Earnings Call Transcript - MITT Q2 2022

Operator, Operator

Welcome to the AG Mortgage Investment Trust Second Quarter 2022 Earnings Conference Call. My name is Vanessa, 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. I will now turn the call over to your host, Jenny Neslin, General Counsel to the Company.

Jenny Neslin, General Counsel

Thank you, Vanessa. Good morning, everyone. And welcome to the second quarter 2022 earnings call for AG Mortgage Investment Trust. With me on the call today are David Roberts, our Chairman and CEO; T.J. Durkin, our President; Nick Smith, our Chief Investment Officer; and Anthony Rossiello, our Chief Financial Officer. Before we begin, please note that the information discussed in today’s call may contain forward-looking statements. Any forward-looking statements made during today’s call are subject to certain risks and uncertainties, which are outlined in our SEC filings including under the headings Cautionary Statement Regarding Forward-Looking Statements, Risk Factors and Management’s Discussion and Analysis. The Company’s actual results may differ materially from these statements. We encourage you to read the disclosure regarding forward-looking statements contained in our SEC filings, including our most recently filed Form 10-K for the year ended December 31, 2021, and our subsequent reports filed from time to time with the SEC. Except as required by law, we are not obligated and do not intend to update or to review or revise any forward-looking statements, whether as a result of new information, future events or otherwise. During the call today, we will refer to certain non-GAAP financial measures. Please refer to our SEC filings for reconciliations to the most comparable GAAP measures. We will also reference the earnings presentation that was posted to our website this afternoon. To view the slide presentation, turn to our website, www.agmit.com and click on the link for the Second Quarter 2022 Earnings Presentation on the home page in the Investor Presentation section. Again, welcome to the call and thank you for joining us today. With that, I’d like to turn the call over to David.

David Roberts, Chairman and CEO

Thanks, Jenny. Good afternoon and thanks to all for joining us. As it turned out, the first quarter was not the end of securitization credit spreads widening. Instead, the credit spread increase accelerated, ending the second quarter at elevated levels we have never seen before. Accordingly, due to mark-to-market valuations, the unrealized losses on the loans we held for securitization were actually more severe in Q2 than in Q1. These unrealized losses were the primary reason we reported a GAAP loss of $2.27 per share. As we discussed last quarter, we hedge against movements in interest rates, but not against movements in spreads. That said, with this difficult quarter behind us, we continue to remain optimistic about our long-term earnings power and our strategy for several reasons. Credit spreads generally reflect the risk of loss. It is important to note that we see no deterioration in credit performance in the residential mortgage whole loans and securities we own. On a further positive note, our current originations reflect fully the move in credit spreads as of today, based on what our team is observing in the securitization market. Our goal remains to increase originations over time subject to our ability to match coupons with financing costs. In the second quarter, we utilized fully our common stock repurchase program. We repurchased 1.4 million shares for an average price of $7.70 per share. This helped to offset our book value decline by about $0.29 per share. Our Board has authorized a new common stock repurchase program of $15 million. We paid a dividend of $0.21 per common share for the second quarter, consistent with the past four quarters. Our dividend policy will continue to be guided by our view of earnings on a go-forward basis, over a multi-quarter period. In other words, our dividend policy is not based on looking in the rearview mirror. Going forward, we will continue to execute on our business plan. We strongly believe in our origination to securitization strategy. Our infrastructure has given us the ability to continue growing our portfolio into higher yielding assets through both Arc Home and other origination partners, supporting our ability to remain active in the securitization market, and to deliver attractive long-term returns to our shareholders.

T.J. Durkin, President

Thanks, David. I’ll review some of the second quarter highlights on page 6. We continued to be an active participant in the market during the second quarter, albeit at a lower volume than the first quarter. During the quarter, we acquired and settled almost $600 million of non-agency and agency eligible loans. Looking ahead, we also have a strong pipeline of loans across both products, which Nick will touch on in more detail later in the presentation. We continue to be disciplined about our warehouse risk and are very proud of the fact we executed two securitizations during another challenging quarter. These transactions not only de-risked our warehouse lines, but also gave us the flexibility to wait out further securitizations until the market started improving, which we do believe has occurred over the last three to four weeks. We are hopeful that this ability to wait on execution will give us the opportunity to recoup some of the unrealized mark-to-market losses we have taken on our unsecuritized loans. We believe we have ample liquidity given the size of our book and as David mentioned, we used approximately $11 million of capital for share repurchases during the quarter at an average price of $7.70, which represented a 31% discount to our June 30th adjusted book value. Nick will cover Arc Home in more detail later in the call, but I’d briefly point out, Arc continues to operate from a position of strength given its strong balance sheet, conservative credit culture, and a number of historical competitors having to take steps back.

Nick Smith, Chief Investment Officer

Good evening. We began this quarter cautiously optimistic that the markets would consolidate in or around levels experienced toward the end of the first quarter. This optimism was unfounded as risk-free rates continued to sell off along with widening of credit spreads. What started primarily as AAA spread widening in the first quarter expanded into the rest of the investment-grade and non-investment-grade stack, ending with a meaningfully steepening of the credit curve. Much of the year, loan spreads lagged this widening. However, at the end of the quarter, we began to see this dynamic fade. At the end of the quarter and into the beginning of this quarter, term financing spreads and loan spreads have come more in line. We expect this trend to continue throughout the rest of this quarter and likely through the rest of the year. One bright spot of the most recent spread widening is the expansion of our expected returns while loans sit on the warehouse. This expansion is due largely to our finance team negotiating favorable terms on the warehouse lines in previous quarters. As you can see on page 7, we expect leverage returns during the warehouse period to be in the 10% to 15% range. It is our view that we have likely seen close to the full impact of the convexity event or lengthening of the underlying asset since prevailing mortgage rates are now at levels last seen nearly 15 years ago, and credit spreads are the widest we have seen in the past decade. As T.J. mentioned, our continued de-risking through regular securitization further mitigates this risk as our underlying non-securitized coupon increases to market rates as we securitize discount coupons. Although the lengthening out of the non-securitized home loan book into widening spreads has caused significant unrealized losses this quarter, the expansion of the duration of our excess spread certificates on our securitized loans offsets the credit spread widening on the retained subordinate certificates. It is also worth noting that despite issuing debt at these wide levels, we retain the option to call this debt three years after issue. Said another way, we will ultimately be able to reduce our costs of debt on the transactions issued this year while leaving the debt issued in previous years outstanding for meaningfully longer periods. We maintain our post-securitization return on equity range of 14% to 25% from the last quarter. As mentioned previously, loan spreads and securitization spreads are more in line versus previous quarters as loan aggregators price in more appropriate liquidity premiums. As we emphasized in previous quarters, as our purchase velocity accelerates, our pace of securitization will have to follow suit. The upcoming quarter’s transactions will show that we have stayed true to this messaging.

Anthony Rossiello, Chief Financial Officer

Thank you, Nick. Turning to slide 12, we provide a reconciliation of our book value per common share. During the second quarter, book value declined by approximately 16% as a result of recording a GAAP net loss available to common shareholders of approximately $53 million or $2.27 per fully diluted share. The loss was primarily driven by unrealized mark-to-market losses recorded on our loan portfolios financed on warehouse, resulting from the unprecedented credit spread widening discussed earlier in the call. The decline in book value associated with our preferred and common dividends was offset by accretion from our share purchases, where we fully utilized the $11 million of remaining capacity on our existing share repurchase program. During the quarter, we purchased 1.4 million shares, or 6% of our total outstanding, at a weighted average price of $7.70 per share. During the quarter, we continued to grow our investment portfolio, which has a fair value of $4.1 billion as of June 30th, up approximately 10% from Q1. With this growth, we continue to see quarter-over-quarter increases in interest income, which approximated $39 million for the second quarter. We recorded net interest income of $16 million, and although we did experience net interest margin compression quarter-over-quarter, this was purely reflective of the sharp rise in borrowing rates, while asset yields lagged as new production comes to market. We have begun to see asset yields catch up as our late June and July purchases have coupons ranging from about 5.5% to 6.5%. Expenses were relatively consistent quarter-over-quarter with the exception of transaction-related expenses, which declined as we executed two securitizations in the second quarter compared to three deals in Q1.

Operator, Operator

We have a first question from George Bose with KBW.

Mike Smith, Analyst

Hi, guys. This is actually Mike Smith on for Bose. Thanks for taking the questions. Just a couple on book value. How much of the 16.6% decline in book has the potential for recovery? And then, as a follow-up, can you just provide any color on the change in book value during the month of July?

David Roberts, Chairman and CEO

Yes, sure. So, in terms of book value, we do have a slide on book value roll forward. And if you take a look, primarily all of the decrease in book value related to our warehouse portfolio. So, in terms of your question, what could be recovered? It would be that portion, which is unrealized, primarily all warehouse. And your second question in terms of an update, just from where we stand right now, we don’t have numbers finalized, but given the sentiment in the market and where spreads have moved since quarter end, we believe book value slightly improved.

Mike Smith, Analyst

Great. That’s a good call. And then, can you just help us get a sense for the current run rate earnings power of the portfolio? The $0.08 implies like a 3% ROE on adjusted book value. So just wondering, how should we be thinking about a normalized ROE on the business?

David Roberts, Chairman and CEO

I think you are going to continue to see the capital that we raised last year be kind of moved from cash to loans on the warehouse, and now into post-securitization return on equity. And so, I think it should keep directionally climbing. I don’t think we want to put an exact number on a guidance on a run rate. But that’s what’s happening organically in terms of the balance sheet and transforming into income.

Mike Smith, Analyst

Great. And then just one more. If we look at gain on sale margins on slide 14, have you seen any changes in terms of the margins during the month of July?

David Roberts, Chairman and CEO

It’s probably early in the month of July. But if you think about there has been some expansion in margin, although just given the broader volatility, the margins have been moving around with it. But, we have generally been able to extract slightly more margin than looking back. But, as mentioned, it’s fairly volatile.

Operator, Operator

We have our next question from Trevor Cranston with JMP Securities.

Trevor Cranston, Analyst

Looking at the return on equity targets, you guys mentioned on securitized loans. There is kind of a wide range there from 14% to 25%. Where are you seeing loan pricing today and securitization execution? Can you maybe kind of generally comment on if you are kind of towards the higher end of that range or lower end or kind of what the current return opportunity is as it fits today? Thanks.

T.J. Durkin, President

Our view, it’s snug in the middle of there, realistically. Obviously, if you look back at the last quarter, there is a lot of volatility around where you can place debt in the securitized place. So, that obviously is why you have such a wide range.

Trevor Cranston, Analyst

Okay. That makes sense. Got it. And then, on the Arc Home results. Obviously, there is value to you guys and the product generation coming from them. But in terms of their operating earnings going forward, with volume and margins where they are at today, is there anything that can be done at Arc to kind of get the operating results up to breakeven type of level in terms of maybe expense savings or anything like that, or would the expectation be that they are probably going to be operating at a kind of modest loss in the near-term?

T.J. Durkin, President

Yes. I mean, I think you’re obviously seeing a lot of rightsizing going on at mortgage companies of all sizes. I think fortunately Arc is a lot smaller from a headcount perspective. It didn’t probably ramp up as much in terms of volumes and headcount in 2020 and 2021. So, there is probably less right sizing to do. And as we continue to probably shift the asset mix of away from agency and into hopefully higher-margin non-agency, that should help push the pendulum into profitability. I don’t think we are miles away. I think we are kind of operating on the cusp there. So, it should be less work than some of the bigger platforms out there.

Trevor Cranston, Analyst

And then, on the share buyback, obviously, it’s pretty accretive buying back shares today. Can you talk about how you think about the Company’s balance between common and preferred equity when you’re looking to share repurchases and if more preferred buybacks are also something that you guys are exploring currently?

David Roberts, Chairman and CEO

We certainly take into account the balance between common and preferred when we’re thinking about common share repurchases. That’s one of the considerations. But as you said at the beginning, a very large consideration is the discount that we can buy it at both to book value and where we ultimately think our earnings are going to be able to get to over the long term.

Operator, Operator

We have our next question from Jason Stewart with Jones Trading.

Matthew Erdner, Analyst

Hey. This is Matthew Erdner filling in for Jason. I know you guys mentioned the credit box, kind of staying similar while other people are expanding. And could you provide a little more detail around that on if you guys are kind of looking at the same credit score or what the details within that are?

David Roberts, Chairman and CEO

Yes. I think more high level, as people became very concerned with convexity, they chased coupon. And as they chased coupon, they sort of got adversely selected, if you will. And that you saw some guys just widening guidelines into this and making wider exceptions. So, that’s really what we saw from others. We actually did the opposite and took this as an opportunity as people were providing less liquidity, and the market became less competitive to dial in certain aspects of the guidelines, but generically still, very similar profile as previous quarters.

Matthew Erdner, Analyst

And then, I’m assuming that your guys’ originations and purchases are going to kind of remain at a constant level based off of that credit box and you don’t really see much being taken away out of that.

David Roberts, Chairman and CEO

Yes, we certainly see that with refinancing activity down and purchases lower, we anticipate that volumes will generally decline, similar to the broader market. However, in terms of market share, we expect to gain rather than lose.

Operator, Operator

We have our next question from Doug Harter with Credit Suisse.

Doug Harter, Analyst

You have a decent amount of activity so far in the third quarter and a significant pipeline. Can you just talk about how much liquidity available cash, ability to take leverage up, kind of how much capacity you have to continue to buy assets with the current equity base?

David Roberts, Chairman and CEO

Sure. I mean, so from a financing perspective, Doug we’ve got ample room on warehouse lines. I don’t have the exact number in front of me, but we’re nowhere near capacity there. And then, I would think of it as the capital that we have currently invested in warehouses is kind of rotating in and out as we securitize and then continue to build that pipeline. So, we can continue our activity that we are doing by recycling that capital for, I think quite some time. And I think we’ve got ample cash on the balance sheet of around $80 million today. So, I think we’ve got a pretty good runway to keep executing the business plan.

Doug Harter, Analyst

Got it. I just want to clarify your commentary. Is the 14% to 25% return on equity for appropriately acquired loans? Additionally, how do you assess the return on the loans currently held on the warehouse line?

David Roberts, Chairman and CEO

I believe this is a forward-looking business. When considering the mark-to-market activity, it adjusts you within those expected returns or within that range. Therefore, it can be examined on its own. If you take into account where we acquired loans, excluding that mark-to-market factor, the returns are certainly higher. However, as mentioned earlier, we have the option to refinance this debt in three years, which provides us the flexibility to reset the debt and align more closely with targeted returns on past acquisitions.

Operator, Operator

Thank you. We have no further questions in queue. I will now turn the call over to our presenters for closing remarks.

Jenny Neslin, General Counsel

Thank you to everyone for joining us and for your questions. Hope you enjoy the evening and we’ll speak to you next quarter. Thank you.

Operator, Operator

Thank you. Ladies and gentlemen, this concludes our conference. We thank you for participating. You may now disconnect.