Earnings Call Transcript - MITT Q1 2023

Operator, Operator

Good day, and thank you for standing by. Welcome to the AG Mortgage Investment Trust First Quarter 2023 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 be advised today's conference call is being recorded. I'd now like to turn the call over to Jenny Neslin, General Counsel for the company. Please go ahead.

Jenny Neslin, General Counsel

Thank you, and good morning, everyone, and welcome to the first quarter 2023 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, 2022, 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 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 first quarter 2023 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. The first quarter of 2023 got off to a constructive start, continuing the signs of recovery in the markets that we saw developing beginning in December. This momentum continued through January and February until the sentiment disappeared in mid-March as a regional bank crisis took over. This reintroduced interest rate volatility back into the market, sending the front end materially lower. Despite this volatile end to the quarter, we grew book value by 4% per share to $11.85 and $11.48 on an unadjusted and adjusted basis, respectively, while maintaining ample liquidity of $88 million and only 1.4 turns of economic leverage. We continue to use our excess liquidity to repurchase our common stock, and during the quarter, we repurchased 923,000 shares at a weighted average price of $5.68, creating 2% accretion for shareholders. During the quarter, we had $0.37 of earnings per share, generating $0.03 of earnings available for distribution (EAD) and payments of $0.18 in dividends. It is notable that while we did experience mark-to-market losses on the assets we owned coming into the year, these losses run through our income statement, and the vast majority of them 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. We were also able to complete the securitization in early February when the capital markets were very healthy, and continue to see better sourcing opportunities as some historical competitors appear to be pulling back after a rough 2022. Based on our early preliminary read, both values were up approximately 1% to 2% for the month of April. Before I pass it to Nick, I'd like to recap the recent performance of the balance sheet. Going back into last year, we remain focused on minimizing our warehouse risk and staying disciplined in terms of issuing securitizations throughout the year, which protected book value in what turned into an extremely volatile year. As we enter the second quarter, we have a loan book that is very clean, without low coupons which continue to be orphaned and do not effectively execute into securitizations today. Our active portfolio management has produced strong first-quarter results and we are well positioned to continue and build upon this momentum throughout the year as our initial April estimates support this. I think it is also important for us to express our view that MITT has reached an inflection point in terms of earnings power. First, regarding our home, we see this happening primarily based on recent organizational changes setting the stage for a near-term return to profitability, which Nick will walk through in more detail. Secondly, we see an environment with higher returns on equity (ROEs) on assets based on competition retreating, and opportunities that we believe are in the early innings of presenting themselves due to disruptions among the regional bank balance sheets. Putting this all together, we believe mixed results will produce both higher earnings available for distribution and EAD metrics per share looking forward. We believe the market should recognize the hard work and solid results being delivered by the team. I will now pass the call to Nick.

Nick Smith, Chief Investment Officer

Thanks, T.J. As T.J. mentioned, we came to market with our first securitization of 2023 in February. For the past few quarters, we've emphasized that going forward, we will right-size and mitigate risks by taking into account both current market volatility along with expected future volatility. This proved to be prudent as we successfully took advantage of the better tone in the early part of the quarter before it became apparent that there were significant challenges ahead in the broader financial sector caused by historic Fed tightening. Our leverage remains close to the lows set at the end of last year, and we have significant liquidity, putting us in a position to take advantage of the ongoing stress in the banking community. Over the past decade, depositories have increasingly used their portfolios to subsidize residential mortgages as a key component of their broader client acquisition strategies. Although this is unlikely to cease entirely, since not all banks have the same amount of balance sheet stress, we expect it to represent a relaxing of what had on the surface seemed like an ever more competitive arms race. This should present an opportunity to source high-quality assets with credit spreads and nominal yields at the highs of over a decade. We also believe there could be opportunities to buy portfolios of loans from failed banks or institutions that need liquidity. In addition to these opportunities, we're finding attractive investments in home equity mortgages, conventional investments in second home residential mortgages, and both qualified and nonqualified residential mortgages. Although origination volumes remain low, we have seen significant increases in volumes at our home or captive originator. Some of this increase can be attributed to seasonality; however, the key drivers are likely lower mortgage rates from the end of last year, less competition from the originator community, and buyers becoming more comfortable with home prices, along with the recent implementation of higher loan level pricing adjustments (LLPAs) at Fannie and Freddie. As of quarter end, our mixed residential home loan pipeline is approximately $280 million. Moving on to the portfolio, our first GCAT securitization of 2023 included all of our out-of-the-money home loan positions, leaving our aggregation pipeline, including both closed and locked loans with a gross weighted average coupon of approximately 8%. While in warehouse, we expect these positions to return to low to mid-teens yields. We expect ROEs in the low to mid-20s post-securitization. Much of the debt we've issued can be refinanced on or after the third anniversary of each transaction. Although we expect much of this to remain out of the money, providing us with valuable term funding. The recent rally in conversion makes it likely we will be able to economically refinance debt issued last year at the highs in both nominal yields and credit spreads. These options effectively allow us to bring forward the monetization of the discounts. Although the market currently does not assign significant value to these options, we believe that as interest rate and spread volatility normalize, this could lend itself to substantial portfolio upside. We have a high-quality, low mark-to-market loan-to-value portfolio of residential mortgage loans providing significant and predictable cash flows with substantial mark-to-market upside. Given historically wide spreads, nominal yields, along with deeply discounted subordinate positions, as we outlined in our presentation, the earnings power of our investment portfolio is strong, consisting of assets generating returns in the mid to high teens. Now for Arc Home: Although the results for this quarter were not materially better than the previous, we are heading into the next quarter with strong momentum, given a significant pickup in registrations and locks, realization of cost and productivity efficiencies along with new client acquisitions. Although we expect gains on sale margins to increase over the coming quarters as the impacts of consolidation provide some relief, the management team is focused on factors within their control. The Board recently hired a new Chief Production Officer; although early, his contributions so far have been impressive. We've also begun seeing significant improvements in productivity, along with reductions in fixed and variable costs as Arc Home's new Chief Operations Officer's changes have been implemented. We expect this momentum to put us in a position to outperform some better-known competitors in the coming quarters. I will now turn the call over to Anthony.

Anthony Rossiello, Chief Financial Officer

Thank you, Nick. I'll provide a brief update on our financial highlights for the first quarter. The key themes of the quarter were continued book value recovery, accretive share repurchases, and derisking our warehouse exposure, leaving us with a portfolio of current coupon loans. We ended Q1 with a book value of $11.85 per share and an adjusted book value of $11.48 per share. Despite the volatility faced during the quarter, our book value per share increased 4%. Coupled with our dividend, we generated a quarterly economic return of 5.7%. Our increase in book value was primarily driven by net unrealized gains in our investment portfolio, along with accretive share repurchases. During the quarter, we recognized GAAP net income available to common shareholders at approximately $8 million or $0.38 per fully diluted share. We experienced net gains on our securitized assets and loan portfolio driven by overall declines in benchmark rates and credit spreads. These gains outweighed unrealized losses recognized on our interest rate swap portfolio, dividends declared, and transaction-related expenses recognized from our February securitization. Regarding our share repurchase program, we were active during the quarter, returning $5.2 million of capital to our shareholders. We repurchased 923,000 shares or 4% of our total outstanding shares at the start of the year, resulting in 2% of book value accretion as our purchase price was approximately 50% of our adjusted book value. We continue to repurchase shares subsequent to quarter end, leaving us with approximately $1.7 million of repurchase capacity. In addition, our board has authorized a new common stock repurchase program with $15 million available for use upon fully utilizing our remaining capacity in the existing program. We also grew our investment portfolio by 6% to $4.5 billion and continue to use our securitization platform to provide term non-mark-to-market finance. Currently, 85% of our financing is funded through securitization at a weighted average cost of 4.2%. As a result, our economic leverage ratio at quarter end was 1.4 turns, of which 0.8 turns relate to our credit portfolio, and 0.6 turns to our agency RMBs portfolio. We ended the quarter with approximately $2 billion of borrowing capacities across four large banking institutions to support continued growth. We generated earnings available for distribution (EAD) of $0.03 per share for the first quarter. Net interest income inclusive of interest earned on our hedge portfolio was $0.68 per share, which was consistent with the prior quarter and exceeded our operating expenses and preferred dividends, generating earnings of $0.11 per share. This was offset by a loss of $0.08 contributed from our home for the quarter driven by lower volumes. However, it is notable that our contribution EAD did improve by $0.05 quarter-over-quarter. Lastly, we ended the quarter with total liquidity of approximately $88 million in cash. This concludes our prepared remarks, and we would now like to open the call for questions.

Operator, Operator

We will take our first question from Doug Harter with Credit Suisse. Please go ahead.

Doug Harter, Analyst

Good morning. Just touching on that last point about kind of the earnings Arc Home being $0.11. Can you help us kind of understand the path that that could get to the $0.18 dividend? Or how you're thinking about the dividend in light of that earnings power?

T.J. Durkin, CEO

Hi, Doug. I think as we continue to see momentum at Arc Home, I think we're kind of walking back to breakeven, and I think not too distant future, we would expect that to swing back to profitability. I think the ROEs on the asset side are probably a bit more straightforward. I think we would probably tell you the very high teens, and if anything, probably leaning towards maybe even higher on the opportunity side. If we can balance effectively swinging the operating company of Arc into line with the high-teens to 20 ROEs, I think that's how you can kind of walk through to get to an $0.18 dividend.

Doug Harter, Analyst

And I guess, what is your and the board's appetite to support the current dividend until that happens?

T.J. Durkin, CEO

Well, I think we're cautiously optimistic that this swing is coming over the next couple of quarters. We're not waiting years into the future.

Doug Harter, Analyst

Okay. And then, just, you talked about the pipeline that you have, I guess, how do you see your capacity to continue to add assets at these wider returns that you talked about?

T.J. Durkin, CEO

Yes. I mean, I think our pipeline can effectively turn assets over fairly quickly. We've been able to demonstrate throughout 2022 that we have access to the capital markets in good markets and even in bad. We are not looking to take a lot of warehouse risk, and I think we're able to turn over new asset opportunities fairly quickly, from sourcing to settlement to effectively terming it out. If that pipeline picks up, could we be getting two to three securitizations a quarter? I think the team here can effectively handle that type of volume.

Doug Harter, Analyst

And you feel like you have the capital to do that as well?

T.J. Durkin, CEO

Yes, because we'd be returning it right back on a post-settlement basis.

Operator, Operator

And we'll take our next question from Trevor Cranston with JMP Securities. Please go ahead.

Trevor Cranston, Analyst

Thanks. On the securitized loan portfolio, can you give an estimate as to how large the current mark-to-market discount is net of the debts relative to par? In other words, I'm trying to figure out how much book value accretion could result if all the loans in the portfolio eventually work to pay off at par.

Anthony Rossiello, Chief Financial Officer

Yeah, Trevor, of course. So, maybe stepping back, in the prepared remarks, we state that much of the debt is highly valuable. By that, we mean a lot of that discount is unlikely to be realized via the acceleration of our optional termination rights. Excluding that discount, and assuming it just plays out over time given accretion, the discount on our 2022 issuances is almost $55 million. Different transactions have different probabilities of the monetization of that discount, but for the portfolio, we believe it is close to the mid-50s.

Trevor Cranston, Analyst

Got it, very helpful. And it looks like you did buy a little bit of agency MBS this quarter. Should we think about that as a liquidity management portfolio or do you think returns in the agency market are strong enough that you would like to have a little capital deployed here on a long-term basis?

T.J. Durkin, CEO

Yeah, it's probably more the former. I mean, we were sitting on a decent amount of cash, and we wanted to get it to work. The basis was effectively at historic wide, so we felt like it was a decent enough entry point without taking much spread risk. But it's not meant to be a core part of the portfolio.

Trevor Cranston, Analyst

Got it. Appreciate the color. Thank you.

Operator, Operator

And we will take our next question from Matthew Erdner with Jones Trading. Please go ahead.

Matthew Erdner, Analyst

Hey, guys. Thanks for taking the question. Where do you see spreads going from this point, given the amount of supply that could come online with these banks?

T.J. Durkin, CEO

Well, I think there's a big unknown there. We've talked about the supply. Over this past weekend, all that supply was absorbed by one large financial institution, and very little is likely to come out on the follow. Our view is that it's less likely to be a supply issue because even if the positions are taken over by the FDIC, it would probably take a long time to find their way to the market compared to more liquid counterparts. We've seen that play out over different financial crises. The more relevant opportunity, as I alluded to in the prepared remarks, is the ending of this arms race—out of business and others chasing. As pricing normalizes, we think that risk-adjusted spreads will be a lot more attractive now that entities are not subsidizing client acquisitions with their portfolios.

Matthew Erdner, Analyst

And then you mentioned LLPAs. Can you expand a little more on that and what opportunities they could bring you guys?

T.J. Durkin, CEO

Yes. It's interesting seeing people write in major publications about LLPAs; I thought only people like us knew about it. Credit spreads are near historically wide, and if even small portions of the agency-eligible cohorts stack into private label securitizations, it doesn’t take much tightening of credit spreads to make even a higher percentage of agency-eligible paper stack into those private label areas. We see the opportunity set as growing over time, and we're excited about it.

Operator, Operator

We'll take our next question from Bose George with KBW. Please go ahead.

Unidentified Analyst, Analyst

I'm curious if there's any interest in pursuing a strategic option, such as selling Arc or obtaining an equity injection from the manager for increased scale. I'm just trying to understand how you plan to address the difference between the stock value and the book value.

T.J. Durkin, CEO

We're obviously frustrated with the stock price. We're focused on investor outreach and trying to get the story out there. We think the results are strong, but I think the manager is supportive of growth in a variety of ways. We are in constant dialogue with them about the opportunities we see out there.

Unidentified Analyst, Analyst

Thank you for taking my question.

Operator, Operator

We'll take our next question from Jacob Asset Management. Please go ahead.

Unidentified Analyst, Analyst

Hi, guys. Thanks for taking my question. I wonder if you could talk philosophically and then ideally even mathematically, the choice to buy back common shares at a discount and not also buy or instead buy preferred shares at a discount, which will also create book value and reduce cash flow obligation to produce earnings. Especially in light of the fact that your relative to other REITs, is your balance top-heavy towards preferred obligations versus common outstanding, and when different or better times when the stock was trading closer to book value you were doing a capital raise in part of the logic back then given to help sort of right side the relationship between equity and preferred. So, just wondering why, although I applaud it, why that choice for common, but not preferred?

T.J. Durkin, CEO

I think if you were to go back historically, we had good dialogue with preferred shareholders about doing some exchanges for common a few years ago. We are obviously aware of the capital structure, and we look at it. From a logistical perspective, it's a more liquid transaction executing in the common market than in the preferred. But we're certainly open to conversations with all shareholders, both common and preferred, to the extent that there's a conversation worth having.

Unidentified Analyst, Analyst

So, you would turn around and issue common shares at these prices to retire preferred shares?

T.J. Durkin, CEO

I thought you were talking about more effective offers of preferred. It's much easier to program on common than in the preferred space.

Operator, Operator

And we'll go next to Eric Hagen with BTIG. Please go ahead.

Eric Hagen, Analyst

Hi, thanks, good morning. Hoping you can talk about a couple of things, one just financing conditions for warehouse lines of credit leading up to securitization, and how much appetite you have to explore new financing arrangements there. And then the amount of liquidity that you have and the space that you have to take your leverage higher at this point. Thanks.

Nick Smith, Chief Investment Officer

Morning, Eric, it's Nick. On the financing conditions, we primarily borrow from G-SIBs. We don't see a tremendous amount of pressure there. Maybe the cost goes up 5 basis points, 10 basis points, or 15 basis points as we renew, although most of our renewals are pretty far out in the future at this point. If anything, we have excess capacity, and we don't see a lot of pressure there. Obviously, away from the warehouse lines, relying on securitization due to the interest rate and credit spread volatility, it’s good to be nimble. We talked about running aggregation risk at the right level relative to the company size, being ready to issue when it makes sense. That market is, well, well off the highs; in fact, if you look at the past 12 months, we're much closer to the highs than the lows. Obviously, it's been very volatile, and a lot of that is simply the supply story today—there's going to be far less supply in this space, and given that backdrop, scarcity becomes a bigger question. Most of this is on the front end of the curve, and there's a lot of demand there. As far as the capacity to build a portfolio, I think we have a lot of room to add leverage, and we look at market conditions when considering adding leverage to build capacity.

Operator, Operator

And it looks like we have no further questions at this time. I'll turn the call back to the speakers for closing remarks.

Jenny Neslin, General Counsel

Thank you very much to everyone for joining us and for your questions. We appreciate it and look forward to speaking with you again next quarter. Have a good weekend.

Operator, Operator

Thank you and this does conclude today's program. Thank you for your participation. You may disconnect at any time.