Earnings Call Transcript - MITT Q4 2022

Operator, Operator

Good day, and thank you for standing by. Welcome to the AG Mortgage Investment Trust Fourth Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. After management's remarks, there will be a question-and-answer session. Please note, today's conference is being recorded. I'd like to turn the call over to Jenny Neslin, General Counsel for the company. Please go ahead.

Jenny Neslin, General Counsel

Thank you, Chelsea. Good morning, everyone, and welcome to the full year and fourth quarter 2022 earnings call for AG Mortgage Investment Trust. With me on the call today are T.J. Durkin, our CEO and 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 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 morning. To view the slide presentation, turn to our website, www.agmit.com, and click on the link for the fourth 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 T.J.

T.J. Durkin, CEO

Thank you, Jenny, and good morning, everyone. 2022 was an extremely challenging year across markets, but particularly in mortgage markets, where an abrupt pivot by the Fed created convexity movements we haven't seen since the taper tantrum of 2013. While MITT did experience mark-to-market losses on assets it owns coming into the year, the vast majority of these losses are unrealized. We continue to have confidence in the earnings power of the portfolio, which Nick will walk you through in more detail later in the call. During this volatile year, MITT remained disciplined by programmatically terming out its financing and avoided taking undue risks by holding loans on warehouse lines, hoping things would simply get better. As a result of this discipline, we believe MITT is materially derisked with ample liquidity as we head into 2023 in a position to play offense when others may not be. We used a portion of our excess liquidity to repurchase almost 2.7 million shares at a weighted average price of $6.82, creating 7% accretion for shareholders. We ended the year in a strong financial position with approximately $87 million of liquidity and a 1.3 return of economic leverage. Those numbers have both improved since quarter-end, which Nick will walk through. Finishing our 2022 year review on Slide 6, MITT created $67.6 million of NIM during the year while recording a loss of $3.12 in earnings per share. MITT declared $0.81 of dividends per share and created $0.08 of EAD per share. EAD is the performance metric we'll be using going forward to replace core, which Anthony will explain in further detail later in the call. Now turning to Slide 7, the fourth quarter opened with continued weakness in the market. However, December was the first month almost all year to show signs of life, with a significant reversal in interest rates, lower new issue volumes, creating a catalyst for spreads within the non-agency space to tighten. As such, we saw our adjusted book value improve 3% from $10.68 to $11.03 per share. MITT had $0.33 of earnings per share while generating $0.05 of EAD and declared its newly stated dividend of $0.18. Based on our early preliminary read, book value is approximately another 3% to 4% for the month of January. While the markets in January got off to a nice start, we don't think the path forward is going to be a straight line towards tighter spreads in our market. We believe the company was able to materially deliver and raise liquidity during a challenging 2022 in order to face 2023, with a clean balance sheet and lots of liquidity to deploy into this new, higher interest rate environment. Lastly, before I pass it to Nick, I'll reiterate what I stated last quarter. The management team is frustrated with our stock price, particularly given what we believe to be a year in which we effectively navigated choppy markets, created lots of excess liquidity, and returned capital to shareholders via our share repurchase program. As a reminder, each of us on the management team and Angelo Gordon, the manager, have a meaningful ownership in MITT. We will continue to work hard in earning the confidence of the market by remaining focused on executing our strategy and taking advantage of compelling opportunities, which we believe will translate into the earnings power to generate attractive risk-adjusted returns for our shareholders over the long-term. Despite what may be another year of challenging market conditions, we and AG are excited about the outlook for the year and look forward to sharing our progress in the coming quarters.

Nick Smith, Chief Investment Officer

Thanks, T.J. Sticking with Slide 7, as you might recall from our Q3 prepared remarks, we stated that we estimated our book value was down approximately 5% to 6% for the month of October. As T.J. noted, our book value ultimately recovered 3% in the fourth quarter, and we estimate that it is up another approximately 3% to 4% in January. We have stated previously that although mark-to-market losses have been significant, most of these losses are unrealized. Consistent with this messaging, this past quarter's modest recovery represents only a small fraction of these unrealized losses. Our economic leverage ratio has significantly declined due to additional Non-Agency securitizations executed in the fourth quarter and into the beginning of the year. Combined, these transactions decreased our warehouse exposure by approximately 600 million, significantly outpacing additional Home Loan purchases of approximately 140 million. Looking at Page 8, our securitization issuance in the fourth quarter and into the beginning of the first quarter continued to outpace our acquisition of new loans. The table on the right shows the continued growth of our securitized loan portfolio, along with the corresponding reduction in warehouse exposure. In previous quarters, we emphasized that we believed it prudent to right-size our aggregation risk considering both current market volatility and expected future volatility. Although we are still cautious and believe it critical to appropriately size our aggregation risk based upon current and expected market conditions, the current positioning likely represents a leaner aggregation pipeline for this year and next. While origination volumes are down considerably given the current economic backdrop, we continue to see opportunity in acquiring high-quality assets with attractive risk-adjusted returns. Recently, we've seen increased competition as a likely consequence of lower volumes coupled with improvements in broader market conditions. Despite the recent tightening, we still believe we can source new credits around an 8% yield with equity returns in excess of 20% on the retained tranches, while the 1.1 to 2 turns of leverage. It is also worth noting that while many other market participants have recently widened their credit box—some significantly to combat lower origination volumes—we have not followed this trend. While we remain constructive on residential mortgage credit fundamentals, we do not think this is a prudent time to be relaxing credit standards as home prices are likely to continue to decline, and a recession is the more probable scenario. On Page 9, we provide high-level summary statistics of our aggregate loan portfolio. As we've emphasized previously, the weighted average mark-to-market LTV of the underlying residential home loans is approximately 66% and the 60-plus day delinquent population across over a $4 billion portfolio is less than 100 bps. Although the forward-looking economic backdrop is likely to remain uncertain, we have not seen any early signs of deterioration in the portfolio's performance. On Page 10, we summarize the earning power of our portfolio. In doing so, we strip out the securitized debt components of our consolidated loans to clearly show only our retained interest in our securitizations, along with the corresponding repo financing held on the retained bonds. The retained interests are a true economic exposure in the securitizations. Notwithstanding the securitized loans that are consolidated on our balance sheet due to GAAP accounting. In this table, we also break out the subordinated positions from the interest-only excess servicing and net interest margin positions. We've stated previously that the combination of these two profiles provides stable cash flows along with mark-to-market upside. The underlying mortgages backing the interest-only and excess spread certificates are substantially out of the money. This provides significant and predictable cash flows while the subordinated certificates represent relatively thick parts of the capital stack at deep discounts. It is worth reiterating that the subordinate certificates are backed by high-quality residential mortgages with low mark-to-market LTVs. While we retain the option to refinance much of the debt we've issued on or after the third anniversary of each transaction, we expect this option to remain out of the money for the transactions issued prior to the second or third quarter of last year. For the transactions issued in the third and fourth quarter, we believe these options are likely to prove valuable given the historically inverted yield curve and wide spreads at the time of issuance. As mentioned earlier, we expect the markets to remain volatile; consequently, we don't expect the recovery in book value to be a straight line. However, we are confident in the underlying credits and the capital structure of the debt we issued to provide long-term value. This table demonstrates the portfolio's current earning power along with its significant total return upside. As you can see, the fair value of the subordinated certificates is at over a 30-point discount to face, representing historically elevated spread and interest rate levels. It's also worth noting the ROE on the far right of the table is achieved by deploying only a modest amount of recourse leverage. On page 11, we outline our investment portfolio, along with the corresponding size and cost of the securitized debt and repo financing. As a reminder, given our continued involvement in securitizations issued, we consolidate the loans and securitized debt on our balance sheet. As noted on this slide, our investment portfolio currently contains asset yields of 5.1% with a weighted average cost of financing of 4.3%. Turning to page 12, the top right bar chart outlines our leverage ratio over the past year. Here you can see the loans transitioning from warehouse lines to securitized debt, bringing down the recourse leverage to where it is today. In the last quarter's prepared remarks, we stated that although we had made substantial progress in renormalizing our recourse leverage ratio from its peak, it was likely to go lower. Today we are comfortable stating that we do not expect recourse leverage to decrease materially from these levels and believe we can prudently increase this over time as we adjust for market conditions and opportunities. As you can see, as of quarter-end, the recourse leverage was approximately 1.3x, which has been reduced further since quarter-end. As of quarter-end, recourse debt accounted for approximately 16% of the aggregate, down from 24% at the end of last quarter. Turning to Page 13. As you can see in the table to the right, origination volumes continue to fall in the fourth quarter contributing to an after-tax loss of $6.1 million for Arc Home. Although there's still room to become more efficient, most of the cost-cutting measures are behind us, and we have likely seen the lows in origination volumes. The combination of historic sell-off seasonality, the lock-in effect in cautious homebuyers, among other factors, are here to stay. But we believe we will experience modest volume increases as the impact of these components wear off and expect the company to return to profitability in 2023. Despite the challenging backdrop, it is important to note Arc Home's strong capital position, as outlined on this page. As of quarter-end, Arc Home has $20.7 million of cash and MSRs validated at approximately $92 million with modest leverage of just under $20 million. We continue to believe Arc Home is well positioned relative to many of its competitors and expect this challenging period to show its resiliency while gaining market share. This strong capital position combined with the current origination environment enabled Arc Home to return capital to the AG investor group in the fourth quarter, of which approximately $4.5 million was distributed to me.

Anthony Rossiello, Chief Financial Officer

Thank you, Nick. Turning to Slide 14, we provide year-to-date and quarter-to-date reconciliations of book value per common share. As we mentioned earlier, the financial markets were extremely volatile throughout the year, and our 2022 earnings are reflective of unprecedented increases in benchmark interest rates, coupled with historic credit spread widening. This resulted in mark-to-market losses on our investment portfolio, partially offset by realized gains on our derivative portfolio. Additionally, a portion of our book value declined during the year related to upfront securitization expenses, as we were disciplined throughout the year, securitizing our warehouse population, executing eight deals during 2022. During the fourth quarter, we did experience some book value recovery, which increased by approximately 3% as a result of recording GAAP net income available to common shareholders of approximately $7 million or $0.33 per fully diluted share. Income during the fourth quarter was driven by unrealized mark-to-market gains recorded on securitized assets due to credit spread tightening in the latter half of the quarter, coupled with realized gains on our interest rate swap portfolio. This was offset by $1.5 million of transaction-related expenses, which were associated with the securitization that closed in October. We also remain active in share buybacks during the year, which contributed to book value accretion of approximately 2% for the quarter and 7% for the year. During the fourth quarter, we repurchased approximately 850,000 shares at a weighted average price of $5.68 per share. For the full year, we deployed approximately $18 million of capital to repurchase 2.7 million shares at a weighted average price of $6.82 per share. Overall, we repurchased about 11% of our outstanding shares during the year at an approximate 40% discount to our December 31st adjusted book value. As a reminder, we authorized a $15 million repurchase program in August of 2022, and our remaining capacity under this program is $7.3 million as of today. As T.J. noted earlier, beginning with the fourth quarter, we've decided to change the name of core earnings to earnings available for distribution, or EAD, with no changes to the definition. We continue to believe that EAD provides useful supplemental information for our shareholders. Although as we've discussed in prior quarters, it continues to have important limitations, as it does not include certain earnings or losses our management team considers in evaluating our financial performance. On Slides 15 and 16, we provide the components of earnings available for distribution, as well as disclose a reconciliation of GAAP net income to EAD for the full year and the fourth quarter. On Slide 15, you can see that EAD for the full year was $0.08 per share. Overall, our net interest income on our investment portfolio exceeded our hedge costs, expense load and preferred dividends by $0.83, which was offset by losses contributed to EAD from Arc Home of approximately $0.75. It is important to note that EAD from Arc Home does not include mark-to-market gains on its MSR portfolio, which was a significant portion of its GAAP earnings during 2022. The mid-portion of the MSR gain was approximately $8.6 million for the year. Arc Home's gain on the sale of loans sold to MITT approximated $6 million or $0.26 per share for the year, which you can see is also excluded from EAD. However, as a reminder, these are recorded unrealized gains contributing to GAAP earnings. Turning to Slide 16, we present the fourth-quarter EAD, which was $0.05 per share. Net interest income, inclusive of interest earned on our hedge portfolio exceeded operating expenses and preferred dividends, generating earnings of $0.18 per share. We recorded a net interest income inclusive of hedge interest of approximately $15 million during the quarter, and our net interest margin at quarter-end was 83 basis points. Our expenses impacting EAD decreased during the quarter, primarily driven by lower non-investment-related expenses and less purchase activity. This was offset by a loss of $0.13 contributed from Arc Home for the quarter driven by lower volumes and gains on sale margins. Lastly, we ended the quarter with total liquidity of approximately $87 million, and as of today, liquidity was approximately $120 million, with the increase primarily due to cash generated from our February securitization. This concludes our prepared remarks, and we would now like to open the call for questions.

Operator, Operator

Thank you, sir. Our first question will come from Doug Harter with Credit Suisse. Your line is open.

Doug Harter, Analyst

Thanks. Just touching on the liquidity point that you made there at the end. Of that 120, how much of that do you think is available for investments as you said you might be able to play some more offense in 2023?

T.J. Durkin, CEO

I think we probably think about running the company with $40 million to $50 million of cash. If you look at kind of our historic leverage ratios over the last 12, 18 months, so I think we've got significant liquidity right now.

Doug Harter, Analyst

And then you mentioned that the calls on older securitizations are kind of unlikely to be exercised. How would you describe the health of kind of financing subordinated pieces in this market? And how would you consider adding leverage to some of the subordinates to build equity since you can't pull it out by resecuritizing?

T.J. Durkin, CEO

Yes, certainly. Obviously, as you leverage the underlying securitizations, the availability of additional financing typically increases. Our expectation is over time that we'd be able to take out more liquidity from those securities, although realistically, while some of them are under-levered today, I think, broadly speaking, we need to see some deleveraging occur before we could take out any substantial cash.

Doug Harter, Analyst

And what is the timeframe for that? Would that be another year or two years just to help us frame that?

T.J. Durkin, CEO

On certain transactions, it could be as soon as 6 to 12 months; for other transactions that might take two years. These tend to be incremental; it's not just taking out another 20%, it's sort of 5% at a time.

Doug Harter, Analyst

Great. Thank you.

Operator, Operator

Our next question will come from Bose George with KBW. Your line is open.

Mike Smith, Analyst

This is actually Mike Smith on for Bose. Can you just help us get a sense for the current run rate earnings power of the portfolio? The $0.05 implies a low-single-digit ROE; just kind of wondering how you're thinking about the timeline for getting to that 16% ROE on Slide 10. And then as a follow-up, how are you thinking about balancing capital deployment versus buying back stock?

T.J. Durkin, CEO

On the earnings power, the reality is our quarter-to-quarter earnings are going to be choppy, due to things like transaction expenses for securitizations, etc. So, we're focusing more on the long-term earnings power, which we're trying to display on Page 10 there. It shows a portfolio or company with significant liquidity to invest at those yields, if not higher, in 2023 terms. We just recently restructured the dividend, and that is how we’re thinking about things in the medium to long term, but I expect the quarter-to-quarter numbers to still be choppy. We hope to take advantage of opportunities to deploy this capital in a timely manner, as we think the opportunity set is probably going to present itself in the near-term. In terms of buybacks, depending on where we are on the stock price, we have good liquidity to continue buying back stock accretively. However, we are conscious of looking at our volumes and the liquidity in the stock, and we don’t want to inadvertently do something damaging over the long term by reducing investor liquidity.

Mike Smith, Analyst

Maybe just on that one on the discount of book, appetite for some type of strategic transaction, whether it be rolling it back into the parent company or merging with a smaller company for some scale and operating leverage. We are curious to hear your thoughts on how you're thinking about that given the discount to book.

T.J. Durkin, CEO

Holistically, we think the company is in a very good position financially from both a balance sheet perspective and from a leverage perspective. We are always looking for opportunities to grow responsibly, and to the extent the right opportunity came to MITT, I think the manager would be supportive in helping grow MITT with its financial assistance to the extent the opportunity was compelling.

Mike Smith, Analyst

Great. Thanks for taking my question.

Operator, Operator

Our next question will come from Eric Hagen with BTIG. Your line is open.

Eric Hagen, Analyst

Couple questions for me. Can you talk a little bit about the warehouse funding for loans right now? Just how the environment is, how readily available that source of funding is? Maybe even what the cost of funds looks like on a new warehouse line today? Even how many counterparties you currently have providing you warehouse funding on the back book? Thanks.

Anthony Rossiello, Chief Financial Officer

So maybe I'll address it on the loan side first. The availability of financing for loans is still far surpassing what we need. If you think, no warehouse lenders lost money in a very volatile year last year and with the short duration of the asset, it's a very desirable lend. Additionally, given the broader pullback in the residential mortgage market, agency volumes are at multi-decade lows as well as on certain balances they have out. So, they are eager to lend what they can. We haven't seen our cost of financing go up, if anything, we expect it to stay the same or get lower. We also haven't seen advance rates decrease, given the number of players looking to enter this space or grow their warehouse positions for non-agencies. We expect that to remain the case. The dynamics for securities are similar, although there tends to be slightly less liquidity for the lower-rated securities. However, for more senior securities, liquidity is fairly comparable to loan liquidity. From a counterparty standpoint, we currently have five. Realistically, that's more than we need, but we're not looking to trim that down, and we're always opportunistically able to add more.

Eric Hagen, Analyst

That's helpful details. Maybe just one more, can you say how big of a margin call you modeled for on the retained bonds from securitization, which are funded with repo? And how do you think about the approach to cushioning with liquidity?

Nick Smith, Chief Investment Officer

Yeah. I mean, generally speaking, we work with our risk department independently. The simple answer is that we're looking at sort of a March 2020 COVID shock in terms of credit spreads. It's a recent enough event that I think that's the right shock to consider when determining if we have enough cash to meet that kind of margin call.

Operator, Operator

Our next question will come from Matthew Erdner with Jones Trading. Your line is open.

Matthew Erdner, Analyst

What do you think is the best allocation of capital, and where do you see opportunities going forward in '23?

Nick Smith, Chief Investment Officer

Yes, certainly. Given the multi-decade loan origination values and this transitional period, I think you don’t necessarily have to be creative, but you have to be open to changing investment theses and considering new products. We saw the announcement regarding new LPAs for Fannie and Freddie, which will be implemented for May deliveries. While these changes are net beneficial to private label execution and competitiveness, some areas become more competitive, potentially taking away from being cherry-picked. We see that as an interesting place to deploy capital as the government further clarifies what was previously implicit in the subsidization of better credits, subsidizing lower credit. We further see opportunities due to wide spreads; as spreads tighten in the private label market, it will become increasingly competitive versus that bid. So I think that represents a longer-term view. We're also interested in looking at prime second liens and HELOCs. Given the lock-in effect for first liens, we believe there is an opportunity, especially since the cash-out market is more or less shut out for HELOCs and second liens, to occupy that space. Those are larger categories we're considering, while always looking for additional opportunities.

Matthew Erdner, Analyst

Do you think the better opportunity is in a securitized product or loan origination?

Nick Smith, Chief Investment Officer

So, as we announced in the last quarter, we see opportunities in securities where we were able to deploy a bit of capital. I think spreads tightened in December and into January, and that has likely shifted back to loans. However, we indicated that we are open to taking advantage of opportunities in new residential mortgage credit. We are certainly not going to buy the loans and take on the credit risk if we can buy it cheaper in the secondary market. I don't think it’s as obvious an opportunity as it was 90 days ago.

Operator, Operator

At this time, we have no further questions, so I would like to turn it back to management for any additional or closing remarks.

Jenny Neslin, General Counsel

Thank you. And thank you to everyone for joining us this morning and for your questions. We appreciate it and look forward to speaking with you again next quarter. Enjoy the rest of the day.

Operator, Operator

Ladies and gentlemen, this does conclude today's call, and we appreciate your participation. You may disconnect at any time.