Angel Oak Mortgage REIT, Inc. (NYSE:AOMR) Q3 2024 Earnings Conference Call November 6, 2024 8:30 AM ET

Company Participants

Sreeni Prabhu - Chief Executive Officer, President
Brandon Filson - Chief Financial Officer, Treasurer
Namit Sinha - Chief Investment Officer, Angel Oak Capital Advisors LLC
KC Kelleher - Head of Corporate Finance, Investor Relations

Conference Call Participants

Don Fandetti - Wells Fargo
Matthew Erdner - Jones Trading
Eric Hagen - BTIG
Matthew Howlett - B. Riley
Chris Kotowski - Oppenheimer

Operator

Good day! And welcome to the Angel Oak Mortgage REIT Third Quarter 2024 Earnings Conference Call. All participants will be in the listen-only mode [Operator Instructions]. Please note, this event is being recorded.

I would now like to turn the conference over to Mr. KC Kelleher. Please go ahead.

KC Kelleher

Good morning. Thank you for joining us today for Angel Oak Mortgage REIT's third quarter 2024 earnings conference call. This morning, we filed our press release detailing these results, which is available in the Investor's 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 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 up the call to your questions. Additionally, we recommend reviewing our earnings supplement posted on our website, www.angeloakreit.com.

Now I'll turn the call over to Sreeni.

Sreeni Prabhu

Thank you, KC, and thank you to everyone on the call for joining us today. We were pleased to see the rate environment begin to shift in the third quarter as easing inflation and employment stability gave the Fed enough confidence to reduce interest rates for the first time since March of 2020.

AOMR was in a position to capitalize on this shift and began the second half of 2024 carrying momentum from our productive first half of the year. We have achieved all our near-term goals communicated during our Q2 earnings call with regard to July's senior unsecured notes issuance, having fully deployed that capital into newly originated accretive high-quality non-QM loans.

These loan purchases, combined with our securitization activity, are currently producing net interest income that exceeds the cost of newly issued debt, making the additional leverage accretive to net interest income within three months of its issuance.

Additionally, in early October, we completed a securitization of many of those newly originated loans, recycling capital into additional loan purchases to drive compounded net interest income and target asset growth.

This is possible due to a disciplined and focused operational strategy and approach that is designed to deliver consistent and attractive investor returns. We operate our business with a focus on sound, long-term decision-making rather than extending into speculated risks.

We observed meaningful balance sheet and net income growth in the third quarter, driven largely by increased valuations across our portfolio. To that end, GAAP book value saw an increase of over 10%, with economic book value increasing by over 6%. As expected, net interest income was down slightly, but stayed relatively flat as we deployed fresh capital from July's debt issuance throughout the quarter.

By end of the quarter, our run rate was more than covering the incremental interest expense, and we expect to see meaningful net interest income growth in the coming quarters. Additionally, September's Fed funds rate cut and our AOMT 2024-10 issuance in October will both drive expanded margin going forward.

Our achievements stem from our proprietary affiliated origination, purchase, and securitization platform, a successful and focused model designed by our management team. This approach prioritizes the creation of sustainable and predictable earnings generation. Our business is highly structured and managed by experienced operators, ensuring that our investment and capital deployment process runs smoothly and efficiently.

Looking ahead, we believe we are entering a constructive macroeconomic cycle for Angel Oak Mortgage REIT and the broader mortgage REIT sector. Historical trends, such as those observed in prior economic cycles, indicate that we may see a period of significant growth potential and heightened capital markets activity.

Investment in non-QM has positive momentum, especially as investors gain enthusiasm around private credit opportunities. Non-QM is essentially a highly collateralized, stable private credit investment with proven and standardized underwriting process.

We are positioning ourselves for those potential opportunities and will be ready to execute on accretive capital raises and transactions that can further enhance our balance sheet and drive shareholder value. As we move forward, we remain dedicated to delivering positive outcomes for our shareholders and capitalizing on the exciting prospects that lie ahead.

With that, I'll turn it over to Brandon, who will walk us through our financial performance for the third quarter in greater detail.

Brandon Filson

Thank you, Sreeni. Our third quarter results were largely in line with expectations from a net interest income and expense perspective, and as Sreeni mentioned, we expect to see significant growth in the near term.

As previously messaged, net interest margin was roughly flat with a slight decrease quarter-over-quarter as a result of July's debt issuance, which added additional interest expense to the income statement.

This increase was mostly offset during the quarter with the additional investment activity by the company, and as Sreeni mentioned, we're exceeding the incremental cost of the debt as of today, with Q4 expected to show a sizable increase in net interest income.

Our concerted efforts to manage our operating cost structure combined with prudent portfolio risk management have delivered sustainably reduced operating expenses thus far this year. These initiatives, along with the embedded advantages of the Angel Oak model and ecosystem featuring our leading origination and securitization platforms, position the company for continued success.

In the third quarter, the company had GAAP net income of $31.2 million, or $1.29 per diluted common share. Distributed earnings results were a loss of $3.4 million, or $0.14 per common share, driven by the exclusion of unrealized gains across our portfolio and the inclusion of realized losses on hedges as rates rallied.

Interest income for the quarter was $27.4 million, an increase of $1.5 million, or 6%, compared to the prior quarter, and a 15% growth compared to the third quarter of 2023. This expansion was driven primarily by our rapid deployment of capital and to newly originated loan purchases.

Interest expense was $18.4 million in the third quarter, compared to $16.4 million in the prior quarter. Approximately half this increase was driven by the interest expense from our July debt issuance, with the other half coming from leverage against our new loan purchases as we continue to optimize return on capital.

Net interest income was $9 million, marking a small decrease relative to the prior quarter and a 22% improvement over the third quarter of 2023. In coming quarters, we expect meaningful net interest income expansion driven by several factors.

First, we'll have a full quarter's worth of earnings for the loans purchased with our debt issuance proceeds during the third quarter. Additionally, we will observe funding cost reductions from the Federal Funds rate cut of 50 basis points.

We also achieved an additional 110 basis point cost savings on the loans underlying the AOMT 2024-10 securitization. And lastly, we are recycling the capital released from AOMT 2024-10 into additional loan purchases.

During Q3, we purchased $264.8 million of loans that carried a weighted average coupon of approximately 7.74%, the weighted average LTV of 70.0%, and a weighted average credit score of 754. A residential whole loan portfolio carried a weighted average coupon of 7.73% as at the end of the third quarter, a nearly 200 basis point increase from the third quarter of 2023.

As of today, our unsecuritized loan balance is just over $200 million, which should grow and be ready for another securitization by the end of the year or shortly thereafter. Currently, loan purchases remain over 7% coupon as the rate rally after the Fed cut has partially reversed due to volatility and uncertainty around further federal fund rate cuts.

Third quarter total operating expenses were $3.8 million or $3.2 million, excluding securitization expense and non-cash stock compensation. This compares to the same metric of $3.5 million in the third quarter of 2023 and $3.4 million in the prior quarter. Our cost reduction efforts continue to bear positive results.

Now turning to the balance sheet, as of September 30th, we had $42.1 million of cash on hand. Our recourse debt-to-equity ratio was 1.8 times at quarter end. As of today's date, our recourse debt-to-equity ratio is approximately 0.7x, reflecting the impact of the AOMT 2024-10 securitization, which replaced warehouse financing with non-recourse term structural leverage, as well as the maturity of our short-term U.S. Treasury assets held at quarter end.

Our GAAP book value increased 10.3% in the third quarter compared to the second quarter of 2024, while economic book value increased 6.5% versus the second quarter. This was a result of the sizable valuation gains across our portfolio, driven by optimism in the interest rate and spread markets.

This growth also illustrates the convergence between GAAP and economic book value that we anticipate over time, either by rate decrease or prepayment activity in the 2021 securitizations, which drive the difference between GAAP and economic book value.

Our residential whole loan portfolio stood at a fair value of $428.9 million as of quarter end, financed with $333 million of warehouse debt. We had $1.5 billion of residential mortgage loans and securitization trust, and $301.8 million of RMBS, including $18.7 million of investments in majority-owned affiliates, which are included in other assets on our balance sheet.

Recently, we closed AOMT 2024-10, which was our second standalone securitization transaction of the year, to which we contributed 661 non-QM loans with a scheduled principal balance of $317 million, a weighted average coupon of 7.8%. The deal lowers the weighted average coupon funding costs for the loans underlying the securitization by over 110 basis points.

With this securitization, we reduced our whole loan warehouse debt by $260 million and released nearly $40 million of capital that is currently being recycled back into newly-originated, accretive, high-quality loan purchases, and will fill our portfolio for the next few securitizations.

We will continue to pursue high-quality loan acquisitions and are dedicated to practicing disciplined daily capital management as a core aspect of our operational approach. As always, we will be deliberate in leveraging our assets with a focus in mind to ensure that we maximize our return on equity while maintaining sufficient liquidity and managing risk.

Turning to credit, delinquencies remain muted, with the total portfolio weighted average percentage of loans 90 days delinquent at 1.95%. This metric has hovered around 2% for roughly six consecutive quarters back to the second quarter of 2023, potentially reflecting some stabilization around that rate.

As we've indicated in prior quarters, we believe that slight increases, such as what we've observed this quarter compared to the second quarter, are indicative of a return to historically normal levels as opposed to a harbinger for large-scale credit deterioration. Further, we believe that if credit becomes an issue, a robust underwriting standard and portfolio-wide low LTVs will mitigate losses throughout the cycle.

Three-month prepay speed for our securitization loans and trusts and RMBS portfolios are approximately 8.1% as of the end of the third quarter, which is flat compared to the second quarter. In a declining rate environment, we would expect prepaid rates to increase, though we would expect this to have a comparatively subdued effect on our portfolio for a couple of reasons.

First, our securitized loan and RMBS portfolios are weighted toward loans that are still well below current rates, reducing or eliminating a homeowner's incentive to refinance. Second, non-QM has historically prepaid in approximately 25 to 30 CPR, meaning we have room for prepayment speeds to increase and still meet our expected model returns. If rates continue to fall, we'll also have an opportunity to use capital to re-lever and re-securitize fees and securitizations, which will increase the effective yield on the investment portfolio.

Due to rate volatility after quarter end, we expect the mark-to-market valuations of our portfolio to have decreased since the end of the third quarter. However, mark-to-mark valuations are currently still well above their second quarter levels, and we expect stable valuations on new loan purchases as well as incremental interest income to partially offset this negative impact.

Finally, the company has declared a $0.32 per share common dividend, which will be paid on November 27, 2024 to stockholders of record as of November 19, 2024. For additional information on our financial results, please review the earnings supplement available on our website.

I will now turn the call back over to Sreeni for closing remarks.

Sreeni Prabhu

Thank you, Brandon. To summarize our commentary, the AOMR model is working. A disciplined and holistic approach, our investor-focused management philosophy, and our affiliated origination, purchase, and securitization platforms are working.

As I mentioned earlier, we believe we are entering a favorable environment for our business, and we intend to position ourselves to capitalize on new opportunities and deliver strong returns to our shareholders in the fourth quarter and beyond.

With that, I'll now open the floor to your questions. Operator?

Question-and-Answer Session

Operator

Thank you very much.[Operator Instructions]. At this time, we will pause momentarily to assemble our roster. The first question comes from Don Fandetti with Wells Fargo. Please go ahead.

Don Fandetti

Brandon, can you talk a little bit about new investment volume expectations for the next few quarters?

Brandon Filson

Yes. I think what we'll see the next few quarters is kind of what we saw this quarter, mid $200 million or so, $200 million of origination and purchases.

Don Fandetti

Okay. And can you just clarify on the book value comment? Are you saying that you'd give back a good bit of the increase this quarter or part of it?

Brandon Filson

Yes. It's just about half of that increase has been given back as of today.

Don Fandetti

Okay. Got it. And I assume that you sort of -- you still feel like you can maintain the dividend at this level?

Sreeni Prabhu

Yes. Absolutely. We should, again, as indicated on the call, we think that now with those proceeds being invested, the securitization going off, new loans coming on as well, and then we also plan to do a securitization late this year or early next as well. You should see that net interest margin widen out more similar to what we saw in Q2.

Don Fandetti

Great. Thank you.

Operator

Thank you. The next question comes from Matthew Erdner with Jones Trading. Please go ahead.

Matthew Erdner

Hey. Good morning, guys. Thanks for taking the question. How should we expect the pace of securitizations? Should we look at it as kind of a one per quarter with a $200 million, I guess, run rate, so to speak on investments?

Brandon Filson

Yes. That's, I think, as we mentioned a few other calls, I think we kind of target one securitization a quarter. Obviously, last quarter, we took a pause in Q3, but now we're expecting two in Q4. So that's probably a good proxy for what we do, and we get up to, somewhere around $300 million for a securitization.

Matthew Erdner

Gotcha. Yeah, that's helpful. And then how has the execution been there? And how is that on the October 1? And then can you guys also speak about what you guys retain from the securitizations? Thanks.

Brandon Filson

Yeah. No, I think the execution we had in the October securitization was very good. We sold about 95% of the capital structure, retained it at about just under 5.5% cost of funds, so dropped out, as we mentioned, 110 basis points of funding cost.

In that particular deal, we retained the IO positions, the excess servicing strip, the excess interest bond, the unrated bond, and there we also sold off a piece and retained a piece of the single B rated bond.

Sreeni Prabhu

Yeah. This is Sreeni here. From execution side, I mean, execution continues to be strong in just overall non-QM securitization market. So, we've done as an Angel Oak entity close to 12 securitizations this year, including for AOMR. So we see continued appetite for AAAs.

Spreads are anywhere from, last couple of weeks, wall spreads widened out a little bit, but they're somewhere in the mid-120s to mid-130s, and they have been consistent there. And I just think that any stability will continue to tighten spreads here.

Matthew Erdner

Yeah, that's very helpful there. Then one last one for me. How are you expecting asset yields going forward? You know, I think it was 7.8 on the last securitization. Do you think that's sustainable for the next couple of quarters? I'm assuming it's kind of all rate vol and how it plays around that, but do you have any insight there?

Brandon Filson

Right. Yeah, no. The weighted average coupon of the assets will obviously float around a bit as rates come in. Now, with the rate volatility we've had, mortgages kind of dipped right after, the Fed rate cut, but now we're essentially back up to that high sevens on our lots coming in today, keeping the good spread to an agency product.

But, I would expect over the next year that that is going to come down. And in concert with that, of course, we should get a little better, lower funding costs on the securitization.

Then our warehouse financing will also, come in as well as it's tied, the floating component there is tied to SOFR, which comes down with, obviously with kind of every rate cut. So, we still expect on a levered, securitized basis, like a 15% to 20% ROE.

Matthew Erdner

Awesome, that's great. Thank you guys for taking the questions, and congrats on the quarter.

Sreeni Prabhu

Thank you.

Operator

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

Eric Hagen

Hey, good morning. I hope you guys are well. How are we looking at the opportunity to buy back stock at these levels? What are the liquidity sources that you might draw upon to make that happen? How high would you take your leverage if there was an opportunity to maybe get more aggressive with the buyback at these levels?

Brandon Filson

Yeah, you know, it's something we're always talking about, right, as the stock price has traded down. I think, two months ago, the question wouldn't have come up here, Eric, I guess, because we would have been $11, $12 a share. I think we're dealing with -- we've got some stock overhang as our largest investor has moved some shares away around $10.

I think the volatility around the election has decreased or you know also created some overhang in the broader REIT market, which we got hit a little extra hard on. But, I believe that over the next quarter or so that you'll see the stock price start to appreciate again.

So, buyback for us right now isn't really on the table, but it is something we monitor almost on a day-to-day basis and try to make the decision. It becomes apparent that if we're trading still at a 14% dividend throughout the quarter, then we might consider doing something. But again, nothing's in the pipe right now.

Eric Hagen

Got you, guys. Thank you. I actually want to ask about loan delinquencies. I mean, they remain very low, but what is the structure of any loan modification activity that's taking place right now? And if we did see delinquencies pick up a little bit more and rates were to stay high, like, how do you feel like the loan mod activity would potentially change?

Sreeni Prabhu

Yeah. There's not a lot. I mean, to be honest with you, these delinquencies, just because of the home price appreciation activity, a lot of these end up probably refinancing just because of the home price appreciation versus modification. So, modification activity is much lower just because of the delinquencies.

What we have to look for, and we are publishing a paper at some point on the delinquencies that we've seen in the originations in 2023. And ours are lower than the market, but we're looking through it. But we'll have a lot more information on that to send to you over the next couple of weeks.

Eric Hagen

All right, interesting. Looking forward to that. Thank you, guys.

Sreeni Prabhu

Yeah. Yeah. Thank you.

Operator

Thank you. We have the next question from Matthew Howlett with B. Riley. Please go ahead.

Matthew Howlett

Hi, Brandon. Hey, Sreeni. Thanks for taking my question. Brandon, did you say the loss-adjusted leverage yield on 24/10 was 15% to 20%?

Brandon Filson

That's right.

Matthew Howlett

So, I guess just a big-picture question, when I look at those type of returns today, and let's just assume that stays consistent. I mean, with your expense ratio, I mean, you could be doing an ROE in the very low teens, which gets me to something well above your current dividend rate.

I don't want to hold you to raising the dividend, but you mentioned calling some legacy deals, which I'm assuming are earning lower than that. What's the -- just talk about recycling some of these legacy securitizations into this new production, and where do you think the ROE of the company could go?

Brandon Filson

Yeah. No, I appreciate the question, and I think you're right. We do have a bit of an ability to exceed the dividend. Maybe not as much at a $9 share price at a 14% yield net, but we've got a lot of securitizations.

We have some securitizations from ‘22 that don't make us a whole lot of money, don't have that 15% to 20% ROE profile. Like I said, when we buy loans, Nomad [ph] is pricing the loan, pricing the credit to target that return.

Obviously, in some scenarios, like in 2021, the reality there was much higher than modeled, and then in 2022, it reversed, and it was much lower. Those deals from ‘22 will start to become callable in ‘25.

Those are going to be your very low coupon, 4.5%, 5% coupon deals. They could get into the money from a call perspective, or even if they're not 100% in the money in terms of completely, being a 15 to 20 ROE, but you could take a single-digit IRR and maybe get to a low double-digit IRR with the funding cost change.

We also have some securitizations back from 2019 that we can kind of package up, re-securitize, and even though those funding costs are somewhat similar to today, actually a little bit inside of where the funding is, those deals have also de-levered a lot, so we can use that as a tool in our toolbox to, juice up the returns.

And like I mentioned a few times, we expect our net interest margin to expand in the next quarter, again, much like Q2, so we should get to an effective dividend coverage ratio, I think, at that time, but then we still have capital and runway to grow into Q1 as well and through 2025, where you start looking at it. Yeah, if we keep expanding that net interest income, operating expenses stay low, there will be a discussion about what to do with the dividend at that time.

Matthew Howlett

Yeah, look, I mean, obviously, these are incredible returns. And that's my next question. You guys have been raising coupons successfully. With these type of returns, I'd love to - it sounds like they're the highest they've been, securitization economics are the highest they've been in quite some time. Are you running, I mean, I know, the cycle's shaking on a lot of competitors, and you guys are the leader and sort of the last guy standing.

I mean, are you running to anybody? With these type of securitization returns, are you going to see new people try to come in, and could that pressure - term sheets or coupons? Just want to hear your thoughts, and where do securitization economics stand today versus where you've seen in the last three, four years? I'm assuming they haven't been this good since you went public.

Sreeni Prabhu

Yeah, Matt, this is Sreeni. No, this is as good as it gets relative to 2021. 2021 was also a great year. From a competitive perspective, I mean, there are more competitors, but again, at the end of the day, this business is about consistency. If you, build a business, which at Angel Oak Mortgage Solutions, which is a mortgage company, which is more of a service-driven.

And what we are targeting over there is our clients over there, and where we are sourcing loans, we tend to be in a less competitive environment just because of our name recognition. So, service becomes more important than price.

Price is important, but we are not competing on price every day. And so that's the model that we have because we are every day in the marketplace buying loans, and there's only very few guys that are doing that.

So, yes, there are a lot of guys wanting to do it. There are a lot of guys that come in and out, but the consistency is what drives us to get more than our fair share in the market at a reasonable price.

Matthew Howlett

Yeah, my last point, I was going to commend you on the credit. It seems like, your credit portfolio is just sort of holding steady, whereas we've seen other shelves, non-QM sort of increase. I mean, any changes in your underwriting at this point in time? Are you just sticking with, what you're noting here?

Sreeni Prabhu

Yeah, we are constantly re-underwriting, Matt, and we brought in a Senior Loan and Credit guy from the mortgage company into asset management. And at some point we will also introduce him to the analyst committee, and what we're really doing is re-underwriting, again, all sorts of loans that we've underwritten, what we are seeing, what type of credits we want to slow down, what type of credits we want to do more.

But, as I said previously, a few minutes ago, we are seeing obviously our delinquencies are trending much lower than our peers. We're also seeing some delinquencies coming out of 2023 originations where a lot of guys, new entrants got aggressive. So, we're doing a little bit of a write-up on that.

So, we will send it out to all of you guys as we get a little bit more deep into it. But no, our goal is to continue to manage credit.

I mean right now, nobody thinks about any sort of landing, but end of the day, we've had a long cycle in non-QM, and at some point, credit will be something that we'll all have to discuss. But we're not there today, but we're seeing trends.

Matthew Howlett

Appreciate it. Look forward to the earnings for next year. Thank you.

Operator

Thank you. [Operator Instructions]. We have the next question from Chris Kotowski with Oppenheimer. Please go ahead.

Chris Kotowski

Yeah, good morning, and thanks for taking the question. I just wanted to follow up on the impact of the securitization you did in October. You said it was about 110 basis points of savings on the interest. So, should we expect that to be like $750,000, $800,000 of incremental net interest income on a quarterly basis? Is that the way to look at it?

Brandon Filson

Well, some of that savings on a cost basis, the lever is going to be taken out by the additional leverage that it took in a place, like I said, that's effectively 95% levered versus in the warehouse phase, it was 80% levered. So, it's going to be a lateral move from that directly.

But really what that affords, again, is the additional capital that freed up $40 million in cash, which we'll use to feed one for new securitization. And we've already deployed that cash into whole loans initially unlevered, which would have a runway of approximately $1 million a year in terms of net interest margin.

Chris Kotowski

So, I understand the capital efficiency of it, and why to do it. But, I was just trying to think of in isolation, the impact of that one securitization, it sounds to me should be like $3.5 million a year or something like that. Am I thinking about that correctly?

Brandon Filson

Well, again, no, because the additional leverage in the securitization, that if that was the only thing we did. The operating results would be effectively flat compared to where we were before, but we've increased the leverage. So, the delta is we effectively have more debt at a lower cost.

Chris Kotowski

Okay. All righty. Thank you. That's it for me.

Operator

Thank you. Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over to the CEO, Mr. Sreeni Prabhu, for closing comments.

Sreeni Prabhu

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

Operator

Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.