TPG Mortgage Investment Trust Inc (MITT) Q4 2018 Earnings Report, Transcript and Summary

Good morning and welcome to the AG Mortgage Investment Trust fourth quarter 2018 earnings call. My name is Brandon and I will be your operator for today. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer-session. [Operator Instructions]. Please note, this conference is being recorded. And I will now turn it over to Karen Werbel. You may begin.

Thanks Brandon. Good morning everyone. We appreciate you joining us for today's conference call to review AG Mortgage Investment Trust's fourth quarter 2018 results and recent developments. Before we begin, I would like to review our Safe Harbor Statement. Today's conference call and corresponding slide presentations contain 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 curve 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, February 27, 2019 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 would like to turn the call over to David Roberts.

Thank you Karen and good morning everyone. I would like to share some highlights of our 2018 financial results with you today. Our core earnings for the year were $2.08 per share, including a positive $0.03 per share retrospective adjustment. We increased our quarterly common dividend approximately 5% to $0.50 per share in the second quarter of the year. And for the entire year, we paid common dividends of $1.975. In the fourth quarter, market conditions were volatile and agency RMBS spreads widened as interest rates fell sharply while credit spreads widened in sympathy with the broader markets. As a result, our book value declined 10.2% in the prior quarter. The fourth quarter decline in book value constituted most of the decline for the full year 2018 book value of 12.3%. Through January, however, there has been a modest recovery in the market for risk assets and the agency basis and we estimate that book value increased approximately 2% through January 31, 2019. Our core earnings for the fourth quarter was $0.57 [sic -- see press release] per share, including a de minimis retrospective adjustment. For the fourth quarter, we declared a dividend of $0.50 per share. We would also like to update you on Arc Home, our residential mortgage origination affiliate. We are pleased to announce that during the quarter, Arc Home appointed a new management team, which among other things, will have an enhanced focus on credit originations. For context, during 2018, Arc Home originated $1.3 billion of government and agency loans through its four channels of origination and retained the originated mortgage servicing rights on its balance sheet. In conjunction with AG Mortgage Investment Trust and other Angelo Gordon funds, Arc Home purchased approximately $7.4 billion notional of Fannie Mae, Freddie Mac and Ginnie Mae Mortgage Servicing Rights from third parties. We believe that Arc Home's new management team will provide us with increased opportunities going forward to invest in excess mortgage servicing rights, nonqualified mortgages and other assets in the credit space. Lastly, I would like to provide a brief update on our common equity raise in February. We successfully raised net proceeds of $57.3 million, including full exercise of the underwriters option to purchase additional shares. We did this through an overnight common equity offering. Our senior management team invested in this capital raise by buying shares. We have fully invested the proceeds of the offering into agency RMBS, but we see a very strong pipeline of credit opportunities and we intend to rotate much of these proceeds into credit over time. Looking forward, our outlook for investment opportunities in return profiles is positive. Our diversification across agency RMBS and credit allows us to identify the best risk adjusted returns and opportunistically deploy capital across both sectors. We continue to leverage the sourcing and diligence strength of our Angelo Gordon team and focus on areas that require greater specialized credit expertise to capitalize on the most exciting credit opportunities we see. With that, I will turn the call over to T.J. Durkin.

Thank you David. Good morning everyone. The extreme period of risk offset into year-end led to credit and equity markets to sell off and the treasury markets rally. Interest rates declined by 40 to 50 basis points across the yield curve during the fourth quarter. Volatility increased significantly due to a sentiment shift and associated market overreaction in response to Fed communication, a softening of select manufacturing data, the absence of optimism on trade negotiations with China and the government shutdown. The Fed increased the federal funds rate by an additional 25 basis points in December, but lowered 2019 growth and inflation forecast and reduced its anticipated number of federal funds rate increases from three to two for 2019. Market pricing, meanwhile, has shifted to pricing the next bid action as a cut to the federal funds rate by the end of 2020. After reaching the Fed's 2% inflation goal in mid-2018, year-over-year core inflation has moderated. Bigger picture global economic activity appears to repeat in mid-2018 and the market is expecting growth to slow over the course of 2019. During the fourth quarter, as David previously mentioned, our book value declined primarily driven by basis widening and the sharp decline in interest rates. The underperformance in agency MBS was mostly pronounced in higher coupon MBS, which represent most of our 30-year fixed-rate holdings. As a vast majority of our holdings have some degree of call protection through either lower average loan balances or less prepayment extensive geographic concentrations, we are comfortable with the yield profiles despite the recent unrealized mark-to-market declines. Spread performance was mixed across other mortgage sectors during the fourth quarter. While legacy RMBS spreads widened modestly, they outperformed other securitized asset classes due to strong technical demand and favorable underlying fundamentals. The credit risk transfer market widened in sympathy with softness in other markets, particularly at the bottom of the capital structure. However, despite this widening, there was little forced selling from investors, while dealers reduced their overall CRT exposure in an orderly fashion into year-end. The CMBS market also saw little forced selling notwithstanding all the volatility. In addition, new supply in 2019 within the CMBS market is likely to be fairly limited, especially for traditional multi-borrower condo deals, which should be a positive technical for the CMBS market. Now focusing on slide seven of our quarterly earnings presentation, we outline our fourth quarter activity. During the quarter we purchased a pool of primarily RPO mortgages and several Non-QM pools alongside other Angelo Gordon funds. We also sold and received payoffs of short duration RPL and NPL securities and sold all of our agency Hybrid ARM positions. On slide 10, we have laid out our investment portfolio composition for the quarter. The net carrying value of the aggregate portfolio was approximately $3.6 billion for the quarter, comprised of approximately 57% agency, 39% credit and 4% single-family rental. Focusing on our agency portfolio on slide 11, you will breakout of our current exposure by product type. The constant prepayment rate for our agency book was 4.4% for the fourth quarter. Our disciplined agency MBS asset selection process allows us to position the portfolio for a variety of prepayment environments and we expect prepayment speeds for our portfolio to generally outperform the overall universe of agency collateral. We also show the portion of our agency fixed rate pools backed by loans with lower loan balance or concentrated prepayment geographic locations is 81% at the end of the quarter, up from 66.8% at the end of the third quarter. Early in the fourth quarter, as an adjusted positioning on the margin for a modestly higher rate environment by adding higher-yielding higher coupon MBS, we also increased the overall prepayment protection on the portfolio to guard against potential periods of lower interest rates that would increase the overall levels of prepayment activity. On slide 12, we highlight the price underperformance by coupon, again with the most dramatic widening occurring in higher coupons as we mentioned earlier. On slides 13 and 14, we would like to highlight that 45% of our residential credit investments, excluding all nonperforming and reperforming whole loans and 75% of our commercial ABS investments are floating-rate in nature and have benefited from the recent increases in Fed funds rate. Now turning to slide 15, we provide portfolio statistics on our single-family rental portfolio. The portfolio's operating margin is approximate 43.8% today. During the quarter, the portfolio experience a temporary increase in vacancies due to seasonality and a strategic initiative by our property manager, Conrex, focused on operational improvements to leasing and the tenant experience. Conrex is seeking to replace sub-performing and shorter term tenants as the leases expire with better quality tenants through the implementation of enhanced credit screening for renters and stricter underwriting standards for prospective tenants. The increased turnover and related expenses were the primary drivers of the decrease in the SFR portfolio's operating margin in the fourth quarter. However, it is important to know, a portion of the turnover expenses are reimbursable from an escrow account established pursuant to the purchase and sale agreement with the seller. With regard to vacancies, we have already seen an improvement since quarter-end with occupancy up to approximately 92%. We expect both occupancy and margins on the portfolio should improve longer-term with reduced tenant turnover and lower ongoing expenses. Moving ahead to slide 18 of the quarterly earnings presentation, we lay out the duration gap of the portfolio. As rates rapidly fell during the quarter, our overall duration gap decreased from 1.12 years at the end of the third quarter to 0.74 years at the end of the fourth quarter. Given what we see as somewhat of a market overreaction in the rates market to an actual slowing of growth from 2018 to 2019, we are comfortable with our shorter duration gap for now. In addition, because of the inversion at the very front end of the yield curve, we are currently in the unusual situation where our pay-fixed swap hedges with maturities all the way up to the seven-year point on the curve carry positively today. This decrease is the interest rate expense associated with running a smaller gap. Now as we look forward into 2019, we are confident that MITT is well positioned to deliver attractive risk-adjusted returns to our investors. Given the purposeful construction of our portfolio, we have ample flexibility to take advantage of opportunities that may arise out of any increase spread volatility. We continue to explore ways to deploy capital in all our target credit asset classes and we see a large pipeline of opportunities at favorable risk-adjusted returns sourced through the Angelo Gordon platform, including newly originated and seasoned residential whole loans, MSRs, CMBS and CRE debt. Additionally, our Agency MBS assets provide MITT with a high-quality liquid core holding base which we can increase and decrease depending on the relative value we see within the different market conditions. With that, I will turn the call over to Brian to review our financial results.

Just before Brian speaks, it's David Roberts again. Apparently, in a slip of the tongue, I misspoke about our core earnings for the quarter. It was $0.47. That's $0.47 per share. All right.

Thanks David and T.J. For the full year of 2018, we reported net loss available to common stockholders of $11.9 million or $0.42 per fully diluted share. Overall for the fourth quarter, we reported net loss available to common stockholders of $41.6 million or $1.45 per fully diluted share. For the full year 2018, we reported core earnings of $59.2 million or $2.08 per fully diluted share. Core earnings in the fourth quarter was $13.6 million or $0.47 per share versus $15.7 million or $0.56 per share in the prior quarter. There was a de minimus retrospective adjustment in the fourth quarter due to the premium amortization on our agency portfolio versus a $0.01 retro adjustment in the prior quarter. During the quarter, we did modify our definition of core earnings to exclude mark-to-market changes on ARC Home's mortgage servicing rights portfolio and their corresponding derivatives. This is consistent with how we treat Excess MSRs held directly by MITT as well as our other assets on our balance sheet. During the fourth quarter, our total operating expenses increased $4.8 million from $3.5 million in the prior quarter. This increase was primarily driven by transaction related expenses that were incurred in connection with the acquisition of credit assets during the quarter and have been excluded from core earnings as defined. In the 10-K, we will be filing, we have broken out our business into securities and loan segment and an SFR segment, with other items classified as general corporate. Transaction related expenses and other ongoing deal expenses are classified within either the securities and loan segments or SFR segment, while ordinary course G&A expenses are shown as part of corporate. We believe this breakout provides greater transparency with respect to the expenses we incur and the part of the business they relate to, especially given all the credit transactions that we have been entering into recently. At December 31, our book value was $17.21, a decrease of $1.95 or 10.2% from last quarter due to the reasons David previously mentioned. During the quarter, we introduced an undepreciated book value metric, which adds accumulated depreciation and amortization back to book value to incorporate our SFR property portfolio at its undepreciated basis. At December 31, our undepreciated book value was $17.30 as compared to $19.18 from last quarter. As described on page six of our presentation, the portfolio at December 31 had a net interest margin of 2.3%. This was comprised of an asset yield of 5.3%, offset by total cost of funds of 3%. The net interest margin decline from prior quarter was primarily due to increase in cost of funds related to a 25 basis point increase in the Fed funds rate in December. As of December 31, we had 44 financing counterparties and we are financing investments with 31 of them. During the quarter, we obtained two-year term financing on the pool of primarily RPL mortgage loans that we purchased. At year-end, the funding markets were tight as a result of a large treasury bill issuance which drove repo rates materially higher. The overnight repo increased over 6% at December 31 from 2.5% the day before. However, we had locked in our funding cost prior to year end, so our repo book did not experience material pressure. After year-end, rates normalized, but the market volatility does highlight some of the balance sheet pressures that have been brought on by increased regulation over the past several years as it relate to quarter end. Lastly, at quarter end, our estimated undistributed taxable income was a $1.58 per share. We continue to evaluate this on a quarterly basis to make sure that we are compliant with our distribution requirements. That concludes our prepared remarks and we would now like to open the call for questions. Operator?

Thank you. We will now begin the question-and-answer session. [Operator Instructions]. And from Credit Suisse, we have Doug Harter. Please go ahead.

Thanks. Can you talk about, one, the timing of the expected rotation into additional credit assets with the new capital and two, kind of how the returns compare on credit assets today versus agency?

Sure. Doug, it's T.J. We started already repositioning into, I will call, with the liquid credit securities, so mostly on the RMBS and CMBS side. And then some of the other asset classes that we are building positions in, whether it be Non-QM or seasoned RPLs or NPLs, those obviously have longer settlement times. So even if we were to agree to do a trade today, it's really not in the portfolio for probably 45 days at a minimum. So you will see that higher agency allocation until some of these potential transaction settle. In terms of credit assets, I think, simply if you were to look at some of the credit risk transfer, liquid securities running three to four turns of leverage, we can see LIBOR plus, 1,000 up to 1,300 depending on the security and financing we take versus we see within Agency ROEs, assuming about eight turns of leverage returns in the 12% to 13% range. So that's kind of the difference between the two products. And then where we see reperforming loans trading at probably a wider band, just given the wider distribution of outcomes are probably on the low-end, 10% to 11% and on the high-end, maybe 15% ROEs.

Great. Thanks for that color, T.J. And then just any updated thoughts on kind of that undistributed taxable income whether, I guess, you plan to sort of keep it undistributed or thoughts about doing kind of an additional special dividend like you had done in the past?

It's Brian. Thanks Doug. Our plan really is kind of the same as it's always been. We have been trying to kind of keep that undistributed to the extent that we have a special required, we would do that. We had a technical a couple years ago on an underlying investment that created a larger amount of taxable. So that was really more tied to that transaction. Away from that, to the extent that we are earning our tax income is close to our expected core or common dividend of $0.50, we wouldn't expect to do a special.

Thanks Brian.

And from JMP Securities, we have Trevor Cranston. Please go ahead.

Hi. Thanks. One more question on the deployment of capital from the raise. Could you give a little bit more detail on how you deployed into agencies? The coupon distribution looks pretty similar to what you already owned. And whether or not it was into specified pools versus TBAs? Thanks.

Yes. So the majority of it was deployed into specified pools and it is going to look similar to our current portfolio in terms of the coupon distribution.

Okay. Great. Thank you for that. And then a question on Arc Home. With the new management team in place, can you expand a little bit more on the type of credit products you guys are interested in originating there? And also as you expand in that direction, do you expect the agency origination volume to fall off or stay at the level it was at for 2018?

Yes. I think I will answer your second question first. I think we look at agency is still majority of the origination. So to the extent, Arc Home's customers are producing agency mortgages, we want to be a purchaser of them. With that being said, we think as obviously the mortgage origination market is quite tough now, adding differential products like Non-QM, which is probably where we are starting with, similar to what we are buying from other originators as somewhat of a hook to get more clients working with Arc Home will be the first iteration of that. But that's not to say over time, we can add other products like second liens, jumbo, et cetera, on the residential side, depending where pricing, et cetera is.

Okay. Got you. And then lastly, you commented on the spread recovery in January. Can you say if you have seen any additional spread tightening in February? Or would you say that markets have been relatively stable versus where they were at the end of January? Thanks.

In any particular asset class?

Yes. I mean, broadly speaking, but I guess primarily I am speaking about the agency book.

I think where we are positioned within the agencies has been roughly flat in Feb.

Okay. Thank you.

[Operator Instructions]. Okay. It looks like no further questions at the moment.

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

Okay. Thank you. Ladies and gentlemen, this concludes today's conference. Thank you for joining. You may now disconnect.