Angel Oak Mortgage REIT, Inc.

Hello and welcome to Angel Oak Mortgage REIT's second quarter earnings conference call. All participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn the call over to your host, Randy Christman, Chief Marketing and Corporate Investor Relations Officer. You may begin.

Good afternoon. Thank you for joining us today for Angel Oak Mortgage REIT's second quarter 2021 earnings conference call. This afternoon, we have filed our press release detailing our second quarter results, which is available in the investor sections on our website at www.angelokereit.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 also 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 call is hosted by Angel Oak Mortgage REIT's Chief Executive Officer, Robert Williams, and Chief Financial Officer, Brandon Filson. Management will make some prepared comments, after which we will open up the call to your questions. Now, I will turn the call over to Robert.

Thank you, Randy, and thank you, everyone, for joining us today. I'll begin with an overview of our strategy and market opportunity. Then I'll turn it over to Brandon to discuss the second quarter financial results. After that, we'll open up the call for your questions. We completed our IPO in June of this year after operating nearly three years as a private REIT. We believe our strategy has been tested and validated, and that we are uniquely positioned to benefit from the robust housing market. We have a distinct product focus, extensive management experience, proprietary access to the Angel Oak platform, which possesses a proven and lengthy track record of asset management and origination success that we can leverage. Let me begin with what makes the opportunity compelling. Angel Oak's affiliated mortgage companies, which collectively comprise Angel Oak Mortgage Lending, have a focus on non-QM loans, a large but underserved section of the consumer mortgage market, providing an opportunity to generate attractive, risk-adjusted returns. Let me emphasize that our borrowers are not inferior credit. In fact, the credit metrics are solid, including prime to near-prime FICO scores, mid-70% loan-to-value, and low debt to income ratios, but largely for documentation reasons fall outside traditional GSE underwriting requirements. They may be self-employed borrowers without required W-2 documentation, or they may be purchasing an investment property, or they may be in a category we call just misprime. Our performance during the COVID pandemic highlights the resilience of the asset type and borrow group. Looking at our performance March through June of 2020, was obviously a challenging time period for everyone managing credit or loans. Our delinquencies peaked in the summer of 2020. The delinquency rate never rose above 16% of our portfolio, and it's now improving back to a historical average of 2% to 4% delinquencies. This performance speaks to our strong underwriting criteria, which includes loans in the mid-70% LTVs, low debt to income, and mid-700 FICO scores. Bars are heavily incented to perform as they have significant equity in these homes. To break that down further, our average loan size is around $400,000, meaning these bars have on average over $100,000 in equity in the home at loan origination. With home prices appreciation that occurred over the last year, our bars generally have significantly more equity in the home now, making this very attractive collateralized lending. Our underwriting of residential non-QM loans requires a specialized skill set for which Angel Oak has invested substantial time and capital, and therefore honed over many years. We mainly source our loans through Angel Oak's robust mortgage, retail, and wholesale origination network, which allows us to tailor our products as the market evolves, managing our exposure or adjusting to emerging risk as needed. Angel Oak's national platform, which recently surpassed $10 billion in total non-QM origination, allows us to cast a wider net, and as a result, we think our diversification has typically been superior to other originators in the market. Because non-QM lending requires a unique combination of sourcing and underwriting expertise, non-QM loans carry a meaningful spread to conventional mortgage rates, with a typical spread over agency loans currently over 200 basis points. While these attractive returns would be expected to draw competitors, the fact is it remains a large moat around our industry, and the barriers to entry are substantial. For starters, this is a market where large banks do not compete, primarily as a result of regulation. Non-QM is dominated by non-bank lenders, and the single largest non-bank originator of non-QM mortgages since 2017 is Angel Oak Mortgage Lending. Our relationship with these affiliated lenders affords us a proprietary pipeline of loan supply underwritten by a team within Angel Oak Franchise. This is a key competitive advantage, securing quality assets with proper collateral value and fair and attractive pricing. Therefore, we do not depend on third-party originated assets and are not subject to buying the widest possible credit at the highest possible price as many of our competitors are. Having this consistent access to targeted assets means that we can spend less time sourcing mortgages and more time on asset management and securitization strategies. where we can generate substantial value. Our advantage within the non-QM market is our ability to identify and underwrite particular borrow characteristics, which allow us to calibrate our risk and tailor our portfolio to meet a desired asset profile. We also have the advantage of minimal financial leverage compared to our peers, with a debt to equity ratio of 2.2 times as of June 30th, 2021. As part of maintaining low leverage, we also seek to achieve low volatility, which we believe will contribute to a consistent dividend and stable growth over time. Our objective is to minimize interest rate and liquidity risk while driving superior returns by properly underwriting and properly pricing credit risk. Regarding the future market opportunity, we believe there's a large and growing pool of borrowers. There are approximately 15 million self-employed borrowers, another 59 million freelance workers who are potential fits for our products. The Bureau of Labor Statistics estimates there's a number of self-employed borrowers will continue to rise significantly over the next five years as a result of structural shifts in the U.S. economy and labor market. Over the years, we have done a large amount of borrower education in order to make people aware that our products exist. As a result, Our affiliates at Angel Oak Mortgage Lending have now become the single largest non-bank originator in the country. Before I turn it over to Brandon, I'd like to summarize the opportunity with the following points. First, this is a business, not a trade. This is an investment in an operating business that has been built over several years. This REIT gives shareholders access to a scarce and proprietary asset. We believe there's a long runway for continued growth with minimal competition and an opportunity to earn meaningful spreads over agency mortgages and other assets, driving better bottom line results with less financial leverage. Second, we have an unparalleled access to the market through Angel Oak Mortgage Lending, which has been the single largest non-bank originator of non-QM loans. Third, we have a programmatic access to capital markets through Angel Oak's securitization platforms with a strong investor following, a low cost of funding, and we have participated in five securitizations to date, which Brandon will discuss in more detail shortly. With that, I'm pleased to turn it over to Brandon.

Thanks, Robert, and thanks, everyone, for joining us. We're excited to close our IPO transaction on June 21st, 2021. We sold 7.2 million shares for proceeds to us of $136.8 million. In addition, we closed a concurrent private placement of 2.1 million shares for $40 million in proceeds. As a reminder, an affiliate of our manager paid all the IPO offering costs and commissions. This means that the company received all the proceeds from these transactions and used them to acquire target assets. Turning to our financial results for the second quarter of 2021, we had net income of $2.2 million, or 13 cents per share, and distributable earnings of $2 million. This compares to net income of $26.2 million, or $1.67 per share, and distributable earnings of $2.2 million for the same quarter in 2020. GAAP book value increased to $19.48 on June 30, 2021, from $19.26 immediately following the completion of the IPO. The increase in book value was primarily due to net interest margin on the loan and RMBS portfolio, as well as additional appreciation on whole loans and investment RMBS portfolios. offset by some interest rate hedging losses during the quarter. During the second quarter, we purchased 396 million of residential mortgage loans. Subsequent to the second quarter through August 12th, 2021, we purchased a total of $186 million in residential mortgage loans and have fully used our IPO proceeds to buy target assets. Our business strategy begins with loan aggregation. We purchase loans and hold them for two to four months on the financing lines that we have in place with a diverse set of banks until we achieve critical mass to execute an efficient securitization, allowing us to lock in term structural financing for the life of the loans. The current total capacity on our financing lines, $800 million, and importantly, we're only relying on those lines for a short period of time during the aggregation phase. After securitization, we typically retain the economics from the lower 10% of the value of securities, which represents the credit of the underlying loans. We have strenuous underwriting standards as we underwrite to own the credit of the underlying borrower and collateral as typically after securitization, we retain the economics from securities which represents the credit of the underlying loans. On a run rate basis and based on a number of assumptions, we believe our residential non-QM whole loan portfolio has the potential to generate a 12% to 15% yield, and the RMBS portfolio has the potential to generate a 17% to 20% yield. During the whole loan aggregation phase, we typically employ three turns of financial leverage through our warehouse lines. Once that is converted over to term financing, we're able to use the structural leverage in the securitization rather than relying on financial leverage to generate those returns. During the second quarter, we did not complete any securitizations given our IPO. Since our inception in 2018, we have participated in four non-QM securitizations and one small balance commercial securitizations. Over time, the average FICO scores in our underlying loan portfolio and our MBS portfolio have increased approximately 20 points. Debt to income ratios have gone down, and we've been able to achieve attractive returns due to the large spread between the coupons of the loans and the cost of funding in both the warehouse and securitization phase. Turning to expenses, we are externally managed by FalconsOne. an affiliate of Angel Oak, which allows us to benefit from their vertically integrated platform and a team of over 800 employees. Our manager earns a base management fee of 1.5% of total equity and a 15% incentive fee over an 8% return threshold on a rolling four-quarter basis. We believe this cost structure allows us to operate efficiently and pay an attractive dividend to shareholders. Our operating expenses, including the management fee for the second quarter, were $2.7 million. which using the average equity for the quarter was 3.2% on an annualized basis. Turning to our balance sheet, as of June 30th, we had $28.9 million of cash and cash equivalents. Our debt-to-equity ratio was 2.2 times. We have a total of $529 million in residential whole loans, $723 million of RMBS, and over $115 million in retained AOMT securities. Over time, we will continue to assess options to reduce our overall cost of funding. We currently have warehouse facilities with four banks with varied maturities, sizes, and counterparty types to manage systematic and idiosyncratic financing risk. With our current loan portfolio, we are primed to execute at least one securitization. The current securitization market is still very strong and should provide very attractive financing and accretive returns. On August 12th, our Board of Directors declared a 12-cent dividend for the post-public period, payable on August 31st to shareholders of record as of August 23rd. This is our first dividend declared since our IPO and is related to the results of the REIT in June, implying an annualized dividend rate of $1.44 per share. As a REIT, we intend to pay a dividend on a quarterly basis and are required to pay out 90% of REIT taxable income on an annual basis. and our board will continue to assess the appropriate dividend rate each quarter based on our performance and outlook. I will now turn it back to Robert for closing remarks.

Thank you, Brandon. We started Angel Oak Mortgage REIT three years ago with the idea of providing investors access to the Angel Oak platform. Just two months ago, we completed our IPO, which was the first residential mortgage REIT IPO since 2015, the largest IPO capital raised by a residential mortgage REIT since 2011, and the largest post-IPO market cap of a residential mortgage REIT since 2008, which is a testament to our unique strategy and to the business we've built over many years. In conclusion, Angel Oak Mortgage REIT provides our shareholders with access to scarce and proprietary assets with strong diversification characteristics, attractive returns, which produce consistent results to drive stable and growing dividends. Notably, our company generates these results by utilizing less leverage and minimizing liquidity risk. While we intend to distribute most of our earnings, we will likely retain a portion of earnings to grow equity and book value over time. We are thrilled to continue our journey as a public company and want to thank our investors for their support. We look forward to driving continued success through the second half of 2021 and beyond. With that, we will open up the call for your questions. Operator?

Thank you. At this time, we will be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Our first question is from Don Fandetti of Wells Fargo. Please state your question.

Hi. Good evening. So question on the acquisitions. It looks like, you know, you've been pretty active through mid-August. Do you think you're going to be on track to exceed the Q2 acquisitions as you look out for Q3 in total?

Hey, Don. This is Brandon. Yes, you know, our mortgage companies actually had a release today where we crossed $10 billion worth of origination. We've had, you know, originations out of the mortgage lending entities are above what we have in Target. And even, you know, we purchased almost $200 million now in August through, you know, essentially that 40-day period Even from this morning when the script was made, we just bought another $11 million on top of that. So it takes us up to about $197 million for Q2. And again, that just puts us in a great position to execute at least one securitization here in Q3.

Got it. And I guess just to clarify, I mean, what you're saying on the dividend is $0.12 was effectively the June activity. So at a minimum, we could sort of multiply that times three, and, you know, you'd expect to be at least at a 36-cent type dividend for the third quarter activity. Is that fair?

Yeah, I mean, subject to, you know, final results of the quarter and what the board is feeling at that time and how we can do it, I think that's not probably far off from where we'd be targeting.

Absolutely. Okay. All right. Thank you.

Our next question is from Chris Katowski of Oppenheimer. Please state your question.

Yeah, good morning. I guess a couple things. One is when we see $529 million of residential loans on your balance sheet, roughly how large do you want that to get before you aggregate that before you get to securitize it?

I mean, our ideal flies on a securitization transaction is probably somewhere between $300 and $500 million. So we had enough loans in June to execute a securitization transaction post-IPO. Like I said, we have at least one most likely going to close in Q3, and then we'll continue to buy loans because we have significant capacity to keep the loans and then just the market dependent and when we can get securitizations out, execute over the next quarter.

Okay. And then when we look at the line that says RMBS at fair value, I mean, just in your filing, you disclosed the Angel Oak RMBS versus the purchased ones. I mean, basically, since there were no securitizations, we should just assume the June 30 Angel Oak securitizations were roughly equivalent to where they were at March 31st?

Yeah, that's correct.

Okay. And, I mean, it seems like roughly, you know, given the pace of originations that you're on, it seems like at the current pace we could conceivably see one per quarter. Is that a reasonable expectation or is that aggressive?

No, I think that's what we'd be targeting is every two to three months legitimately going out with a securitization transaction. Okay. For the foreseeable future.

And then the kind of middle lines on your P&L, the net realized loss on derivative contracts, RMBS, and the unrealized gains on derivative contracts, Can you tell us how we should think about them, what importance should we put on them, and how would you advise us to model those going forward?

Yeah, the realized losses that you see in that for Q2 really relates to our interest rate hedging strategy, where we're hedging out some of the securitization execution risk. Those are just typical short futures. on interest rates, you know, approximating the curve of the eventual securitization. So if you look at what those two-year and five-year curves are doing, you should be able to model that out. And, of course, this quarter, like many quarters here in the recent future since COVID, has had a little bit of noise. Offsetting that, of course, is some of the value increase you see in the other unrealized gains and losses, which is the loan values themselves going up as those interest rates continue to fall.

And so, I mean, if we were thinking about kind of the run rate of distributable earnings, I mean, we'd just basically ignore those lines, right?

Yes, that's correct.

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

Thank you.

As a reminder, if you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for additional questions. Our next question is from Matthew Howlett of B Reilly. Please state your question.

Hello, you guys. Thanks for taking my question. On the guidance for the high teen's yield on the RMBS Can you talk about what you're seeing for prepayments? I'm assuming that's the biggest variable here. Have they begun to slow down? What's the origination coupon?

We're still in a period of pretty high prepayment speeds. Our deals we have in the portfolio right now are approaching a 50% three-month CPR. They haven't shown many signs of slowing down as of yet, but we expect them to slow down in the near future. And then the newer securitizations have a naturally slower speed. One thing that's happened over time is now non-QM rates have come down from, if you look at the 19-2 securitization at like a 7% coupon. Some of the later deals under the AONT shelf have had mid-5% coupons, let's call it. I'd expect that those would have a little bit more muted prepayment speed over the coming quarters. which would include the next securitization that we do out of this REIT.

Gotcha. And then just with, when you talk about securitization economics, you're paying a premium for the loans, you bring it in, you securitize, and given what spreads are on the securitization market, could we see a gain on the securitization? And then just remind us again how long, if the deal is deleveraging after you do it, how long can you call the deal and then just replace it again? And I think you have one coming up where it's callable. Can you just go over that again?

Right. So the four deals we have in the portfolio now had two or three-year no-call periods, meaning that we have over the next about six months now, three of those deals become callable. which again, we can call and then re-securitize, you know, taking advantage of the lower spreads in today's securitization market to, you know, before. I mean, if you look at the 19-2 deal, we had coupons on the AAAs, you know, close to 3%. Currently, the latest deals out of our shelf have had sub-1% coupons on the AAA with a larger, you know, deal size or tranche size at that level. And then, you know, the current securitizations, again, when we're setting that up, should benefit from, you know, the securitization market that stands now that's still pretty strong and holding it for us.

Matt, this is Robert, but you're exactly right. So the hedge that we were discussing earlier is offset by gain. When he does the securitization, he'll take a gain on that in the securitization, which offsets that, and that's how it bleeds through the P&L. Gotcha.

And then when you call those three securitizations, I mean, will there be a gain or will it just reflect in that higher ROE because you're going to re-lever it under a better spread environment?

Yeah, those could potentially have a gain as well. It depends on those deals. The earlier deals were all commingled with other Angel Oak funds. So it depends on who's calling the deal and who's going to actually get the loans and re-securitize. Gotcha, great. Okay, thank you.

Our next question is from Derek Hewitt of Bank of America. Please state your question.

Good afternoon, everyone, and congrats on completing the IPO. So how long do you think it'll take to transition the portfolio to Angel Oak-originated RMBS versus the kind of those third-party purchases and kind of given that timeline, what are the parameters for contemplating raising additional capital just given the potential growth opportunity for non-QM longer term?

Yeah, so what we did in the 10 days post-IPO, you know, is we really just wanted to immediately deploy as much of the capital as possible. So you're right, we went out and we purchased, we had some whole loans from the affiliates queued up, We purchased a couple hundred million dollars in Q2. Then we used some of the rest of the money to buy some other assets with very low cost of repo financing, but a very large amount of bonds to give us some additional carry. Subsequent to quarter end, we started removing those RMBS already from the portfolio because as we were buying more non-QM loans from our originators, And now we're at the point where we're beginning to add the leverage naturally in the portfolio. Of course, as we securitize, that financial leverage will go away, free up additional capital. So it's going to take another quarter or two to be in what would be a most efficient balance sheet position in terms of financial and structural leverage. And then as far as the capital raise perspective, we're really looking I mean, we wouldn't necessarily need additional capital for the next several quarters, given the natural almost capital raise every time we do a securitization, getting additional capital back.

Okay, thank you.

We have reached the end of the question and answer session. I will now turn the call back over to management for closing remarks.

Listen, this is Robert. I want to thank everyone for your time and interest in Angel Oak Mortgage REIT. You can tell we're very excited about the opportunity we have in front of us. We look forward to connecting with you next quarter. In the meantime, if you have any questions, feel free to reach out to our team and have a great evening. Thank you.

This does conclude today's conference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.