Angel Oak Mortgage REIT, Inc. Q2 FY2022 Earnings Call

Greetings and welcome to the Angel Oak Mortgage Second Quarter Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Randy Chrisman, Chief Marketing Officer at Angel Oak Capital. Thank you, Randy. You may begin.

Good afternoon. Thank you for joining us today for Angel Oak Mortgage REIT’s second quarter 2022 earnings conference call. This afternoon we filed our press release detailing our second quarter 2022 results, which is available in the Investors Section on our website. As a reminder, remarks made on today's conference call may include forward-looking statements. Forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those discussed today. We do not undertake any obligation to update our forward-looking statements in light of new information or future events. For a more detailed discussion of the factors that may affect the company's results, please refer to our earnings release for this quarter and to our most recent SEC filings. During this call, we will be discussing certain non-GAAP financial measures. More information about these non-GAAP financial measures and reconciliations to the most directly comparable GAAP financial measures are contained in our earnings release and SEC filings. This afternoon's conference call is hosted by Angel Oak Mortgage REIT’s Chief Executive Officer, Robert Williams; Chief Financial Officer, Brandon Filson; and Angel Oak Capital's Co-CIO, Namit Sinha. Management will make some prepared comments, after which we will open up the call to your questions. Additionally, we recommend viewing our earnings supplement posted on our website. Now, I will turn the call over to Robert.

Thank you, Randy. Thank you everyone for joining us today. In the second quarter of 2022, Angel Oak Mortgage REIT demonstrated resilience against the continued volatile environment that saw further increases in interest rates and widespread dislocation across fixed income and securitization markets. In spite of these challenges, AOMR celebrated the one-year anniversary of its IPO, and we are proud of the growth of the company in our first year of being publicly traded. Some notable one-year milestones include our target asset base more than doubling to $3.2 billion, the purchase of over $1.5 billion of high-quality non-QM loans, and as of today, an increase in our loan financing capacity since IPO of over $1 billion to a total of $1.9 billion. Additionally, with today's dividend announcement, we have paid $1.83 per share in dividends well covered by distributable earnings. We remain fully aligned with the Angel Oak Ecosystem, which continues to demonstrate its strategic advantages, and our strategy remains consistent. We deploy capital into our targeted high-quality non-QM mortgage loans, programmatically securitize these loans to lock in a fixed cost of funding and term structural leverage, and reinvest capital into our targeted assets. As I mentioned, we again observed an extremely volatile and uncertain fixed income market in the second quarter, as the Fed continues to increase interest rates, exerting downward pricing pressure on our mark-to-market assets. This impact was partially offset by our interest rate hedging strategy. As a reminder, we do not hedge credit spreads, which widened significantly during the quarter, putting material short-term pressure on book value. We faced an extremely limited securitization market and did not find it beneficial to execute a securitization during the quarter. However, we remain vigilant and were able to execute a securitization in July. We will continue to monitor the securitization market daily. The securitization of current loan production is generating attractive returns with potential upside, and we believe book value will stabilize over the next few quarters. With that said, we continue to believe our non-agency asset portfolio, methodical growth, and sound liquidity management strategy position us well to withstand market volatility. As we stated last quarter, the Angel Oak Ecosystem enables AOMR to effectively customize our desired loan characteristics as markets evolve, which includes the ability to adapt to and capitalize on higher mortgage rates. So far in 2022, non-QM loan volumes have retreated slightly but remained strong. Home price appreciation, while appearing to flatten slightly, has continued and delinquency rates remain near historical lows. Angel Oak growth continues to be driven by quality origination, as our recently originated loans have higher average FICO scores and lower average LTV than those in prior years. Looking forward, we believe we can continue to capitalize on our key differentiators, which I would like to highlight. First, the origination of non-QM loans on a large scale requires unique capabilities that take years to develop and refine. Extensive applicant underwriting and verification must be conducted for a non-QM loan, which creates a high barrier to entry. Angel Oak has invested substantial time and capital over 11 plus years to develop thorough and efficient systems of underwriting and origination, providing enormous amounts of data that we alone can utilize. Second, Angel Oak Mortgage lending, as the loan originator, has the ability to adjust their credit, borrow and origination characteristics as circumstances evolve. This includes the ability to increase or decrease mortgage rates in a volatile rate environment. Due to our proprietary access to the Angel Oak Ecosystem, we can similarly purchase loans with our desired characteristics. Importantly, members of the mortgage and portfolio management teams meet daily to discuss credit and current pricing metrics, enabling AOMR to quickly adjust to changing market conditions. Third, Angel Oak has unmatched experience in the marketplace, brand recognition in aggregating non-QM loans, and executing on securitizations. Over the years, Angel Oak has completed over 30 securitizations, including four for AOMR in 2021 and 2022. The securitizations lock in long-term financing and net interest margin while reducing our liquidity risk. As stated, because non-QM loans typically carry a meaningful spread to conventional mortgage rates, we can often achieve superior returns with lower leverage than many of our peers. We remain confident that we can achieve strong portfolio growth over time, supporting robust and durable distributable earnings, cash flow, and dividends. As such, we are pleased to declare a second quarter 2022 dividend of $0.45 per common share, payable on August 31, 2022, to shareholders of record as of August 22, 2022. With that, I'm pleased to turn it over to Brandon.

Thanks, Robert. And thanks everyone for joining us. For the second quarter of 2022, we had a GAAP net loss of $52.1 million or $2.13 per common share, and distributable earnings of $22.8 million or $0.90 per common share. Q2 annualized distributable return on average equity was 23.1%. The difference between GAAP and distributable earnings is attributable to the growth of our income-generating investment portfolio. The impact of realized gains from interest rate hedges and the add back of unrealized losses on our mark-to-market loan and securitized loan portfolios. In the current quarter, we saw our target asset portfolio increase from $2.7 billion to $3.2 billion, representing a 19% increase. Interest income for the quarter was $29.7 million, a 10% quarter-over-quarter increase. Net interest margin was $16.4 million, representing a slight quarter-over-quarter decrease due to the increased financing cost on our loan portfolio during Q2. GAAP book value per share was $14.73 on June 30, 2022, including the impact of our $0.45 per share common dividend paid in May, down from $16.80 as of March 31, 2022. This 12.3% decrease was driven by unrealized mark-to-market losses on our whole loan, on-balance sheet securitizations, and RMBs portfolios. This quarter, we introduced a new non-GAAP book value measurement which we call economic book value. Economic book value includes valuing all securitization obligations at their fair value. We believe this new metric will provide meaningful information to investors on the current value of the company. Economic value was $16.05 per share on a diluted basis on June 30, 2022, down 8.8% from $17.61 per share as of March 31, 2022. During the second quarter, we purchased $257 million of non-agency mortgages. Increased coupons of our new loan purchases are beginning to have an impact on our loan portfolio. The weighted average coupon loans in our portfolio increased from 4.52% to 4.68% from the end of Q1 to the end of Q2. The weighted average coupon of loans purchased in June and July were 6.46% and 6.93%, respectively. The latest locks on our loans are affiliated mortgage companies with over a 7.5% weighted average coupon. Note that due to the loan origination process, our loan purchases in any given month will typically reflect loan locks from one to two months prior. Turning now to our securitization activity. As Robert previously stated, we did not find any accretive opportunity to execute a securitization during the second quarter. While our target is and continues to be to execute one securitization per quarter, we do not attempt to time the securitization market. The illiquidity and dislocation of the securitization market during the second quarter prevented us from identifying an accretive securitization opportunity. However, July proved to be a bit more accommodative. We completed our fourth securitization since our IPO, a $185 million securitization, where we placed 86% of the capital structure at a 5.8% weighted average cost of funding. The deal included 407 loans with a weighted average coupon of 5.22%, an average credit score of 730, a loan to value ratio of 75.1%, and a debt-to-income ratio of 32.1%. This transaction was also rated by Fitch, with a senior tranche receiving a triple A rating. While the securitization will not have the absolute return generation of some of our previous securitizations, it is still an important step in fixing liquidity and funding costs through the life of the loans. The securitization deal freed up additional cash, reduced loan financing facilities by over $150 million, and helped to clear out lower coupon loans to be replaced with loans over 7% in weighted average coupons. Going forward, we'll continue to target at least one securitization each quarter. However, we could have a quarter with more than one securitization or, depending on the securitization market, may decide to commingle our loans with loans from other Angel Oak Affiliates to ensure that we are taking advantage of the securitization market in a focused and diligent way. Turning to expenses, our operating expenses for the second quarter were $7.3 million. Overall operating expenses decreased by approximately $2.9 million in the current quarter compared to Q1 2022. The key driver of this decrease in operating expense is that there were no securitization costs in the quarter, and a reduction in due diligence and transaction expenses as the loan purchase volume decreased in the quarter. With regard to our balance sheet at June 30, we had $16.1 million of cash and cash equivalents. Our recourse debt to equity ratio was 3.4 times. We have a total of $1.3 billion in residential home loans, $983 million of residential mortgages in securitization trust, and $923 million of RMBs, including $74.7 million in retained AOMT securities from the pre-IPO securitizations. We have unencumbered assets totaling over $160 million and undrawn loan financing capacity of over $540 million. Additionally, note that as of July 31, we held $39.8 million in cash and cash equivalents and reduced our borrowings after the July securitization. As of June 30, we have loan financing facilities with seven financial institutions. We increased our total loan financing capacity by $340 million to $1.64 billion in the second quarter. This was done by closing an additional line with a new counterparty. Subsequent to quarter end, this line was increased an additional $240 million, bringing our total loan financing capacity to $1.9 billion. This, combined with our unencumbered asset balance as of the end of the quarter, demonstrates our commitment to a sound liquidity management strategy during this period of rising rates. Given the strong income-generating foundation of our portfolio and significant distributable earnings coverage, we've declared a $1.45 per share common dividend, payable on August 31, 2022, to shareholders of record as of August 22, 2022. This implies an annual dividend rate of over $1.80 per share or a yield of over 12% as of the closing price on August 8, 2022. Lastly, in the second quarter, we repurchased approximately 190,000 common shares for approximately $3 million through our 10b5-1 stock repurchase plan. This plan expired on July 18 and was not renewed. For additional color on our financial results, please review the earnings supplement available on our website. I will now turn it back to Robert for closing remarks.

Thank you, Brandon. We are proud of Angel Oak's resilience amid this challenging environment. Going forward, we continue to believe that we are differentiated in several ways. First, as part of the Angel Oak Ecosystem, we are aligned with the most seasoned and experienced originators and managers of non-QM mortgages, providing unique access to a steady flow of investments. Second, we have a strong balance sheet with ample liquidity to execute our strategy. And third, we have superior credit underwriting; we are focused fundamentally on credit and credit metrics, which remain better than ever. This has always been core to Angel Oak, and it will not change. In summary, our portfolio remains strong, and we are confident that we can operate in this complex environment by focusing on strong underwriting and sound liquidity. As always, I'd like to thank the entire Angel Oak team for their hard work and contributions to our successes. With that, we'll open up the call for your questions.

Thank you. We will now be conducting a question-and-answer session. Thank you. Our first question is from Don Fandetti with Wells Fargo. Please proceed with your question.

Yes, so good to see the securitization done. I guess if you think about the next couple of quarters, the coast is certainly not clear with a lot of uncertainty. How are you thinking about managing your cash position and future securitizations? Good to see the cash position moved back up in July, but I didn't know if you felt like you needed to build up a larger position.

Yes, hi. This is Namit Sinha. So on the liquidity side, obviously, we keep close tabs on not just the cash but also on the unencumbered assets because sometimes, we don't want to run a very big cash position. But at the same time, you could have a decent chunk of loans sitting unlevered or without any financing, which could be turned into cash on very short notice. So we'll look at that in combination. And we are obviously going to monitor the market and act accordingly. On the securitization side, we're definitely seeing some green shoots. Right now, as you said, it's a pretty choppy environment and things have gone back and forth over the last few months in terms of the strength of the market as it relates to securitizations. But, we are prepared to go, as Brandon mentioned, we are prepared to go into a commingle securitization with other funds or potentially a standalone as the need arises. And as the market presents opportunities, at the very moment, I would say that it looks like a decent opportunity. Obviously, it could change again tomorrow with the CPI print and etcetera. It's a very data-sensitive macro environment that we are living in. But to the extent that we continue to see the trends we have over the last couple of weeks, we would obviously love to tap into the securitization market more frequently than we have in the last quarter.

And then just one housekeeping question: what was the denominator share count for the $0.90 of distributable earnings this quarter?

It was our fully diluted share count. Since that was undiluted, I don't have that right off the top of my head. But I can give that to you after the fact.

Okay, got it. All right, I'm all set. Thank you.

Thank you. Our next question is from Chris Kotowski with Oppenheimer. Please proceed with your question.

Good afternoon. Thank you. I guess, first of all, looking at Slide 8 on the details of your securitization. It just struck me that in prior securitizations, there was a big credit spread, as you'd expect, between the A tranche and the B lower tranches, whereas here, there's hardly any spread at all. I'm wondering why that would be? And then also, maybe I missed it, but did I hear you say the total cost of the financing was something like 5.6%? Because I see the coupon here is 5.22%.

Yes, hi. This is Namit Sinha again. So what you see in the coupon is just the coupon on the bonds, and they can be priced at a discount that reflects the true spread. So if you were to look at the actual spread at which these bonds were priced, the A1’s were priced at 240 over, the A2’s, which is the double A, was priced at 370 over, and the A3’s, which is the single A, was priced at 425 over. But obviously, the coupons on the bond are limited by the coupon on the loan itself. So all three of them carried the same coupon but were priced at different discount prices.

Thank you very much. I understand that, but I guess what's the overall cost of the securitization too, and how much did you retain?

So that the end, weighted average cost of funding on the securitization was 5.8%. And we retained tranches, triple B and below as shown in the slide.

Okay. And so presumably, these were mainly lower coupon loans originated late last year and early this year.

Yes. So that the average coupon on the loan pool that was securitized was 5.22%. So it is materially lower than the coupon that we are locking in today, which is in excess of 7.5%.

Okay. Then I'm also wondering, can you walk us through exactly the difference between the GAAP book value and your new measure? I read that sentence at the bottom, the economic book value marks the amortized cost liability balances of our non-recourse financing obligations. I read that a couple of times, and I'm not sure exactly what it means. So what's the underlying concept behind this new measure?

Yes, it's really related to our own balance sheet securitizations we did in 2021. The obligation related to the 21-4 and 21-7 securitizations, at the time, we didn't elect the fair value option for those securitizations, meaning that we're not marking that to fair value. It's just basically staying at cost. And those bonds were issued nearly at cost. So unlike a dominant was just mentioning some of these bonds being issued at a discount, those were essentially at par. So they're staying at par. But in a rising rate environment, the bonds we sold are now worth a bit less. And that's what we're adjusting back out on those two earlier securitizations. So those bonds that were issued at par during 2021 are now trading at a bit of a discount, and we marked down the liability in that economic book value calculation accordingly.

Okay, all right. And then last for me is Page 8, where you have the bill back to the distributable earnings and the $24.7 million add back on the derivatives. Normally, I always cut and the $38 million on the losses on the residential loans. It always seems to me that in theory those two lines should be going in different directions because presumably the derivative hedges or hedging the residential loans is the issue here that explains the pattern. I guess, let me leave it there.

Part of the situation is related to timing because as we roll those hedges, we recognize realized gains. Additionally, some of the mark-to-market losses in the loan book were caused by spread widening, which is not being hedged. We experienced a slight rally in rates, leading to some unrealized losses on the hedge, but this was offset by the spread widening in the loan book. On the loan side, this is also a cumulative effect over the quarter, where the unrealized losses on the hedges arise periodically as we need to roll those hedges every couple of months. These are the most recent hedges we've implemented, and we did incur some unrealized losses towards the end of the quarter.

And then, I mean, I guess I don't know how to quantify this, but the securitization that you're able to do, how much of the backlog of kind of low coupon loans from the back half of '21 and early '22 mortgages were you able to clean out with that? I mean, obviously, I guess it's $185 million, but I'm just kind of curious how much compares to the similar kind of low coupon loans left on your balance sheet?

Yes, so I mean, as you rightly said, the deal was $185 million. And that leaves us with the rest of the loans that we are working through the securitization. The coupon drift is expected to be higher as we take any cash release coming out of the securitizations and we invest in loans with 7.5% coupons. The effective idea is to keep bringing these deals out on average. As Brandon mentioned in the call earlier, the coupon is right in that context. The coupon that we're starting off on the entire pool is still relatively low coupon loans, and the only way to make the coupons go off is to effectuate the securitizations on these lower coupon loans and then reinvest the cash into the 2.5 to 3% higher coupons that you're making today.

Good morning, guys. Thanks for taking my question. I'll start off with the state of the non-QM market. There have been a lot of headlines and some originators folding, with expectations for consolidation. Just want to hear from you on how you're positioning to take advantage of the market and just sort of what's the update on the state of the industry?

Yes, as you rightly said, there's obviously been pain in the industry over the last three to four months, with the extreme levels of volatility in the interest rate world. And obviously, I would say that you're right; we saw some headlines around a couple of originators folding, and there are more that are struggling. I would say in that kind of environment, we do expect Angel Oak to sort of cement its leadership position and take advantage from a market share standpoint. Obviously, it's not all clear by any means. And given where we are in the macro environment, there are certain events that could happen, starting from the CPI print tomorrow, that could make the environment even tougher going forward, or it could improve over time. The amount of uncertainty in the macro environment is still quite high. That said, given what is happening from a competitive landscape, it does present us with a big opportunity to solidify our leadership and increase market share. From a volume standpoint, we are doing very healthy volumes at our affiliate originators. They're down from our peak but definitely at very healthy levels. We have the ability to grow without taking any expanded risk from a credit standpoint because of the competitive landscape shifting and some of the originators losing their ability to make these loans. So, broadly speaking, while the overall challenges in the market are not great, the silver lining for us is that the stability of our platform allows us to increase our market share and take advantage of the situation.

Yes. I mean, the coupons that you're getting are usually over 7.5%. I mean, for the credit quality, they just look tremendous, and I guess that's my next question. I mean, how aggressive do you want to get in insurance? You've expanded your credit lines, and liquidity looks terrific. In terms of you think you did about 37 million of acquisitions post-quarter in the pool loans? How aggressive do you want to get in the back half of the year if you continue to raise rates like this? Is it dependent on the acquisition market sort of coming back and taking some loans off the line? Because it just seems to me that these are going to be very high returning loans if you continue to put them in the portfolio.

Yes. So we are obviously very mindful of the fact that the loans being created today have very high total return potential. That also needs to be coupled with being disciplined around managing the securitization of the existing pipeline. We are working on both ends effectively, actively looking to hit the securitization market as opportunities present themselves. As I mentioned earlier, we are seeing some green shoots around in that market with spreads coming in, and more than spreads, it's actually the level of demand. It could be driven potentially by a change in expectation; investors have been very reluctant over the last three to four months, and that seems to be showing up as a difference over the last few weeks, where we are seeing more deals come out that are multiple times oversubscribed. Quite aside from the spread, we are very encouraged by the investor participation in these deals. That gives us more visibility around our ability to securitize not just the lower coupon loans but also cement the higher returns on the higher coupon notes that we are originating today. So to the extent that we have more visibility going forward over the next two to three weeks, we are definitely going to look at how aggressively we want to be in originating these higher coupon loans and buying into the entity.

So, if I heard you correctly, you mentioned that things are beginning to tighten across the stack or replace?

Yes, we have seen some of that happen over the last week or two weeks. I just want to caveat that with the fact that over the last three to four months, we have had multiple periods where we saw improved execution and then it would revert. But we definitely are seeing levels of participation and subscription that look very healthy right now.

Great, thanks. I appreciate the economic book disclosure; it makes things much easier to understand. So I appreciate that new disclosure. That's it for me. Thank you.

Thank you, Matt.

Thank you. There are no further questions at this time. I would like to turn the floor back over to management for any closing comments.

Thank you everyone for your time and interest in Angel Oak Mortgage REIT. We look forward to connecting again with you next quarter. In the meantime, if you have any questions, please feel free to reach out to us and have a great evening.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.