Earnings Call Transcript - MITT Q3 2021

Operator, Operator

Welcome to the AG Mortgage Investment Trust Third Quarter 2021 Earnings Conference Call. My name is John, and I will be the operator for today's call. Please be aware that the conference is being recorded. I will now hand it over to Jenny Neslin.

Jenny Neslin, Speaker

Thank you, John. Good morning, everyone, and welcome to the Third Quarter 2021 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, 2020, and our subsequent periodic reports filed 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 morning. To view the slide presentation, turn to our website, www.agmit.com and click on the link for the third quarter 2021 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, CEO

Thanks, Jenny, and good morning to everyone. I'm pleased to report that we had a terrific third quarter as we continue to execute on our transition to a pure-play residential credit mortgage REIT. As part of our new focused mission, we substantially completed the exit of our legacy assets at prices and terms that were better than or in line with our expectations. These transactions contributed to a material increase in our book value per share. As of September 30, our book value per share was $16.92, and our adjusted book value per share was $16.45, both figures represent a net increase of 12% from June 30. These successful sales and resolutions of our legacy assets provide us with significant liquidity. We have been using a portion of that liquidity to execute on and expand our go-forward business plan of originating and securitizing non-agency loans. We continue to believe that we have a competitive advantage in executing that plan, an advantage based on our proprietary origination engine of Arc Home, combined with the broad resources and expertise of Angelo Gordon's structured credit group. As T.J. and Nick will discuss, our origination and securitization activities year-to-date have been comfortably within our projected range of 14% to 18% return on equity. We have also been pleased with the volume and quality of our originations as well as the continued rollout of new origination programs and new origination channels, all of which will help propel our growth over the long term. As we shift our lower-yielding investments and excess liquidity into these very attractive returns, we have continued to make progress towards realizing the full earnings potential of our go-forward strategy. For the third quarter, our earnings were heavily influenced by the exit of our legacy assets. Our third quarter GAAP earnings per share was $1.87, and our core earnings per share was $0.96. As we did on our second quarter earnings call, we'd like to point out that core earnings does not capture certain important elements of our originate and securitized go-forward business plan, and Anthony will highlight that later in the call. For the third quarter, we maintained our dividend of $0.21 per share. Future dividend decisions, which, of course, are always subject to Board approval, will be influenced by our expectations and projections of the continued execution of our rotation into our go-forward strategy and the resulting positive effect we believe that will have. I will now turn the call over to T.J.

Thomas Durkin, President

Thank you, David, and good morning, everyone. As David mentioned, we increased our adjusted book value by about 12% this quarter, reaching $16.45 per share from $14.72 per share last quarter. We expanded our portfolio from $2 billion to $2.2 billion while reducing our economic leverage ratio from 2.2x to 1.8x. During the quarter, we also doubled our liquidity to over $143 million, comprising cash and unencumbered Agency MBS. We'll discuss our strong pipeline and how we plan to rapidly deploy this new capital. To provide more insight into our activities, we purchased around $610 million of non-agency loans. Our mortgage affiliate, Arc Home, achieved record production in its non-agency channel during the third quarter, and Nick will elaborate on that later. In October, we continued our active acquisition strategy by buying an additional $386 million of loans, showcasing the reliability of our asset pipeline to support MITT's growth. As previously mentioned, both legacy commercial loans on our books entering the third quarter were paid off at par. The proceeds, along with our earlier disclosed sale of CMBS during the quarter, generated net proceeds of over $63 million for reinvestment. As David highlighted, MITT has no remaining commercial exposure and is fully dedicated to expanding our residential loan portfolio. During the quarter, we also decreased our exposure to Agency MBS as we believed the basis was unlikely to tighten further and sold our remaining MSR portfolio. Additionally, we bolstered our liquidity by generating nearly $30 million from a significant sale of our legacy RPL and NPL whole loans, which we will discuss in more detail later. Regarding our financing and capital activities this quarter, we successfully completed another securitization in August, with more details provided later in the presentation. As I have stated in previous calls, we remain committed to being disciplined with the pace of our securitizations to minimize risk in our warehouse lines. To accommodate our growing investment pipeline and provide flexibility, we increased our borrowing capacity for non-QM products to $1.1 billion and added $500 million for financing GSE non-owner-occupied loans. This quarter, we actively utilized our existing share repurchase program, repurchasing approximately 260,000 shares at a weighted average price of $11, significantly below our book value, using about $2.8 million of our excess liquidity. The company still has around $11.8 million of capacity left under the current buyback plan and will continue to assess repurchases if they are beneficial to our balance sheet. Moving on to Slide 7, we want to take a moment to explain visually what was a notably active and crucial quarter for MITT as we reposition to a pure residential mortgage credit REIT. We began the quarter with $71 million in liquidity. Securitization proceeds exceeding warehouse lines contributed an additional $30 million. The payoff of our remaining commercial real estate loans and sales of CMBS generated another $63 million in net proceeds. The sale of reperforming and nonperforming loans added $29 million, and we received another $6.8 million from agency sales. We effectively utilized this liquidity during the quarter to invest $58 million net of financing into non-QM loans, invest another $16 million net of financing into GSE non-owner-occupied loans, repurchase $2.8 million of common shares at a weighted average price of $11, and pay out a total of $8.9 million in common and preferred dividends. In summary, during the quarter, we managed to double our liquidity, successfully exited non-core business lines at a profit, and gained substantial capacity to continue deploying funds within the residential whole loan sector. Following the end of the quarter, we invested $48 million of liquidity into new whole loan investments, leaving us with $91 million in liquidity as of October 31.

Nicholas Smith, CIO

Thanks, T.J., and good morning, everyone. Turning to Page 10. Here, we provided a breakdown of our residential portfolio where you can further see the migration of assets into newly originated non-agency loans, driven by sales of legacy assets and continued reinvestment into residential mortgages. Given our acquisition pace, we thought it would be helpful to highlight our post-quarter activity, which included further growing the residential mortgage book by approximately $386 million, with loans sourced from both Arc Home and third-party originators. While I'll discuss more on Arc in later slides, I think it's worth noting here that we have seen a meaningful pickup in registrations and locks through various Arc Home origination channels, which we believe will further support our portfolio growth. Also on this slide, we highlighted the assets currently on warehouse totaling $760 million, which we will seek to securitize in the near term as part of our strategy. On Page 11, we provided a summary of loan characteristics for our non-QM portfolio as well as the GSE non-owner-occupied loans we began acquiring in the third quarter. We believe we can continue to acquire similar credits through the expansion of existing acquisition channels and the rollout of new ones. Year-to-date, we have acquired approximately $1.3 billion of newly originated non-agency product and continue to grow our footprint at Arc Home, which I will cover in more detail on the next slide. During the quarter, we also purchased approximately $213 million of investor loans, an additional $105 million in October. As many expected, the FHFA and Treasury suspended certain amendments to the PSPA implemented by the previous administration. One amendment was the 7% GSE acquisition cap on non-owner-occupied and second homes. Although we've seen a slowdown in the pace of GSE eligible non-owner-occupied acquisitions subsequent to the suspension, we remain confident in our ability to deploy capital in this space at attractive returns. We are happy with our progress this year in repositioning our portfolio and currently have adequate warehouse capacity and liquidity to support continued growth. To reiterate what T.J. said earlier, as we grow, we are focused on increasing the pace of our securitizations to keep up with the pace of acquisitions and decrease our warehouse exposure. Over the summer, we successfully completed multiple securitizations significantly improving our cost of financing, which we expect to benefit our net interest margin and earnings going forward, and we continue to work through various securitizations for the fourth quarter.

Anthony Rossiello, CFO

Thank you, Nick, and good morning. Turning to Slide 16, we provide a summary of our current financing profile. In executing our non-agency strategy, we continue to focus our efforts on increasing the pace of securitizations to obtain nonrecourse, non-mark-to-market financing on our loan portfolio, which significantly lowers financing costs compared to financing loans on warehouse. On this slide, we highlight that approximately 37% of our financing comes from securitized debt, which saw an increase this quarter due to our recent securitizations. We expect this allocation to keep rising given our existing loan population available for securitization, further enhancing the earnings potential in our current portfolio. Additionally, our current liquidity position, mentioned by T.J. earlier, along with our available capacity of $944 million, places the company in a favorable position for further growth. We also included a slide in our appendix with details on how we structured our most recent deal, which is reflected on the company's balance sheet. Overall, we securitized about $268 million of non-QM UPB, and this appendix will provide further details on our retained interest. On Slide 17, we provided a reconciliation of our book value per common share, which increased by $1.74 quarter-over-quarter. During Q3, we reported net income available to common shareholders of approximately $30 million or $1.87 per fully diluted share. Earnings during the quarter were driven by various factors, including mark-to-market gains across our new origination and RPL/NPL portfolios; gains from the resolution of our 2 remaining commercial loans and the sale of our remaining CMBS portfolio; gains from the sale of RPL/NPLs; and earnings contributed from our 45% equity method investment in Arc Home, which is held in a taxable REIT subsidiary. This increase in book value is reflective of our current quarter earnings, offset by the preferred and common dividends declared during the quarter and our common share repurchases approximating $2.8 million. As discussed on our previous earnings call, we also disclosed adjusted book value per common share of $16.45, which is computed based on total equity less the entire liquidation preference of our preferred stock. Turning to Slide 18, we disclosed a reconciliation of GAAP net income to core earnings for the third quarter, where you will see core earnings was $0.96. Core earnings was primarily driven by 2 items. The first included receiving 12 months of deferred interest upon the resolution of Commercial Loan L, which was modified during 2020. The second related to previously mentioned RPL/NPL sale. Specifically, the proceeds from the sale went to pay down the bonds secured by the underlying loans, and the company held certain of those bonds at discounts. As the company received par value on the bonds, this resulted in accelerated accretion on these assets during the quarter. It should be noted that core earnings does not include $1.6 million of gains Arc Home recognized during the quarter on loans sold to MITT. However, these earnings are recognized as unrealized gains contributing to our overall book value increase. Lastly, I'll reiterate that we ended the quarter with total liquidity of approximately $144 million, which was inclusive of $102 million of cash and $42 million of unlevered Agency RMBS. And as we continue to purchase non-agency residential loans subsequent to quarter end, we ended October with $91 million of liquidity. This concludes our prepared remarks. And we would now like to open the call for questions.

Operator, Operator

And our first question is from Doug Harter from Crédit Suisse.

Douglas Harter, Analyst

You just said you ended October with $91 million of liquidity. How are you thinking about what is the liquidity cushion that you guys want to maintain? So how should we think about kind of the "excess liquidity" position today?

Thomas Durkin, President

Yes. It's T.J. We have our internal risk models in place to ensure we maintain liquidity for margin calls and similar needs. Considering the cash we generated during the quarter, we are in a good position. We believe we can spend down a significant amount as we approach year-end, roughly $40 million to $50 million, based on our pipeline and the size of our gestation financing or warehouse risk.

Douglas Harter, Analyst

Got it. How do you view the timing of future sales in the NPL market, which is currently quite strong? How do you plan to take advantage of that, even if the need for liquidity is still a bit away? How do you balance those two factors?

Thomas Durkin, President

Yes, there are a couple of factors at play. Firstly, we have financed a significant amount of that asset class through various securitizations, which means we are working through periods where we can sell the assets or engage in traditional non-performing loan securitizations, whether through collapsing, refinancing, or selling. This introduces a timing element. Additionally, we find that aggregating assets to achieve a critical mass yields better execution compared to selling in smaller groups. These two factors lead us to prefer less frequent but larger and hopefully more beneficial dispositions. We plan to continue this approach into 2022.

Douglas Harter, Analyst

Got it. From a REIT perspective, is there any amount of agency that you would want to hold long-term as you continue to build towards the future?

Anthony Rossiello, CFO

Yes, Doug. The way we think about it is the assets that we're currently acquiring with the new origination are qualified assets for REIT. So the idea would be to wind down the agency portfolio, and we would need to be relying upon it for REIT and the AG Trust.

Operator, Operator

Our next question is from Bose George from KBW.

Bose George, Analyst

Actually, I just wanted to go back to Slide 18, I guess it was where you had the GAAP reconciliation. Can you just go over that $15 million again sort of the different drivers of that?

Anthony Rossiello, CFO

Yes. That $15 million refers to the RPL/NPL sale. When we sold or liquidated those assets, we had bonds that were valued below par, and we received par on those bonds. This resulted in accelerated accretion.

Bose George, Analyst

Okay. That makes sense. Can you remind me what is included in the investment in the affiliate line item on your balance sheet? I assume Arc is part of it, but I wanted to clarify what's in there since it's decreased over time.

Anthony Rossiello, CFO

That's correct. Arc is approximately $52 million of that balance. The remainder is what we refer to as land-related financing, and we also have a small joint venture that has non-QM loans that we invest in.

Bose George, Analyst

Okay. Is the decline in those investments just a result of them decreasing over time, as we've seen over the past few quarters?

Anthony Rossiello, CFO

That's correct. And that decline also related to the RPL/NPL sale because the loans we sold were in that line item.

Bose George, Analyst

Okay. Great. And then just 1 more for me. The 14% to 18% ROE on the purchased loans, can you just go through a little bit just the leverage structural? And then what repo on top of that you're assuming?

Thomas Durkin, President

Yes. When we refer to the 14% to 18%, that reflects the situation after securitization. During the initial phase, we are strongly motivated to reduce that ramp-up period. The leverage we are applying to the securitizations is around the mid-90s percent, which may vary slightly compared to our acquisition cost. This is how we reach the 14% to 18% range. As certain assets reduce their leverage over time, we can strategically introduce additional financial leverage during our holding period for those assets. However, this addition is generally quite modest. I was going to add that we've also been able to take that sort of traditional repo financing and term that out with non-mark-to-market as well.

Bose George, Analyst

Okay. So just excluding the repo, do you reach the 14% with the securitization leverage? Yes, I was curious what that figure would be if there was no repo at all.

Thomas Durkin, President

Yes, we're probably slightly lower than that.

Anthony Rossiello, CFO

Slightly lower.

Operator, Operator

Our next question is from Eric Hagen from BTIG.

Eric Hagen, Analyst

A couple of questions. Can you highlight some more detail around how you think about the trade-off between potentially raising the dividend and buying back stock? And then can you also describe the profile of the non-QM loans that you're buying at this point how the credit has maybe evolved over the last, call it, year from what you've been buying?

David Roberts, CEO

On the dividend matter, we evaluate our dividend policy based on the current quarter and our future outlook, and we will continue to do so. Regarding the choice between stock repurchase and dividends, I would say that stock repurchases are more opportunistic, while dividends are central to why investors are drawn to the mortgage REIT sector for income. Our primary focus is on increasing our earnings, which would allow us to grow our dividend over time if we succeed.

Nicholas Smith, CIO

Eric, this is Nick. On the credit quality and sort of positioning of the assets. The nice thing is we do have, and have emphasized in the presentation a bunch, the Arc Home channel. Through that channel, we've had minimal or almost no expansion of our guidelines. We still don't feel a tremendous amount of pressure. It's generally very up in credit. We're talking high 60s, low 70 type LTV in aggregate and mid-700s FICOs. We actually see a decent amount of opportunity going up in credit. So we continue to be constructive on the availability to source attractive assets without really having to go further and further out in credit.

Operator, Operator

Our next question is from Jason Stewart from Jones Holding.

Jason Stewart, Analyst

Nice quarter. I wanted to get your updated thoughts on Arc and given the strength in that platform, if there's any new thoughts about continuing to be a JV or if it makes sense to be a separate entity at some point?

David Roberts, CEO

We have no current thoughts of changing that structure. I think that answers your question.

Jason Stewart, Analyst

Yes. No, sure, does. Okay. Fair enough. And then just switching to FHFA and thoughts around product structure that potentially could be evolving with Sandra Thompson and any sort of thoughts around the credit box changing and what that market opportunity looks like for Arc would be helpful.

Thomas Durkin, President

So the current administration I don't think is going to be the sort of changes out of there will impact sort of our ability to source assets. Obviously, the suspension of the 7% cap that's already happened. And as mentioned in the presentation, we've already seen a slowdown there, albeit we're still sourcing those assets. We still like the returns. Certainly, it's still on the table that you could see that get reversed. It's currently sort of pending review by the FHFA. We would have seen other changes, but I think that has more to do with sort of the capital base of Fannie and Freddie and the CRT coming back as they revisit sort of capital rules there. So I don't see that as impacting our current book of business, if anything, that's just another asset class that down the road we could potentially look at. Obviously, today, we are not. So I think it's still the same sort of policy changes that happened earlier in the year are in place. And that's where we really see growth and expansion for our business. So that's sort of what we see for now.

David Roberts, CEO

Thanks, Jason.

Operator, Operator

And we have no further questions at this time.

David Roberts, CEO

Okay. It's David Roberts. To conclude, I hope you can see from all the information we've shared that we are enthusiastic not only about our position but also about the strength of our team and resources, as well as the successful execution of our transition so far. As a management team, we are very excited about the future and truly believe we have all the necessary tools to complete this transition and continue our growth. Thank you very much for your time, and we look forward to reporting to you next quarter.

Operator, Operator

Thank you, ladies and gentlemen. That concludes today's call. Thank you for participating, and you may now disconnect.