Earnings Call: Q3 2022

Nov 8, 2022

Greetings, and welcome to Angel Oak Mortgage third quarter earnings conference call. At this time, all participants are in a listen-only mode. Question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Randy Chrisman, Chief Marketing and Corporate Investor Relations Officer. Thank you, and over to you, sir. Good morning. Thank you for joining us today for Angel Oak Mortgage REIT's third quarter 2022 earnings conference call. This morning, we filed our press release detailing our third quarter 2022 results, which is available in the investor section on our website at www.angeloakreit.com. As a reminder, remarks made on today's conference call may include forward-looking statements. Forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those discussed today. We do not undertake any obligation to update our forward-looking statements in light of new information or future events. For a more detailed discussion of the factors that may affect the company's results, please refer to our earnings release for this quarter and to our most recent SEC filings. During this call, we will be discussing certain non-GAAP financial measures. More information about these non-GAAP financial measures and reconciliations to the most directly comparable GAAP financial measures are contained in our earnings release and SEC filings. This conference call is hosted by Angel Oak Mortgage REIT's Chief Executive Officer, Sreeni Prabhu, Chief Financial Officer, Brandon Filson, and Angel Oak Capital's Co-CIO, Namit Sinha. Management will make some prepared comments, after which we will open up the call to your questions. Additionally, we recommend reviewing our earnings supplement posted on our website at www.angeloakreit.com. Now I'll turn over the call to Sreeni. Thank you, Randy, and thank you everyone for joining us today. Before I dive in, I would first like to express my sincere gratitude to Robert Williams, my predecessor as CEO, for his many contributions to both our launch as a publicly traded REIT, as well as his guidance to our first-year post-IPO. Robert helped set a strong foundation for the company, and I'm excited to lead the team through this next phase of its growth. As such, I will turn to our Q3 results and outlook. As you all know, 2022 has presented unprecedented challenges across financial markets, and mortgage REITs, in particular, have felt the impact of many factors driving this instability. These challenges did not abate in Q3. Inflation remained elevated, forcing the Federal Reserve to persist with interest rate hikes, the pace and the magnitude of which continued to cause widespread disruption across fixed income assets. Spreads have widened substantially, contributing to less liquidity in capital markets, and conforming mortgage rates have more than doubled from about 3% a year ago to over 7% today. Consequently, mortgage originations have slowed during the third quarter as higher rates eliminated most of the benefit of refinancing and home sales slowed amid affordability concerns. However, there remains a meaningful shortage in the supply of quality housing across the country, and unemployment remains low. Importantly, credit performance remains strong. Delinquencies are low, foreclosures are infrequent, and loss severity rates are near zero. For example, the percentage of loans in the AOMR portfolio that are ninety-plus delinquent was 1.15% as of the end of Q3 and has trended downward each quarter since Q3 2020. It'll come as no surprise that interest rate and the spread volatility and the uncertainty had an impact on the AOMR portfolio in Q3. We faced downward pressure on our mark-to-market assets, which drove GAAP and economic book value declines of 27.8% and 19.4% respectively. These book value declines are driven substantially by fair value marks associated with our whole loan on balance sheet securitization and RMBS portfolios. I do like to emphasize that these marks represent unrealized losses. As I've consistently said, stated previously, the credit performance of these assets remains strong, and they're expected to pay off at par, at which point the mark-to-market losses would be offset. Given the current market, AOMR shifted to a more defensive strategy in Q3, managing liquidity while protecting our capital structure so that we are in a position to grow once markets and the economic activity stabilize. We purchased fewer loans than in the previous quarters, though it is worth noting that the average coupon rate for these mortgage purchases was over 7%. The Angel Oak Mortgage Lending, which is the sister mortgage company of Angel Oak, the most recent mortgage locks are over 8.5%. Over the coming quarters, we plan to reposition our portfolio to be more reflective of these current rates and to resume our methodical process of purchasing and securitizing newly originated high coupon loans. As a part of the process, we'll evaluate loan sales and securitizations as well as potential new non-mark-to-market credit facilities. Lastly, in order to reflect current market conditions and to rightsize our dividend yield, we have made the decision to reduce our quarterly dividend to $0.32 per common share payable on November 30, 2022, to common stockholders of record as of November 22, 2022. With that, I'll turn it over to Brandon. Thank you, Sreeni, and thanks everyone for joining us. For the third quarter 2022, we had a GAAP net loss of $83.3 million or $3.40 per common share. Unrealized losses on our securitized loan portfolio contributed $1.58, or 47% of this GAAP net loss. Note that the return profile of the securitized loan portfolio is fixed upon securitization, but that the value of the underlying loans is used for GAAP reporting. Distributable earnings were $20.8 million or $0.84 per common share. The difference between GAAP and distributable earnings is primarily attributable to the add back of unrealized losses on our mark-to-market loan and securitized loan portfolios, as well as the impact of realized gains from interest rate hedges. Interest income for the quarter was $30.1 million, and net interest margin was $11.7 million as variable financing costs increased on our whole loan portfolio. Srini stated, GAAP book value per share declined 27.8% to $10.63 as of September 30, 2022, down from $14.73 as of June 30, 2022. This includes the impact of our $0.45 per common share dividend paid in August. Economic book value, which includes valuing all securitization obligations to their fair value, was $12.94 per share on a diluted basis on September 30, 2022, down 19.4% from $16.05 per share as of June 30, 2022. Unrealized mark-to-market losses driven by rate and spread widening were the key contributors to the book value decline. During the quarter, we purchased $62 million of non-agency mortgages at an average loan coupon of 7.1%. The weighted average coupon of whole loans in our portfolio increased to 4.72% as of the end of the third quarter. The weighted average coupon across our securitized loan portfolio is 4.74%, with a weighted average cost of funds of 2.72%. As we deploy capital into loan purchases, newly originated loans with coupons of over 8.5% will help drive up the weighted average coupon of the loan portfolio and improve securitization execution. As always, please note that due to the loan origination process, our loan purchases in a given month will typically reflect loan locks from 1-2 months prior. Turning now to our securitization activity. In July, we were able to take advantage of a short window of opportunity to complete our fourth securitization since our IPO, a $185 million securitization, where we placed 86% of the capital structure at 5.8% weighted average cost of funding. The deal included 407 loans with a weighted average coupon of 5.22%, an average credit score of 730, loan to value of 75.1%, and a debt to income ratio of 32.1%. This transaction was rated by Fitch with the senior tranche receiving a AAA rating. This securitization deal freed up additional cash, reduced loan financing ex-facilities by over $150 million. Our operating expenses for the third quarter were $11.5 million. When adjusted for severance and securitization expenses, operating expenses were $6.4 million, representing a savings of about $1 million versus the comparable $7.4 million in Q2, during which there was not a securitization. With regard to our balance sheet, at September 30th, we had $20.5 million in cash and cash equivalents. Our recourse debt to equity ratio was 3.7x. We have unpaid principal balance of $1.3 billion of residential whole loans at a fair value of $1.1 billion, $1.1 billion of residential mortgage loans in a securitization trust, and $1.1 billion of RMBS, including $65.4 million of retained AOMT securities from the pre-IPO securitization. We finished the quarter with undrawn loan financing capacity of $695 million. As of September 30, we had loan financing facilities with six financial institutions. After quarter end, one financing facility matured, and we added a new facility, bringing our total financing capacity to $1.4 billion as of today. As Sreeni mentioned, we plan to evaluate new facilities, including non-mark-to-market facilities. We remain committed to a sound liquidity management strategy during this period of rising rates. Finally, the board has declared a $0.32 per share common dividend payable on November 30, 2022 to shareholders of record as of November 22, 2022. This implies an annualized dividend rate of $1.28 per share or a yield of 13% as of the closing price on November 7, 2022. For additional color on our financial results, please review the earnings supplement available on our website. I will now turn it back to Sreeni for closing remarks. Thank you, Brandon. While the current market has presented challenges and has necessitated change, Angel Oak's fundamental differentiators have not changed. We are aligned with the most seasoned and experienced originators and the asset managers of non-QM mortgages, providing access to high quality investments that meet our return and risk profile. We have a strong balance sheet that has proven its resilience among the unprecedented market dislocations so far this year. We perform superior credit underwriting. Originating non-QM loans in any environment takes unique skills, and our diligent underwriting processes provide more insight into borrowers and risks. This has always been core to Angel Oak and will not change. We remain confident that our platform is uniquely positioned for the success and look forward to continuing to capitalize on our strength in the future. As always, I do like to thank the entire Angel Oak team for their hard work and contributions to our successes. With that, we'll open up the call to your questions. Operator? Thank you. At this time, we will be conducting a question and answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Our first question is from the line of Donald Fandetti from Wells Fargo. Please state your question. What about your near-term liquidity position in terms of how you filled up your cash, and are you getting any repayments on the loans that are not securitized? Yeah. Hey, Don, I think the very first part of that question may have gotten cut off, when you. Sure. when you started playing. No problem. Can you talk a little bit about your near-term liquidity position and your cash position, and whether or not you're getting any repayments on loans that could help that position? Yeah, no, I think we've been in a position now for, you know, a little bit where we're, you know, not buying many loans. There's, you know, just too much volatility, I think, in the market. So we've been in a, you know, just using liquidity to pay down debt to, you know, keep a good cash position. You know, we had $20 million in cash, but we still have plenty of unlevered securities to raise additional cash and, you know, unlevered loans and additional financing capacity, you know, as we, you know, if we're to use it. Would you consider selling loans? I wasn't sure if that was part of the sort of thinking of the portfolio. Yeah, no, I think you'll see, hopefully this quarter, you know, a few things. I believe that Sreeni touched on it in his prepared remarks. You know, we're always targeting to get securitizations out, you know, on a regular basis to the extent we can. That market's been very choppy lately. We are looking at selling a portion of the loans, you know, to move ahead, and that would free up a lot of liquidity that we can easily turn into, you know, significantly higher coupons, you know, as soon as that's done. Yeah. Hey, Don, this is Sreeni. Quickly, what we wanna do is optimize our balance sheet for liquidity and also to play some offense. You know, we have a combination of low coupons. We don't wanna give up all that optionality by just selling the loans because we want to retain them into a securitization, which is, we believe, our best execution. We look at everything and optimize it over this quarter. Got it. Thank you. Thank you. If you would like to ask a question, please press star one on your telephone keypad. Our next question is from the line of Matthew Howlett from B. Riley. Please go ahead. Oh, hey, guys. Thanks. Good morning. Thanks for taking my question. Just a few housekeeping. What's the UPB on the unsecuritized loans? Is it the $1 billion plus the $9 million, the commercial? What's the coupon? Our UPB of unsecuritized loans is about $1.3 billion today. That coupon is just over 4.7%. Okay. Those have been presumably marked down below par. Yeah. The fair value of those is about $1.1 billion. Gotcha. Okay. The $1 billion in RMBS and CMBS, I mean, how much of that is pledged to repurchase facilities? About $60 million worth. Gotcha. Okay. Then just stepping back. I mean, Brandon, when you said that, you know, that you hold the stuff to par, right, on the securitizations and then some of the loans you end up keeping. If there's no credit events and losses remain within your expectations, can you just give us a sense, you know, where book value would be? I mean, then what's the duration? What are we talking in terms of duration? Yeah. I think the point on that comment was just to say, look, this is, you know, the loans that are unsecuritized, obviously we're marking down as interest rates rise. We do expect barring a credit event, those will be paid off at par, which at this point, you know, if every loan paid off today, it would be, you know, 11-point-ish pickup back on that loan value. So they'd be paying off at $1.3 billion instead of $1.1. So it'd be, you know, $200 million with the recovery. Now, the 4.7% coupon loan today is prepaying very slowly. You know, so that'll take some time to work its way through the system. In the meantime, over the next several quarters, we hope to securitize those loans anyways, which will help, you know, book value from that perspective. I think securitization execution is still a few points ahead of, you know, like a loan sale in terms of, the economic value to the company. Gotcha. Appreciate it. Then just the last question, there's been a lot of headlines on Angel Oak Mortgage Lending, Angel Oak Asset Management. I mean, just, you know, use this next just, you know, a couple of minutes to spend on what's going on at the mother company and, you know, just personnel, key movements, just things of that nature. Matt, this is Sreeni. Yeah, there has been a lot of conversations about everything Angel Oak. At the Angel Oak holding company level, there is Angel Oak Asset Management and there is Angel Oak Mortgage Company. I'll go through Angel Oak Asset Management. There have really been no changes over there to speak of. You know, we have mutual funds and we have our private credit vehicles. You know, we continue to operate as normal. We face the same volatility as any fixed income markets, but that's not been any issue. We've had no issue across our funds in terms of financing lines or anything like that. That's on the asset management side. On the mortgage company side, you know, the things that you hear, to be clear, we have a retail mortgage company and we have a wholesale mortgage company. The wholesale mortgage company does predominantly non-qualified mortgages, which is what we buy in the REIT and our other funds. In the retail company, we did all sorts of things, including agency mortgages, which is actually predominant what we did. Just like any other mortgage company, we had to shrink workforce over there, shrink what we do. Our focus on non-QM has not shifted. I would still like to speculate that, yes, our volumes are down as they would be in this environment, but I would still speculate that we still originate more mortgages per lender than anybody else in the space. That's primarily going either in our funds or, you know, hopefully in the REIT in the near future. There's definitely shrinkage in the mortgage company, but nothing out of usual in asset manager. Okay. You're saying just there's been traditional layoffs and just that, but you still are, you're still sort of number one in the space, I mean, on the league tables. I know there's been a few of your competitors that have just gone completely out of business. Yeah. Yeah. You know, we came into this, you know, in a much better place. Obviously, we always have the partnership with the asset manager, which helps. We have raised the money as we have always said that we are not a originate to sell model, we originate to own credit. Now that being said, as Brandon mentioned, you know, the mortgage REIT had to be prudent on how it deploys cash in an environment where the rates are going up fast and furious. We thoughtfully slowed down our origination in the mortgage company because we wanted to preserve the cash in our funds along with the REIT. We definitely slowed down. In terms of our credit underwriting, in terms of our operations, in terms of our people for non-QM, we are. We haven't done any sort of shrinkage there. Great. Thanks, guys. Appreciate it. Thank you. Our next question is from the line of Derek Hewett from Bank of America. Please go ahead. Good morning, everyone. Could you talk about how GAAP book value has trended quarter to date, given that rates have continued to grind higher? Yeah. You know, from a duration standpoint, these loans carry duration. As rates have trended higher, obviously the mark-to-market on these loans have brought the book value down. In tandem, you know, a big part of that rate equation is actually hedged through interest rate futures. What has happened in addition to rate moves, the spreads have actually widened significantly over the last few months. There was spreads that had gone out in the summer to pretty wide levels. Then there was a pretty meaningful tightening that happened over a couple of months period when there was a respite in rate vol. Almost all of that, actually, all of that and some more was given up in that September bout of volatility in the rates market. We went back all the way to the wide general rate higher. That has created what we see in the decline in the book value. Okay. I'm not sure if you answered my question, but what about book value as of the end of October? Yeah. I mean, I think what Namit was getting at, that's why I passed it over to him, is just we continue to see an environment where rates are increasing, spreads widening. I would expect, you know, end of October book value to be down another couple of points from where we are, you know, at the end of September. Okay, great. Thank you. Thank you. Ladies and gentlemen, we have reached the end of the question and answer session, and I would like to turn the call back to the management for closing remarks. Thank you everyone for your time and interest in Angel Oak Mortgage REIT. We look forward to connecting with you guys again next quarter. In the meantime, if you have any questions, please feel free to reach us. Have a great day.