AG Mortgage Investment Trust Inc (MITT) Q4 2018 Earnings Conference Call Transcript
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AG Mortgage Investment Trust Inc (NYSE: MITT)
Q4 2018 Earnings Conference Call
Feb. 27, 2019, 9:30 a.m. ET
Contents:
Prepared Remarks
Questions and Answers
Call Participants
Prepared Remarks:
Operator
Good morning, and welcome to the AG Mortgage Investment Trust Fourth Quarter 2018 Earnings Call. My name is Brandon, and I'll be your operator for today. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions) Please note this conference is being recorded.
And I will now turn it over to Karen Werbel. You may begin.
Karen Werbel -- Investor Relations
Thanks, Brandon. Good morning, everyone. We appreciate you joining us for today's conference call to review AG Mortgage Investment Trust's fourth quarter 2018 results and recent developments.
Before we begin, I'd like to review our safe harbor statement. Today's conference call and corresponding slide presentation contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All such statements are intended to be subject to the safe harbor protection provided by the Reform Act. Statements regarding our business and investment strategy, market trends and risks, assumptions regarding interest rates and prepayments, changes in the yield curve and changes in government programs or regulations affecting our business are forward-looking statements by their nature.
The Company's actual results may differ materially from those projected due to the impact of these factors and others beyond its control. All forward-looking statements included in this conference call and the slide presentation are made as of today, February 27th, 2019, and we disclaim any obligation to update them. We will refer to certain non-GAAP measures on this call, and for reconciliations, please refer to the earnings press release and 8-K, which are posted on our website and have been filed with the SEC.
At this time, I would like to turn the call over to David Roberts.
David Roberts -- Chairman of the Board, Chief Executive Officer and President
Thank you, Karen, and good morning everyone. I'd like to share some highlights of our 2018 financial results with you today.
Our core earnings for the year were $2.08 per share, including a positive $0.03 per share retrospective adjustment. We increased our quarterly common dividend approximately 5% to $0.50 per share in the second quarter of the year. And for the entire year, we paid common dividends of $1.975.
In the fourth quarter, market conditions were volatile and Agency RMBS spreads widened as interest rates fell sharply, while credit spreads widened in sympathy with the broader markets. As a result, our book value declined 10.2% from the prior quarter. The fourth quarter decline in book value constituted most of the decline for the full year 2018 book value of 12.3%. Through January, however, there has been a modest recovery in the market for risk assets and the agency basis, and we estimate that book value increased approximately 2% through January 31st of 2019.
Our core earnings for the fourth quarter was $0.57 (ph) per share, including a de minimus retrospective adjustment. For the fourth quarter, we declared a dividend of $0.50 per share.
We'd also like to update you on Arc Home, our residential mortgage origination affiliate. We are pleased to announce that during the quarter, Arc Home appointed a new management team, which among other things will have an enhanced focus on credit originations. For contacts during 2018, Arc Home originated $1.3 billion of government agency loans through its four channels of origination and retained the originated mortgage servicing rights on its balance sheet.
In conjunction with AG Mortgage Investment Trust and other Angelo Gordon funds, Arc Home purchased approximately $7.4 billion notional of Fannie Mae, Freddie Mae and Ginnie Mae mortgage servicing rights from third parties. We believe that Arc Home's new management team will provide us with increased opportunities going forward to invest in excess mortgage servicing rights, non-qualified mortgages, and other assets in the credit space.
Lastly, I would like to provide a brief update on our common equity raise in February. We successfully raised net proceeds of $57.3 million, including full exercise of the underwriters' option to purchase additional shares. We did this through an overnight common equity offering. Our senior management team invested in this capital raise by buying shares. We have fully invested the proceeds of those offering into Agency RMBS, but we see a very strong pipeline of credit opportunities and we intend to rotate much of these proceeds into credit overtime.
Looking forward, our outlook for investment opportunities and return profiles is positive. Our diversification across Agency RMBS and credit allows us to identify the best risk adjusted returns and opportunistically deploy capital across both sectors. We continue to leverage the sourcing and diligence strength of our Angelo Gordon team and focus on areas that require greater specialized credit expertise to capitalize the most exciting credit opportunities we see.
With that, I will turn the call over to T.J. Durkin.
T.J. Durkin -- Chief Investment Officer
Thank you, David. Good morning, everyone. The extreme period of risk-off sentiment into year-end led the credit and equity markets to sell-off and the treasury market to rally. Interest rates declined by 40 basis points to 50 basis points across the yield curve during the fourth quarter. Volatility increased significantly due to a sentiment shift in associated market overreaction in response to Fed communication, a softening of select manufacturing data, the absence of optimism on trade negotiations with China and the government shutdown.
The Fed increased the federal funds rate by an additional 25 basis points in December, but lowered its 2019 growth and inflation forecasts and reduced its anticipated number of federal funds rate increases from 3 to 2 for 2019. Market pricing meanwhile has shifted to pricing the next Fed action as a cut to the federal funds rate by the end of 2020. After reaching the Fed's 2% inflation goal in mid-2018, year-over-year core inflation has moderated. Bigger picture global economic activity appears to have peaked in mid-2018 and the market is expecting growth to slow over the course of 2019.
During the fourth quarter, as David previously mentioned, our book value declined primarily driven by basis widening and the sharp decline in interest rates. The underperformance in AC CMBS was mostly pronounced in higher coupon MBS, which represent most of our 30 year fixed-rate holdings. As the vast majority of our holdings have some degree of call protection through either lower average loan balances or less prepayment sensitive geographic concentrations, we are comfortable with their yield profiles despite the recent unrealized mark-to-market declines.
Spread performance was mixed across other mortgage sectors during the fourth quarter, while legacy RMBS spreads widened modestly, they outperformed other securitized asset classes due to strong technical demand and favorable underlying fundamentals. The credit risk transfer market widened in sympathy with softness in other markets, particularly at the bottom of the capital structure. However, despite this widening, there was little foreselling from investors, while dealers reduced their overall CRT exposure and then orderly fashioned into year-end.
The CMBS market also saw little foreselling notwithstanding all the volatility. In addition, new supply in 2019 within the CMBS market is likely to be fairly limited, especially for traditional multi-borrower conduit deals, which should be a positive technical for the CMBS market.
Now focusing on Slide 7 of our quarterly earnings presentation, we outline our fourth quarter activity. During the quarter, we purchased a pool of primarily RPL mortgages and several non-QM pools alongside other Angelo Gordon funds. We also sold and received payoffs of short duration RPL and NPL securities, and sold all of our agency Hybrid ARM positions.
On Slide 10 we've laid out our investment portfolio composition for the quarter. The net carrying value of the aggregate portfolio was approximately $3.6 billion for the quarter, comprised approximately 57% agency, 39% credit, and 4% single-family rental.
Focusing on our agency portfolio on Slide 11, you will see a breakout of our current exposure by product type. The constant prepayment rate for our agency book was 4.4% for the fourth quarter. Our disciplined agency MBS asset selection process allows us to position the portfolio for a variety of prepayment environments and we expect prepayment speeds for our portfolio to generally outperform the overall university of agency collateral.
We also show the portion of our agency fixed rate pools backed by loans with lower loan balance or concentrated prepayment geographic locations is 81% at the end of the quarter, up from 66.8% at the end of the third quarter. Early in the fourth quarter, as we adjusted positioning on the margin for a modestly higher rate environment by adding higher yielding, higher coupon MBS, we also increased the overall prepayment protection on the portfolio to guard against potential periods of lower interest rates that would increase the overall levels of prepayment activity.
On Slide 12, we highlight the price underperformance by coupon, again with the most dramatic widening occurring in higher coupons as we mentioned earlier.
On Slides 13 and 14, we'd like to highlight that 45% of our residential credit investments, excluding non-performing and reperforming home loans and 75% of our commercial and ABS investments are floating rate in nature and have benefited from the recent increases in Fed funds rate.
Now turning to Slide 15, we provide portfolio statistics on single-family rental portfolio. The portfolio's operating margin is approximately 43% today. During the quarter, the portfolio increased -- the portfolio experienced a temporary increase in vacancies due to seasonality and a strategic initiative by our property manager, Conrex, focused on operational improvements to leasing and the tenant experience. Conrex is seeking to replace sub-performing and shorter-term tenants as their leases expire. with better quality tenants through the implementation of enhanced credit screening for borrower -- for renters and stricter underwriting standards for prospective tenants.
The increased turnover and related expenses were the primary drivers of the decrease in the SFR portfolio's operating margin in the fourth quarter. However, it is important to know a portion of the turnover expenses are reimbursable from an escrow account established pursuant to the purchase and sale agreement with the seller.
With regards to vacancies, we have already seen an improvement since quarter-end with occupancy up to approximately 92%. We expect both occupancy and margins on the portfolio should improve longer-term with reduced tenant turnover and lower ongoing expenses.
Moving ahead to Slide 18 of the quarterly earnings presentation, we lay out the duration gap of the portfolio. As rates rapidly fell during the quarter, our overall duration gap decreased from 1.12 years at the end of the third quarter to 0.74 years at the end of the fourth quarter. Given what we see as somewhat of a market overreaction in the rates market to a natural slowing of growth from 2018 to 2019, we are comfortable with our shorter duration gap for now.
In addition, because of the inversion at the front -- very front-end of the yield curve, we are currently in the unusual situation where our pay-fixed swap hedges with maturities, all the way up to the 7-year point on the curve carry positively today. This decreases the interest rate expense associated with running a smaller gap.
Now as we look forward into 2019, we are confident that MITT is well positioned to deliver attractive risk-adjusted returns to our investors. Given the purposeful construction of our portfolio, we have ample flexibility to take advantage of opportunities that may arise out of any increased spread volatility. We continue to explore ways to deploy capital in all our targeted credit asset classes and we see a large pipeline of opportunities at favorable risk adjusted returns sourced through the hands of Gordon platform, including newly originated and seasoned residential home loans, MSRs, CMBS and CRE debt.
Additionally, our Agency MBS assets provide MITT with a high-quality liquid core holding space, which we can increase and decrease depending on the relative value we see within the different market conditions.
With that, I will turn the call over to Brian to review our financial results.
David Roberts -- Chairman of the Board, Chief Executive Officer and President
Hi, just before Brian speak, it's David Roberts again. Apparently, in a slip of the tongue, I misspoke about our core earnings for the quarter, it was $0.47 -- that's $0.47 per share. All right.
Brian Sigman -- Chief Financial Officer and Treasurer
Thanks, David, and T.J. For the full year of 2018, we reported net loss available to common stockholders of $11.9 million or $0.42 per fully diluted share. Overall for the fourth quarter, we reported net loss available to common stockholders of $41.6 million or $1.45 per fully diluted share.
For the full year 2018, we reported core earnings of $59.2 million or $2.08 per fully diluted share. Core earnings in the fourth quarter was $13.6 million or $0.47 per share versus $15.7 million or $0.56 per share in the prior quarter. There was a de minimus retrospective adjustment in the fourth quarter due to the premium amortization on our agency portfolio versus a $0.01 retro adjustment in the prior quarter.
During the quarter, we did modify our definition of core earnings to exclude mark-to-market changes on ARC Home's mortgage servicing rights portfolio and their corresponding derivatives. This is consistent with how we treat Excess MSRs held directly by MITT, as well as our other assets on our balance sheet.
During the fourth quarter, our operating expenses increased $4.8 million from $3.5 million in the prior quarter. This increase was primarily driven by transaction related expenses that were incurred in connection with the acquisition of credit assets during the quarter and have been excluded from core earnings as defined. In the 10-K, we will be filing -- we have broken out our business into securities and loan segment, and an SFR segment, with other items classified as general corporate.
Transaction related expenses and other ongoing deal expenses are classified within either the securities and loan segments or SFR segment, while ordinary course G&A expenses are shown as part of corporate. We believe this breakout provide greater transparency with respect to the expenses we incur and the part of the business they relate to, especially given all the credit transactions that we have been entering into recently.
At December 31st, our book value was $17.21, a decrease of $1.95 or 10.2% from last quarter due to the reasons David previously mentioned. During the quarter, we introduced an undepreciated book value metric, which as accumulated depreciation and amortization back to book value to incorporate our SFR property portfolio at its undepreciated basis. At December 31st, our undepreciated book value was $17.30 as compared to $19.18 from last quarter.
As described on Page 6 of our presentation, the portfolio at December 31st, had a net interest margin of 2.3%. This was comprised of an asset yield of 5.3%, offset by total cost of funds of 3%. The net interest margin decline from prior quarter was primarily due to the increase in cost of funds related to a 25 basis point increase in the Fed funds rate in December.
As of December 31st, we had 44 financing counterparties and financing investments with 31 of them. During the quarter, we obtained two-year term financing on the pool of primarily RPL mortgage loans that we purchased. At year-end, the funding markets were tight as a result of a large treasury bill issuance which drove repo rates materially higher. The overnight repo increased over 6% at December 31st from 2.5% the day before. However, we had locked in our funding cost prior to year end, so our repo book did not experience material pressure. After year-end, rates normalized, but the market volatility does highlight some of the balance sheet pressures that have been brought on by increased regulation over the past several years as it relate to quarter end.
Lastly, at quarter end, our estimated undistributed taxable income was a $1.58 per share. We continue to evaluate this on a quarterly basis to make sure that we're compliant with our distribution requirements.
That concludes our prepared remarks and we would now like to open the call for questions. Operator?
Questions and Answers:
Operator
Thank you. We will now begin the question-and-answer session. (Operator Instructions). And from Credit Suisse, we have Doug Harter. Please go ahead.
Douglas Harter -- Credit Suisse -- Analyst
Thanks. Can you talk about, one, the timing of the expected rotation into additional credit assets with the new capital? And two, kind of how the returns on -- returns compare on credit assets today versus agency?
T.J. Durkin -- Chief Investment Officer
Sure. Doug, it's T.J. We started already repositioning into our call with the liquid credit securities. So mostly on the RMBS and CMBS side. And then some of the other asset classes that where, you know building positions in, whether it be non-QM or season RPLs or NPLs, those obviously have longer settlement times. So even if we were to agree to do a trade today, it's really not in the portfolio for probably 45 days at a minimum. So you'll see that higher agency allocation until some of these potential transaction settle.
In terms of credit assets, I think, simply if you were to look at some of the credit risk transfer liquid securities running 3 to 4 turns of leverage, we can see LIBOR plus a 1,000 up to 1,300 depending on the security and financing we take versus we see -- within Agency ROEs, assuming about 8 turns of leverage returns in the 12% -- to 12% to 13% range. So that's kind of the difference between the two products.
And then within -- where we see reperforming loans trading at probably a wider band, just given the wider distribution of outcomes are probably on the low end, 10% to 11% on the high end, maybe 15% ROEs.
Douglas Harter -- Credit Suisse -- Analyst
Great, thanks for that color, T.J. And then just any updated thoughts on kind of the undistributed taxable income, whether -- I guess, plan to sort of keep it undistributed or thoughts about doing, kind of, an additional special dividend like you had done in the past.
Brian Sigman -- Chief Financial Officer and Treasurer
It's Brian. Thanks, Doug. Our plan really is kind of the same as it's always been. We've been trying to kind of keep that undistributed to the extent that we have a special required, we would do that. We had a technical a couple years ago on underlying investment that created a larger amount of taxable. So that was really more tied to that transaction. Away from that, to the extent that we're earning our tax is -- our tax income is close to our expected core or common dividend of $0.50, we wouldn't expect to do a special.
Douglas Harter -- Credit Suisse -- Analyst
Thanks, Brian.
Operator
And from JMP Securities, we have Trevor Cranston. Please go ahead.
Trevor Cranston -- JMP Securities -- Analyst
Hi, thanks. One more question on the deployment of capital from the raise. Can you give a little bit more detail on how you deployed into agencies, the coupon distribution looks pretty similar to what you already owned and whether or not it was into specified pools versus TBAs? Thanks.
David Roberts -- Chairman of the Board, Chief Executive Officer and President
Yeah, so the majority of it was deployed into specified pools and it is going to look similar to our current portfolio in terms of the coupon distribution.
Trevor Cranston -- JMP Securities -- Analyst
Okay, great. Thank you for that. And then a question on Arc Home. With the new management team in place, can you expand a little bit more on the type of credit products you guys are interested in originating there? And also as you expand in that direction, do you expect the agency origination volume to sort of fall off or sort of stay at the level it was at for 2018?
T.J. Durkin -- Chief Investment Officer
Yeah, I think -- I'll answer your second question first. I think we look at -- agency is still majority of the origination. So to the extent, our customers are producing agency mortgage if they want to be a purchaser on them. With that being said, we think as obviously the mortgage origination market is quite tough now, adding differential products like non-QM which is probably where we're starting with, similar to what we're buying from other originators as somewhat of a hope to get more clients working with Arc Home will be the first iteration of that, but that's not to say overtime, we can add other products like second liens, jumbo, et cetera, on the residential side, depending where pricing et cetera is.
Trevor Cranston -- JMP Securities -- Analyst
Okay. Got you. And then, lastly, you commented on the spread recovery in January. Can you say if you've seen any additional spread tightening in February or would you say that markets have been relatively stable versus where they were at the end of January? Thanks.
David Roberts -- Chairman of the Board, Chief Executive Officer and President
In any particular asset class or?
Trevor Cranston -- JMP Securities -- Analyst
Yeah, I mean, broadly speaking, but I guess primarily I'm speaking about the agency book...
David Roberts -- Chairman of the Board, Chief Executive Officer and President
I think we're positioned within agencies has been roughly flat in Feb (ph).
Trevor Cranston -- JMP Securities -- Analyst
Okay. Thank you.
Operator
(Operator Instructions). Okay, it looks like no further questions at the moment.
Karen Werbel -- Investor Relations
All right. Great, thank you. We look forward to speaking with everyone next quarter.
Operator
Thank you. Ladies and gentlemen, this concludes today's conference. Thank you for joining. You may now disconnect.
Duration: 25 minutes
Call participants:
Karen Werbel -- Investor Relations
David Roberts -- Chairman of the Board, Chief Executive Officer and President
T.J. Durkin -- Chief Investment Officer
Brian Sigman -- Chief Financial Officer and Treasurer
Douglas Harter -- Credit Suisse -- Analyst
Trevor Cranston -- JMP Securities -- Analyst
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