Participants

Sreeniwas Prabhu; President, Chief Executive Officer; Angel Oak Mortgage REIT Inc

Brandon Filson; Chief Financial Officer, Treasurer; Angel Oak Mortgage REIT Inc

Don Fandett; Analyst; Wells Fargo

Eric Hagen; Analyst; BTIG

Matthew Howlett; Analyst; B. Riley

Chris Kotowski; Analyst; Oppenheimer & Co.

Presentation

Operator

Good day and welcome to the Angel Oak Mortgage REIT third quarter, 2024 earnings conference call. (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.

Good morning. Thank you for joining us today for Angel Oak Mortgage REITs third 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 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 REITs 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.

Sreeniwas 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 easy 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 note sessions having fully deployed that capital into newly originated accretive high quality non-QM loans.
These loan purchases combined with a securization 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 competed a securization 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 our 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 speculative 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 [Destin Isu] in October, we both drive expanded margins going forward.
Our achievements stem from our proprietary affiliate 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 run 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 actively. 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 a creative 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 decreased 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. Distributor earnings results were a loss of $3.4 million or $014 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 20,-- 2023. This expansion was driven primarily by a rapid deployment of capital to newly originated loan purchases.
Interest expense was $18.4 million in the third quarter compared to $16.4 million in the third quarter. Approximately half this increase was driven by the interest expense from our July debt issuance with the other half coming from a 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, 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 points of 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 home loan portfolio carried a weighted average coupon of 7.73% as of the end of the third quarter, a nearly 200 basis points 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 30, 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 0.7 times 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 US 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 and 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.
A residential hold on 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 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 reduce our whole loan warehouse debt by $260 million and release nearly $40 million of capital that is currently being recycled back into newly originated accretive high quality loan purchases and we 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 internal equity while maintaining sufficient liquidity and managing risk.
Turning to credit delinquencies remain muted with the total weight 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 have observed this quarter compared to the second quarter are indicative of a return to historically normal levels as opposed to a harbinger or a large scale credit deterioration.
Further, we believe that if credit becomes an issue, a robust underwriting standards and portfolio wide low LTVs will mitigate losses throughout the cycle. Three months, prepay speeds for our securitization loans and trust 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 will also have an opportunity to use capital to relever and resecuritize seasoned 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 market 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.

Sreeniwas Prabhu

Thank you, Brandon. To summarize your commentary, the AOMR model is working a disciplined and holistic approach. Our investor focused management philosophy and our affiliate origination purchase and securization 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

(Operator Instructions) Don Fandett, Wells Fargo.

Don Fandett

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

Brandon Filson

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

Don Fandett

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

Brandon Filson

Yeah, it's just about half of that increase has been given back as of today.

Don Fandett

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

Brandon Filson

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 very early next as well. You will -- you should see that in that interest margin wide now more similar to what we saw in Q2.

Don Fandett

Great. Thank you.

Operator

[Matthew Ner], Jones trading.

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

Yeah, 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.

Got you. Yeah, that's helpful. You know, and then how is the execution been there? And how is that on the October 1? And then can you guys also speak about what you guys retained from the securitizations like.

Brandon Filson

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

Sreeniwas Prabhu

Seeni here. From the execution side, I mean, the execution continues to be strong in a non-QM securitization market. So, we've done as an Angel Oak entity. Close to 12 securitizations this year including for ar, so we see continued appetite for spreads are anywhere from the last couple of weeks, spreads widen out a little, but it's somewhere in the mid-120 s to mid-130 s and they have been consistent there. And I just think that any stability will continue to tighten spreads here.

Yeah, that's very helpful there. And then one last one for me, how are you expecting asset yields going forward? 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 allrate ball 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 the 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 locks 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. You lower funding costs on the securitization and then our warehouse financing will also come in as well as it's tied. The floating component there is tied to sulfur which comes down obviously with kind of rate cut.
So we still expect on a levered, secure space like a 15% to 20%. ROE.

Awesome. That's great. Thank you, guys, for taking the questions. Congrats on the Quarter.

Sreeniwas Prabhu

Thank you.

Operator

Eric Hagen, BTIG.

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. It's something we're always, we're 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, you $11 $12 a share. I think we're dealing with, -- we've got some stock overhang as our largest investors move some shares away around $10.
I think the volatility around the election has decreased or also created some overhang in the broader market which we got hit a little extra hard on. But I would, 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 if it becomes apparent that if we're trading still at a 14% dividend throughout the core, then we would, we might consider doing something. But again, nothing is 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 say hi, like how do you feel like the loan mod activity would potentially change?

Sreeniwas Prabhu

Yeah, there's not a lot, I mean, to be honestly with 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 are seeing in the originations in 2023, and ours are lower than the market, but we're looking to 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.

Sreeniwas Prabhu

Yeah, thank you.

Operator

Matthew Howlett, B Riley.

Matthew Howlett

Brandon, do you see the loss adjusted leverage deals on on 24-10 was 15% to 20%.

Brandon Filson

That's right.

Matthew Howlett

So, I mean, I guess just a big picture question when I look at those type of returns today, and let's assume that things that stays consistent. I mean, with your expense ratio, I mean, you could be doing and are we in the very low teams which gets me to something in earnings power? 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, 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, [normad] 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% coupon deals. We 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 resecuritize. 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 delevered 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, the -- 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 and yeah, you know, if we start to keep expanding that and it's just income operating expenses stay low there is, 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 types of returns. I'd love that. It sounds like that they're the highest, they've been securization economics are the highest they've been in quite some time. Are you running, I mean, the cycle shaken on a lot of competitors, and you guys are a leader and sort of the last guy standing.
I mean, are you running into anybody with these types of returns? Are you going to see new people try to come in? Could that pressure term sheet or coupons? Just want to hear your thoughts and where the securitization economics stand today versus where you've seen the last 34 years. I'm assuming they haven't been this good since you went public?

Sreeniwas Prabhu

Yeah, Matt, this is Sreeni. 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.
And if you build a business which is an Angel Oak Mortgage solution, 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 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 yeah, 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, that was my last part. I was going to commend you on the credit. It seems like your credit portfolio is just like it is sort of holding steady whereas we've seen other shelves, non-QM sort of increase. I mean, any change in your write at this point in time you're just sticking with, you know what you know, you're noting here.

Brandon Filson

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 end committee. And what we're really doing is re-underwriting again, all sorts of loans that we have 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 are 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.
We will send it out to all of you guys as we get a little bit more deep into it. But now our goal is to continue to manage credit, 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 initial next year. Thank you.

Operator

Chris Kotowski, Oppenheimer.

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 [750,800,000 of] incremental net interest income on a quarterly basis. Is that the way to look at it.

Brandon Filson

That will some of that savings on a cost basis leverage is going to be taken up by the additional leverage that it took in -- took into place. So 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, it freed up $40 million in cash, which we'll use to feed one full new securitization. And we've already deployed that cash into home loans that 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 it 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 because the additional leverage and the securitization, 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. Alrighty. 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.

Sreeniwas 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.