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

Good day, and welcome to the Angel Oak Mortgage REIT Second Quarter 2023 Conference Call. [Operator Instructions] Please note this event is being recorded. I would like now to turn the conference over to Randy Chrisman, Chief Marketing and Corporate Investor Relations. Please go ahead.

Good morning. Thank you for joining us today for Angel Oak Mortgage REIT's Second Quarter 2023 Earnings Conference Call. This morning, we filed a press release detailing these results, which is available in 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. 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 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 first lead off the call by making 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 the call over to Sreeni.

Thank you, Randy, and thank you, everyone, for joining us today. We were proud to see the work we have done over the previous quarters, we demonstrated in our second quarter results. In the second quarter, we began purchasing newly originated loans, securitized the pool of low coupon loans and built upon the work we have done to reduce expenses. Since quarter end, we have increased the pace of our loan purchases, are actively working towards our next securitization and have taken additional expense savings actions. In a period of time, marked by continued uncertainty in the broader economy and rising rates, we believe we have demonstrated the strength and the resilience of our business model and its unique competitive advantage. During the second quarter, interest rates and spreads continue to widen, which negatively impacted mark-to-market valuations of our portfolio and drove down earnings and book value. However, market volatility dampened compared to prior several quarters and expectations are that the Fed is at or near the end of interest rate hike cycle. While mortgage originations and applications are suppressed, we are experiencing some modest but encouraging recovery to demand, supporting our view that our business is well positioned to capitalize and drive growth. We continue to progress through the year with optimism and with a number of key strategic successes under our belt. We have returned our focus towards our execution of our growth strategy. We captured additional value by executing our second securitization of the year during the quarter, AOMT 2023-4, enhanced our liquidity position and supported our ability to purchase newly originated higher-yielding loans from our affiliated loan origination, which allows us to tailor the credit quality and the characteristics of the loans we purchased. The securitization also strengthened our balance sheet by reducing our warehouse debt and converting it to nonrecourse term structural leverage. Additionally, the loans contributed to AOMT 2023-4 were previously carried on our most expensive warehouse facility, while the new loan purchases will be placed on lower cost facilities. To that end, our current whole loan portfolio is equivalent to the size of roughly one securitization transaction and although our warehouse debt is expected to increase as we continue purchasing newly originated loans, we don't expect to reach a whole loan position more than 1.5 to 2x the estimated value of a single securitization. On the debt side, we are proud to have reduced our warehouse debt by over 63% since the beginning of the year. Though the positive impact of this reduction was partially offset by the effect of continued interest rate increases that compressed net interest margins. With that said, we are proud to have accelerated purchases of newly originated high coupon loans this quarter. These loans carry significantly higher coupons than our current whole loan portfolio, and we believe we can continue purchasing loans at an attractive mid-8% range. As a result, we expect net interest margin to expand in the coming quarters, especially as we continue to execute securitizations, consisting of loans from the legacy portfolio. In addition, the immediate impact of net interest income expansion, a higher coupon in the whole loan portfolio will improve future securitization execution as well. Going into the second half of the year, we expect continued rotation of our portfolio into newly originated higher coupon loans to be increasingly demonstrated in our results. We plan to continue with quarterly securitization, which will support both our growth and our liquidity goals. While the risk continues to remain in the market, we are focused on truly assuming those risks where we feel that we have competitive and comparative advantage. We believe that our ability to tailor the credit characteristics of our loans is and will continue to be a differentiator. We are proud of the flexibility we have achieved with our capital structure, and we are confident in our ability to adapt and capitalize on opportunities in the second half of the year. I will now turn the call over to Brandon.

Thank you, Sreeni. We are pleased with our results in the second quarter. In particular, we are proud of the current position of the portfolio, both from a growth and risk management perspective. I'll go through the details of our financial results, and we'll provide some additional color and context as we look to the second half of the year. For the second quarter of 2023, we had a GAAP net loss of $3.7 million or $0.15 per diluted common share. Distributable earnings were negative $3.9 million or a loss of $0.16 per common share. The key driver of our GAAP net loss was a $4.8 million unrealized loss on loans in securitization trust and their corresponding liability due to mark-to-market valuations. Note that although these assets are marked at a discount, principal payments are received apart. Interest income for the quarter was $23.8 million, and net interest margin was $6.5 million, which remained compressed due to higher variable rate interest expense. As Sreeni mentioned, we expect net interest margin to expand in coming quarters as the AOMT 2023-4 securitization and subsequent securitizations reduced financing costs and interest income grows in line with new loan purchases. Total operating expenses were $5.6 million or $4.5 million, excluding securitization cost. This represents a savings of $2.8 million versus Q2 2022 and a year-to-date savings of $6.2 million versus the first half of 2022. We are pleased with our sustained operating expense reductions and are actively working to achieve additional savings in the coming quarters. Turning to the balance sheet. As of June 30, 2023, we had $59.1 million in cash, representing an increase of $30 million from Q4 of 2022. Our strong cash position in the trailing 6 months showcases our focused on maintaining healthy liquidity levels. This additional liquidity provides us with the dry powder for sustained loan purchases that will grow net interest income, improved cash flows and support securitization execution. Our recourse debt-to-equity ratio as of June 30 was 2.5x. As of today's date, our recourse debt-to-equity ratio is 1.2x, which reflects the maturity of repurchase obligation from short-term trades that matured in early July. This is a decrease of 0.8x versus the comparable recourse debt-to-equity ratio as of the last earnings call of 2x. We have residential whole loans at fair value of $296 million financed with $234 million of warehouse debt, $1.2 billion of residential loans and securitization trust and $71.9 million of RMBS from retained AOMT securities from off-balance sheet securitizations. Additionally, we held $388 million of holdco RMBS as of quarter end. We finished the quarter with undrawn warehouse financing capacity of approximately $695 million. As of today, we have a total of approximately $230 million of warehouse debt, representing a decrease of approximately 48% over the previous quarter. We were pleased with the AOMT 2023-4 securitization, which had a weighted average loan coupon of 4.5%. This lower coupon deal helped improve the weighted average coupon rate of our remaining whole loan portfolio, which subsequently improves our future securitization pipeline. We have executed on our goal of one securitization per quarter, and we expect it to continue to do so headed into the second half of the year. GAAP book value per share decreased to $9.34 as of June 30, 2023, from $9.80 as of March 31, 2023. The previously mentioned mark-to-market impact of our loans and securitization trust and corresponding liability, which are the loans underlying securitizations for which the cost of funding has been fixed, drove $0.19 of the total $0.46 decrease in GAAP book value. Economic book value, which fair values all nonrecourse securitization obligations was $13.16 per share as of June 30, 2023, down $0.23 from Q1, driven by our $0.32 quarterly dividend. As with last quarter, we expect valuation changes resulting from interest rate and spread movements to cause GAAP and economic book value to fluctuate in the near term. The weighted average coupon rate of our whole loan portfolio was 4.63% as of the end of the first quarter and increased 21 basis points to 4.84% as of the end of second quarter. Since the end of the second quarter, we have purchased and locked for purchase approximately $40 million of additional loans. Our loan purchases this year carry a weighted average coupon rate of 8.4%, a weighted average LTV of 72% and a weighted average FICO score of 754. With these new loans, the weighted average coupon of our residential whole loan portfolio is approximately 5.17%, representing an increase of over 50 basis points since the end of the first quarter. The increase in the weighted average coupons will continue as additional loans are purchased. Finally, the company has declared a $0.32 per share common dividend payable on August 31, 2023, to shareholders of record as of August 22, 2023. This implies an annualized dividend of $1.28 per share or a yield of approximately 14% as of the closing price on August 7, 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. Before turning the call over to the operator for Q&A, I do like to conclude with some brief remarks. We are excited to have turned our focus to growth as we head into the second half of the year. While market and rate volatility is likely not completely in the rearview mirror, the current composition of our portfolio has a strong foundation with flexibility to respond as market conditions evolve. Credit risk remains on the radar for the industry. However, we feel that credit risk management is one of our key competitive strengths. By leveraging the Angel Oak ecosystem, we have the ability to adjust credit offerings based on certain characteristics. Credit selection is risk we like to own, and we have the ability to select profitable loans with sound credit. Credit performance of the portfolio has been strong, and we expect it to continue to perform comparably well. We believe our results in the first half of the year have demonstrated the strength and the resilience of our business model, and we look forward to demonstrating our growth potential in the second half of the year. As always, I would like to thank the entire Angel Oak team for their hard work and 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 will come from Don Fandetti with Wells Fargo.

Yes. It sounds like NII is heading higher due to the sort of higher coupons on loans and more efficient funding and then there's some expense saves. Do you think you can grow into the dividend over time? Or do you feel like maybe at some point, it makes sense to trend that?

No. Thanks for the question, Don. Yes. No, net interest margin should start to increase next quarter. I mean one of the things that with the securitization as we went off of our most expensive warehouse financing over a 9% cash paying rate, the securitization debt, which was a significantly lower amount and then what the new loan purchases. We also should see, like you mentioned, the additional cost savings. So we believe over the next few quarters, we're going to grow into that dividend to the point where we're adequately covering not just from a cash flow basis, but from a true net earnings perspective.

The next question comes with Matthew Howlett with B. Riley.

My question is just on -- you're in the market and securitization market. I'd like to hear an update on the way spreads are on '23-4 and I think it's been tightening, where they are now up to date? And then just give us -- these coupons are tremendous going into the securitization trust now. When you look at what you're retaining of the securitization, what type of IRR or ROE should we be thinking about? And are you still selling down to the rated bonds? Just give us a little update on the securitization market today and how you foresee the next few deals going.

Sure. This is Namit. So from a securitization spread standpoint, you're right, like from second quarter end to today, we have seen meaningful tightening in spreads, not just for non-QM, but across the board tightening and the risk on overall in the market. And so we have seen the benefits of that as well, which is likely going to show up. If it doesn't reverse itself over the rest of the quarter, potentially in the next quarter. We have seen meaningful spread tightening for current coupon deals that have been securitized in the market over the last month and change. And the rates market have generally been sort of unchanged in a little bit of a volatile manner. So overall, we see a benefit to that spread tightening to our portfolio. And then to your question around the NIMs around the new coupons. So when we create these loans at 8 1/4%, 8 1/2% coupons, generally speaking, the gross returns per securitization on the retained portfolio is high teens. And so that is what we generally pencil in for the marginal loans that come in at these higher coupons. Obviously, they get mixed up with the lower coupons and bring the coupons higher. So that is an element of securitization that comes with a blended pool of these higher coupons versus the lower coupon loans. But on the margin, these loans are accretive to the portfolio and per securitization carry a high-teens IRR.

When you talk about high teens, I think equity investors get really excited. I mean these are -- that incorporates like a loss adjusted and...

It incorporates -- yes, it incorporates the cost of funds as we see in the market today. And it incorporates a reasonable assumptions around prepayments, delinquencies and defaults down the line. Obviously, those are to the base case scenarios. And there's obviously stresses you can run that bring the returns down. But to the base case, high teens is what we usually see at these higher coupons. And if you think of these coupons as maybe a slightly elevated speed assumption down the line, it probably brings it down to mid-teens.

Okay. I think the next question most people would ask like how much can you add? How much can you grow that your loan portfolio securitization portfolio today with the existing capital base of the company, we obviously paid that down your REPO lines, you freed up a lot of capital. And given where advanced rates are in the securitization market, I don't know if they've changed or not, how much can we grow -- how much can you grow here the next -- until you get to full capacity?

Matt, it's Brandon. We have probably enough capacity for 3 to 4 good-sized securitizations with new coupon loans before we either have to wait and get principal payments back in to keep growing or look to the capital markets at that time to grow.

3 to 4 more securitizations by -- you say around $300 million, $400 million in size, something like that?

Yes. So exactly, somewhere $1 billion -- call it maybe $1.5 billion worth of loans that goes through the system a few times, a few cycles.

Great. Well, look, we look forward to that. Congrats on getting back to growth.

[Operator Instructions] The next question comes from Derek Hewett with Bank of America.

Could you provide an update in terms of where spreads have trended quarter-to-date? And then kind of how that impacts the book value per share?

Yes. So on quarter-to-date since the end of second quarter, we have seen senior AAA spreads come in somewhere between 15 and 25 basis points. It is very -- because historically, in the non-QM space, pretty much all securitizations would happen at the same coupon, which would be the current coupon. One shelf versus the other was easily transportable. But when you look at the landscape today, there are 8.5 deals, 8.5 coupon deals, 7.5 coupon deals, 6.5 coupon deals and so on and so forth. So there's a little bit of a basis there. But generally speaking, we have seen about 15 to 25 basis points of spread tightening in the new issue space for AAAs and commensurately down the capital structure.

Okay. And then do you have a like an update in terms of quarter-to-date book value either as of the end of July or through early August?

No, nothing right now, Derek.

Ladies and gentlemen, and with that, we have finished our question and answer session. I would like to turn it over to Mr. Brandon Filson, CFO of the company. Please go ahead.

Thank you, everyone, for your time and interest in Angel Oak Mortgage REIT. We look forward to connecting you -- with you shortly. In the meantime, if you have any questions, please feel free to reach out to us, and have a great day.

This conference has now concluded. Thank you for attending today's presentation. You may now disconnect. Have a good day.