AG Mortgage Investment Trust, Inc. (NYSE:MITT) Q3 2018 Earnings Conference Call November 8, 2018 9:30 AM ET
Karen Werbel - Head of Investor Relations
David Roberts - President and Chief Executive Officer
T.J. Durkin - Chief Information Officer
Brian Sigman - Chief Financial Officer
Douglas Harter - Credit Suisse
Eric Hagen - KBW
Welcome to the AG Mortgage Investment Trust Third Quarter 2018 Earnings Call. My name is James and I will 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. [Operator Instructions] And also note that this conference is being recorded.
And I will now turn it over to Karen Werbel. Karen, you may begin.
Thanks James. Good morning everyone. We appreciate you joining us for today's conference call to review AG Mortgage Investment Trust third quarter 2018 results and recent developments. Before we begin, I'd like to review our Safe Harbor Statement. Today's conference call and corresponding slide presentation 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 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, November 8, 2018 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.
Thank you Karen and good morning everyone. I'd like to share some highlights from our third quarter 2018 results with you today.
Our core earnings for the quarter, $0.59 per share with three notable item; first, our core earnings benefited by approximately $0.03 per share due to the payoffs in sales of certain of our prime securities. Second, our core earnings benefited about $0.02 a share from the rise in three months LIBOR that we received as part of our swap hedge book, which was above the increase of our Repo funding costs.
As we mentioned in prior quarters, we expect this benefit in differential to dissipate overtime. As a basis of comparison this differential added about $0.05 per share to core earnings last quarter. Third and finally, core benefited $0.01 per share from a retrospective adjustment. During the quarter we declared a dividend of $0.50 per share for the second quarter in a row.
Book value per share at quarter end increased 0.9% from the prior quarter, primarily due to tightening in credit spreads, which was partially offset by modest spread widening in agency RMBS spreads. In October, book value was off approximately 2% due to spreads widening across the portfolio.
We are very pleased to announce our entrance into the single-family rental business during the third quarter. MITT was able to leverage the resources of the Structured Credit Group an Angelo Gordon to complete this transaction. We acquired a stabilized portfolio of 1,225 single-family homes located predominantly in the Southeast United States from funds affiliated with Conrex, the property manager in this transaction.
The purchase price of the portfolio was approximately $140 million. Conrex will continue to manage the properties and has built a robust infrastructure and a regional concentration strategy leading to operational efficiencies and improved execution over site and additional sourcing opportunities. This additional asset class has an attractive risk reward return profile and is a complimentary business to MITT's existing strategies.
MITT is a leader in investing in a wide range of housing and real estate credit transactions and we continue to focus on constructing MITT's portfolio to expand into areas that leverage our platforms specialized housing and real estate credit expertise.
With that I'll turn the call over to T.J. Durkin.
Thank you, David. Good morning, everyone. During the quarter, interest rates rose by 20 to 30 basis points across the yield curve, with the front end leading the move higher as the Fed increased the federal funds rate by an additional 25 basis points in September.
Year-over-year core inflation has moved to the Fed's 2% goal that shows little sign of accelerating and expectations remain well anchored. This combined with the continued robust labor market should keep us on this gradual tightening trajectory into the first half of next year, resulting in some further modest upward pressure on rates.
Bigger picture, global economic activity appears to have peaked in mid 2018, with speeding fiscal tailwinds and tightening financial conditions ultimately calming the market's fears of an overly hawkish Fed.
Agency MBS spreads were marginally wider during the quarter in the face of deteriorating market technicals. On the supply side, origination volumes increased during the quarter as the Federal Reserve reached peak portfolio run off tax. With respect to demand, money managers continued to lend support to the sector on the margin, but have reduced their underweight allocation materially over the past year. Thanks to foreign investors meanwhile remain largely absent.
We see more significant widening so far in the fourth quarter as increased rate volatility in overall risk asset under performance has added to near term pressure on the basis. Although risks prefer their spread widening remain, agency MBS spreads have retraced much of their outperformance versus corporate investment grade spreads from over the last year.
At this point, we anticipate further idiosyncratic widening to be limited, with performance more closely aligned with that of overall fixed income spread products. We will look to maintain our more conservative leverage pasture until spread show greater stability.
In the third quarter, legacy RMBS continued to trade well due to the favorable supply demand dynamic. The CRT market saw broad based spread tightening along with the broader credit markets as well. In the continuation from the second quarter, investors generally favored seasoned CRT deals with comparatively better underwriting collateral versus new issue deals.
Spreads continued to tighten at the bottom of the CMBS capital structure and the credit curve flattened even further. With 10 year BBB minus rated CMBS trading a 100 basis points tighter than at the start of the year, while 10 year AA spreads were largely unchanged.
The demand for higher yielding debt has been both broad and deep, with a wide range of buyers including money managers, hedge funds and dealers aggressively positioning bonds for inventory.
Focusing on Slide 6 of our quarterly earnings presentation, we outline our third quarter activity. As David mentioned earlier, we are very happy to announce the acquisition of the Stabilized portfolio of single-family rental properties during the quarter. We also purchased two commercial loans, several non-QM pools alongside other Angelo Gordon funds and benefited from sales and payoffs from certain prime RMBS securities during the quarter.
Now turning to Slide 7, we discuss our rationale regarding the SFR transaction and the benefits of entering this new strategic product channel. The SFR opportunity sec continues to expand across geographies, quality classes and strategies. In addition to market growth, consolidation of smaller single-family rental operators and the turnover of stabilized portfolios from early investors in the space, all creates a potential pipeline of SFT opportunities in both large and small scale. We believe that permanent capital vehicles such MITT are best positioned as long-term holders of these stabilized assets.
Turning to Slide 8, we provide portfolio statistics on the acquired properties. The portfolio currently has an operating margin of approximately 57%. We expect this margin to improve as vacancies decline following a strategic initiative focused on improvements to leasing and the tenant experience. We anticipate these improvements to result in rent growth across the portfolio. We expect targeted levered returns of approximately 10% on the portfolio with upside to increasing rents and continued operating efficiencies.
On Slide 11, we've laid out our investment portfolio composition for the quarter. The net carrying value of the aggregate portfolio was 3.7 billion for the quarter, comprised of our agency book, which was approximately 2.1 billion; our credit book, which was approximately 1.5 billion and our SFR properties, which was approximately 140 million.
Focusing on our agency portfolio on Slide 12, you'll see a breakout of our current exposure by product type. The constant prepayment rate for our agency book was 6% for the third quarter. Because of the size of our agency portfolio relative to the overall market and the discipline and selectiveness of the investment team when adding agency risk, we expect prepayment speeds for our portfolio to generally outperform the overall universal agency collateral.
On Slides 13 and 14, we'd like to highlight that 44% of our residential credit investments excluding re-performing and nonperforming loans and 76% of our commercial and ABS investments are floating rate in nature and are directly benefiting from the recent increases in the Fed Funds rate.
Moving ahead to Slide 16 of the quarterly earnings presentation, we lay out the duration gap of our portfolio which remained essentially unchanged at 1.12 years versus 1.08 years in the prior quarter.
And as we look ahead we continue to explore ways to deploy capital into our target credit asset classes and deepening the breadth of investment opportunities. SFR is an asset class we're excited about and like to expand into further. Additionally, we're focused on new originated and seasoned residential home loans, MSR, CMBS and CRE debt. We see a large pipeline of opportunities at favorable risk adjusted returns that we continue to source via the Angelo Gordon platform.
Additionally, our agency MBS portfolio provides MITT with a high quality liquid core holding space which we can increase or decrease depending on the relative value we see within different market conditions.
With that I'll turn the call over to Brian to review our financial results.
Thanks T.J. Overall for the third quarter we reported net income available to common stockholder of 20 million or $0.70 per fully diluted share; core earnings in the third quarter was16.7 million or $0.59 per share versus 15.4 million or $0.5 per share in the prior quarter. It was a retrospective adjustment in the third quarter due to the premium amortization on our agency portfolio versus de minimis retro adjustment in the prior quarter.
At September 30, our book value was 19.16 and increase of $0.18 or 0.9% from last quarter due to the reasons David previously mentioned. To give you a better sense of our current 3.7 billion portfolio, I'd like to highlight a few more statistics.
As described on Page 5 of our presentation, the portfolio at September 30, 2018, has a net interest margin of 2.5%. This was comprised of an asset yield of 5.2% offset by a total cost of funds of 2.7%. The net interest margin declined from the prior quarter was primarily due to increase in cost of funds related to the 25 basis point increase fed funds rate in September, as well as the addition of the SFR portfolio, which we have included in our portfolio NIM.
As of September 30, we had 41 financing accounts parties and are financing investments with 31 of them. We financed the SFR portfolio with 37 million of cash on hand and 103 million of five year 4.625% fixed rate debt from an insurance company. The financing is non-mark-to-market and non-recourse.
During the quarter we also entered into a floating rate CRE loan facility to finance the commercial loans that we purchased during the quarter. The borrowing capacity of the facility is 100 million and we have additional capacity for new deals as we've only joined 37 million.
Additionally, we secured favorable financing on our Freddie Mac senior securities that were previously unlevered. During the third quarter we did not any yield effects in the financing market from rate increase and in general funding continues to intensify with new entrants in both the credit and agency space.
At quarter end we had strong liquidity of 121 million, comprised of 30 million of cash and 91 million of unlevered agency fixed rate securities and CMOs. Additionally, at quarter end, our estimated undistributed taxable income was $1.58 and we continue to evaluate this on a quarterly basis to make sure that we are in compliance with the distribution requirements.
During the quarter, we also utilized our at-the-market equity offering program or ATM and we issued approximately 512,000 shares of common stock for net proceeds of 9.5 million.
That concludes our prepared remarks and we would now like to open the call for questions. Operator?
Thank you. We're going to now open our call for questions. [Operator Instructions] Our first question is from Doug.
Thanks. Can you talk a little bit more about the single-family rental portfolio you acquired? I guess how you see the returns there relative to other asset classes and your expectations for growth in that asset class?
Sure Doug. Yeah, so I think as we mentioned, we see sort of a base case levered return had underwrite of approximately 10%. We do think that there is probably upside to that case depending on what we can achieve in both rent growth and sort of operating efficiencies. I think we've laid this out versus just the other asset classes that we see in terms of whole loans, credit securities, CRE et cetera and we think this is attractive and that it's got a very long duration obviously of cash flows and we think it adds good diversification in terms of our core earnings and sort of book value stability. In terms of forward looking purchase, we've really only owned this for about a month at quarter end, so call it two months now, I mean we're still evaluating new opportunities, but also want to be prudent in terms of how we add risk into the portfolio.
Great and then can you just talk about - yeah, obviously we've seen sort of spread widening in agencies in the fourth quarter, kind of what you've seen in other credit assets and how that's impacted your book value?
I would say, the structure - credit space whether it's in Resi or CMBS definitely been more benign than the corporate markets or the equity markets and we've seen some softness in some of the more beta elect sectors of CRT, but it certainly hasn't been as volatile as some of the more generic equity or high yield markets.
Great, thanks TJ.
Our next question is from Steve Delaney.
Good morning. Thanks for taking the question. In terms of the financing on the initial SFR portfolio, I think it was indicated 102 million. Is that debt that you assumed and/or is it debt you placed on, should we assume that it's optimally financed with that 102?
So Steve, no, that was not that we assumed. We ran a competitive process to finance the portfolio, so selected a counter party and negotiated the terms et cetera.
Great, great, so I think we can consider that to optimize. When you bought the portfolio did that under - the process did you revalue, reappraise and book the portfolio at a fresh start valuation per unit or was it just the negotiated -
We did, yeah.
You did, okay. Now, so that begs the question going forward and I'd like to comment about not only long duration cash flow but book value stability. Should we assume that you're going to carry it at depreciated cost and that there's not going to be any kind of fair value noise in that investment class?
It's Brian. That's correct. It's going to be at a depreciated cost, so the depreciation will lower our GAAP book value when we are clear on that depreciation amount is so that folks can easily kind of get back to our cost basis, which is purchase price plus any CapEx that we put in. But we are not - we're not going to fair value it, which is kind of the GAAP treatment for properties.
So just a quicker side Brian, you may be the first residential sort of hybrid residential mortgage REIT turning your property, but if you haven't already taken note of how Starwood, Ladder and others add back accumulated depreciation and they instead just tangible book they use un-depreciated tangible book. I just thought I would mention that. So if your book - we would consider your book conservative if you are not - may be that value that's not reflected because of your cumulated depreciation, that's all I wanted to get.
Yeah. No, very helpful. We've seen those - depreciation for the quarter was $0.02, so our tangible as you call that would have been 19.18. So at this point we just didn't feel like introducing a new metric for such a small amount, but I think in Q4, when it does become more sizable because some of the leases depreciate a little faster than others. Our idea is to try to make some of those companies that you mentioned.
Great and one final thing for me, I'm just curious, we seem to be seeing a lot of momentum in non-agency Resi whole loans across the group whether it's SFT lending, whether it's just in QM, I'm just curious if you guys are looking at that and if you think that something could develop as another asset class going forward over the next year or so?
Sure. We've been in the nonperforming and re-performing loan space for quite some time. We've been acquiring non-QM loans for about a year. We have looked at some of the other asset classes, whether it's SFR loans et cetera. We do kind of see that during our normal course of business and I think we've selective gone after the asset classes that we think make the more sense at that time.
Thank you for the comments.
Our next question is from Eric Hagen.
Hey, thanks. Good morning. To your point on the fact that you're only on the single-family rental stuff for about a month, what is the fee that you guys are paying to Conrex to manage that portfolio?
It's 8% property management fee.
Okay and that's - go ahead.
And we've structured incentives to the extent that they can drive net cash flow yield or rent higher.
Okay, great. Yeah, that was my next question actually, can you scale the - can you scale those fees and it sounds like you will be able to do that, but we can't really get a sort of a run rate feel for what that will really be.
Yeah, it's a bit more complicated than our correction board rack rate.
Yeah, and Conrex, I feel like we've spoken about this TJ, but Conrex is not the sole manager that you guys may use in this strategy. You guys already -
That's correct. We have no corporate affiliation to Conrex. They're simply the property manager on this distinct pool of assets.
Okay and the management fee would be fixed with other potential managers as well. In other words you -
I think there's a general - I think there's a generally accepted range among the property managers that are - at least some amount of scale. So I mean, it could differ a little bit with a different property manager, but it should be within a pretty tight context.
Got it, great. Okay, thanks. Thanks for the comments and congrats on a good quarter.
[Operator Instructions] And it looks we have no more questions.
Great, thank you everyone. We look forward to speaking with you next quarter.
Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.