Angel Oak Mortgage REIT, Inc. Q2 FY2023 Earnings Call

Good morning. Thank you for joining us today for Angel Oak Mortgage REIT’s second quarter 2023 earnings conference call. This morning, we filed our press release detailing these results, which is available on the Investors section on our website at www.angeloakreit.com. 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. 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 morning’s conference call is hosted by Angel Oak Mortgage REIT’s Chief Executive Officer, Sreeni Prabhu; Chief Financial Officer, Brandon Filson; and Angel Oak Capital’s Co-CIO, Namit Sinha. Management will first lead off the call by making some prepared comments, after which we will open up the call to your questions. Additionally, we recommend reviewing our earnings supplement posted on our website at www.angeloakreit.com. Now I will turn the call over to Sreeni.

Thank you, Randy, and thank you everyone for joining us today. We were proud to see the work we have done over the previous quarters demonstrated in our second quarter results. In the second quarter, we began purchasing newly originated loans, securitized a pool of low coupon loans, and built upon the work we have done to reduce expenses. Since quarter end, we have increased the pace of our loan purchases, are actively working towards our next securitization, and have taken additional expense savings actions. In a period marked by continued uncertainty in the broader economy and rising rates, we believe we have demonstrated the strength and resilience of our business model and its unique competitive advantages. During the second quarter, interest rates and spreads continued to widen, which negatively impacted mark-to-market valuations of our portfolio and drew down earnings and book value. However, market volatility dampened compared to prior guidance several quarters ago, and expectations are that the Fed is at or near the end of the interest rate hike cycle. While mortgage originations and applications have suppressed, we are experiencing some modest but encouraging recovery in demand, supporting our view that our business is well positioned to capitalize and drive growth. We continue to progress through the year with optimism and a number of key strategic successes under our belt. We have returned our focus to the execution of our growth strategy. We captured additional value by securing our second securitization of the year during the quarter. AOMT 2023 Dashboard enhanced our liquidity position and supported our ability to purchase newly originated high yielding loans from our affiliated loan originator, allowing us to tailor the credit quality and characteristics of the loans we purchase. The securitization also strengthened our balance sheet by reducing our warehouse debt and converting it to non-recourse term structural leverage. Additionally, the loans contributed to AOMT 2023 Dashboard previously carried on our most expensive warehouse facility, while the new loan purchases will be placed on lower-cost facilities. To that end, our current whole loan portfolio is equivalent to the size of roughly one securitization transaction, and although our warehouse debt is expected to increase as we continue purchasing newly originated loans, we don’t expect to reach a whole loan position more than 1.5 to 2 times the estimated value of a single securitization. On the debt side, we are proud to have reduced our warehouse debt by over 63% since the beginning of the year, though the positive impact of this reduction was partially offset by the effect of continued interest rate increases that compressed net interest margins. With that said, we are proud to have accelerated purchases of newly originated high coupon loans this quarter. These loans carry significantly higher coupons than our current whole loan portfolio, and we believe we can continue purchasing loans at an attractive mid-8% range. As a result, we expect the net interest margin to expand in the coming quarters, especially as we continue to execute securitizations consisting of loans from the legacy portfolio. In addition to the immediate impact of net interest income expansion, a higher coupon whole loan portfolio will improve future securitization execution as well. Going into the second half of the year, we expect continued rotation of our portfolio into newly originated higher coupon loans to be increasingly demonstrated in our results. We plan to continue with quarterly securitization, which will support both our growth and liquidity goals. While the risks continue to remain in the market, we are focused on prudently assuming those risks where we feel that we have competitive advantages. We believe that our ability to tailor the credit characteristics of our loans is and will continue to be a differentiator. We are proud of the flexibility we have achieved with our capital structure, and we are confident in our ability to adapt and capitalize on opportunities in the second half of the year. I will now turn the call over to Brandon.

Thank you, Sreeni. We are pleased with our results in the second quarter. In particular, we are proud of the current position of the portfolio, both from a growth and risk management perspective. I will go through the details of our financial results and provide additional color and context as we look to the second half of the year. For the second quarter of 2023, we had a GAAP net loss of $3.7 million or $0.15 per diluted common share. Distributable earnings were negative $3.9 million or a loss of $0.16 per common share. The key driver of our GAAP net loss was a $4.8 million unrealized loss on loans, securitization trust, and the corresponding liability due to mark-to-market valuations. Note that although these assets are marked at a discount, principal payments are received apart. Interest income for the quarter was $23.8 million and net interest margin was $6.5 million, which will remain compressed due to higher variable rate interest expense. As Sreeni mentioned, we expect net interest margin to expand in coming quarters as the AOMT 2023 Dashboard securitization and subsequent securitizations reduce financing costs and interest income grows in line with new loan purchases. Total operating expenses were $5.6 million or $4.5 million excluding securitization costs. This represents a savings of $2.8 million versus Q2 of 2022 and a year-to-date savings of $6.2 million versus the first half of 2022. We are pleased with our sustained operating expense reductions and are actively working to achieve additional savings in the coming quarters. Turning to the balance sheet. As of June 30, 2023, we had $59.1 million in cash, representing an increase of $30 million from Q4 of 2022. Our strong cash position in the trailing six months showcases our focus on maintaining a healthy liquidity level. This additional liquidity provides us with the dry powder for sustained loan purchases that will grow net interest income, improve cash flows, and support securitization execution. Our recourse debt to equity ratio as of June 30 was 2.5 times. As of today’s date, our recourse debt to equity ratio is 1.2 times, which reflects the maturity of repurchase obligations from short-term trades that matured in early July. This is a decrease of 0.8 times versus the comparable recourse debt equity ratio as of the last earnings call of 2 times. We have residential whole loans at fair value of $296 million, financed with $234 million of warehouse debt, $1.2 billion of residential loans in securitization trust, and $71.9 million of RMBS from retained AOMT securities from off-balance sheet securitizations. Additionally, we held $388 million of whole loan RMBS as of quarter end. We finished the quarter with undrawn warehouse financing capacity of approximately $695 million. As of today, we have a total of approximately $230 million of warehouse debt, representing a decrease of approximately 48% over the previous quarter. We were pleased with the AOMT 2023 Dashboard securitization, which had a weighted average loan coupon of 4.5%. This lower coupon deal helped improve the weighted average coupon rate of our remaining whole loan portfolio, which subsequently improves our future securitization pipeline. We have executed our goal of one securitization per quarter and we expect to continue to do so heading into the second half of the year. GAAP book value per share decreased to $9.34 as of June 30, 2023 from $9.80 as of March 31, 2023. The previously mentioned mark-to-market impact of our loans and securitization trust and corresponding liability, which are the loans underlying securitizations for which the cost of funding has been fixed drove $0.19 of the total $0.46 decrease in GAAP book value. Economic book value, which fair values all non-recourse securitization obligations was $13.16 per share as of June 30, 2023, down $0.23 from Q1, driven by our $0.32 quarterly dividend. As with last quarter, we expect valuation changes resulting from interest rate and spread movements to cause GAAP and economic book value to fluctuate in the near term. The weighted average coupon rate of our whole loan portfolio was 4.63% as of the end of the first quarter and increased by 21 basis points to 4.84% as of the end of the second quarter. Since the end of the second quarter, we have purchased and locked for purchase approximately $40 million of additional loans. Our loan purchases this year carry a weighted average coupon rate of 8.4%, a weighted average LTV of 72%, and a weighted average FICO score of 754. With these new loans, the weighted average coupon of our residential whole loan portfolio is approximately 5.17%, representing an increase of over 50 basis points since the end of the first quarter. The increase in the weighted average coupons will continue as additional loans are purchased. Finally, the company has declared a $0.32 per share common dividend payable on August 31, 2023 to shareholders of record as of August 22, 2023. This implies an annualized dividend of $1.28 per share or a yield of approximately 14% as of the closing price on August 7, 2023. For additional color on our financial results, please review the earnings supplement available on our website. I will now turn it back to Sreeni for closing remarks.

Thank you, Brandon. Before turning the call over to the operator for Q&A, I would like to conclude with some brief remarks. We are excited to have refocused on growth as we head into the second half of the year. While the market and rate volatility is likely not completely in the rearview mirror, the current composition of our portfolio has a strong foundation with flexibility to respond as market conditions evolve. Credit risk remains on the radar for the industry. However, we feel that credit risk management is one of our key competitive strengths. By leveraging the engine of the ecosystem, we have the ability to adjust credit offerings based on certain characteristics. Credit selection is a risk we like to own, and we have the ability to select profitable loans with sound credit. The credit performance of the portfolio has been strong, and we expect it to continue to perform comparably well. We believe our results in the first half of the year have demonstrated the strength and resilience of our business model, and we look forward to demonstrating our potential in the second half of the year. As always, I would like to thank the entire Angel Oak team for their hard work and contributions as we seek to build long-term value for our shareholders. With that, we will open up the call to your questions.

Thank you. The first question comes from Don Fandetti with Wells Fargo. Please go ahead.

Yes. It sounds like NII is heading higher due to the higher coupons on loans and more efficient funding, and then there are some expense savings. Do you think you can grow into the dividend over time, or do you feel like at some point it makes sense to trend that?

Yeah. No. Thanks for the question, Don. Yeah. No. Net interest margin should start to increase next quarter. I mean, one of the things that we did with the securitization is we went off of our most expensive warehouse financing over a 9% cash paying rate to securitization debt, which was a significantly lower amount, and then with the new loan purchases. We also should see, like you mentioned, the additional cost savings. So we believe that over the next few quarters, we are going to grow into that dividend to the point where we are adequately covering it, not just from a cash flow basis but from a true net earnings perspective.

Okay. Great. That’s all I have. Thanks.

Thank you. The next question comes from Matthew Howlett with B. Riley. Please go ahead.

Okay. Thanks. My question is just on your position in the market. I’d like to hear an update on which spreads are on 2023 forward and where they have been tightening, where they are now up-to-date? And then just give us a sense of these coupons are tremendous going into the securitization trust now. When you look at what you are retaining off the securitization, what type of IRR or ROE should we be thinking about, and are you still selling down to the rated bonds? Just give us a little update on the securitization market today and how you foresee the next few deals going?

Sure. This is Namit. So from a securitization spreads standpoint, you are right, from the second quarter end to today we have seen meaningful tightening in spreads, not just for non-QM but across the board tightening and the risk overall in the market. We have seen the benefits of that as well, which is likely going to show up, if it doesn’t reverse itself over the rest of the quarter, potentially in the next quarter. We have seen meaningful spread tightening for current coupon deals that have been securitized in the market over the last month unchanged, and the rates market has generally been sort of unchanged in a little bit of a volatile manner. Overall, we see a benefit to that spread tightening to our portfolio. To your question regarding the new coupons, when we create these loans at an 8.25 or 8.5 coupon, generally speaking, the gross returns for securitization on the retained portfolio is high-teens, and that is what we generally penciled in for the marginal loans that come in at these higher coupons. Obviously, they get mixed up with the lower coupons and bring the coupons higher. So that is an element of securitization that comes with a blended pool of these higher coupons versus the lower coupon loans. But on the margin, these loans are accretive to the portfolio and post-securitizations carry high-teens IRR.

When you talk about high-teens IRR, I think equity investors get really excited. That incorporates like a loss-adjusted expectation?

It incorporates — yeah. It incorporates the cost of funds as we see in the market today, and it incorporates reasonable assumptions around prepayments, delinquencies, and defaults down the line. Obviously, those are to the base case scenario, and there are stressors you can run that bring the returns down. But to the base case, high-teens is what we usually see at these higher coupons, and if you think of these coupons as maybe a slightly elevated speed assumption down the line, it probably brings it down to mid-teens.

Okay. And the next question most people would ask would be, how much can you grow your loan portfolio, securitization portfolio today with the existing capital base of the company in the ups you paid down your REPO lines, you freed up a lot of capital? Given where advanced rates are on the securitization market, I don’t know if they have changed or not, how much can we grow here in the next full capacity?

Yeah. We — hey, Matt. It’s Brandon. We have probably enough capacity for three to four good sized securitizations with new coupon loans before we either have to wait and get principal payments back in to keep growing or look to the capital markets at that time to grow.

Will you perform securitization around, say, around $300 million, $400 million, something like that?

Yeah. Exactly. Somewhere around $1 billion, call it, maybe $1.5 billion worth of loans that goes through the system a few times, a few cycles.

Great. We'll look forward to that. Congrats on getting back to growth. Thank you.

Thanks, Matt.

The next question comes from Derek Hewett with Bank of America. Please go ahead.

Good morning, everyone. Could you provide an update in terms of where spreads have trended quarter-to-date and then how that impacts the book value per share?

Since the end of the second quarter, we have observed senior AAA spreads tighten by approximately 15 to 25 basis points. In the past, nearly all securitizations in the non-QM space occurred at the same coupon, which was the current coupon, making it easy to compare one offer against another. However, the current market shows a variety of deals with different spreads, such as 8.5, 7.5, and 6.5 deals. Overall, we have experienced a spread tightening of about 15 to 25 basis points in the new issue market for AAAs, directly affecting the capital structure.

Okay. And then do you have an update in terms of quarter-to-date book value either as of the end of July or through early August?

No. Nothing right now, Derek.

Ladies and gentlemen, with that, we have finished our question-and-answer session. I would like to turn it over to Mr. Brandon Filson, CFO of the company. Please go ahead.

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

This conference has now concluded. Thank you for attending today’s presentation. You may now disconnect. Have a good day.