AG Mortgage Investment Trust, Inc. (NYSE:MITT) Q4 2016 Earnings Conference Call March 1, 2017 9:30 AM ET
Karen Werbel - Investor Relations
David Roberts - Chief Executive Officer and Chief Investment Officer
TJ Durkin - Co-portfolio Manager and Head Trader
Brian Sigman - Chief Financial Officer
Michael Antilety - Head Agency RMBS and Derivatives Trader
Eric Hagen - KBW
Douglas Harter - Credit Suisse
Trevor Cranston - JMP Securities
Good morning and welcome to the AG Mortgage Investment Trust Fourth Quarter 2016 Earnings Call. My name is Brandon, and I'll be your operator for today's call. 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.
Thanks, Brandon. Good morning everyone. We appreciate you joining us for today's conference call to review AG Mortgage Investment Trust's fourth quarter and full-year 2016 results and recent developments. Before we begin, I'd like to review our Safe Harbor statements.
Today's conference call and corresponding slide presentation contains 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 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 are forward-looking statements by their nature. 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 the slide presentation are made as of today, March 1, 2017 and we disclaim any obligation to update them. We will refer to certain non-GAAP measures on this call and for reconciliations please refer to the earnings press release and 8-K, which are posted on our website and have been filed with the SEC.
At this time, I would like to turn the call over to David Roberts.
Thanks, Karen, and good morning everyone. I would like to share some highlights from 2016 with you today. Including retro adjustments, we produced 2016 core earnings of $1.90 per share, which matched the dividends we paid of the $1.90 per share.
Excluding retro, core earnings for the year were $1.92 per share. Book value per share was almost the same at the end of the year as it was at the beginning $17.88 per share at the start, $17.86 at the end. We began the year with at risk leverage of 3.5 times and over the course of the year, we reduced our leverage, particularly in the fourth quarter, ending the year at leverage of 2.9 times.
Our reduced leveraged was a reflection both of adding certain unlevered positions to our credit book, as well as our decision to take a more defensive posture to this election as rates began to raise rapidly. Our duration gap started the year at 1.79 years, and ended the year at 1.53 years, again reflecting our decision to be to be defensive post-election.
During the year, we repurchased about 615,000 shares or $8.7 million of common stock at an average purchase price of $14.20 per share that represented 2.2% of shares outstanding as of December 31, 2016. On the capability side, we established Arc Home to serve as our residential mortgage origination affiliate.
We believe Arc Home will provide us with significant opportunities to purchase mortgage servicing rights and various whole loan products going forward, and we are very pleased with the company's progress in its first seven months of operations.
Now focusing on our fourth quarter results, book value decreased during the quarter by 3.4% to $17.86 at quarter and year's end. The book value decline was driven primarily by the agency portion of our portfolio, as the rise in interest rates during the quarter resulted in an extension of the duration of our agency portfolio.
We responded to the rate rise and the increased uncertainty post-election by having hedges reducing leverage and adding to our overall liquidity. In the fourth quarter, our core earnings was $0.57 per share, which included a positive $0.06 retrospective adjustment, and a positive $0.03 adjustment for lower G&A expenses in the first three quarters of the year. Without those two adjustment factors, core EPS would have been $0.48 per share.
During the quarter, we declared a dividend of $0.475 per share for the fifth quarter in a row. As I mentioned, we ended the year with a conservative position in terms of leverage, liquidity, and duration gap. Additionally, our borrowing hedging costs have increased. As a result, we expect our core earnings to dip in the first quarter. That said we are currently seeing our opportunities to deploy capital, which will have a positive impact on core earnings going forward.
In terms of our dividend, at this time we do not anticipate any change. Our portfolio is composed of approximately 57% of credit investments on a fair market value basis, while approximately 75% of our equity is allocated to the credit portion of our book. We continue to see opportunities that add to our credit portfolio subject to 40 add constraints by leveraging the Angelo Gordon platform.
As an example in the fourth quarter, we purchased a $15 million commercial real estate loan and what we believe was a very attractive yield. This loan was sourced and analyzed by Angelo Gordon CMBS Group.
Turning to the management team, as announced in our 8-K filing on February 14, Jonathan Lieberman has stepped down as CIO of MITT and will continue in his role as President and Board Member of MITT. In addition to my role of CEO, I have assumed the CIO role. I would like to introduce the other team members in the room.
Co-portfolio Manager and Head Trader, TJ Durkin; Co-portfolio Manager and Head of Quantitative Research, Young Joe; and Head Agency RMBS and Derivatives Trader, Michael Antilety. TJ and Young have helped manage MITT’s portfolio since its IPO, while Mike has been a trader in the firms residential and consumer debt team since 2013.
With that, I will turn the call over to TJ Durkin.
Thank you David, good morning. The outcome of the US presidential race during the fourth quarter resulted in a reprising of a broad array of financial instruments from risk assets to risk free benchmark rates. Pre-election credit spreads have continued a steady ground trader, while interest rates were slowly drifting higher.
Post-elections, the 10-year U.S. Treasury rate increased dramatically, ending 85 basis points higher on the quarter and equity markets rallied on hopes of fiscal stimulus and easing government regulations. The US election brought a paradigms shift to the macro investing environment and was coupled with only the second increase in the federal funds raised since the implementation of its zero interest rate policy.
Amidst this backdrop, mortgage credit markets where liquid and spreads broadly tightened during the fourth quarter. Following the election, we’ve positioned the portfolio defensively against higher interest rates and added a mix of interest rate hedges shortening the duration gap of the portfolio and taking down overall leverage. These and CMBS performed well during the post-election interest rate move on the spread in OAF [ph] basis, much more so than during the taper tantrum of 2013, which was the last time we saw such a dramatic rate lift.
This is impart due to a wider or relative valuation at the onset of the rate move and also due to more stable real money buyer base in the post-QE period of domestic banks for foreign central banks and money managers. Spreads for the credit risk transfer sector where relatively volatile during the fourth quarter as a heavy new issue calendar weight on the market caught and spread widening an underperformance.
After the year's final CRT deal was priced in early December, spreads reverse some of this underperformance. Specifically favorable fundamentals and a strong net demand technical continued to support positive performance in the legacy residential mortgage sectors. Fundamental collateral performance of residential mortgages continue to remain steady and in some cases improving benefiting from continued price appreciation and credit curing.
We anticipate residential mortgage credit will become more available as we expect the new administration to reduce some of the regulatory burden placed on mortgage originators. Additionally, we think the rise in interest rates points to expectations of higher economic growth and rising incomes, both of which will be supportive of home prices and fundamental collateral performance.
And we do not lead a higher rate so materially hamper a housing affordability. We remain constructive on housing and believe home price stability is durable at this time. CMBS and multi-family performance in the fourth quarter also remain healthy, while CMB has generally participated in the broader rally as well.
Focusing on our portfolio on Slide 9 of our quarterly earnings presentation, we have laid out the investment portfolio composition for the quarter. The aggregate portfolio size decreased to approximately $2.5 billion as we took down leverage given increased uncertainty following the election results.
The fair value of our agency book was approximately $1.1 billion and the fair value of our credit book was approximately $1.4 billion. Focusing on our agency RMBS portfolio on Slide 10, the constant prepayment rate for our agency book was 12.9% for the fourth quarter.
The moderate increase in prepayments fees from the previous quarter was driven by the near all time low and primary mortgage rates offered to the borrower during the third quarter. Prepayments fees for our portfolio remain benign and stable, owing to the favorable characteristics of our holdings.
Moving on to our credit portfolio on Slide 11, we are actively managed the credit book during the quarter selling a portion of our CRT positions and residential loans. Additionally, we purchased a commercial real estate loan, other CMBS, including Freddie K multi-family securities.
An interesting credit investment that we made in the fourth quarter was partnering with the broker-dealer that owned a pool of re-performing mortgage loans they were looking to securitize. Having already preplaced the senior debt, they approached Angelo Gordon and a small set of our competitors to sell the mezzanine and first loss risk.
We were able to successfully structure the transaction to making investment appealing to MITT and other Angelo Gordon funds, which included the rate to collapse the transaction in three years. We think this could be repeatable investment strategy as we look ahead to 2017.
On Slide 14 of the quarterly earnings presentation, we lay out the duration gap of our portfolio, which decreased from the prior quarter from 1.81 years to 1.53 years. During the quarter, the agency duration of our fixed rate both extended approximately 60%. We chose to hedge the extension of our agency RMBS portfolio by adding pay fixed swaps, Treasury Futures, and selling Agency RMBS.
In response to the post-election market moment and increased uncertainty introduced, we felt the prudent to reduce our risk profiles during the quarter by reducing both leverage and duration gap. With deferred rates over the next quarter or so to remain within the recent trained rangers as we await details of a broader array of potential fiscal policy actions.
And as we look forward to 2017, we believe MITT is well-positioned to take advantage of a wide range of agency and credit market opportunities and increasingly favorable returns. Specifically, investments we find attractive to add are commercial assets sourced by Angelo Gordon CMBS and real estate private equity group, certain agency MBS, and newly originated residential home loans, and MSRs.
With that, I will turn the call over to Brian to review our financial results.
Thanks TJ. For the full year 2016, we reported net income available to common stockholders of $50.2 million or $1.80 per fully diluted share. Overall, for the fourth quarter, we recorded a net loss available for common stockholders of $4.4 million or $0.16 per fully diluted share.
For the full year 2016, we reported core earnings of $53 million or $1.90 per fully diluted share. Overall for the quarter, core earnings was $16.8 million or $0.57 per fully diluted share versus $14 million or $0.50 per share in the prior quarter. As a result of the rise in interest rates, we had a $0.06 retrospective adjustment in the current quarter due to the premium amortization in our agency portfolio versus a de-minims retrospective adjustment in the prior quarter.
Additionally, the $0.57 of core earnings does include a one-time highlight of $0.03 impact from certain reduced operating expenses. At December 31, our book value of $17.86, a decrease of $0.63 of 3.4% from last quarter, due to the reasons David previously mentioned. To give you a better sense of our current 2.5 billion portfolio, I like to highlight a few more statistics.
As described on Page 6 of our presentation, the portfolio at December 31, 2016 had a net interest margin of 3.16%. This was comprised of an asset yield of 5.18%, offset by a repo and hedging cost of 1.72 and 0.30 respectively for total cost of funds of 2.02%. The increase in yield is primarily due to the increase of interest rates and rotation into higher yielding unlevered investments.
The increase in cost of funds from the prior quarter was due to the addition of the hedges that TJ mentioned, coupled with an increase cost of financing, due to the increase in overnight rates by the feds. As of December 31, we had 35 financing counterparties and are financing investments with 23 of those.
In February, we extended the funding period for another year and would now like $50 million facility that finances our residential mortgage loans. In the fourth quarter, we did not see any illustrate from the financing market from either of the rate increase or money market reform. In general, funding continues to be plentiful with new entrants in both the credit and agency space.
Our liquidity remains strong at quarter-end as we hedge liquidity of $137.9 million, comprised of $52 million of cash and $52 million of unlevered agency hold accretive and $33 million of unlevered agency IO securities. Additionally, at quarter-end, our estimated underserviced taxable income was $1.90 per share.
We continue to evaluate this on a quarterly basis to make sure that were compliant to our distribution requirements. As a reminder, we have until September 2017 to distribute out our 2000 taxable income.
That concludes our prepared remarks. We would now like to open the call for questions. Operator?
Thank you. We will now begin the question-and-answer session. [Operator Instructions] And from KBW, we have Eric Hagen. Please go ahead.
Thanks, good morning. Are you seeing the likelihood for the fed increase later this month being priced in to the repo market right now? And I think you touched on in your opening comments, but how are you thinking about leverage in the portfolio based on our expectations for additional hikes this year, and next year?
Hi this is Michael. With respect to the price in the repo markets, repo has been very stable relative to where versus LIBOR, so the expenses we have seen, three months LIBOR push-up expectations getting the Dundee comments yesterday. We have seen LIBOR obviously push-up at the likelihood of a rate move increase, but those funding spreads versus LIBOR have remained very stable. We see, versus two month three-month LIBOR actually re-trading inside of our agency repo financial trading inside of that with respect to leverage. I will turn it over to David and TJ.
Sure. I think leverage, more a function of the opportunities that we are seeing then, necessarily our funding costs. So, as we move forward and we see attractive investments that will probably affect our overall leverage more so than absolute funding rates.
This is David. And I think also depends on which price of opportunities we see. There are certain investments such as commercial whole loans split come typically without leverage to the extent we increased opportunistically the agency side that would come with leverage.
Got it. Thank you, that’s helpful. And then the yield you guys reported for some of your range of credit assets it looked like it may have jumped a little more than I would have expected quarter-over-quarter, how much of that is just using a higher discount rate versus an actual improvement in your outlook for credit fundamentals?
Of course it is a mixture of a lot of things, but a couple of things like I mentioned, we did buy a couple of higher yielding unlevered assets. Simply commercial real estate loans good example, because unlevered to the yield is pretty high. So that’s picked it up a little bit, some of this because of the increase in rates and some of it is because of improved credit underwriting in the forward cash flows that we’ve seen. Someone says one of those three, but it’s a combo of those three.
Right. Okay, well thanks for the color guys. Appreciate it.
From Credit Suisse we have Douglas Harter. Please go ahead.
Thanks. On the securitized loans or that structured product - structured securitized investment you made this quarter, can you talk about the underlying loan characteristics and what type of sort of leverage you might be putting on the piece that you are retaining?
Sure. They were re-performing mortgages, so all current loans that were purchased from a money centre bank, we effectively took again the bottom part of the capital structure the broker-dealer already pre-placed the senior and we were using modest repo leverage on that investment. We are really benefiting from the structural leverage of the securitization.
Got it. I mean, I guess can you talk about the relative, I mean there has been a strong bid for those types of assets from insurance companies or other asset managers that kind of have a lower cost of capital, can you just talk about the relative advantage that you have in acquiring those loans versus a buyer like that?
Sure. I think those buyers that you mentioned have a little bit more stringent credit box in terms of looking for specific durations of a current pay history. They may not want to look at assets that haven't been occurring for less than three or two years. We can be a little bit more flexible in our credit box and therefore pick up incremental yield.
Make sense, thank you.
From JMP Securities we have Trevor Cranston. Please go ahead.
Hi, thanks. Question on Arc Home, can you just give us an update on sort of what the growth strategy is going to be there in terms of getting origination volumes to larger levels and therefore producing more investment opportunities in terms of MSRs and potentially non-QM loans? Thanks.
Sure. I mean again as David mentioned they are really only in the seventh month of operations. They continue to look to expand both their corresponding and wholesale channels that's not something that happens overnight, and additionally as we look forward to 2017, I think we’ve steadied the platform where we can start adding more non-agency products, which should attract sellers to their platform.
Okay, that's helpful. And then just a question on the yield on the investment portfolio just looking at Slide 6, are you able to quantify how much of the increase in the asset yield is related to the retrospective adjustments versus other factors?
So, I have that information, it is not with me. In the 10-K that we are going to file later today you will be able to see that clear. Definitely some of the piece of the agency was due to that, we had the big increase and rates and there was a $0.06 retrospective adjustment. So, I don't think you can get that information from here and I don't have it on me. So that’s [indiscernible] 10-K later, and if you like you can give me a call back.
Okay, that's fine. Thank you.
[Operator Instructions] Okay, it looks like no further questions at this time. I’ll turn back to the speakers for closing remarks.
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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