TPG Mortgage Investment Trust Inc (MITT) Q2 2019 Earnings Report, Transcript and Summary

Welcome to the AG Mortgage Investment Trust’s Second Quarter 2019 Earnings Call. My name is Vanessa, and I will be your operator for today’s call. [Operator Instructions] Please note that this conference is being recorded.I will now turn the call over to your host, Raul Moreno.

Thank you, Vanessa. Good morning, everyone, and welcome to the second quarter 2019 earnings call for AG Mortgage Investment Trust, Inc. Before we begin, please note that information discussed on today’s conference 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 the Risk Factors section in our most recent annual and quarterly SEC filings. The company’s actual results may differ materially from these forward-looking statements. We encourage you to read the forward-looking statements disclosure in our earnings release and presentation in addition to our quarterly and annual SEC filings.During the call today, we will also refer to certain non-GAAP financial measures. Please refer to our SEC filings for reconciliations to the most comparable GAAP measures. Throughout the call this morning, we will reference the earnings presentation that was posted to our website after the market closed yesterday. To view the slide presentation, turn to our website, www.agmit.com, and click on the Q2 2019 earnings presentation link on the home page. Again, welcome and thank you for joining us today.With that, I would like to turn the call over to our CEO, David Roberts. David?

Thanks, Raul, and good morning to everyone. I’m going to share some of our second quarter 2019 financial results with you today. Our core earnings for the second quarter were $0.36 per share after subtracting a $0.04 retrospective adjustment. Core earnings were negatively impacted mainly by the effects of yield curve compression and changing prepayment expectations as asset yields have reset lower while funding costs have remained sticky, not adjusting until late in the quarter when it became clear the Fed would be lowering policy rates.That said, our book value was roughly flat quarter-over-quarter as the shortfall between our $0.50 dividend and our $0.36 of core earnings was offset by tightened spreads and gains in our Credit portfolio. As well, we are pleased with the prepayment performance of our specified Agency pools, which continued to perform better than the overall universe of Agency mortgage-backed securities. In light of this quarter’s shortfall of core earnings versus our dividend, I’d like to spend some time addressing our dividend going forward.As we’ve stated on previous calls, our board takes into account our expected multi-quarter run rate core earnings, our undistributed taxable income and our general outlook on the market and our portfolio among other factors when setting our common stock dividend. Based upon our current view of the market and our portfolio, we felt it was prudent to announce our expectation that our Board will adjust our quarterly common dividend to $0.45 per share for the third quarter of 2019 subject to any changes in our outlook. This compares to $0.50 declared for the second quarter.We believe that this level of dividend, $0.45, better reflects the modeled earnings power of our targeted asset portfolio, of our anticipated leverage and our projected funding costs in the current market environment. As I mentioned earlier, while our asset yields have been pulled lower by longer-term rates that reflect the market’s anticipation of future interest rates, our funding costs are more closely tied to policy rates at the front end of the yield curve that are set by the Federal Reserve. The compression of this spread reached its narrowest point during the second quarter. However, as it became clear late in the quarter that the Fed would be adjusting rates lower in the second half of the year, which was then confirmed at the July FOMC meeting last week, we have begun to see funding costs improve.While residual headwinds may still be present in the very near term, we anticipate that further expected rate cuts and our continued progress in adding higher-yielding whole loans to our mix of – our portfolio mix should improve net interest margins over time. T.J. will provide more detail on my comments regarding agencies, our whole loan strategy and the performance of the other material components of our portfolio.And with that, I will turn the call over to T.J. Durkin.

Thank you, David. Good morning, everyone. As David mentioned, the second quarter continued to challenge levered investors as yield on assets further out on the curve sell more sharply than shorter-term funding costs that are timed more directly to Fed policy rates.In response to persistently low inflation, slowing economic activity and uncertainty over global trade, the Fed has pivoted from its tightening policy to neutral to the first interest rate cut in over 10 years, all in the period of just seven months. Between November of last year and the middle of the second quarter, the spread between the three-month overnight indexed swap or OIS rate and the 10-year swap rate has tightened by 120 basis points to negative 22 basis points. The last time we experienced inversion in this relationship was briefly in 2006.While amounts are unscathed, we feel that our diversified portfolio of credit, whole loans and Agency MBS has performed well in this environment and also versus our peer group, generating a 7.3% economic return on equity for the first six months of the year or 14.6% annualized year-to-date.Despite the rate moves, book value has been stable, roughly unchanged quarter-over-quarter. Our hedged Agency MBS portfolio did experience some basis widening, but this was minimized by the high percentage of quality specified pools in our Agency portfolio and was more than offset by spread tightening in our whole loan and credit portfolios.I’d now like to briefly discuss our core earnings. In Q2, core experienced a $0.09 hit compared to last quarter primarily due to an increase in modeled lifetime prepayment expectations on our Agency MBS. Agency RMBS were down approximately $0.11, which was comprised of approximately $0.07 in response to benchmark swap rates that were 45 to 60 basis points lower across the curve and approximately $0.04 due to a onetime change due to our transition during the quarter from an investment bank’s agency prepayment model to the more widely used yield book model. Away from agencies, there were a handful of other items that provided a positive $0.02 offset to these changes in the prepayment expectations of our Agency book.Turning to our investment activity. We are pleased to announce that during the second quarter, MIT, along with other Angelo Gordon funds, completed its first rated non-QM securitization in June. We were able to lock in the cost of funds from AAA to BBB at a duration weighted average spread of 106 basis points over swaps, which is a dramatic improvement from our warehouse line cost of funds. Based on the current volumes we are seeing in the market, we would hope to become a quarterly issuer via our well-known GCAT shelf.The credit sector performed well during the second quarter. The credit risk transfer market, which serves as a barometer of overall residential mortgage credit, extended its first quarter spread tightening, outperforming high-yield corporates and other broader markets throughout the quarter.Fannie Mae and Freddie Mac made structural modifications to their CRT deals as their programs evolved to balance their needs and the changes were well received by the market with new issued deals often being multiple times oversubscribed. However, tighter spreads have some CRT tranches at significantly higher price premiums to par, creating some prepayment concerns should refinancing activity pick up as a result of lower prevailing mortgage rates. Legacy RMBS spreads were unchanged to modestly tighter unrelatively light trading volumes. CMBS spreads were relatively unchanged after a strong performance in the first quarter.Turning to Slide 6 of our quarterly earnings presentation, details of our second quarter activity. We reduced our overall Agency MBS exposure, which had increased during the first quarter as we deployed proceeds from our capital raise. During the quarter, we increased our residential loan exposure both in reperforming and nonperforming loans and in newly originated non-QM loans. Additionally, on the credit side, we continue to add to our CRT securities portfolio and fund draws on our existing CRE loan book.On Slide 9, we played out our investment portfolio composition for the quarter. The net carrying value of the aggregate portfolio was down from $4.1 billion to $4 billion for the quarter and at quarter end, was approximately 58% Agency, 39% credit and then 3% SFR.Focusing on our Agency portfolio on Slide 10 is a breakout of our current exposure by product type. As mentioned, we modestly reduced our Agency MBS exposure during the quarter by shelving pools back by generic and less call-protected collateral, which resulted in an increase in our percentage of pools backed by lower loan balance loans or loans into favorable geographic locations to 96% from 90% quarter-over-quarter.We have benefited from holding a high percentage of higher quality specified pools that have greatly outperformed TBA year-to-date. Our disciplined Agency MBS asset selection process allows us to position the portfolio for a variety of prepayment environments. The constant prepayment rate for our Agency book was 7.1% for the second quarter versus 12.4% for the overall 30-year Fannie Mae universe. We expect the portfolio to continue to outperform the overall universe of Agency MBS as prepayments are anticipated to pick up over the coming months in response to lower interest rates.Turning to Slide 12, focusing on our commercial real estate loans portfolio. We funded approximately $4 million of equity commitments related to construction loans during the first quarter and have approximately $15 million remaining in equity commitments. These construction loans are primarily first mortgages that sit in senior positions at the top of their respective capital structures.Turning to Slide 13. We provide portfolio statistics on our single-family rental portfolio. Occupancy decreased slightly during the quarter from 93.7% to 92.1% and rents were relatively unchanged. Operating margin declined from 45.2% to 41.5% primarily due to the aging and subsequent write-off of certain rental receivables.On Slide 15, you can see our duration gap of 0.98 years, which is fairly constant versus 0.95 years at the end of the first quarter. We reduced our hedges in concert with both a smaller Agency portfolio and shorter asset duration given the move-lowering rates. During the quarter, we were able to lower our weighted average pay fixed rate down to 1.9% from 2.2%.Looking ahead, we continue to see a large pipeline of credit opportunities as favorable risk-adjusted returns sourced via Angelo Gordon’s platform. We are excited that we’re able to successfully complete our first rated non-QM securitization and to – intend to remain active in utilizing the securitization markets to fund our various whole loan activities.With that, I’ll turn the call over to Brian to review our financial results.

Thanks, T.J. Overall for the second quarter, we reported net income available to common stockholders of $15.3 million or $0.47 per fully diluted share. Core earnings in the second quarter was $11.8 million or $0.36 per share versus $13.6 million or $0.45 per share in the prior quarter. There was a negative $0.04 retrospective adjustment in the second quarter versus a negative $0.01 retrospective adjustment in the prior quarter for the reasons David and T.J. discussed.At June 30, our GAAP book value was $17.42 per share as compared to $17.44, a decrease of 0.1% from last quarter. Our undepreciated book value remained relatively unchanged increasing from $17.56 to $17.57. This was due to credit spreads tightening offset by Agency spreads widening and core earnings below our dividend, as David mentioned.As described on Page 5 of our presentation, the portfolio at June 30 had a net interest margin of 2%. This was comprised of an asset yield of 5%, offset by a total cost of funds of 3%. The net interest margin decline from the prior quarter was mostly due to reduced yields on our Agency portfolio due to increased projected prepayment.Additionally, our at-risk leverage ratio is 4.4 times at June 30 as compared to 4.7 times at March 31. The decrease is primarily the result of Agency sales during the period. As of June 30, we had 45 financing counterparties and our financing investments were 33 of them, and general funding continues to be principal with new entrants in both the credit and the agency space.During the second quarter, we entered into agreements to purchase two pools of reperforming and nonperforming mortgage loans and added corresponding hedges. For GAAP, purchases of mortgage loans are accounted for as commitments until the completion of due diligence and the removal of any contingencies. Therefore, it will only be included on our balance sheet and within our portfolio upon settlement.Separately, the hedges were included on the trade date. As such, we have presented two forms of duration on Slide 15 of our presentation: 0.67 years, which solves the gap presentation, excluding the commitments and including the hedges; but also 0.98 years, which is pro forma of the inclusion of the loan purchases in our portfolio alongside corresponding hedges.At quarter end, we have liquidity of approximately $120 million, which was comprised of $60 million of cash and $60 million of unlevered Agency whole pool securities. During the quarter, our first rated non-QM securitization. Both of these were alongside other funds affiliated with Angelo Gordon. These transactions allowed MITT to pull back a total of $31 million of equity, which added to our liquidity.Additionally, at quarter end, our estimated undistributed taxable income was $41.8 million or $1.28 per share. We continue to evaluate this on a quarterly basis to make sure that we’re in compliance with our redistribution requirement.That concludes our prepared remarks and we’d now like to open the call for questions. Operator?

[Operator Instructions] It seems we have our first question from Eric Hagen with KBW. Please go ahead, sir.

Thanks. Good morning. On the dividend guidance, you guys came in a little bit below that $0.45 you expect to pay out going forward. I’m just trying to narrow down the drivers that will get you back up to that kind of $0.45 level.

It’s David Roberts. We anticipate that the further expected rate cuts and our continuation of adding high-yielding whole loans are going to improve our net interest margin going forward.

Okay. Great. What is the levered return on the whole loan piece now relative to, let’s just say, a few months ago?

There’s two components to that, Eric. So I think when we’re in the warehouse phase, we’re funding on a LIBOR plus spread basis, which has been stickier in anticipation of the Fed cuts versus – so that’s probably in the very high single digits to very low double digits during that warehouse phase. We think we get a pretty big pop once we term out the funding via securitization at that fixed cost and higher advance rate probably into the mid-teens.

Mid-teens. Great.

So that’s kind of two components on the non-QM part.

Yes. As a follow-up to that, how much capital would be needed to support that kind of quarterly run rate that you talked about in your prepared remarks, securitization loans a quarter?

Look, I think as we sort of scaled our network of sellers of the product, we now anticipate being a more frequent issuer, and so that – some of that capital that we’ve had in the warehouse is almost being turned on a more frequent basis than the longer lead time that we’ve had in getting to our first deal. So it’s more of a constant rotation of that capital funding, the equity of the warehouse than we’re scaling up the notion of the warehouse in meeting our capital. So I think we’re pretty comfortable with the capital that we have kind of at the end of this quarter deployed into the warehouse.

Got it. That’s helpful color. Thank you very much.

Our next question comes from Doug Harter with Credit Suisse.

Thanks. Just sticking with the non-QM for a second. Obviously, the CSPB made comments a couple of weeks ago. Just your thoughts on kind of what that might mean for the market and kind of what the next steps you would be looking for to see if that could scale up the opportunity size for you?

Sure. I think there’s a lot of talk about the DTI patch and its sort of shelf life and whether it will be renewed or not or just the rules of non – of what QM mortgages will be kind of going forward. I don’t – I think we know it won’t be the status quo post the patch end date. But we find a lot of – we’re finding a lot of products sort of in this – in the current environment while the patch exists. We think different products like investor loans, could present opportunities to the extent the rules change in the next couple of years.But in the interim, we’re finding more originators really start to understand the product and how to originate it that had previously been solely focused on Agency or FHA paper. And so we think there’s plenty of volume to be had in the interim period before the patch rules change. And we do expect things to look different in the coming years, but we’re not – we don’t have an educated guess on what they’ll look like at this point in time.

All right. And then obviously, the past few days have been volatile. Can you just talk about how – what the residential credit markets have looked like over the past few days? And kind of what might need to happen to shake free of some more opportunities for new investments?

Yes. I mean look, the most liquid product in residential credit is CRT, and that has kind of the most what we say beta to the bottom markets. Maybe spreads are 10 wider over the past week, so not marginally wider but obviously reacting to the equity sell-off of yesterday, et cetera.

Great. Thank you.

[Operator Instructions] Our next question comes from Trevor Cranston with JMP Securities.

Thanks. Good morning. One more question about the drop in rates we’ve seen in particular over the last few days. You talked about the impact of lower rates and faster prepay expectations on the results this quarter. It’s – can you talk about if rates were to sort of stay where they are today or even incrementally move lower? What do you think the impact of that would be on your portfolio? And how much faster you’d expect to see prepayments get in light of that?

Sure. I mean I think the majority of our book was sort of through the refi incentive on our books. So sort of the next five basis points lower, not really that material versus sort of what we’ve already seen in the last, call it, 15 to 30 days. And going back to just – the size of our Agency book is relatively small at $2 billion in the overall scheme of the market. And so we do have fairly well played out collateral stories, will it be low loan balance or New York only pools that historically have exhibited better prepayment characteristics in these refi ways.So we don’t think – on our book in particular, while we readjust the models based on the new rate environment, I mean we would expect that or would be hopeful that we would be able to, on a prepayment speed performance basis, go better than modeled. So that’s on the prepayment side, and I think this is confirming that I think funding rates will be lower or faster than maybe we thought 30 days ago, right? I think this is sort of somewhat forcing the hand on where and when rate cuts will be from an ROE point of view.

Right. Okay. Thank you for that. And a couple more questions on the non-QM side. I guess first, can you talk about what you guys are seeing in terms of how sticky loan rates are in the non-QM market, I mean, compared to conventionals, I guess, as rates have come down? And then second question would be just as you guys continue to complete securitizations in that space, can you say exactly like how much of MITT’s capital is in the retention of each securitization because I know there’s some other funds that are also participating on those?

Sure. So tackling the second question first. MITT has approximately 45% of the retention in the capital stack amongst the other Angelo Gordon funds. In regards to the stickiness of brands, I mean they have definitely been stickier. We are seeing spreads on actual whole loan bulk packages widen as rates have come in, and there’s somewhat of a $1 price cap that people are willing to pay on whole loans in anticipation of a potentially faster prepayment. So we actually have seen spreads on non-QM packages widen over the last, call it, 30 days as the rates has been sticky, but the baseline risk-free rates have come in. And so therefore, the spread has widened as people are really pricing it. And more to a yield perspective now than I would say – than in lockstep with where rates are moving.

Okay. Great. Appreciate the comments. Thank you.

Thank you. I see no further questions in queue at this time.

Thank you, everyone. Look forward to speaking next quarter.

Thank you.

And thank you. Ladies and gentlemen, this concludes today’s conference. We thank you for participating. You may now disconnect.