Angel Oak Mortgage Inc

NYSE:AOMR

Earnings Call Analysis

Earnings Call Transcript 2024-Q2

[Operator]

Good day, and welcome to the Angel Oak Mortgage Second Quarter 2024 Earnings Call. [Operator Instructions] 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, executive]

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 Prabu; 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.

[Sreeniwas Prabhu, executive]

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, AOMT2024-4, 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 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 90-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 trend 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 growth for AMR.

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, executive]

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 noncash 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 noncash 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. And while the bulk of the savings 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 30, 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 31, 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 stand-alone securitization transaction of the year, to which we contributed loans with the $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 towards 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 1 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 30, down from $10.55 in the first quarter. Our economic book value, which fair values all nonrecourse securitization obligations was $13.16 per share as of June 30, 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 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 from 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 to the end of July. On July 25, 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, the $40 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 30, 2024, to stockholders of record as of August 22, 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.

[Sreeniwas Prabhu, executive]

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 and 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]

[Operator Instructions] Our first question comes from Don Fandetti with Wells Fargo.

[Donald Fandetti, analyst]

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

[Brandon Filson, executive]

Don, yes, absolutely. We've been increasing the NII for now 4 quarters. I think if you look at it from a net interest margin perspective, less cash expenses were up to -- we probably improve that coverage by about 20% this quarter to 80% coverage of the dividend just from a cash basis. We -- like I said, we 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 Q4, we expect a further expansion that, again, will -- I believe, will be an effective covering of the dividend.

[Donald Fandetti, analyst]

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

[Brandon Filson, executive]

Yes, 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 it 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 -- as of June 30 would be now at least flat, if not up.

[Operator]

Our next question comes from Doug Harter with UBS.

[Douglas Harter, analyst]

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

[Brandon Filson, executive]

Yes. We think that this -- the $30 million or so of net proceeds that's left after the repurchase, you're probably going to provide us the runway for the next kind of 3 or 4 quarters of consistent loan acquisition. I mean just on space, the first round, the $30 million we can buy about $200 million worth of loans. We could then securitize. After that, we'll buy another $180 million, and it kind of steps down from that point forward. But again, several quarters and probably will be supportive of something like $1 billion in residential loan purchases over the next several quarters.

[Douglas Harter, analyst]

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

[Brandon Filson, executive]

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

[Operator]

And the next question comes from Eric Hagen with BTIG.

[Jake Katsikas, analyst]

This is Jake Katsikas on for Eric. 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?

[Brandon Filson, executive]

Yes. We've already seen a little bit of a prepayment pickup even before the move in rates at why our GAAP and economic book value were a little bit down this quarter compared to where you would otherwise think. I mean rates didn't really move but prepayment speeds did move up slightly. I think there's -- at least in our portfolio, right, we have a very -- we have a tail of 2 sides, right? We've got the 5% coupon portfolio that's going to take a huge move in rates to really move prepayment speeds up materially, and we've got the 8% portfolio, which is going to be much more sensitive to prepayments.

But the thing is that 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, those proceeds back into the assets with a similar or maybe even catch a little tailwind yield. But a long way to answer your question, I mean, we've got quite a bit of, I think, protection in our performance in case the prepayment speeds increased by 10 points. Remember, non-QM historically has like a 25 to 30 CPR. That's what we base most of our modeling and assumptions on the securitization market. Recently, that's been much slower than that, like single-digit level. So we are expecting a return 25% to 30% level over the next several quarters.

[Operator]

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

[Matthew Howlett, analyst]

Congrats on a great report. I know things are fluid right now, but with the move herein rates and you're putting on coupons around 80%, any sense on what the ROEs will be on retained interest with securitizations going forward? I mean I'm assuming they're going to be a lot higher than we you thought they were a couple of quarters ago.

[Brandon Filson, executive]

Yes. Well, I think there's a potential, Matt, for a little, what I'll call, maybe a Goldilock securitization that will have a higher coupon relative to funding cost. We saw that back in '21 right after our IPO with 21-4 and 21-7. But long term, so -- I mean long-term meaning next year, really, we'd expect that if rates do come in, stay in, our loan coupons will reduce, our funding costs will reduce, and we'll still be looking at that mid- to high teens to low 20% ROE. 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]

Have you started lowering -- has the mortgage company started lowering rates?

[Sreeniwas Prabhu, executive]

Matt, Sreeni here. So last -- I would say before the last few days, yes, we have been lowering rates because as you noticed, rates have been going lower over the last few weeks, not just last 2 days. But last 2 days, really the credit -- 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 -- and across the board, people to lower rates. And to answer your question before also on that side, part of that is you will see if we keep rates high, you're going to see prepayment activity pick up too. So I think the industry as a whole will lower rates here.

[Matthew Howlett, analyst]

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

[Brandon Filson, executive]

Yes. That should be what we had an available fund and then plus the senior unsecured notes will also support that is a piece of that $1 billion.

[Matthew Howlett, analyst]

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

[Sreeniwas Prabhu, executive]

No. Yes, the guys in the previous batch, they've gotten cleaned out. I would say, from a consistency of origination to credit management securitization, we would consider ourselves to be a leader. 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 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, 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 of the company. Appreciate it.

[Operator]

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, executive]

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]

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