Angel Oak Mortgage REIT, Inc. Q2 FY2024 Earnings Call

Good day, and welcome to the Angel Oak Mortgage Second Quarter 2024 Earnings Call. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to KC Kelleher, Head of Corporate Finance and Investor Relations. Please go ahead.

Good morning. Thank you for joining us today for Angel Oak Mortgage REIT's second quarter 2024 earnings conference call. This morning, we filed our press release detailing these results, which is available in the Investors section on our website at 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. 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 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 Chief Investment Officer, Namit Sinha. Management will make some prepared comments, after which we will open the call to your questions. Additionally, we recommend reviewing our earnings supplement posted on our website, angeloakreit.com. Now I will turn the call over to Sreeni.

Thank you, KC, and thank you to everyone on the call for joining us today. AOMR had a very productive first half of the year, continuing an upward trajectory that began in Q3 2023, and we expect to continue to capitalize on going forward. For the fourth consecutive quarter, we increased net interest income by purchasing current coupon loans while managing and reducing borrowing costs. We led a securitization during the quarter, AOMT2024-4, a $300 million deal. We also had a modest participation in a deal alongside other Angel Oak strategies. These securitizations reduced funding costs and freed up capital to rotate into higher-yielding assets. We are currently projecting securitization yields in the mid to high-teens, which is more aligned to what we observed historically. Additionally, we filed a $750 million shelf to be used for our future capital raises over the next few years. We then immediately used that shelf to issue $50 million in senior unsecured notes that will be used to fund the next several quarters of growth. Now highlighting some of our results. The second quarter marked our fourth consecutive quarter of net interest income growth with sizable improvements on a quarterly, year-to-date, and year-over-year basis. This is a result of methodical new loan acquisition, diligent management of capital and financing costs, and efficient securitizations. Additionally, targeted efforts to judiciously manage our operating cost structure alongside prudent portfolio risk management have led to sustained low operating costs. These efforts are enabled and supported by the Angel Oak ecosystem with its market-leading origination and securitization platforms positioning the company for continued success. Looking ahead to the second half of 2024, while origination dynamics continue to reflect a variable and high interest rate environment, we remain optimistic and believe we are well prepared to capitalize on additional accretive loan purchases. Our GAAP book value decreased 3% in the second quarter, primarily due to our quarterly dividend payment. Economic book value decreased 4.5% versus the first quarter, a decrease of 2.2% net of our dividend, demonstrating the conversion between the GAAP and economic book value that we expect to see over time as our early securitizations pay down at par value. When assessing our credit performance in the quarter, the weighted average 90-day delinquency rate across our portfolio of whole loans, securitized loans, and RMBS was 1.7% versus 1.8% at the end of the first quarter of this year. Delinquency activity for the quarter remained muted, indicating that our partnership with Angel Oak's affiliated mortgage originator is a useful tool in managing our credit quality and allows us to maintain a unique advantage relative to other competitors in the marketplace. We continue to display excellent trend performance and are determined to maintain the health of our portfolio in a disciplined and thoughtful manner. These accomplishments propel the positive momentum we carried into our $50 million senior unsecured notes issuance in July, which we expect to catalyze the next phase of growth for AMR. With this additional capital, we intend to deliver greater net interest income and earnings, facilitated by the purchase of additional high-quality, newly originated loans and continued execution of profitable securitizations. We'll continue to maintain our vigilant and methodical capital allocation, credit underwriting, and liquidity management strategy. With that, I'll turn it over to Brandon, who will walk us through the financial performance for the second quarter in greater detail.

Thank you, Sreeni. In the second quarter, the company had a GAAP net loss of $0.3 million or a loss of $0.01 per common share. Distributable earnings results were a loss of $2.3 million or $0.09 per common share. The exclusion of unrealized gains on residential loans was the primary driver of the difference between GAAP and distributable earnings. As Sreeni mentioned, the second quarter of 2024 demonstrated continued upward progress in top line interest income and net interest growth. We saw sizable gains in net interest income over the course of the past quarter and year-over-year, which marks an annualization of our return to growth after taking a defensive stance through much of 2022 and the first half of 2023. The company's net interest income expanded for the fourth consecutive quarter, growing by nearly 50% compared to Q2 2023, signaling the sustained and growing strength of the portfolio. We continued our pace of averaging one securitization per quarter and have maintained reduced levels of operating expense. We believe that our progress in recent quarters serves as a precursor to future quarters when we expect the deployment of the proceeds from July's senior unsecured notes issuance to catalyze the next phase of growth for AOMR. Interest income for the quarter was $25.9 million and net interest income was $9.5 million, marking a nearly 50% improvement over the second quarter of 2023 and a 10% improvement over the first quarter of 2024. Interest income grew over 9% compared to the year-ago quarter and interest expense decreased 5%. While interest rates have remained elevated, net interest margin has expanded by over 250 basis points from the first quarter. Growth has been driven by accretive loan purchases, pragmatic securitizations, and focused capital allocation. We remain committed to our disciplined approach to loan acquisition and expect net interest income to continue growing in the next few quarters, though we may see a temporary pause in net interest income growth as we deploy proceeds from July's debt issuance. In the second quarter, our operating expenses were $5.5 million or $3.4 million excluding securitization expense and noncash stock compensation. This represents a decrease of $400,000 versus the same metric in the prior quarter and a decrease of $900,000 compared to the same metric in Q2 2023. When we analyze our expenses, we choose to exclude our noncash stock compensation expense as well as securitization costs since our cash returns are not impacted by stock compensation and costs related to securitization activity are directly in line with the execution of our business plan. We are confident we will be able to maintain these low level operating expenses. And while the bulk of the savings efforts are most likely behind us, we will, as always, diligently explore opportunities to optimize our cost structure going forward. Turning to the balance sheet. As of June 30, we had $44 million of cash on hand. Our recourse debt-to-equity ratio was 1.2 times at quarter end compared to 1.8 times as of March 31, 2024. As of today's date, our recourse debt-to-equity ratio is approximately 0.9 times, reflecting the maturity of our short-term U.S. treasury assets and corresponding repurchase agreements held at quarter end as well as our $50 million senior unsecured notes issuance and $20 million share repurchase. As we continue to opportunistically acquire loans, we do expect debt levels to increase. However, we believe that our recourse debt-to-equity ratio will remain below 2.5 times on a long-term basis. Our residential whole loan portfolio stood at a fair value of $159 million as of quarter end, financed with $101 million of warehouse debt. We had $1.4 billion of residential mortgage loans and securitization trust and $285 million of RMBS, including $19 million of investments in risk retention vehicles, which are included in other assets on our balance sheet. In the second quarter, we closed AOMT 2024-4, which was our first stand-alone securitization transaction of the year, to which we contributed loans with a scheduled unpaid principal balance of $300 million and a weighted average coupon of 7.4%. The deal enabled us to save approximately 100 basis points on the financing rate of the loans underlying the deal. Additionally, we participated in AOMT 2024-6 in June, to which we contributed loans with approximately $23 million of scheduled unpaid principal balance. These securitizations combined with AOMT 2024-3 executed towards the end of the first quarter, effectively cleared out our unsecuritized residential loan portfolio, and we've been steadily purchasing newly originated loans to work toward our next securitization. We remain confident in averaging one securitization per quarter going forward, though our next securitization may not be until late third quarter or early fourth quarter as we replenish the portfolio with newly originated loans. We continue to methodically target high-quality loans primarily through our affiliated originator. Furthermore, we are committed to maintaining disciplined daily capital management as part of our operating strategy. We will remain judicious when applying leverage to our assets, ensuring that we continue to maximize earnings while operating with adequate liquidity. Looking to book value. Our GAAP book value per share decreased 3% to $10.23 as of June 30, down from $10.55 in the first quarter. Our economic book value, which fair values all nonrecourse securitization obligations, was $13.16 per share as of June 30, down 4.5% from $13.78 per share as of the first quarter. We expect that rate and spread movements over the course of the last month, as well as a reduction in dividend costs as a result of our share repurchase, had a positive impact on GAAP and economic book value as of today's date. In the second quarter, we purchased $114.4 million of loans that carried a weighted average coupon of approximately 7.9%, with a weighted average LTV of 70.4% and a weighted average FICO score of 757. Our residential whole loan portfolio carried a weighted average coupon of 7.71% as of the end of the second quarter, a 60-basis point increase since the end of the first quarter of 2024 and a nearly 300-basis point increase from the second quarter of 2023. As of today's date, and including committed purchases, the projected unpaid principal balance of our unsecuritized loan portfolio is over $200 million. These loans and additional purchases will form the next securitization from AOMR and should be highly accretive to the company and its stockholders. Additionally, the pricing spread on our largest warehouse facility has been reduced by 25 basis points, which should lead to additional net interest income now to expand on our capital issuance to the end of July. On July 25, we successfully closed an offering of $50 million in 9.5% senior unsecured notes due 2029. We intend for this to be an accretive capital raise that feeds the next phase of growth for AOMR. We plan to deploy the majority of the proceeds into high-quality newly originated non-QM loans, driving further incremental earnings and investment portfolio growth. Additionally, we used $40 million of the proceeds to repurchase shares from one of our pre-IPO investors, which we viewed as an opportunity to reduce our overall cost of capital and drive up economic book value per share. Finally, the company declared a $0.32 per share common dividend, which will be paid on August 30, 2024, to stockholders of record as of August 22, 2024. For additional information on our financial results, please review the earnings supplement available on our website. I will now turn it back over to Sreeni for closing remarks.

Thank you, Brandon. We are pleased with the significant progress we have made over the past 12 months and believe that we are well positioned to begin the next phase of growth for our shareholders. Powered by newly raised capital, we plan to increase our investment into the business through the continued acquisition of loans, securitization execution, and focused capital allocation. From a rate perspective, the consensus is that we are likely entering into a more accommodative environment. All else being equal, a declining rate environment would have a positive impact on our business in general, primarily because we would expect to see financing cost reductions and increases in the valuation of our existing portfolio. While there may also be a reduction in the coupon of newly originated loans, we would still expect to see a net benefit, and sticky financing costs based on SOFR would decrease with Fed funds rate cuts. With that said, weaker employment and earnings trends in recent days have sparked fears of a potential economic downturn and with that heightened credit risk. We believe that credit risk management is a competitive strength of ours due to our relationship with the Angel Oak ecosystem, which provides us the ability to adjust credit offerings based on our specific desired characteristics. Credit is the risk we choose to own, and we expect our portfolio to continue to perform comparably well. We are optimistic that the broader economic backdrop will be generally supportive of our outlook and may potentially lead to additional opportunities not only in the non-QM residential mortgage market but in capital markets as well. We will now open the call to your questions.

We will now begin the question-and-answer session. Our first question comes from Don Fandetti with Wells Fargo. Please go ahead.

Yes. Brandon, can you talk a little bit about with NII increasing, do you feel like you're in a position to maintain the current dividend level?

Don, yes, absolutely. We've been increasing the NII for the past four quarters. I think if you look at it from a net interest margin perspective, with fewer cash expenses, we managed to improve that coverage by about 20% this quarter to 80% coverage of the dividend just from a cash basis. Like I said, we probably have a little pause this next quarter as top line grows, but we work to deploy and leverage the proceeds from the debt issuance. But then in Q4, we expect a further expansion that, again, will believe will be an effective covering of the dividend.

Got it. And then you've had a pretty big move in rates. What is your economic book value in July and August?

Yes, that we actually haven't had a chance to precisely assess since it's been so dramatic. There's the rate move and then there's also a spread component which we need to consider as spreads in our business kind of widened out to meet the decrease in rates at least temporarily. But I think empirically any of the decreases we had as of June 30 would be now at least flat, if not up.

Our next question comes from Doug Harter with UBS. Please go ahead.

Thanks. Can you talk about how much growth do you think that the unsecured issuance can provide, kind of net of the repurchase that you did?

Yes. We believe that the approximately $30 million of net proceeds remaining after the repurchase will likely give us the ability to consistently acquire loans over the next three to four quarters. Initially, this $30 million will enable us to purchase about $200 million worth of loans. Following that, we plan to buy an additional $180 million, with a gradual decrease thereafter. Overall, this will support close to $1 billion in residential loan purchases in the upcoming quarters.

And then I guess, given kind of where your recourse leverages, how do you think about the ability to issue additional unsecured as you look to be able to continue to scale up the business?

We are definitely considering this. Our goal is not to grow indiscriminately. We have just raised capital and are starting to utilize it. We expect to see around $200 million in committed loan purchases coming in the next few weeks due to this debt. However, we believe our balance sheet can support more, and we want to ensure we act at the appropriate time. With the recent changes in rates, we might explore another tranche to refine pricing slightly.

And the next question comes from Eric Hagen with BTIG. Please go ahead.

Hey, this is Jake Katsikas on for Eric. Thanks for taking my questions. Just talking about prepayment activity, are you expecting a pickup in prepayment activity as a result of the recent interest rate moves? And at what level of rates do you think prepayment activity will begin to accelerate more meaningfully? Thank you.

Yes. We've already observed a slight increase in prepayment activity even prior to the rate changes, which is why our GAAP and economic book value declined a bit this quarter compared to expectations. While rates themselves didn't change much, prepayment speeds did rise slightly. In our portfolio, we have a diverse range. On one hand, we have the 5% coupon portfolio, which requires a substantial rate change for prepayment speeds to rise significantly, and on the other hand, we have the 8% portfolio, which is more reactive to prepayments. If prepayments are increasing due to falling rates, our financing costs should decrease, allowing us to reinvest those proceeds back into assets, potentially benefiting from a slight yield increase. In summary, we have a good level of protection against prepayment speed increases of 10 points. Historically, non-QM has seen prepayment rates around 25 to 30 CPR, and we base most of our modeling and assumptions in the securitization market on that. Recently, the rates have been much slower, at single-digit levels. We anticipate a return to the 25% to 30% range in the upcoming quarters.

Great. Thank you so much.

Our next question comes from Matthew Howlett with B. Riley. Please go ahead.

Hey, guys. Congrats on a great report. I know things are fluid right now, but with the move in rates and your coupons around 80%, any sense on what the ROEs will be on retained interest with securitizations going forward? I mean I'm assuming they're going to be a lot higher than what you thought they were a couple of quarters ago.

Yes, I believe there is potential for a type of securitization that could result in a higher return relative to funding costs. We experienced something similar in 2021 shortly after our IPO. Looking ahead to next year, if rates decrease and remain low, we expect our loan coupons and funding costs to decrease as well, while still aiming for a return on equity in the mid to high-teens to low 20% range. However, it is possible that the next few securitizations may have a slightly higher return hurdle, depending on economic conditions.

Have you started lowering rates?

Matt, Sreeni here. Before the last few days, we have been lowering rates because rates have been decreasing over the past few weeks, not just the last two days. However, in the last two days, the spreads on the securitization side have widened due to the overall market conditions. Currently, we have maintained flat rates, but you should anticipate that the mortgage company and others will reduce rates soon.

So just in summary, if I can summarize what I heard. I mean you could do about $1 billion of loan acquisition here with the new capital that you raised in July, which will take you a couple of quarters. You still do a couple of securitizations per quarter, but you think you can grow that kind of non-recourse leverage up pretty good with access to the securitization market. And that's going to have a huge impact on your NII probably way above the dividend. Did I hear you right about $1 billion of loan acquisitions in the next few quarters?

Yes. That should be what we had available to fund, and then plus the senior unsecured notes will also support that as part of that $1 billion.

Absolutely incredible. I guess just the last question is, are you seeing competition in the non-QM space? Or has this been somewhat cleared out following the last couple of years? You guys are the leaders in it, and we haven't observed much activity from anyone of your size. Are you encountering any competitors?

No. Yes, the guys in the previous batch have been cleaned out. I would say, from a consistency of origination to credit management and securitization, we would consider ourselves to be a leader. We are seeing small competition from insurance companies, but not from the REIT industry; from the insurance company, but they're very selective about how they get involved. As rates continue to decrease and the securitization bid gets stronger, I think that the insurance companies may be less competitive. Obviously, there will still be buyers. But from what we are trying to achieve, we have enough in what we're doing where we don't feel constrained or stretched.

Right. Exactly. Well, certainly, we look forward to the next wave of growth for the company. Appreciate it.

Thank you.

This concludes our question-and-answer session. I would like to turn the conference back over to Brandon Filson for any closing remarks.

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

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.