Angel Oak Mortgage REIT, Inc. (AOMR) Earnings Call Transcript & Summary

Greetings, and welcome to the Angel Oak Mortgage Fourth Quarter Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Randy Chrisman, Chief Marketing Officer. Thank you, and you may begin.

Good morning. Thank you for joining us today for Angel Oak Mortgage REIT's Fourth Quarter and Full Year 2022 Earnings Conference Call. This morning, we filed our press release detailing these results, which is available on the Investors 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 morning's conference call is hosted by Angel Mortgage REIT's Chief Executive Officer; Sreeni Prabhu; Chief Financial Officer; Brandon Filson; and Angelo 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 will turn over to the call over to Sreeni.

Thank you, Randy, and thank you, everyone, for joining us today. As you all know, 2022 was a very challenging year as we battle rising inflation, heightened market volatility and spread widening across most asset classes. The Fed approval and unprecedented 7 increases to the Fed funds rate over the course of the year, beginning in March. These increases took the benchmark interest rate from 0.25% as of December 31, 2021, to 4.75% as of December 31, 2022, marking its highest level in 15 years. Mortgage rates rose in kind, more than doubling and peaking about 7% in October. At the same time, non-QM mortgages approach 9%. Additionally, the securitization markets were extremely challenging, especially in the second half of the year. However, as we mentioned in our last earnings call, we commenced a strategic plan in the fourth quarter to reduce warehouse financing risk and increase liquidity. Over the last several months, we have made tremendous progress including 3 key accomplishments. First, in November, we sold residential mortgage loans with gross weighted coupon of approximately 4.5%, reducing financing risk and releasing incremental liquidity. This was a calculated decision, and we found that the price that we received was commensurate with a lack of liquidity in the securitization markets at that time; second, in December and early January, we converted approximately $286 million of mark-to-market debt from non-mark-to-market financing for continually performing loans, further reducing financing risk. This facility was with one of our existing large bank counterparties, which also speaks to our strong partnerships with global banks; finally, we participated in an AOMT 2023-1 securitization subsequent to year-end. This was the first Angelo securitization in which we participate alongside other Angel Oak entity since our initial public offering. We retain our pro rata share of bonds and the proceeds from the deal. As a result of this accomplishment, as of today, we have reduced our whole loan warehouse debt by over 50% and mark-to-market percentage of total warehouse debt by over 60% since the end of Q3 2022. Additionally, it is important to note that we have not taken on any corporate debt or preferred equity and that we own the call rights to all our deals, which gives us tremendous flexibility in the future. The goal of this strategy was not only to reduce risk and create liquidity, but to also restart our growth engine. And to that end, we intend to resume purchases of newly originated loans at market interest rates. With respect to the current mortgage landscape, there are a couple of dynamics that I would like to reiterate. First, there remains a meaningful shortage in supply of quality housing across the country. While mortgage rate increases have slowed down demand for home purchases, this underlying constraint should help support a baseline level of mortgage activity. Second, credit performance remained strong. Delinquencies remained low. Foreclosures are exceedingly rare and loss severities are near 0. Additionally, there has been a significant home price appreciation since many of these loans were originated, lowering LTVs and limiting losses in the rare event of default. Even if we factor in a slight-to-moderate decrease in home prices this year, we still expect meaningful growth versus where loans were originated. Finally, the volatility of this past year has resulted in even higher barriers to entry for the non-mortgage origination business. This reinforces the competitive advantage of our relationship with Angel Oak's well-established and streamlined non-QM origination platform. Over the coming quarters, we plan to rotate our portfolio into higher coupon mortgage loans and other high-yielding mortgage assets and sustain a methodical securitization process, all while continuing to stress liquidity management and protect the balance sheet. With that, I'll turn it over to Brandon.

Thank you, Sreeni. First, I would like to talk through the details of our financial results and then provide some additional context around our current position and where we're headed. For the fourth quarter of 2022, we had a GAAP net loss of $8.8 million or $0.36 per share. The loss was driven by the November loan sale, which drove roughly $19 million of incremental loss or $0.77 per share. Distributable earnings were negative $61.5 million or a loss of $2.50 per share. The November loan sale contributed approximately $63 million of realized loss or $2.56 per share in distributable earnings. The loans sold carried an unrealized loss of approximately $44 million as of the end of Q3, all of which were realized upon the sale in addition to the $19 million incremental loss. Interest income for the quarter was $28.4 million, and net interest margin was $7.4 million, which compressed due to higher variable borrowing costs. Our operating expenses for the fourth quarter were $4.3 million, representing a decrease of over $7 million from Q3. Excluding securitization and severance expenses, operating expenses were $2 million lower than Q3, which was approximately $1 million lower than Q2, demonstrating continued progress in scaling our operations. Now digging into our balance sheet. As of December 31, we had $29.3 million of cash. Our recourse debt-to-equity ratio decreased to 2.9x versus 3.7x at the end of the third quarter. We have residential whole loans at a fair value of $771 million, financed with $640 million of warehouse debt. $1 billion of residential mortgage loans and securitization trusts and $1.1 billion of RMBS, including $62 million in retained AOMT securities from the pre-IPO securitizations. We finished the year with undrawn loan financing capacity of $573 million. And as of today, our capacity is approximately $767 million. This difference is driven by our participation in January's AOMT 2023-1 securitization, which released approximately $190 million of mark-to-market warehouse debt. As of today, we have approximately $440 million of warehouse debt only $155 million of which is subject to mark-to-market risk. We were pleased to reenter the securitization market in January of this year. The AOMT 2023-1 securitization was an approximately $580.5 million securitization, and we contributed approximately $241 million scheduled principal balance of loans. Additionally, we retained bonds with base value of $26.6 million and a fair value of $21.8 million, while releasing $15.9 million in cash. We expect these retained bonds to yield between 10% and 15%. GAAP book value per share declined 10.7% to $9.49 as of December 31, 2022, down from $10.63 as of September 30, 2022. This includes a $0.76 impact from the November loan sale as well as the impact of our $0.32 per share common dividend paid in November. Excluding these impacts, GAAP book value was relatively flat for the quarter. Economic book value, which fair values all nonrecourse securitization obligations was $13.11 per share as of December 31, 2022, up 1.3% from $12.94 per share as of September 30, 2022. The fair value of the bonds underlying our securitization obligations declined as rates increased and duration expectations lengthened driving the increase in economic book value. Assuming that loan and security pricing has remained relatively flat so far in 2023, with January's rally being offset by a retreat in February, we estimate our GAAP and economic book value as of the end of February to be fairly flat as well, inclusive of the known impact of the dividend payment to be made in March. Looking forward, we plan to resume purchases of newly originated loans. We'll do this selectively, and we'll continue to emphasize liquidity throughout the process. Recent rate locks are in the mid-8% range with average LTVs of 72% and FICO scores of 752. We believe that purchasing these loans and maintaining a methodical securitization process is the best way to organically grow the earnings potential of the portfolio. Finally, the company has declared a $0.32 per share common dividend payable on March 31, 2023, to shareholders of record as of March 22, 2023. 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. 2022 was a year of unique challenges for the market. This set with rising inflation, higher interest rates and recession concerns. While Angel Oak was not immune to these challenges, we acted decisively to ensure the strength of our capital structure and have positioned ourselves to restart our growth programs. As always, I do like to thank the entire Angel Oak team for their hard work and the contributions as we seek to build long-term value for our shareholders. With that, we'll open up the call to your questions. Operator?

[Operator Instructions] The first question comes from Chris Kotowski from Oppenheimer.

I guess just given the large number of moving parts with the sale and the securitization and so on and given that we're like 68 days into a 90-day quarter, I wonder if you could give some guidance on expectations for net interest income in, say, the first and/or second quarter, if you can see that far out?

Yes. No. What we're seeing, we haven't added much things to the portfolio with the securitization going out, the top line NIM will go down slightly. I'd expect with that securitization that the net interest margin should stay slightly compressed due to higher borrowing costs, but we've -- as we've moved another $240 million off to fixed securitization costs, we'll see some of that bleed through in NIM.

And you mean that in dollar terms?

In dollar terms.

Relative to $7.4 million. Okay. And then -- okay, that's very helpful. And then presumably, in the coming quarters, it will be a function of when and if you add to the balance sheet overall. And I know it's a very fluent environment, but any guess as to the likely balance sheet trends over the course of the year?

Yes. We expect to get another securitization out much like we did in January that would be probably a little bit smaller than the one we did, but reducing the whole loan balance, securitizing more loans. And then very soon start purchasing newly originated loans, which I think Sreeni had mentioned in his section, approaching 9% coupons. So that -- as we build that balance sheet, the loan balance will come up some where we won't go as high as we did like in Q1 of '22. But as we buy those market coupon loans, you'll see both top line and bottom line NIM or interest widen out.

Okay. And then on the expenses, I mean, they had been kind of in the $4 million to $5 million range and $1.8 million this quarter. Any thought on what one should expect there?

Yes. Well, the $8 million includes a decent amount of securitization costs. Going forward over the next year, looking at management fees will be decreasing. Our management fee that we pay the manager is based on distributable earnings. So as we had distributable earnings loss this quarter, that's going to reduce. Run rate's going to go down about $1 million there. And then as some of the other things happen, we're doing a lot of analysis and we've brought in some services that we previously outsourced at a good cost savings you should see another, call it, $1 million in savings kind of on a normalized basis.

I'm sorry, you said $8 million. I was looking at the...

$1 million. So $1 million in...

$1.8 million...

$1 million less on management fee and then $1 million on operating expenses.

And that's relative to the $1.79 million this quarter on OpEx?

It's -- yes. For that. But that's -- yes, the $1.8 million is a quarter. I'm saying annually savings is about $1 million on OpEx and $1 million on management fee.

Okay. Those are annual numbers, though.

That's right.

The next question comes from Don Fandetti from Wells Fargo.

Yes. Can you talk a little bit about the securitization markets? Obviously, you had a little window in January, but has that shut, do you think another deal can get done in this type of environment? And how do you feel generally speaking about liquidity? I mean the Fed's still raising rates still uncertain time? Does it make sense to start originating and growing? Or should you continue to just really hunker down here?

It's -- Don, Sreeni here. So we -- I'll give you a broader -- because through [ the ] franchise, we are securitizing to different vehicles. Obviously, the REIT was able to take advantage of a good January, we hit the securitization markets. But we're consistently in the markets, and we follow it. I would tell you, we have done another securitization here in February to our other vehicles. And the difference between the markets today as of right now, Don, markets are getting fickle. But as of right now, what we're seeing is deals are getting done. They obviously they'll widen out as the markets get volatile, but we're not in a situation of -- in August, September, October, November of last year when there was absolute illiquidity in the system. And also remember, there's not a lot of new originations that have been done. So if buy side guys want to buy bonds of non-QM shelf, they got to buy now. There's not much supply that's going to be out there. I mean if you look at the REIT, we don't have -- I mean, we don't literally have no -- nothing left anymore after 1 or 2 more securitizations. So the markets are behaving. Spreads have to widen when stuff happens. But we did a very large securitization in February. We intend to go back to the market in March. We are already working on that and REIT will have some loans in that. It could change, but right now, we're not seeing that. In terms of your other question of liquidity. And look, we went through a lot of these iterations last year, as you guys know. But where we are, I mean, if you think about the loans we have in the non-mark-to-market facility, we have a little bit over $100 million in a mark-to-market facility, which will -- which is not significant risk. So we're not going to go out and just double down and use all the liquidity and buy loans. So that's why, as Brandon was saying, even if we look to buy loans, by the time the loans get locked, loans get closed, we're looking at putting money to work next month or the following month, and we will do it very thoughtfully relative to risk and relative to securitization markets. So for example, in March, the securitization markets don't behave that we may slow down even more to buy new loans. So we feel we're in a good position to do both now and that's what we are focused. So yes, please don't expect us to just go double down and buy every single 9% coupon out there.

What is the plan in terms of a sustainable dividend level?

Yes, that we -- like we said last quarter, when we did the cut from 45% to 32%, we thought when we looked out at the opportunity set for 2023 that 32% would have been a sustainable level that we could maintain comfortably throughout, at least throughout the 12-month period, always subject to review and analysis, but we're still comfortable with that as well. Like I said, when we -- we did this last securitization. It will function like our pre-IPO deals where we just retained bonds. And those bonds themselves that we retained have a go-forward expected yield of between 10% and 15%. So that -- the discount that we inherently had because of the loans marking down is basically behind us and now it's going to be a good return. Then as we start buying the new loans, building back that NIM, it looks relatively good on the out couple of quarters this year, especially like as Sreeni said, we're almost through or through a lot of the lower coupon loans, the risk of margin calls has significantly reduced. I mean, just put some numbers around it. Sreeni mentioned, we have about $140 million on our mark-to-market facility. But that's down for about $1.1 billion Q1 of '22. So the risk is -- I mean it's not 0, but it's significantly less than it has been in a year.

[Operator Instructions] The next question comes from Matthew Howlett from B. Riley.

First, could you address the potential or the opportunity to repurchase stock here at 50% of economic book value. And I recognize you're paying down the warehouse line and the focus on liquidity. Maybe you could give us the unrestricted cash position today. But in terms of looking at buying new loans going forward versus buying back the stock, I mean, how do you feel? How do you look at that analysis?

Yes. No, I think we are looking at that analysis. We've continued to look at that analysis. There -- nothing has been decided today on that. We believe at this point, where we have and look at future returns. There's -- obviously, we have a point in time today that looks like you've got a large dividend yield, you take an immediate return, if you will, because you repurchase shares. But at the same time that it's going to shrink the size of this company. We've had -- we've gone from about $500 million in equity capital base to $235 million today. So we don't want to necessarily shrink it anymore, also keep the float up in the stock to help with trading. And -- but again, we're evaluating that, and we'll see where it goes. So unrestricted cash today is about $30 million, but that is -- and then we also have about another $60 million of unlevered assets, bonds that are easily convertible and then about $18 million of unlevered loans that we could either lever or sell pretty easily.

No, look, you did a great job getting on the warehouse line and paying it down and sort of look forward for the next securitization. It's great that you have access to it and it's a big step. And on that note, I mean, could you just address -- I mean, you talked about credit and the embedded HPA. But I think for investors, non-QM is getting a lot of press, I mean people is always the sort of area that people are cautious about 2023. And I know non-QM is a broad sector. Could you just talk about where your non-QM is in terms of credit versus maybe the overall industry? And why you feel that it's going to hold up better than just generic non-QM?

Yes, Matt, I'll take this one and, Namit, jump in if you want to add to it. But look, I mean, we've always told people that in a non-QM of today is not the subprime of 2007. And in a combination of full underwriting of credit, loan to values in the '70s, true appraisals, et cetera, et cetera, when you originate a loan, and you have all these qualities that you're underwriting your risk of default goes low. Now that being said, look, if we are going to go in a hard recession, we're not naive to think that there will be delinquencies and defaults. I mean that's going to happen through a cycle, right? It's just a matter of when and how it happens. But the new originations that we have, by the way, just so you know, we have gone really up in credit and not just in the read across our franchise, we have almost slowed down our investor cash flow loans. We are not doing high LTV loans at all. We are very, very conservative in terms of what we're originating as of right now. But -- so we are clearly conscious that even though we think that the credit is good, you definitely need to tighten your credit even more going into a potential recession. We know that, and we are thoughtful about that. But Namit, you have more details on that because you talk to the mortgage company about credit almost daily.

Sure. Yes. So to Sreeni point, like there's an aspect in mortgage credit of the quality of loans that you originate, right? And so when we talk about our average FICO scores being 740 plus and our average loan to value is in the low 70s, these are attributes that sort of look similar to agency originations, quite different from the historical non-agency originations that used to happen in the pre-global financial creditors period. And these loans have performed really, really well. We've hardly had any losses in the last 7, 8 years of our originations. Now if we do go into a bumpy macro environment, as Sreeni mentioned, we do expect some increase in delinquency. But if you have a book with where the delinquency numbers are running with a 1% handle and we go into a recession and that delinquency goes up like 50%, you're still talking about a delinquency that is close to 2%, and that is not a huge retraction from the return potential of these loans, especially when you think of the loan coupons that are being originated, right? We are talking about a 9% coupon being originated with a 740 plus FICO and a 70 LTV. And if you have -- and because of the current market spreads, these loan prices have remained very suppressed. So if your delinquencies go from 1% to 2%, it does not take much. I mean if you do the rough math around it, and let's say that marginal extra 1% loans default at a 50% rate. So now you have an extra 50 basis points of default, you apply 50 severity, you have an extra 25 basis points of loss spread over 3 years, that's an 8 basis point reduction in loan yield. That's hardly anything when you look at the current coupons on these loans. So yes, in any macro environment, which goes into a recessionary period, no matter what the quality of the loans, you're going to see a percentage sort of increase in delinquencies. But given the platform, given the loan underwriting, given the quality of these loans, that number is not expected to be where some of the earlier non-agency programs used to go to in prior tough periods.

I certainly see that the disconnect between what you're seeing and what the market is anticipating. Last question, just a quick update on Angel Oak Mortgage Company. The -- are they -- do you feel like you rightsize the platform? Do you feel like it's in a position to grow in '23?

Yes, I'll take that one. Yes, I mean, there's a lot of conversations about the Angel Oak Mortgage Company. Just to reiterate, we had 2 mortgage companies. So one is important for this discussion, one was just a business venture we had. So we had a retail mortgage originator, which was largely an agency mortgage originator, and that's where we had some of our licenses. And that's the business that we dramatically reduced because that was not a -- that was a noncore function. We made a good amount of money in 2021 and market got really tough in 2022. And that was not the business we really wanted to be in. In terms of non-QM, which really came from our wholesale mortgage originator, which is mortgage solutions, really, the majority of our infrastructure is exactly the same. It's not any different. We made -- obviously, every mortgage company has gone through cost cuttings. But we really have not much risk on balance sheet. We're originating volume here and flowing through coupons are approaching 9% as we speak. But volumes have dropped. They're probably going to end up being half of what they were early last year. But what we're focused on right now in the mortgage company is not volume, it's more volume and credit, and that's what we're focused on, but not many changes from that perspective.

There are no further questions at this time. I'd like to turn the call back to management for closing remarks.

Thank you, everyone, for your time and interest in Angel Oak Mortgage REIT. We look forward to connecting with you again next quarter. Please feel free to reach out to us. And we invite you to our offices anytime you guys would love to come and sit down with us. Thank you so much. Bye.

Thank you very much. Ladies and gentlemen, this does conclude today's call. Thank you very much for your time. You may now disconnect your lines.