Angel Oak Mortgage REIT - Q2 2024

Transcript

Operator (participant)

Good day, and welcome to the Angel Oak Mortgage Second Quarter 2024 Earnings Call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then one on a touchtone phone. To withdraw your question, please press star, then two. Please note this event is being recorded. I would now like to turn the conference over to KC Kelleher, Head of Corporate Finance and Investor Relations. Please go ahead.

KC Kelleher (Head of Corporate Finance and Investor Relations)

Good morning. Thank you for joining us today for Angel Oak Mortgage REIT's Second Quarter 2024 Earnings Conference Call. This morning, we filed our press release detailing these results, which is available in the Investors section on our website at 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 Oak Mortgage REIT's Chief Executive Officer, Sreeni Prabhu, Chief Financial Officer, Brandon Filson, and Angel Oak Capital's Chief Investment Officer, Namit Sinha. Management will make some prepared comments, after which we will open the call to your questions. Additionally, we recommend reviewing our earnings supplement posted on our website, angeloakreit.com. Now, I will turn the call over to Sreeni.

Sreeni Prabhu (President and CEO)

Thank you, KC, and thank you to everyone on the call for joining us today. AOMR had a very productive first half of the year, continuing an upward trajectory which began in Q3 2023, and we expect to continue to capitalize on going forward. For the fourth consecutive quarter, we increased net interest income by purchasing current coupon loans while managing and reducing borrowing costs. We led a securitization during the quarter, AOMT 2024-4, a $300 million deal. We also had a modest participation in a deal alongside other Angel Oak strategies. These securitizations reduced funding costs and freed up capital to rotate into higher-yielding assets. We are currently projecting securitization yields in the mid- to high teens, which is more aligned to what we observed historically.

Additionally, we filed a $750 million shelf to be used for our future capital raises over the next few years. We then immediately used that shelf to issue $50 million in senior unsecured notes that will be used to fund the next several quarters of growth. Now highlighting some of our results. The second quarter marked our fourth consecutive quarter of net interest income growth, with sizable improvements on a quarterly, year-to-date, and year-over-year basis. This is a result of methodical new loan acquisition, diligent management of capital and financing costs, and efficient securitizations. Additionally, targeted efforts to judiciously manage our operating cost structure alongside prudent portfolio risk management have led to sustained low operating costs. These efforts are enabled and supported by the Angel Oak ecosystem, with its market-leading origination and securitization platforms, positions the company for continued success.

Looking ahead to second half of 2024, while origination dynamics continue to reflect a variable and high interest rate environment, we remain optimistic and believe we are well prepared to capitalize on additional accretive loan purchases. Our GAAP book value decreased 3% in the second quarter, which is essentially the impact of our quarterly dividend payment. Economic book value decreased 4.5% versus the first quarter, a decrease of 2.2% net of our dividend, which demonstrates the conversion between the GAAP and the economic book value that we expect to see over time as our early securitizations pay down at par value.

When assessing our credit performance in the quarter, the weighted average ninety-day delinquency rate across our portfolio of whole loans, securitized loans, and RMBS was 1.7%, versus 1.8% at the end of the first quarter of this year. Delinquency activity for the quarter remained muted, indicating that our partnership with Angel Oak's affiliated mortgage originator is a useful tool in management of our credit quality and allows us to maintain a unique advantage relative to other competitors in the marketplace. We continue to display excellent credit performance and are determined to maintain the health of our portfolio in a disciplined and thoughtful manner.... These accomplishments propel the positive momentum we carried into our $50 million senior unsecured notes issuance in July, which we expect to catalyze the next phase for growth for AOMR.

With this additional capital, we intend to deliver greater net interest income and earnings, facilitated by the purchase of additional high-quality, newly originated loans and the continued execution of profitable securitizations. We'll continue to maintain our vigilant and methodical capital allocation, credit underwriting, and liquidity management strategy. With that, I'll turn it over to Brandon, who will walk us through the financial performance for the second quarter in greater detail.

Brandon Filson (CFO)

Thank you, Sreeni. In the second quarter, the company had GAAP net loss of $0.3 million, or a loss of $0.01 per common share. Distributable earnings results were a loss of $2.3 million, or $0.09 per common share. The exclusion of unrealized gains on residential loans was the primary driver of the difference between GAAP and distributable earnings. As Sreeni mentioned, the second quarter of 2024 demonstrated continued upward progress in top-line interest income and net interest growth. We saw sizable gains in net interest income over the course of the past quarter and year-over-year, which marks an annualization of our return to growth after taking a defensive stance through much of 2022 and the first half of 2023.

The company's net interest income expanded for the fourth consecutive quarter, growing by nearly 50% compared to Q2 2023, signaling the sustained and growing strength of the portfolio. We continued our pace of averaging 1 securitization per quarter and have maintained reduced levels of operating expense. We believe that our progress in recent quarters serves as a precursor to future quarters, when we expect the deployment of the proceeds from July's senior unsecured notes issuance to catalyze the next phase of growth for AOMR. Interest income for the quarter was $25.9 million, and net interest income was $9.5 million, marking a nearly 50% improvement over the second quarter of 2023 and a 10% improvement over the first quarter of 2024. Interest income grew over 9% compared to the year-ago quarter, and interest expense decreased 5%.

While interest rates have remained elevated, net interest margin has expanded by over 250 basis points from the first quarter. Growth has been driven by accretive loan purchases, pragmatic securitizations, and focused capital allocation. We remain committed to our disciplined approach to loan acquisition and expect net interest income to continue growing in the next few quarters, though we may see a temporary pause in net interest income growth as we deploy proceeds from July's debt issuance. In the second quarter, our operating expenses were $5.5 million, or $3.4 million, excluding securitization expense and non-cash stock compensation. This represents a decrease of $400,000 versus the same metric in the prior quarter and a decrease of $900,000 compared to the same metric in Q2 2023.

When we analyze our expenses, we choose to exclude our non-cash stock compensation expense as well as securitization costs. Since our cash returns are not impacted by stock compensation and costs related to securitization activity are directly in line with the execution of our business plan, we are confident we will be able to maintain these low-level operating expenses. While the bulk of these saving efforts are most likely behind us, we will, as always, diligently explore opportunities to optimize our cost structure going forward. Turning to the balance sheet, as of June 30th, we had $44 million of cash on hand. Our recourse debt-to-equity ratio was 1.2x at quarter end, compared to 1.8x as of March 31st, 2024.

As of today's date, our recourse debt-to-equity ratio is approximately 0.9x, reflecting the maturity of our short-term U.S. Treasury assets and corresponding repurchase agreements held at quarter end, as well as our $50 million senior unsecured notes issuance and $20 million share repurchase. As we continue to opportunistically acquire loans, we do expect debt levels to increase. However, we believe that our recourse debt-to-equity ratio will remain below 2.5x on a long-term basis. Our residential whole loan portfolio stood at a fair value of $159 million as of quarter end, financed with $101 million of warehouse debt.

We had $1.4 billion of residential mortgage loans and securitization trust and $285 million of RMBS, including $19 million of investments in risk retention vehicles, which are included in other assets on our balance sheet. In the second quarter, we closed AOMT 2024-4, which was our first standalone securitization transaction of the year, to which we contributed loans with $300 million of scheduled unpaid principal balance and a weighted average coupon of 7.4%. The deal enabled us to save approximately 100 basis points on the financing rate of the loans underlying the deal. Additionally, we participated in AOMT 2024-6 in June, to which we contributed loans with approximately $23 million of scheduled unpaid principal balance.

These securitizations, combined with AOMT 2024-3, executed toward the end of the first quarter, effectively cleared out our unsecuritized residential loan portfolio, and we've been steadily purchasing newly originated loans to work toward our next securitization. We remain confident in averaging one securitization per quarter going forward.... though our next securitization may not be until late third quarter or early fourth quarter as we replenish the portfolio with newly originated loans. We continue to methodically target high-quality loans, primarily through our affiliated originator. Furthermore, we are committed to maintaining disciplined daily capital management as part of our operating strategy. We will remain judicious when applying leverage to our assets, ensuring that we continue to maximize earnings while operating with adequate liquidity.

Looking to book value, our GAAP book value per share decreased 3% to $10.23 as of June thirtieth, down from $10.55 in the first quarter. Our economic book value, which fair values all non-recourse securitization obligations, was $13.16 per share as of June thirtieth, down 4.5% from $13.78 per share as of the first quarter. We expect that rate and spread movements over the course of the last month, as well as a reduction in dividend costs as a result of our share repurchase, have had a positive impact on GAAP and economic book value as of today's date.

In the second quarter, we purchased $114.4 million of loans that carried a weighted average coupon of approximately 7.9%, with a weighted average LTV of 70.4% and a weighted average FICO score of 757. Our residential whole loan portfolio carried a weighted average coupon of 7.71% as of the end of the second quarter, a 60 basis point increase since the end of the first quarter of 2024, and a nearly 300 basis point increase from the second quarter of 2023. As of today's date, and including committed purchases, the projected unpaid principal balance of our unsecuritized loan portfolio is over $200 million.

These loans and additional purchases will form the next securitization for AOMR and should be highly accretive to the company and their stockholders. Additionally, the pricing spread on our largest warehouse facility has been reduced by 25 basis points, which should lead to additional net interest income. Now, to expand on our capital issuance at the end of July. On July 25th, we successfully closed an offering of $50 million, 9.5% senior unsecured notes due 2029. We intend for this to be an accretive capital raise that feeds the next phase of growth for AOMR. We plan to deploy the majority of the proceeds into high-quality, newly originated non-QM loans, driving further incremental earnings and investment portfolio growth.

Additionally, $20 million of the proceeds to repurchase shares from one of our pre-IPO investors, which we viewed as an opportunity to reduce our overall cost of capital and drive up economic book value per share. Finally, the company declared a $0.32 per share common dividend, which will be paid on August 30th, 2024, to stockholders of record as of August 22nd 2024. For additional information on our financial results, please review the earnings supplement available on our website. I will now turn it back over to Sreeni for closing remarks.

Sreeni Prabhu (President and CEO)

Thank you, Brandon. We are pleased with the significant progress we have made over the past 12 months and believe that we are well-positioned to begin the next phase of growth for our shareholders. Powered by newly raised capital, we plan to increase our investment into the business through the continued acquisition of loans, securitization, execution, and focused capital allocation. From a rate perspective, the consensus is that we are likely entering into a more accommodative environment. All else being equal, a declining rate environment would have a positive impact on our business in general, primarily because we would expect to see financing cost reductions and increases in the valuation of our existing portfolio.

While there may also be a reduction in the coupon of newly originated loans, we would still expect to see a net benefit as sticky financing costs based on SOFR would decrease with Fed funds rate cuts. With that said, weaker employment and earnings trends in the recent days have sparked fears of a potential economic downturn, and with that, heightened credit risk. We believe that credit risk management is a competitive strength of ours due to our relationship with Angel Oak Ecosystem, which provides us the ability to adjust credit offerings based on our specific desired characteristics. Credit is the risk we choose to own, and we expect our portfolio to continue to perform comparably well.

We are optimistic that broader economic background will be generally supportive of our outlook and may potentially lead to additional opportunities, not only in the non-QM residential mortgage market, but in capital markets as well. We will now open the call to your questions. Operator?

Operator (participant)

We will now begin the question-and-answer session. To ask a question, you may press star, then one on your touch-tone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star and then two. Our first question comes from Don Fandetti with Wells Fargo. Please go ahead.

Donald Fandetti (Managing Director)

Yes, Brandon, can you talk a little bit about, you know, with NII increasing, do you feel like you're in a position to maintain the current dividend level?

Brandon Filson (CFO)

Yeah. Hey, hey, Don. Yeah, absolutely. We, we've been increasing the NII for now four quarters. You know, I think if you look at it from a net interest margin perspective, less cash expenses, we're up to, you know, we, we probably improved that coverage by about 20% this quarter to 80% coverage of the dividend.

... just from a cash basis, we, like I said, we'll probably have a little pause this next quarter as top line grows, but we work to deploy the and lever the proceeds from the debt issuance. But then in, you know, Q4, we expect a further expansion that, again, I believe will be an effective covering of the dividend.

Donald Fandetti (Managing Director)

Got it. And then, you know, you've had a pretty big move in rates. What is your economic book value in July and August?

Brandon Filson (CFO)

Yeah, that we actually haven't had a chance to put pen to paper on since it's been so dramatic. I mean, there's the rate move, and then there's also a spread component, which we need to see if spreads in our business kind of widened out to meet the decrease in rates, at least temporarily. But I think empirically, any of the decreases we had in Q as of, you know, June 30th, would be now at least flat, if not up.

Donald Fandetti (Managing Director)

Got it. Thanks.

Operator (participant)

Our next question comes from Doug Harter with UBS. Please go ahead.

Douglas Harter (Analyst)

Thanks. Can you talk about, you know, how much growth do you think that the unsecured issuance can provide, kind of, net of, you know, net of the repurchase that you did?

Brandon Filson (CFO)

Yeah, we think that, you know, this, the $30 million or so of net proceeds that's left after the repurchase, they're probably gonna, you know, provide us the runway for the next kind of three or four quarters of, you know, consistent loan acquisition. I mean, just on its face, the first round, the $30 million, we can buy about $200 million worth of loans. We have then securitized, you know, after that, we'll buy another, you know, $180 million, and it kind of steps down from that point forward. But, you know, again, several quarters and probably, you know, will be supportive of something like $1 billion in residential loan purchases over, you know, the next several quarters.

Douglas Harter (Analyst)

And then, I guess, given kind of where your recourse leverage is, you know, how do you think about the ability to issue additional unsecureds as you look to kind of be able to continue to scale up the business?

Brandon Filson (CFO)

I mean, it's something we'll certainly be looking at. I think we're you know, we wanna, we don't wanna just grow at any cost. We're we just raised this money, and we're just putting it to work. You know, we have about, call it $200 million in committed loan purchases that should come in based on the backs of this debt, you know, very in short order here in the next, you know, few weeks. But we I mean, we think that the balance sheet could hold more. We just wanna make sure we're gonna do it at the right time, and obviously maybe with the latest rate moves, if we did another tranche, could tighten in pricing a little bit.

Douglas Harter (Analyst)

Great. Appreciate it. Thank you.

Operator (participant)

The next question comes from Eric Hagen with BTIG. Please go ahead.

Jake Katsikas (Analyst)

Good morning, this is Jake Katsikas on for Eric. Thanks for taking my questions. Just talking about prepayment activity, are you expecting a pickup in prepayment activity as a result of the recent interest rate moves? And at what level of rates do you think prepayment activity will begin to accelerate more meaningfully? Thank you.

Brandon Filson (CFO)

Yeah, we, we've already seen a little bit of a prepayment pickup even before the move in rates. It's one of the reasons why our GAAP and economic book value were a little bit, you know, down this quarter compared to where you would otherwise think. I mean, rates didn't really move, but prepayment speeds did move up slightly. You know, I think there's at least in our portfolio, right, we have a tale of two sides, right? We've got the 5% coupon portfolio that's gonna take a huge move in rates to really move prepayment speeds up materially. And then we've got the 8% portfolio, which is gonna be much more sensitive to prepayments.

But, you know, the thing is, if the prepayments are increasing because rates are going down, that means our financing costs should be going down, and we'll just keep investing that money, you know, those proceeds back into, you know, assets with a similar or maybe even a, you know, catch a little tailwind yield. But I-- you know, long way to answer your question, I mean, we've got quite a bit of, of, I think, protection in our performance in case, you know, prepayment speeds increase by 10 points. Remember, non-QM historically has like a 25-30 CPR. That's what we base most of our modeling and assumptions on in the securitization market. Recently, that's been much slower than that, you know, like single digits level.

We are expecting a return to that 25-30 level over the next several quarters.

Jake Katsikas (Analyst)

Great. Thank you so much.

Operator (participant)

Again, if you have a question, please press star and then one. Our next question comes from Matthew Howlett with B. Riley. Please go ahead.

Matthew Howlett (Analyst)

Hey, guys, congrats on a great report. Hey, I know things are, you know, fluid right now, but with the move here with rates and, you know, you're putting on coupons around 8%, any sense on what the ROEs will be on retained interest from securitizations going forward? I mean, I'm assuming they're going to be a lot higher than what you thought they were a couple of quarters ago.

Brandon Filson (CFO)

Yeah. Well, I think there, there's a potential, Matt, for a little, what I'll call maybe a Goldilocks securitization, and that will have a higher coupon relative to funding costs. We saw that back in 2021, right after our IPO with 2021-4 and 2021-7. But, you know, long term, so next, I mean, long term meaning next year really, we'd expect that if rates do come in, stay in, you know, our loan coupons will reduce, funding costs will reduce, and we'll still be looking at that, you know, mid- to high-teens to low 20% ROE portfolio. But it could be, there could be a period where the next few securitizations have a little bit higher return hurdle than that if the economic conditions allow.

Matthew Howlett (Analyst)

Has the mortgage company started lowering rates?

Sreeni Prabhu (President and CEO)

Hey, Matt, Sreeni here. So, you know, last, I would say before last few days, yes, we had been lowering rates because as you notice, rates have been going lower over the last few weeks, not just last two days. But last two days, you know, really the credits, the spreads on the securitization side have widened, just from the sympathy of what's happening in the entire market. So right now I would say we have stayed flat on rates, but you should expect the mortgage company or, or and across the board, people to lower rates. And to answer your question before, also on that side, you know, part of that is, you know, you will see if you keep rates high, you're gonna see prepayment activity pick up too. I think the industry as a whole will lower rates here.

Matthew Howlett (Analyst)

Got you. So just in summary, if I can summarize what I heard, I mean, you could do about $1 billion of loan acquisitions here with the new capital that you raised in July. It'll take you a couple of quarters. You'll still do one securitization per quarter, but you think you can, you know, you can grow that kind of non-recourse leverage up pretty good with the access to securitization market, and it's gonna have a huge impact on your NII. You know, probably you're way above the dividend, and I don't want to put those words in your mouth, but, I mean, it's about $1 billion in loan acquisitions. Did I hear you right, in the next few quarters?

Brandon Filson (CFO)

Yeah, that's that, that should be what we had, you know, available funds, and then plus the Senior Unsecured Notes will also support, you know, that it is a piece of that $1 billion.

Matthew Howlett (Analyst)

Absolutely incredible. I guess just the last question is, I mean, are you bumping into any competition in a non-QM space? I mean, or has this been sort of cleaned out, you know, following, you know, the last couple of years? And you guys are the league leader in it, and we haven't seen much activity, anyone that's quite the size as you guys, but are you bumping into anybody?

Namit Sinha (Chief Investment Officer)

No. you know, yes. So, the guys in the previous past, you know, they have gotten cleaned out. I would say from, from a consistency of origination to, to credit management to securitization, you know, we, we would consider ourselves to be a leader. Then we are seeing small competition from insurance companies, not from the REIT industry, from the insurance company. But they're very selective about how they get involved. And, you know, as the rates continue to go lower and the securitization bid gets stronger, I think that the insurance companies may be less competitive. Obviously, there'll still be buyers, but from what we are trying to achieve, you know, we have enough in what we're doing, where we're not, we don't feel constrained or stretched.

Matthew Howlett (Analyst)

Right. Exactly. Well, certainly we look forward to the next wave of growth in the company. Appreciate it.

Namit Sinha (Chief Investment Officer)

Thank you.

Operator (participant)

This concludes our question and answer session. I would like to turn the conference back over to Brandon Filson for any closing remarks.

Brandon Filson (CFO)

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

Operator (participant)

Conference is now concluded. Thank you for attending today's presentation. You may now disconnect.