we currently have 38 financing counterparties and our financing investments of 22 of the counterparties. In general, funding continues to be plentiful and stable for the company. Our hedge tables are widely laid out on slide 15, we continue to address our hedge positions in responses to changes in our portfolio, U.S. economic conditions, interest rates, and the potential normalization of U.S. monetary policy. Specifically, the rally in interest rates from the quarter put downward pressure on operation gap. In response, we added duration limited to shrinkage our gap with the agency credit of 1.94 years to 1.63 years.

So in closing, we believe that as 2016 unfolds, MITT is well-positioned to take advantage of wider range of credit -- more market opportunities with an increasingly favorable product.

With that, I'll turn the call over to Brian to review our financial results.

Brian Sigman

Thanks, Jonathan. In the second quarter, we reported core earnings of 11.9 million or $0.43 per fully diluted shares versus 11.3 million or $0.40 per share in the prior quarter.

At June 30th, we had a negative $0.03 retrospective adjustment to our premium amortization on our agency portfolio. Overall for the quarter, we reported net income available to common stockholders of 17.7 million or $0.63 per fully diluted share. In the second quarter, the $0.43 core was coupled with $0.22 of net realized and unrealized gains on the agency and derivatives portfolio.

At June 30th, our book value was 17.42, increase of about $0.20 or 1.2% from last quarter. This increase is mostly attributable to the gains I previously mentioned. Additionally, we repurchased 313,000 shares or 4.3 million common stock during the quarter; a net accretion to book value after repurchase of $0.03 per share.

To give you a better sense of our current 2.8 billion portfolio, I would like to highlight some more statistics. As described on page five of our presentation, the portfolio at June 30, 2016, had a net interest margin of 3.06%. This was coupled by the capacity asset yield of 4.64%, offset by increasing cost of 1.52 and 0.4% respectively for total cost of funds of 1.76%.

Additionally, our hedging our corporate hedging increased modestly at the end of the quarter due to the removal of credit loans coupled with increased financing cost of [technical difficulty] that we saw a little bit of spike at quarter end, although this was offset by reasonable swaps mostly related to the future.

During the quarter, we received net equity of 9.6 million from the pay off at maturity of one of our commercial loans. We also redeemed a majority of our FHLB stock receiving proceeds of $8 million. Additionally, we received net equity of 3.2 million on some of our countrywide bonds as a result of settlement by Bank of America with RMBS investors related to mortgages sold by its countrywide unit.

All of these factors contributed to our strong [technical difficulty] which at quarter end was 166.3 million comprised of 42 million of cash, 80 million of unlevered agency hold full securities and 44 million of unlevered agency IO securities.

That concludes our prepared remarks. And we would now like to turn over the call for questions. Operator?

Question-and-Answer Session


Thank you. [Operator Instructions] From Wells Fargo, we have Joel Houck online. Please go ahead.

Joel Houck

Thanks, guys, and good morning. Just really solid quarter, I think that's the overall theme that we are seeing from most of the companies. I am curious on the movement toward agency, is that -- would you characterize it as more opportunistic given what's happened, or, is it more kind of a -- more of core holding? You are more minimal to holding agency given kind of the lower rate volatility [ph], as you mentioned, I think the hedging costs are more favorable, at least the swaps are cooperating with respect to being more of an appropriate hedge.

Jonathan Lieberman

Good morning. I would characterize it as more opportunistic moment in time where we felt that we should and could add agency effectively on a hedge basis, and part of a rotation of portfolio, because -- modest rotation on the agency side into a little bit lower coupon and just an adjustment for just the interest rate environment and really prepayment protection.

Joel Houck

Okay. And I guess the next question is more a macro-related. We see strong job support this morning on the heels of a previous good report. Yet, the bottom [indiscernible] rates are taking it with stride. Do you still kind of maintain lower for longer stance. That's one of the themes we have heard on many conference calls. So despite kind of the strong jobs report, there is still kind of an income problem, if you will, globally. And are you worried that with -- if this jobs trend continues, that rates may move systemically higher?

Jonathan Lieberman

I think we've stated that we believe in lower for longer in the medium-term. I think we ultimately need to see real sustained growth, and some income growth, and more aggregate demand. I mean, if you look at tax receipts in the last couple of months, they've certainly come down, and we're seeing lower economic activity at many companies. Earnings in many companies have disappointed this quarter [indiscernible] quarter. So if you couple that with some of the other big macro themes that are dominating the bond market, we're not implying that we're going into recession. We just think that basically growth is really pegged at a low number, and the Fed is really contained on their ability to push rates up, or even the markets are really contained in their ability to push the bond yields higher because of just the world-wide demand for yield.

Joel Houck

Okay, very good. Thank you very much for the comments.


From Credit Suisse, we have Douglas Harter. Please go ahead.

Douglas Harter

Thanks. You talked about Arc Homes starting to deliver credit products in the third quarter, can you talk about the competition there, and what we could expect around pacing of new investments added?

Jonathan Lieberman

I think we're trying to guide you to just a slow build-up of Arc Home. We're not trying to push an agenda that Arc Home is going to deliver products at too rapid pace this year. I think the first product that we would expect would be MSR off of traditional agencies' product. And then over time, we envision basically expanding the menu of products to include more credit-oriented products, including non-QM. But it will be really I think a 2017 story on some of these incremental products. We are very, very pleased with the management team and the small retail originators that we acquired that came with licenses. The management team, led by Barry Bier is an experienced mortgage banker with over 25 years experience, and he has the ability and capability of putting together a business very, very rapidly. And he's -- we will say that he is ahead of plan, but we're only several months into this, and so we look forward to being able to add more credit product, but initially the first credit -- the first product that will be added is MSR into the portfolio.

Douglas Harter

I guess, how should we think about the overhead cost or the cost of running that business in light of kind of the slow ramp-up as you've seen others, you know, I know a different business, but other of your mortgage REIT peers kind of closing the [indiscernible] businesses as they can't generate enough volume to support the costs?

Jonathan Lieberman

I think I will answer the first part of that. It's really the cost at the mortgage company, which MITT only owned 45% of. So, to the extent, [indiscernible] down there, MITT only fix up the 45% of that, I think we started it from scratch as opposed to going out and really buying a larger one that is in place in order to build this up the right way with partners that we think can do great jobs scaling it. And yes, for sure, we've talked about the first year or so there being some start-up cost, but I think I'd give an estimate that maybe about a 10 year or so a quarter to submit books. But at the operator level, very happy with what we see in terms of how they are scaling up, and we think we've chosen the right partners that it's not going to get to the point of where some of our other competitors are. And then, yes, for the second part, David?

David Roberts

It's David Roberts speaking. I think we said at the beginning that the management team and we were very focused on making this as much of a variable cost business as possible. And it's the expertise needs [ph]. We're very conscious of the risk of growing too quickly and building up too much infrastructure and then getting on a treadmill that can be negative. So we're building the business plan specifically to avoid those circumstances.

Douglas Harter

And then just a clarification, you have -- you own 45% of the mortgage company, are you guys taking -- you get 45% of the inventory investments that comes up, so you're getting sort of the pro rata investments as well, or how does that allocation work?

Jonathan Lieberman

The allocation of MSR is in arms length transaction between the mortgage company and any of the vehicles, including the REIT. So the management team is incentivized to sell the MSR to the best execution counterparty. And so, if the REIT has appetite, but gets certainly the benefit of the counterparty that can protect us legally and has the appropriate licenses, it is potential if they could get 100% of the allocation of MSR. In other cases, they may share it with other private funds, but those private funds will so pay the same price that MITT would pay for that asset.

David Roberts

And it will be allocated again based on the appropriateness of whatever the asset is to the various deal flows, and so, that's the way that we run Angelo, Gordon and everyone at MITT.

Douglas Harter

Got it. Makes sense.


From KBW, we have Eric Hagen. Please go ahead.

Eric Hagen

Thanks, good morning. A few of my questions were the same as or very similar to Doug's, I guess I will go in a different direction, how much of your asset yield was due to discount accretion this past quarter?

Jonathan Lieberman

I don't have it on me, we get more detail on the Q, which we will be filing later today, but the discount accretion acts on the credit, it typically were around what the amortization of the premium is on the agency book, but [indiscernible] but they are roughly in line. So net-net, we end up really coming close to tax yielding close enough to what the true coupon is.

Eric Hagen

Got it.

Jonathan Lieberman

But that's the impression I have on it right now.

Eric Hagen

So going forward, is it kind of same to assume that we can neutralize -- we can really just run with the coupon in the portfolio?

Jonathan Lieberman

Yeah, I mean we are pretty close to that. We do give all the coupons and do give all the yields, you know, because we have to [ph] actually work through it from our books and the information that we put in the press release in the Q, but it is close to actually to offsetting just given that we buy the agency premium and the credit at discounts.

Eric Hagen

Great, thanks. And you sort of alluded to in your opening comments, but want to get a better sense for what you are predicting for speed on the agency book this quarter in 3Q, we saw the print coming last night it was little bit lower, and I assume you agree with I guess my opinion that doesn't reflect the post-Brexit activity, would you say that is on par?

Jonathan Lieberman

I would agree in concepts, but I would say that [indiscernible] trades or agency book has done a good job of positioning us in you know, some New York, some Northeast type of product, and hence we did rotate and add a little bit of 3% coupon products through the portfolio. So I think that we are very comfortable with the speeds. And then the other thing I would say is that you have to take into account the day count as well for this period, but I would say we certainly know that speed for the next one, two, three months will pick up as the post-Brexit euphoria with bond market really comes through. And then we moved up in the yield once again on the 10-year side. And in often cases, we have seen some of the originators really expand their margin. So you are not seeing nearly the volumes that you have historically seen that a lot of originators had curtailed their origination capacity and really using this is an opportunity to pick up profitability to make up for negative performance on their MSR side.

Eric Hagen

Right. That's helpful, Jonathan, thanks.


[Operator Instructions] We are standing by for any additional questions.

Okay, we have no further questions. Karen, we will turn it back to you for final remarks.

Karen Werbel

Thank you, everyone, and we look forward to speaking with you next quarter.


Thank you. Ladies and gentlemen, this concludes today's conference. Thank you for joining. You may now disconnect.

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