Earnings Call Transcript - MITT Q2 2021

Operator, Operator

Welcome to AG Mortgage Investment Trust Second Quarter 2021 Earnings Call. My name is Sylvia, and I'll be your operator for today's call. Please note that this conference is being recorded. I will now turn the call over to Jenny Neslin. Jenny, you may begin.

Jenny Neslin, Moderator

Thank you, Sylvia. Good morning, everyone, and welcome to the Second 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 first quarter 10-Q. 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 second 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

Thank you very much, Jenny, and good morning to everybody. Since our last call, AG Mortgage Investment Trust has made great progress in our transition to a company focused on residential mortgage origination and securitization. On the buy side of our business, in the second quarter, we purchased $446 million of non-QM loans from our affiliate Arc Home as well as third parties. In June, we completed a non-QM securitization of $224 million, raising non-mark-to-market, nonrecourse financing on these assets. Additionally, Arc Home doubled its production of non-QM loans during this quarter to $376 million. Going forward, we intend for our business model to be fueled primarily by non-QM and other residential origination, followed by securitizations on a quarterly or more frequent basis. On the sell side of our business, we have sold all of our CMBS and certain RMBS positions throughout the quarter and subsequent to quarter end, supporting our continued transition. We also have good reason to believe we are progressing towards being paid off on our two remaining commercial real estate loans. The CMBS sales have resulted in favorable gains during and subsequent to quarter end, and potential payoffs of the commercial loans are expected to be favorable to our second quarter remarks. These completed and anticipated sales provide ample liquidity to fund continued expansion of our go-forward business model. In terms of our financial results for the quarter, our book value increased by 3%, driven by earnings of $0.70 per share. This is after accounting for the declared second quarter dividend of $0.21 per share. Both per share numbers are on a post-split basis. Core earnings for the quarter were approximately breakeven. However, the definition we use for core earnings does not capture important elements of our go-forward business strategy. Specifically, core earnings do not include MITT's share of the gain that Arc Home recognizes when it sells loans to us, nor does it include earnings that MITT recognizes when we securitize the loans purchased from both Arc Home and third parties. As I mentioned before, the sales of commercial assets have and are expected to continue to increase our liquidity. This comes at the short-term cost of reduced net interest margin. But more importantly, in the longer term, this liquidity will enable us to continue growing our origination securitization strategy, a strategy we believe offers a superior risk-reward to AG Mortgage Investment Trust and its shareholders. For our dividend policy going forward, we will be looking most closely at those earnings metrics that most accurately reflect the evolution of our business strategy. And as we always do in our dividend policy, we will consider not only the current quarter but our outlook for earnings over the intermediate term. Thanks very much. And with that, I will turn it over to T.J. Durkin.

T.J. Durkin, President

Thank you, David, and good morning, everyone. To dig a bit deeper into the company's activity during the quarter, we were active in purchasing $446 million of non-QM loans during the quarter from five originators, including our mortgage affiliate, Arc Home, which originated $376 million during the quarter with MITT purchasing approximately 50% of that production. MITT contributed loans into two securitizations during the quarter, and we intend to be very disciplined with regards to the pacing of our securitizations to de-risk our warehouse lines. In other asset classes, we continue to prudently dispose of non-core assets and reposition to MITT's forward-looking strategy by selling CMBS and other RMBS securities where we don't have any control or access to the underlying whole loans. During the quarter, we also reduced our exposure to Agency MBS as we thought the basis had reached a point where further tightening was unlikely. Subsequent to quarter end, we sold the remaining CMBS positions and a slight gain from Q2 marks, generating gross proceeds of $34 million or approximately $15 million of equity proceeds. And moving on to our capital activity during the quarter, we successfully utilized our ATM program to raise $3.1 million of fresh capital by issuing 226,634 shares at an average price of $14.21 per share, adjusting for the split. We also completed our fifth exchange with a preferred holder, exchanging 240,861 shares of preferred for 429,802 shares of common. This brings our cumulative preferred to common exchange notional to approximately $51 million of par value. And lastly, we completed a 1-for-3 reverse stock split, which went effective July 22 with the ultimate goal of reducing volatility in the stock price in the future. Our investment portfolio grew slightly over the quarter based on the rotation I previously mentioned out of Agency MBS and CMBS into non-QM whole loans. We made progress increasing our allocation to non-QM by nearly doubling the fair value as a percentage of our investment portfolio from 19% to 37% this quarter. Also, given the strength in the housing market, we are seeing solid performance regarding our land-related financing, and we expect lot takedowns to run this asset class off organically over the coming 12 to 18 months while we earn a healthy yield. On slide eight, we present our CMBS and commercial real estate exposure. As previously mentioned, subsequently to quarter end, we exited the single asset, single borrower CMBS securities for gross proceeds of $33.7 million. Currently, MITT only has two remaining commercial real estate loans left under our commercial designation, and we wanted to provide some more detail today. Commercial loan K is a first lien construction loan to a recently completed and fully opened destination hotel in Times Square. The loan continued making interest payments during COVID, but its original maturity date was due in May of this year. MITT's loan exposure is part of a larger consortium and is actively engaged with the lender group on working towards a productive resolution in the near term. However, we can't guarantee such resolution will occur. We are very comfortable with our basis in the finished product. Commercial loan L is a fully drawn loan to a hotel located off the Magnificent Mile in Downtown Chicago. Immediately following the initial COVID shutdown, we completed a modification with the sponsor in September of 2020, turning off the cash coupon and letting the deferred interest accumulate. However, we did not accrue interest income during this quarter during this period. In exchange for the interest deferral, we received an additional $2.1 million of equity. We remain in close contact with the sponsor and have seen operating metrics continue to improve into the larger reopening. On slide nine, you can see we continue to be able to create an Agency MBS book with better prepayment performance due to our size and selectiveness when purchasing specified pools. A reduction in agencies was solely based on relative value, not based on performance. We will continue to use Agency MBS to absorb excess liquidity when at prudent valuations and to meet our '40 Act tests. Lastly, in June, we entered into an agreement to sell all our remaining excess MSRs, which we'll settle during the third quarter. With that, I'll turn the call over to Nick.

Nick Smith, Chief Investment Officer

Thank you, T.J., and good morning, everyone. Year-to-date, we've acquired over $650 million of non-QM loans with over $250 million acquired from our affiliate Arc Home. In July, we increased our uncommitted warehouse capacity to $1.1 billion to accommodate future acquisitions while simultaneously terming out approximately $224 million of non-mark-to-market and nonrecourse debt. We also securitized approximately $171 million of non-QM loans alongside other Angelo Gordon funds within an unconsolidated joint venture. The remaining assets held in this joint venture are primarily retained interest from prior securitizations. The tables on this page show the continued delinquency curing over the past year for our non-QM portfolio, along with collateral characteristics of our current borrower base. Subsequent to quarter end, we also entered into agreements to acquire GSE-eligible nonowner-occupied pools. In connection with these acquisitions, we added $500 million of uncommitted warehouse capacity specifically for GSE-eligible loans. We expect these credits to continue to offer attractive risk-adjusted returns and look forward to adding additional sellers and capacity. This page provides a high-level summary of the performance of our credit-sensitive loan positions over the past 12 months. As you can see, this portfolio has benefited from strong housing tailwinds and historically low mortgage rates. Prepayment speeds have increased significantly, and approximately 75% of the borrowers that received COVID-related assistance are either contractually current or making payments on a loss mitigation plan. Over the past year, approximately 30% of the portfolio has been liquidated through a combination of opportunistic loan sales, voluntary and involuntary prepayments. As mentioned in previous quarters, Arc Home, our licensed mortgage origination affiliate, continues to benefit from being one of the first originators to reenter the non-QM business. The tables below clearly show the benefit of these early investments as Arc Home's non-QM volumes offset declines in agency volumes and were able to mitigate margin compression during the quarter. Mark-to-market losses in Arc Home's MSR portfolio driven by lower nominal yields and a full flattening of the curve generated pretax net losses of $3.7 million resulting in $2.7 million of losses from MITT, which does not include $1.4 million of gains recognized by Arc Home in connection with its mortgage loan sales to MITT. With that, I'll turn it over to Anthony.

Anthony Rossiello, CFO

Thank you, Nick, and good morning. Before providing an update on the second quarter, I wanted to reiterate that we completed a 1-for-3 reverse stock split post quarter end, which became effective on July 22. This reduced our common shares outstanding from approximately 48.5 million to 16.2 million. As a result, you will see that we adjusted all common share and per share metrics within our press release, earnings presentation, and 10-Q on a retroactive basis to reflect the reverse split for all periods presented. During the first quarter, we reported net income available to common stockholders of approximately $10.9 million or $0.70 per fully diluted share. Earnings during the quarter were driven by mark-to-market gains on residential and commercial assets within our portfolio, along with realized gains from the sales of certain RMBS and CMBS. These gains were offset by mark-to-market losses within our interest rate swap portfolio driven by the decline in interest rates during the quarter as well as the previously mentioned loss from our 45% equity method investment in Arc Home, resulting from mark-to-market losses on its MSR portfolio. Operating expenses increased slightly from the first quarter. However, this was attributable to transaction expenses related to the non-QM securitization that occurred in June. On slide 14, we provide a reconciliation of our book value per common share, which increased by $0.41 during the quarter. This increase reflects our current quarter earnings offset by the preferred and common dividends declared during the second quarter. You'll also see the increases related to a preferred stock exchange transaction entered into during the quarter as well as net proceeds raised from issuing common stock through our ATM program approximating $3 million. As discussed on our previous earnings call, we also disclosed adjusted book value per common share of $14.72, which is computed based on total equity less the entire liquidation preference of our preferred stock. Turning to slide 15, we disclosed a reconciliation of GAAP net income to core earnings for the second quarter, where you will see core earnings was breakeven for the quarter. One item to note is that core earnings does not include $1.4 million of gains Arc Home recognized during the quarter on loans sold to us. Lastly, we ended the quarter with total liquidity of $71 million, which is inclusive of $64 million of cash and $7 million of unlevered Agency RMBS. This improvement in liquidity from the first quarter was a result of the previously mentioned two non-QM securitizations transacted along with the sale proceeds on our MBS portfolio offset by the purchase activity to grow our non-QM portfolio. This concludes our prepared remarks, and we would now like to open the call for questions. Operator?

Operator, Operator

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

Doug Harter, Analyst

Can you discuss the current level of competition in the QM market and how returns compare today to when Arc was initially one of the first movers?

Nick Smith, Chief Investment Officer

Of course. There certainly is more competition. That being said, capacity has returned to the market as sort of agency stuff has run off or refis have runoff, and we still see plenty of opportunity to buy these assets and others at attractive levels. We don't see that changing in the near future.

Doug Harter, Analyst

Got it. And then could you just compare the relative attractiveness of returns of kind of non-QM versus nonowner-occupied loans and kind of which is a more attractive opportunity today?

Nick Smith, Chief Investment Officer

We see them fairly comparable. If anything, in the non-QM side, a lot of those positions are investor properties already, and they're fairly similarly priced. On the Agency side, it's one of those things where we expect that to be opportunistic and to be sort of interesting opportunities for the coming years, and we expect pricing to come in and out, and we'll obviously keep the relative value between the two products in mind.

Doug Harter, Analyst

Got it. And then just one kind of accounting question. You mentioned that there was the negative MSR mark at Arc Homes. What was the size of that? And I guess how would the profitability of Arc have looked if you excluded the net MSR mark?

Anthony Rossiello, CFO

The net MSR mark was down about $4 million for the quarter. So if you think about pulling that out from earnings, you'd probably be around plus $2 million to $3 million during the quarter without the MSR markdown.

Doug Harter, Analyst

Great. Even if you exclude the $1.4 million in gains, I think the contribution would be slightly positive or close to breakeven, rather than the loss you mentioned.

Anthony Rossiello, CFO

That's correct. One clarification of the mark-to-market loss that I mentioned was pre our 45% share. So that $4 million, we would only get 45% of that.

Operator, Operator

Next question comes from Bose George from KBW.

Bose George, Analyst

Actually, just first, just a clarification. You mentioned that the mid-quarter earnings doesn't include the sales of the Arc Homes to MITT. Can you just remind me what from Arc is included in the core earnings?

Anthony Rossiello, CFO

Their operating business, which is their gain on sale on the agencies and the non-QM that are not sold to us are included in core.

Bose George, Analyst

Is the percentage of what you purchase from them going to stay stable? It seems that if it increases, it could negatively impact your core income since it wouldn't be included.

Anthony Rossiello, CFO

Yes, that's correct. It has remained stable. We have bought approximately 50% of the production from non-QM from them, but your thinking is correct.

Bose George, Analyst

Great. Looking ahead, what needs to occur to achieve a more normalized core number? Your returns are good in terms of economic performance, but many people focus on core. What is the best way to consider this?

David Roberts, CEO

This is David Roberts answering that. I think the best way to think about this is that this quarter and in all likelihood, the next few quarters, we're in a transition to the new business model or to the go forward, I should say, business model. It's a mix of the two. We've got legacy assets that we're rotating into first cash and then into our origination securitization business, and that's going to take some time.

Operator, Operator

Our next question comes from Trevor Cranston from JMP Securities.

Trevor Cranston, Analyst

I wanted to clarify something on the commercial loans, and thanks for all the additional detail on those. In the prepared comments, I think you made the comment that you were hopeful that there could be a payoff on those in the near term. I just wanted to clarify, was that comment related to both of the loans? Or was that maybe more directed towards the construction loan in particular?

T.J. Durkin, President

Yes, we are addressing the maturity issue with the borrower on that specific loan. As for the other loan, we fully expect that it will stay contractually current once the modification period ends, and they may explore other financing options at that time.

Trevor Cranston, Analyst

Okay. And can you remind us when that period ends?

T.J. Durkin, President

Yes. It was a one-year modification from last September, so it will end this September.

Trevor Cranston, Analyst

Okay. Got it. Can you discuss the opportunity related to GSE-eligible non-owner occupied loans and help us understand the potential market size compared to the more traditional non-QM opportunity?

Nick Smith, Chief Investment Officer

Historically, the supply of investor properties sourced from the GSEs, or Fannie and Freddie, has varied between approximately $75 billion to $95 billion annually. It doesn’t have the same cyclical impacts. If the refinancing occurs, you would effectively decrease the denominator of other non-owner acquired assets. As that denominator decreases, the 7% cap introduced in the recent PSPA amendment with Fannie and Freddie is expected to normalize, increasing the excess. If that number rises to 12%, we need to account for the excess over 7%. Even before this, a significant portion of GSE loans provided attractive returns for investors like us. We anticipate that as originators become more accustomed to selling in private markets rather than relying on Fannie and Freddie, this sector could see growth. The exact share of the overall market remains uncertain and depends on various factors, but there is a substantial potential.

Trevor Cranston, Analyst

Got it. Okay. That's very helpful. And then last thing, I think you noted that you guys had a short TBA position in the second quarter. Can you say how large that position is and if you're still carrying that into the third quarter?

Anthony Rossiello, CFO

The position size is $130 million notional on the TBA that went on at quarter end.

Operator, Operator

Our next question comes from Jason Stewart from JonesTrading.

Jason Stewart, Analyst

A couple of follow-ups. On commercial loan, is the mark at the end of June at 86% of par reflective of the coupon or your confidence in the payoffs?

T.J. Durkin, President

We use third-party vendors to help us determine the mark, which is 86% of par, equating to a $51 million notional.

Jason Stewart, Analyst

So is your thinking updated that you're going to get a full par payoff at September 30 when the modification period is over?

T.J. Durkin, President

Well, no, at September 30, their coupon will turn back on. I think we'll see what pricing vendors, how they view these modifications that are all starting to expire, if you will, right? We're kind of getting to that point in the calendar from a year ago. I don't have any certainty into how they'll look at that, but we expect that based on our conversations that the loan will start cash paying come Q4.

Jason Stewart, Analyst

Okay. So not necessarily a payoff, but it will be turned back on. Okay, got it. And then if you can update us on book value quarter-to-date, if you don't mind.

Anthony Rossiello, CFO

Yes. Book value quarter-to-date was up 3%, approximately, and that was primarily driven by some of the mark-to-market gains that we've been talking about in the residential and commercial portfolios as well as some of the realized gains through the sales that we mentioned during the quarter.

David Roberts, CEO

Was your question about the current third quarter or were you referring to the previous third quarter?

Jason Stewart, Analyst

Yes, David, to the latest point available.

David Roberts, CEO

Yes, we're going to stick with what we've reported.

Jason Stewart, Analyst

Okay. And then on the Arc MSR, when we look at that portfolio, can you give us any detail in terms of what SATO looks like or maybe like what a plus 50 or 100 move in the rates market looks like for the valuation of that MSR?

T.J. Durkin, President

Well, just to be clear, so we sold the third-party purchased MSR. So the volatility going forward will be lower. I would say we're not at this point really reporting like SATO or shifts. The goal is really to reduce that volatility in that business and really have them focused on the origination side.

Jason Stewart, Analyst

Okay, okay. Last one for me then. I guess I understand sort of the rationale for the TBA sort of given valuations in the space, but how does that fit into the overall hedging strategy? And what's your propensity to carry that position going forward?

Nick Smith, Chief Investment Officer

This is Nick. So part of the TBA short is the contemplation that we'll be selling debt off of the recently acquired GSE positions. When you think about when you sell that debt, it's benchmarked against TBA. So when you actually go sell that debt to third parties in the market, your benchmark is TBA because you're selling loans backed by agency collateral. So it's really just a hedge similar to other hedges we put on against non-QM loans.

T.J. Durkin, President

So Jason, yes, the pricing convention for traditional non-QM debt is off of swaps. For AAA seniors on the agency eligible, it will be benchmarked off TBAs.

Operator, Operator

Our next question comes from Eric Hagen from BTIG.

Eric Hagen, Analyst

Within the debt and equity of affiliates, can you give a snapshot of what the balance sheet looks like there, including the amount of capital that's sitting at Arc Home?

Anthony Rossiello, CFO

Sure. In that line item, Arc Home is approximately $51 million of equity in that balance and then we also have approximately $30 million investment in a joint venture where we historically acquired non-QM. If you recall, we're now acquiring the non-QM directly into the REIT. And then the other asset in there is approximately $80 million of the land-related financing that T.J. mentioned earlier.

Eric Hagen, Analyst

Got it. Okay. That's helpful. And then on the non-QM securitizations, how much leverage are you guys applying to the retained tranches to get to the return profile that you outlined in the deck?

Nick Smith, Chief Investment Officer

Somewhere between 1.5 to 2.5 turns.

Eric Hagen, Analyst

Okay. And are those mark-to-market, refi?

Nick Smith, Chief Investment Officer

Correct.

Operator, Operator

Our next question comes from Jim DeLisle from Seven Canyon.

Unknown Analyst, Analyst

The MSI, I'm presuming that Arc continues to carry some MSR on its self-generated portfolio.

Anthony Rossiello, CFO

Yes, that's correct.

Unknown Analyst, Analyst

And that would be in the $50 million or so line item you just referenced to Eric Hagen.

Anthony Rossiello, CFO

It's embedded within the way we account for it; we show the net equity that we own of Arc. We don't look through into Arc Home's balance sheet within our financials, but the asset would be flowing up into that net equity.

Unknown Analyst, Analyst

Right. Can you give us some understanding as to what percentage of that $50 million carrying value of your holding of Arc is represented by the MSR of their self-generated portfolio?

T.J. Durkin, President

Jim, we don't have that number in front of us, but we can look into that.

Operator, Operator

We have no further questions at this time. I'll now turn the call over to our host for closing remarks.

Jenny Neslin, Moderator

Thank you, Sylvia, and thank you to everyone for joining the call today. Enjoy the rest of your weekend.

Operator, Operator

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.