Angel Oak Mortgage, Inc. (NYSE:AOMR) Q1 2022 Earnings Conference Call May 12, 2022 5:00 PM ET

Company Participants

Randy Chrisman - CMO
Robert Williams - CEO
Brandon Filson - CFO
Namit Sinha - Co-CIO

Conference Call Participants

Don Fandetti - Wells Fargo
Matthew Howlett - B. Riley
Chris Kotowski - Oppenheimer & Company

Operator

Greetings and welcome to the Angel Oak Mortgage, Inc. First Quarter 2022 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions]. Please note that this conference is being recorded.

I'll now turn the conference over to our host, Randy Chrisman, Chief Marketing Officer with Angel Oak. Thank you. You may begin.

Randy Chrisman

Good afternoon. Thank you for joining us today for Angel Oak Mortgage REIT first quarter 2022 earnings conference call.

This afternoon we filed our press release detailing our first quarter 2022 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 into 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 afternoon's conference call is hosted by Angel Oak Mortgage REIT's Chief Executive Officer, Robert Williams; 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 will turn the call over to Robert.

Robert Williams

Thank you, Randy, and thank you, everyone, for joining us today.

In the first quarter of 2022, AOMR demonstrated the strength of its core business model against the backdrop of a historically volatile rate and yield environment. As we near the one year anniversary of our IPO this June, we are proud of the 113% growth of our target asset base and the continued execution of our loan acquisition, securitization and reinvestment strategy. From our IPO through the end of the quarter, we have purchased over $2 billion of high quality non-premium loans, including $676 million in the first quarter of 2022. Closed three securitizations and as of today, have increased our loan financing capacity by close to $1 billion. The Angel Oak ecosystem continues to demonstrate its strategic advantages, and as our strategy remains consistent, we quickly deploy our capital in targeted, high quality, non-QM mortgage loans, programmatically securitize those loans to secure a fixed cost of funding and lock in term structural leverage and reinvest capital in our targeted assets.

As I mentioned, we observed an extremely volatile and uncertain fixed income market in Q1. As the Fed took action in March to attempt to mitigate higher inflation by increasing target interest rates.

Over the course of the quarter, two and five-year treasury swap rates, which we use as part of our interest rate hedging strategy, more than tripled and nearly doubled, respectively. This, of course, was accompanied by a downward pricing pressure on our mark-to-market assets in the first quarter. And we expect this headwind will continue to some degree in the near future as the Fed makes further rate increases. With that said, we believe our non-agency asset portfolio and methodical growth strategy positions us well to withstand market volatility.

The Angel Oak ecosystem enables AOMR to effectively customize our desired loan characteristics as markets evolve, including adapting to higher interest and mortgage rates, which Brandon will discuss in more detail later. The non-QM market has remained strong and steady so far in 2022. We continue to see growing non-QM volumes through our proprietary origination channels. Home price appreciation, while appearing to flatten slightly has continued and delinquency rates remain near historic lows. Angel Oak growth continues to be driven by and not in spite of quality origination.

As our recently originated loans have higher average FICO scores and lower average LTVs and DTIs than in prior years. We believe the first quarter of 2022 reinforced the strength of AOMR, and I'd like to highlight a few of the accomplishments we realized so far this year.

In the first quarter of 2022, we purchased $676 million of high quality non-QM mortgages. At March 31st, our total assets were $3.2 billion, a 24% increase over the prior quarter. Our target assets, which include our residential and commercial whole loans and securities and loans in securitization trust, were $2.7 billion, a 20% increase over the prior quarter.

In February, we completed our third post-IPO securitization for $537.6 million. Additionally, we added $50 million to our committed available financing capacity in the first quarter, plus an additional $340 million in April of 2022 bringing our total capacity to $1.64 billion as of today.

Looking forward, we believe we continue to capitalize on our key differentiators, which I'd like to highlight. First, the origination of non-QM loans on a large scale requires unique capabilities, and that takes years to develop and refine. Extensive application, research and verification must be conducted for a non-QM loan, which creates a high barrier to entry. Angel Oak has invested substantial time and capital over 11 plus years to develop thorough and efficient systems of underwriting and origination, providing enormous amounts of data which we alone can utilize.

Second, Angel Oak Mortgage Lending as the mortgage loan originator has the ability to adjust their underwriting standards and origination characteristics as circumstances evolve. As mentioned previously, this includes the ability to increase or decrease interest rates, as well in a volatile rate environment. Due to our proprietary access to the Angel Oak ecosystem, we can similarly purchase loans with our desired characteristics. Importantly, members of the mortgage and portfolio management teams meet daily to discuss credit and current pricing metrics enabling AOMR to quickly adjust to changing market conditions.

Third, Angel Oak has unmatched experience and marketplace brand recognition in aggregating non-QM loans and executing on securitizations. Over the years, Angel Oak has completed over 30 securitizations, including three for AOMR in 2021 and 2022. These securitizations lock in long term financing and net interest margin while reducing our liquidity risk. As stated, because non-QM loans typically carry a meaningful spread to conventional mortgage rates, we can often achieve superior returns with lower leverage than many of our peers. We remain confident we can achieve strong portfolio growth over time, supporting a robust and durable distributable earnings, cash flow and dividends. As such, we are pleased to declare a first quarter 2022 dividend of $0.45 per common share, payable on May 31, 2022, to shareholders of record as of May 23, 2022.

With that, I'm pleased to turn it over to Brandon.

Brandon Filson

Thank you, Robert, and thank you, everyone, for joining us.

For the first quarter of 2022, we had a GAAP net loss of $43.5 million or $1.77 per common share and positive distributable earnings of $37.3 million or $1.49 per common share. Q1 annualized distributable return on average equity was 32.7%. The 67% increase in quarter-over-quarter and distributable earnings is attributable to the growth of our income generating investment portfolio, the impact of realized gains from interest rate hedges, and the add-back of unrealized losses on our mark-to-market loan and securitized loan portfolios.

In the current quarter, we saw our target asset portfolio increase from $2.2 billion to $2.7 billion, representing a 20% increase.

Interest income for the quarter was $27.1 million or 19% quarter-over-quarter increase. Net interest margin was $16.9 million, representing a slight quarter-over-quarter increase.

GAAP book value per share was $16.80 on a fully diluted basis on March 31, 2022, including the impact of our $0.45 per common share dividend paid in March down from $19.47 as of December 31. This 13.8% decrease was driven by unrealized mark-to-market losses on our whole loan, on balance sheet securitizations and RMBS portfolios. During the first quarter, we purchased $676 million of non-agency mortgages. Also, as of April 30, 2022, we have purchased an additional $108 million of non-agency mortgages.

Our loan portfolio is beginning to reflect increased coupon in response to the higher rate environment that accelerated in late Q1. The latest rate locks on loans that are affiliated mortgage companies are over 7% weighted average coupon, which is approximately 250 basis points higher than our March 2022 loan portfolio. The loans we purchased in April had a weighted average coupon of 4.9%, and May purchases have so far a weighted average coupon of 5.4%. Note that during the loan -- due to the loan origination process, loan purchases in a given month will typically reflect loan locks from one or two months prior.

Turning now to our securitization activity. In February, we completed our third securitization since our IPO of $538 million securitization where we placed 96.9% of the capital structure and 3.06% weighted average cost of funding. The deal included 1,138 loans with a weighted average coupon of 4.48% with an average credit score 744 the loan to value ratio of 70.6% and the debt to income ratio of 32.7%. This transaction was also rated by Fitch, with a senior tranche receiving a AAA rating. The higher cost of funding for the securitization is reflective of the broader market spread widening we've observed in recent months.

Going forward, we plan to continue to methodically and judiciously use the securitization market to reduce liquidity and interest rate risk. We will diligently monitor the uncertainty in the securitization market, but we do not believe that attempting to time the securitization market is in the best long-term interest of our shareholders. As such, we maintain our target of one securitization per quarter.

Turning to expenses, our operating expenses for the first quarter were $10.2 million, including $2 million of securitization costs associated with our February securitization. Excluding these securitization cost, operating expenses decreased by approximately $1.5 million in the current quarter compared to Q4 2021. Recognition of the securitization cost is attributable to a change in accounting policy in which we have elected to recognize the fair value of our non-recourse securitization obligations. This change requires that we recognize the full cost of the securitization when the securitization takes place. Previously these costs were being amortized over the non-callable period of the bond.

With regard to our balance sheet at March 31, we had $90.4 million of cash and cash equivalents. Our recourse debt to equity ratio was 3.4x. We have a total of $1.1 billion in residential whole loans and securitization trust and $491.3 million of RMBS, including $84.4 million in retained AOMT securities from pre-IPO securitizations. As of March 31, we had loan financing facilities for six banks with varied maturities, sizes and counterparty types to manage our exposure to any individual counterparty. We increased our total committed loan financing capacity by $50 million in Q1. Our total undrawn financing capacity was $344 million as of March 31.

Subsequent to quarter end, we added a new $340 million credit facility, bringing our total current capacity to $1.64 billion. This, combined with our increased cash balance as of the end of the quarter, demonstrates our commitment to a sound liquidity management strategy during this period of rising rates.

Given the strong income-generating foundation of our portfolio and significant distributable earnings, we've declared a $0.45 per share common dividend payable on May 31, 2022, to shareholders of record as of May 23, 2022. This implies an annualized dividend rate of a $1.80 per share or a yield of over 12% as of the closing price on May 11, 2022.

Lastly, in the first quarter, we repurchased approximately 180,000 common shares for approximately $3 million through our 10b5-1 repurchase program. This plan will run through the one-year anniversary of the IPO date and we'll continue to buy during that time if the stock trades at a discount to book value. For additional color on our financial results please review the earnings supplement available on our website.

I will now turn it back over to Robert for closing remarks.

Robert Williams

Thank you. Brandon.

Clearly, the current environment has presented challenges to mortgage rates and this may continue. Fortunately for Angel Oak, we believe we are differentiated in several ways. First, as part of the Angel Oak ecosystem, we are aligned with the most seasoned and experienced originators and managers of non-QM mortgages, providing unique access to a steady flow of investments. Second, we have a strong balance sheet with our debt largely fixed rate, with ample liquidity to execute on our balance sheet. And third, is our superior credit underwriting.

As Brandon said, our first quarter results were impacted by unrealized mark-to-market losses on our balance sheet. And a big part of that was due to significant widening of credit spreads. I would like to note that as a strategy, we do hedge against interest rate changes. However, we do not hedge against credit spread changes. We are focused fundamentally on credit performance. And credit metrics remain better than ever. This has always been core to Angel Oak and that will not change.

In summary, our portfolio remains strong. We are confident we can operate in this complex environment, focusing on strong underwriting and sound liquidity. Our distributable earnings are well in excess of the $0.45 quarterly dividend, which at today's share price reflects a dividend yield north of 12%.

As always, I would 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?

Question-and-Answer Session

Operator

Thank you. And ladies and gentlemen, at this time, we'll be conducting a question-and-answer session. [Operator Instructions].

Our first question comes from Don Fandetti with Wells Fargo. Please go ahead.

Don Fandetti

Hi. Can you talk about where you think book value is currently?

Robert Williams

Yes. I think the interest rate moves continued through April. I believe that book value is probably down, low-single-digit percentages so far in Q1.

Don Fandetti

Okay. And what is your -- are you saying you plan to do a securitization in the next month or two? Is that sort of plan? And where do you think that costs are on securitizations today relative to the seven plus asset yields or coupons?

Namit Sinha

Yes, this is Namit Sinha. We do plan to bring the securitization in the coming-- in the coming month or so. And what we are seeing is a somewhat stabilized securitization market. See the market was obviously very choppy in the first quarter, but there was a lot more volatility around March and April that seems to have subsided as the supply/demand challenges have abated to some extent. And what we are seeing is, is a more supply/demand technical that is more in equilibrium, that has also resulted in a credit spreads coming in on the senior parts of the capital structure.

To give you some context, there were certain deals that were done at around 180 to 185 spread on the AAA level. And then over the course of the next three to four weeks, the AAA spreads came into right around 140 on quoting versus interest rate swaps and not treasuries. But to that extent, what we have seen is that more robust demand and supply side has also gone down somewhat, and the demand side has shown more resilience. So we do expect to take the securitization to the market. And under the current context of the market, we are confident that it should -- it should do that.

Operator

Thank you. Our next question comes from Matthew Howlett with B. Riley. Please state your question.

Matthew Howlett

Hey, guys. Thanks for taking my question. Just on the trajectory of the purchases, you did over $500 million in the first quarter, $300 million in April, just over that. But now you have losses about 7%. Will that go up? I mean, are you seeing any decrease in demand at that level of coupon?

Namit Sinha

Yes. So what we have seen is the market resetting very quickly from what used to be a mid-first coupon on these loans to at least 200 to 250 basis points jump in the loan rate and the speed with which the things happened obviously unsettle the market a little bit. But the long-term story is still intact. More often, non-QM rates are pegged as compared with agency rates. And agency rates are closer to 5.3% today. So in that context, if you look at non-QM rates of 6.75% to 7%, it is very much in line. And what we do believe is that when the agency re-fi business kind of evaporates, which I think it is already happening in a big way because of where agency rates are, a lot of the focus across the mortgage industry, turns toward non-agency and long-term lending. And that generally helps the sector and helps us. It happened in the 2015 to 2018 hiking cycle where our volumes were almost doubling every year in the face of a rising rate environment.

So we do believe that as things settle, the volumes are going to be on an upswing and that's at least our expectation going forward. That said, with the choppiness that we have experienced, that has been somewhat of a decline in volume across the -- across the industry. And we are not immune to that either. But it is still running at a pretty healthy clip, even versus compared to where we were just a year back.

Matthew Howlett

Got it. And then, just on capital, I mean, can you do, would you be able to do a fourth securitization in the third quarter just looking ahead?

Namit Sinha

Yes. So we would -- we would look to do at the same rate of about one securitization every quarter. And we would obviously use the securitizations to term finance the loans that are sitting as whole loans today. But securitization also help us release cash, because the advantage to securitization are usually higher than to warehousing. And that release of cash allows us to buy more loans, presumably at a much higher prevailing interest rate. And that helps us from a return standpoint as well.

Matthew Howlett

And the target still a mid to high teens return on that retainer that's still the case?

Namit Sinha

Yes. The current coupon that always is the target. Now, as rates become volatile and they move around when those loans eventually are securitized, those terms can vary. And we do hope to capture most of that variation through interest rate hedges. But again, as Robert had mentioned earlier, the credit spreads can move around, too. That can change things. But when we underwrite and when we are doing current coupon loans to today's rate sheet, we usually target mid-to-high teens.

Operator

Thank you. [Operator instructions].

Our next question comes from Chris Kotowski with Oppenheimer & Company. Please go ahead.

Chris Kotowski

Yes. I mean obviously, your originations or purchases of non-QM loans have been running ahead of the level of securitizations we've seen. And so, presumably there's -- you've had this -- there are mortgages and long pools now that are kind of off market. And I'm wondering to what extent, you've had success in being able to pull some of those loans that may have been originated six or nine months ago that were off market. And then you -- can you mix them with the higher coupon mortgages originated more recently. And were you able to do that in the first quarter and, and therefore reduce your, overall exposure to some of those loans again, originated six or nine months ago that may not be at market?

Namit Sinha

Sure. So, I mean, you're spot on in that determination, except that the timeframe itself, six to nine months back was like I mean, the loans usually the loans that get locked today will potentially close in 45 days, 60 days. And by the time the fund buys it, it's another week or two. And so when they hit the securitization it's just another lag. So generally speaking, the loans we have bought in the first quarter are still loans that were locked in at market rate at that time, which were -- which were in the mid -- mid to high 4%. The loans that are being locked today by the mortgage companies are the high sixes coupons that will show up in the pipeline at a later time. But the rest of your conclusions are exactly how we think about things.

So what we do is, first of all, to answer your question, we have got three securitizations across our Angel Oak family of funds this year. One of them was out of AOMR. And we have done two more securitizations. And all of these deals have had coupons in the mid to high fours which you would consider to be in the current context of the market discount coupons. But we have had a lot of success getting these deals out. And one of the deals just closed today had a very good success in terms of the bond placements, et cetera.

So we, given the current context of the market and if this continues, we are very confident that these loans that we are, that housing today can be securitized, that leads to cash and leads -- that leads to us buying more of the high coupon loans and eventually securitizing both.

And to your last point, around mixing these loans that's absolutely how we look at these things so we are continuing to buy current coupon loans, I mean from Angel Oak or even from outside sellers mixing them with the local partner to create somewhat of a higher coupon pool and execute securitizations over the next six to 12 months to make the securitization process easier for us.

Chris Kotowski

I guess let me put it another way. Is there a way for us to gauge, how much -- how much, what portion of the whole loans that are in your balance sheet are saved, have been there for more than six to nine months?

Namit Sinha

There would be, assume like there would not be a substantial chunk of loans that are that seasoned, but there will definitely be loans that are seasoned between three and six months as we prepared for securitizations, et cetera. And if the exact number we can probably do a follow-up in terms of what exact percentage of the portfolio sits in that seasoned bucket.

Chris Kotowski

So -- so, but the way I should think about it is that most of the really seasoned loans that are more than six months old, those have been moved into the securitization trusts and that what sits on your balance sheet as residential whole loans currently that is more stuff originated in the last three to six months.

Namit Sinha

Yes, that would be -- that would be a paradigm shift.

Operator

Thanks. And that concludes our Q&A period. I will now turn the call back to management for closing remarks.

Randy Chrisman

Thank you everyone for your time and your interest in AOMR. 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 everybody have a great evening.

Operator

Thank you. This concludes today's conference. All parties may disconnect. Have a good evening.