August 01, 2011 - 3:53pm EST by
2011 2012
Price: 18.02 EPS $0.00 $0.00
Shares Out. (in M): 10 P/E 0.0x 0.0x
Market Cap (in $M): 180 P/FCF 0.0x 0.0x
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 180 TEV/EBIT 0.0x 0.0x

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Before outlining the fairly simple case for AMTG as a buy I need to talk about the backdrop in the mortgage REIT sector in general.   At the highest level, I firmly believe that the mortgage REIT sector provides several very compelling opportunities at present given a steep yield curve, accommodating monetary policy, cheap non-agency assets available to the hybrid players like TWO, MFA and IVR and valuations generally at or just below book with mid- to high-teens dividend yields .  The yields are achieved with modest (based on historical levels) leverage of 7x debt/equity on average for the agency players like NLY,  AGNC, ANH, CYS and HTS which use more leverage than their hybrid peers who can’t typically lever the legacy non-agency paper.   The sector is in tumult right now (check out the Friday morning flash crashes in most of the names) due to concerns about the debt ceiling and potential downgrade affecting both the pricing of the underlying RMBS assets as well as the availability of cheap repo financing.  Underlying RMBS pricing has held relatively firm for agency paper and has stabilized in the non-agency sector following a selloff in June precipitated by the Fed’s botched attempt at selling the Maiden Lane II portfolio of old AIG RMBS bonds.

As far as the prospects for a big selloff following a potential downgrade of the U.S. credit rating, there are lots of ways to look at this but I will point out that as far as agency paper goes, RMBS should arguably strengthen relative to Treasuries given that there is hard collateral backing the obligations while Treasuries are only backed by the full faith and credit of Uncle Sam. Non-agency RMBS paper is already either junk or non-rated so a downgrade is irrelevant.   As far as repo financing, which is more relevant for the pure agency players, there are no indications that anything exciting is going on at repo desks.  All of the major agency REITs hold sufficient excess collateral to withstand increases in the haircut more than 2x what occurred following the failure of Lehman.  If rates went from 5% to 7% (much higher than they were following Lehman) then the maximum leverage available on good agency RMBS collateral would be 14x which is 5 turns higher than the highest levered agency m-REIT.  Basically the curve is steep enough and the paper offering a wide enough spread to the swap curve (unlevered asset return) that these guys don’t need to run with the higher levels of leverage that used to be needed to generate a outsized return.

AMTG is really a special situation within the mortgage REIT universe and may be attractive even to those who are agnostic or undecided with respect to the bullish case for m-REITs as a group.  The company completed its IPO on the NYSE on July 22nd, selling 10 million shares at $20 each for $200 million of gross proceeds.  The green shoe has yet to be exercised and likely won’t be given the turmoil in the sector that has stranded several deals that were at various advance stages (mostly notably Orchid which couldn’t get a deal done despite a big cut in pricing).  Given the flood of deals in the space, Apollo, the manager of AMTG, covered the underwriting commissions to make pricing implicitly more attractive.  That left about $2 million of deal expenses  and other front-end costs to be absorbed by the IPO proceeds.  This equates to book value per share at $19.80. Incidentally, if the shoe is exercised it should take pro-forma book value per share up a few pennies to $19.83.  This deal almost didn’t get done, had a large retail component (retail is hugely influential in the mortgage REIT space given its appeal to income oriented investors) and has gotten pummeled in its first week of trading.  It closed at $18.02 on Friday, a 9% discount to book value.

AMTG will eventually deploy a hybrid strategy, investing in both agency and non-agency RMBS and is led by CEO Mike Commaroto, who has 25 years of experience in this market.  They stated that they are likely to build the agency book first and then eventually settle out at 60 to 70% non-agency on an unlevered / portfolio level basis.  Given that the IPO just closed AMTG is likely still in cash, though they could have been buying agency RMBS on a forward settlement basis.  Regardless of the mix of cash, agency RMBS or perhaps some opportunistically purchased non-agency paper, clearly this is a clean portfolio with good price discovery that shouldn’t be trading at such a big discount.  AMTG estimates that by the end of the year, the portfolio will be fully deployed and earning 14 to 16% yields, which is about average for the hybrid players.  This is on the basis of book value and doesn’t incorporate the discount. 


So, there  is some total return drag from owning AMTG while it ramps up the portfolio versus say TWO or IVR which is already sporting a mid to high teens dividend yield.  However, there is also no real downside (other than another flash crash that produces a mark-to-market  loss) given that we are at a material discount to book already.   The fees are competitive, particularly given the small market cap, at 1.5% of stockholder equity with no incentive fee.   In addition, one of the nice things about the current turmoil in the mortgage REIT market is that it will be more difficult for smaller players to get secondary offerings done which, if history is any guide, will mean that we may see some of the better managed m-REITs trade at premiums to book value, pushing the dividend yields down to more reasonable levels. I am not banking on this and in fact would be happy to participate in AMTG deals as long as they are priced above book value (accretive) and the environment is still attractive (some combination of cheap assets and a steep curve).

Another way at looking at comparing the risk/reward of AMTG versus say TWO or IVR is that if IVR or TWO get to 1.05 or more of their book values, they will DEFINITELY come back to market with a deal priced 3 to 5% below the close so that they deploy more capital in what they see as a target rich environment (and generate more fees of course).  AMTG would have to rally 10% just to get to book  value and I can’t see Apollo trying to push a deal through to grow this thing at a discount to book.  They will have to be patient, generate good yields for a while and earn the right to become greedy pigs like TWO and IVR and become serial issuers. 

So to summarize, upside would be that this trades to book value (up 9%) and then the bullish m-REIT thesis briefly summarized herein persists, meaning mid to high teens returns net of fees.  Downside is limited for now given that they just closed on the IPO and started putting this capital to work.  Once the book clipping along as a mix of levered agency RMBS and unlevered non-agency RMBS, it will have the same downside risks as the other names: Fed aggressively raises rates, housing collapses again and non-agency prices tank, the next crisis is worse than 2008 and repo lines really are pulled from the agency RMBS book this time, pre-payment speeds pick up and hurt agency RMBS, etc, etc.


- sector calms down and AMTG trades back to book value

- two quarters from now AMTG starts payout out dividends (if current rate, asset prices and repo rates hold) of $3.00 annualized

- better analysts in the space (who are very influential given that there is a lot to keep track of) like JMP and Barclays pick up coverage

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