TPG Mortgage Investment Trust Inc (MITT) Q2 2017 Earnings Report, Transcript and Summary

Welcome to the AG Mortgage Investment Trust Second Quarter 2017 Earnings Call. My name is Christine, and I will be the operator for today's call. [Operator Instructions] Please note that this conference is being recorded. I will now turn the call over to Karen Werbel, Head of Investor Relations. You may begin.

Thanks, Christine. Good morning, everyone. We appreciate you joining us for today's conference call to review AG Mortgage Investment Trust's Second Quarter 2017 Results and recent developments. Before we begin, I'd like to review our safe harbor statement. Today's conference call and the corresponding slide presentation contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All such statements are intended to be subject to the safe harbor protection provided by the Reform Act. Statements regarding our business and investment strategy, market trends and risks, assumptions regarding interest rates and prepayments, changes in the yield curves and changes in government programs or regulations affecting our business are forward-looking statements by their nature. The company's actual results may differ materially from those projected due to the impact of these factors and others beyond its control. All forward-looking statements included in this conference call and the slide presentation are made as of today, August 9, 2017, and we disclaim any obligation to update them. We will refer to certain non-GAAP measures on this call. And for reconciliations, please refer to the earnings press release and 8-K, which are posted on our website and have been filed with the SEC. At this time, I'd like to turn the call over to David Roberts.

Thanks, Karen, and good morning to everyone. I’d like to share some highlights from the second quarter with you today. Our book value increased during the quarter by 3.3% to $18.77 per share at quarter's end. The increase in book value was driven by the credit portion of our portfolio as credit spreads tightened during the quarter. This was slightly offset by a decline in the value of our Agency RMBS and associated hedges as spreads on shorter duration hybrid ARMs and post-reset interest-only securities widened in response to further flattening of the yield curve. Our core earnings for the quarter was $0.47 per share, including a negative $0.01 retrospective adjustment and $0.03 per share from dollar roll income associate with our net TBA position. The 47% [ph] per share of core earnings this quarter compares to $0.41 per share in our first quarter. As we discussed on our last earnings call, we have maintained excess liquidity, which we intended to deploy. We did, and the increase in core earnings this quarter was driven by the deployment of much of that excess liquidity into the agency sector, which we view as offering compelling risk-adjusted returns. This deployment led to an increase in our overall portfolio size during the quarter to $3.4 billion from $2.6 billion as well as increased leverage to 4.2x from 3.0x. We actively managed our duration gap by adding hedges in concert with our increased allocation to agency MBS. We also saw opportunities to deploy capital and to credit during the quarter, which TJ will discuss in more detail. We continue to see opportunities to add to our credit portfolio subject to '40 Act constraints by leveraging the Angelo, Gordon network. As always, we remain opportunistic and evaluate investment opportunities on a relative value and risk-reward basis. During the quarter, we declared a dividend of $.475 per share for the seventh quarter in a row. With that, I will turn the call over to TJ Durkin.

Thank you, David. Good morning, everyone. During the second quarter, the fed, in its June meeting, raised the federal funds rate by 25 basis points as anticipated. Progress continues to be made with respect to the Fed's dual mandate of full employment and price stability. And unemployment remains below 5% even though inflation remains stubbornly below the Fed's target. Despite the recent softness in inflation data, we anticipate the Fed to announce the slowing of balance sheet reinvestment and raise the federal funds rate another 25 basis points before year-end. Ultimately, however, in light of both a cyclically and structurally depressed neutral interest rate, we do not anticipate that Fed will raise the federal funds rate by more than 50 to 75 basis points in total over the next 12 to 24 months. As such, we maintain our benign range down outlook for the interest rates throughout the balance of this year. The uncertainty we see remains in the future composition of the Federal Reserve Board and its potential new chairperson in 2018. During the second quarter, there was increased discussion of the federal reserves planned reduction in the pace of its balance sheet reinvestment program. Despite this increased discussion, Agency mortgage spreads were relatively stable but lagged the tightening that occurred in most other structured products. The favorable backdrop of falling implied interest rate volatility in a range-bound interest rate environment encouraged enough yield buying to hold spreads largely in line with benchmark interest rates. In light of the broad-based spread tightening that continues to take place within credit markets, Agency mortgages remains one the most attractive asset classes for the marginal dollar of capital invested. As such, we've increased our sector allocation to agencies and continue -- and look to continue this activity over the near term. Strong demand for credit assets and stable fundamentals drove credit spreads to tighter levels during the second quarter. The new issued calendar was active with subscription levels that were often several times larger than offered amounts. And secondary markets did not provide enough supply to satisfy the market's appetite for bonds. In mortgage credit, demand can most -- demand could most directly be measured in the credit risk transfer market, which rallies during the quarter based on attractive relative value to other fixed income asset classes. Long-duration subordinate tranches led the CRT rally, as spreads tightened around 100 basis points during the quarter, brining price premiums up 5 to 10 points. Fundamental collateral performance of residential mortgages continue to remain steady and in some cases, improving, benefiting from continued home price appreciation and borrower credit carrying. We anticipate residential mortgage credit will become more available as we expect the new administration to reduce some of the regulatory burden placed on the mortgage originators. The Department of Treasury recently put out a release in June, explicitly encouraging such reform. Additionally, we think any rise in interest rates points to the expectations of higher economic growth and rising incomes, both of which will be supportive of home prices and fundamental collateral performance. We do not believe that higher interest rates will materially hamper housing affordability. We remain constructive on housing and believe home price stability is durable at this time. Focusing on slide 5 of our quarterly earnings presentation, we outline the second quarter activity. We actively managed the Agency and credit book, increasing our investments in both categories by a net equity amount of $104.1 million during the quarter. We increased our allocation to Agency mortgages on a hedged basis during the quarter. And at quarter-end, there was $250.2 million of unsettled Agency purchases, which settled in July with $237.7 million of associated repo financing. These purchases were financed through monetizing predominantly shorter duration credit assets post quarter-end. Once these Agency purchases and credit sales settled, our equity allocation to the Agency sector increased to approximately 36% following quarter-end. Turning to slide 6. We increased our allocation to CRT as spreads lagged the broader rally that the legacy Non-Agency sector had experienced. While we increased our net position in CRT, we've also sold certain season securities where we felt that the premium dollar prices were too high, given the prepayment risk. We also participated, along with other Angelo, Gordon funds in 2 single borrower securitizations backed by hotels. We purchased subordinate tranches in these securitizations due to the favorable risk-adjusted returns rather than purchasing generic CMBS [indiscernible]. We continue to find value in both the new issue market as well as in lesser known niche opportunities we obtained through the Angelo, Gordon platform. To specifically highlight one of these credit purchases in the quarter, MITT, along with other Angelo, Gordon funds helped lead a credit card backed ABS rate securitization. This opportunity came to Angelo, Gordon through our broader-structured credit business. Angelo, Gordon is a well-known preferred counterparty because of our ability to work on complicated transactions with short time lines. The bridge securitization was used to help fund a specialty finance company acquiring a large US credit card portfolio that was being sold by European bank. We were able to purchase well-enhanced mezzanine risk at unlevered low double-digit yields or mid-teen ROEs with modest leverage. Additionally, MITT, along with other Angelo, Gordon funds participated in a term securitization in April, which refinanced our previously securitized nonperforming mortgage loans into a new lower-cost fixed-rate long-term financing. We maintained exposure to the securitization through interest in the subordinated tranches as well as through our ownership of the vertical risk retention portion of the capital structure. Slide 8 of our quarterly earnings shows updated hypothetical ROEs on the investment opportunity set as we currently see across the Agency, residential credit, commercial and ABS sectors. It is important to note that our ability and willingness to invest in each of these sectors varies over time. And the investment team constantly evaluates where the best long-term road of value lies for our shareholders. On slide 9, we've laid out the investment portfolio composition for the quarter. The aggregate portfolio size increased to approximately $3.4 billion from $2.6 billion in the prior quarter. The fair value of our Agency book was approximately $1.9 billion and the fair value of our credit book was approximately $1.5 billion. You will see an 8.7% increase in the fair value of our Agency book compared to a reduction of 1.7% in our equity allocation to agencies. While we don't always highlight this, this outcome is a result of our financing team optimizing the assets we lever and the amount of leverage we used in order to minimize our overall borrowing costs. Focusing on our Agency portfolio, on slide 10, you will see a breakdown of our current exposure by product type. The constant prepayment rate for our Agency book was 8.7% for the second quarter. Given the size of our Agency portfolio relative to the overall market, the investment team is able to be disciplined and selective when adding Agency risk into the portfolio. Because of this, we expect prepayments fees on our portfolio to generally be slower and exhibit greater stability than other -- than the overall universe of Agency collateral, owning to the favorable characteristics of our holdings. Moving ahead to slide 14 of the quarterly earnings presentation. We lay out the duration gap of our portfolio, which declined modestly this quarter to 1.44 years from 1.52 years in the prior quarter, despite the overall portfolio growing by approximately 30%. During the quarter, we were disciplined in handling hedges as we increased our exposure to Agency mortgages to maintain the duration gap. As we look forward, we believe MITT is well positioned to take advantage of a wide range of agency and credit market opportunities at favorable returns. We continue to deploy our liquidity into investments that we find attractive to add, such as Agency mortgages, commercial assets sourced by Angelo, Gordon CMBS and real estate private equity group and newly-originated residential whole loans and MSRs. With that, I'll turn the call over to Brian to review our financial results.

Thanks, TJ. Overall, for the second quarter, we reported net income available to common stockholders of $29.8 million or $1.07 per fully diluted share. Core earnings in the quarter was $12.9 million or $0.47 per share versus $11.5 million or $0.41 per share in the prior quarter. There was a negative $0.01 retrospective adjustment in the second quarter due to the premium amortization on our Agency portfolio versus de minimis retro adjustment in the prior quarter. At June 30, our book value was $18.77, an increase of $0.60 or 3.3% from last quarter due to the reasons that David previously mentioned. To give you a better sense of our current $3.4 billion portfolio, I'd like to highlight a few more statistics. As described on Page 4 of our presentation, the portfolio at June 30 had a net interest margin of 2.48%. This was comprised of an asset yield of 4.75%, offset by repo and hedging costs of 1.93% and 0.34%, respectively, for a total cost of funds of 2.27%. The decrease in yield is primarily related to the addition of Agency securities. The increase in the cost of funds from the prior quarter is primarily due to the increase in the Fed funds raised in June. As of June 30, we had 39 financing counterparties and are financing investments of 26 of those counterparties. In the second quarter, we did not see any offsets in the financing market from the rate increase. And in general, funding continues to be plant a solid new interest in both the credit and Agency space. At quarter-end, we had liquidity of $114 million, comprised of $29 million of cash, $66 million of unlevered Agency whole pool securities and $19 million of unlevered Agency IO securities. Additionally, at quarter-end, our estimated undistributed taxable income was $1.74. We continue to evaluate this on a quarterly basis to make sure that we're in compliance with their distribution requirements. As a reminder, we have until September of 2017, to fully distribute our 2016 taxable income. We also utilized our at-the-market equity offering program or ATM during the quarter. We issued approximately 100,000 shares of common stock for net proceeds of $1.8 million. That concludes our prepared remarks. And we would now like to open the call for questions. Operator?

[Operator Instructions] Our first question comes from Douglas Harter from Crédit Suisse. Please go ahead.

Just hoping you could talk about - you guys had an active quarter on credit. Is there still the availability to sort of hit the targeted returns? And can you source enough product to sort of keep that - to keep funding - to keep that allocation up to credit?

Yes. I mean - I think, we adjusted, however, looking at the universe on Page 8. I mean, second quarter was definitely a strong quarter for credit. So I would say the ROEs are lower, but we still see supply coming from the various new issue markets. The secondary markets were slow. That's partly a function of longer-term trends as well as getting into the spring/summer months of May, June. But we're still an active new issue market.

It's David Robert speaking. I think also, as TJ outlined in his comments on the credit side, we're seeing opportunities come out of the broader Angelo, Gordon network. And that's helpful to us.

And then just your thoughts on capital as the stock is close to book value, kind of how you're thinking about capital - potential capital raises?

Look, we always look at a number of things. We look at what a capital - how a capital raise would affect our book value per share. And we look at how a capital raise would affect our earnings per share going forward, depending upon what we would use for the capital, what we would purchase with the capital. So we're always thinking about those questions. And that's generally how we look at the world.

Our next question comes from Eric Hagen from KBW. Please go ahead.

Following up on Doug's question, if you can just give us a breakout or any sense of the prepayment speeds in the non-agency portfolio, any break up between the segments like prime and sub-prime and that would be really helpful? Thanks.

If you turn to page 11, we don't have a lot of premium securities, which are at risk of prepayment. We're generally still - aside from the CRT bonds that we've bought that have rallied us for this time, we are generally on the legacy side still. It is discount position where any increase in prepayments would be accretive to yield. We don't have anything specifically broken out on this page. But I mean, that's the way the book is set up again, with the exception of - the CRTs, which could have rallied into a premium and the RTL, MTL securities which are generally carried around par.

I mean, are we talking mid teens or low teens CPRs for the non-agency portfolio generally? Or we're talking something slower?

Probably a little bit slower for what we own.

And then the regulatory reform that you mentioned in your opening comments that you expect to see from this administration, and its impact on credit availability, how do you think about using Arc Home and to capitalize on that value?

Yes, so I mean - so the report that was put out, I believe, in June, had 10 pages of 100 and just what the administration thinks of the banking sector and financial reform. At a higher level, for Arc Home, we're seeing non-QM securitizations compound in terms of issuance year-over-year. I think we expect that to triple from last year. And we look to use Arc Home to create credit products as those markets continue to open up.

Our next question comes from Trevor Cranston from JMP Securities. Please go ahead.

Question on the Credit investments you made this quarter. And specifically the subordinate securities on the single borrower hotel deals. I was wondering if you could give a little bit more color on what in particular you liked about those specific hotel deals you invested in. And also, just maybe help us with some general comments on how single spreads on single borrower deals compared to more generic conduit deals in the CMBS space?

Sure, so within CMBS, I think you have to take it a level higher and look at the impact that, this is the first year risk retention has been in place on the CMBS. So where we're traditionally, we're looking at BBB, BB risk in conduit deals depending on how the securitization is set up with risk retention. There isn't as much bond available at those attachment points. It's the issuer take the 5% vertical. So there's been sort of a lack of supply in that part of the capital structure. As you move to single asset, there's typically shorter duration on the maturity to loans and typically more enhancement almost being equal at the various rating agency levels. So we're able to fund floating-rate credit traditionally on those deals, which we'd like. And we think we have relative value compared to where the conduit deals are getting done, which is more of a function of, I think, there's just a lack of supply that the broader community wants to buy a diversified conduit pool versus we're willing to credit work on a much more single asset deal where you really have to roll up your sleeves and do the credit work on the borrower and the asset. So that's why we've been focusing on deals like that versus the generic conduit deals.

And then, obviously, the credit spreads in the quarter had a nice positive impact on your book value. Can you comment how spreads have generally performed since quarter-end, if there continued to be a nice tailwind for book value?

Yes, I’ll take credit further. I wouldn't say that we're experiencing what we saw in Q2 up to this point. Trading volumes are generally lower, given the summer months. New issue supply has slowed down as well, which could sometimes reset the market tighter or wider. So I would say it's not as much of a ferocious tightening as we saw in Q2.

[Operator Instructions] We have no further questions at this time.

Thank you everyone. We look forward to speaking with you next quarter.

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