AOMR - Angel Oak Mortgage: Don't Lose Faith Better Times Will Come

Summary

• Strong headwinds and the Hawkish Fed have not spared the real estate industry either.
• Angel Oak Mortgage could thrive after Fed starts cutting rates.
• About the headwinds that have affected Angel Oak Mortgage's stock price and balance sheet so far.
• Where Angel Oak Mortgage shares are headed.

Strong Headwinds and Hawkish US Federal Reserve Weigh on the Real Estate Industry

Strong headwinds from Europe's energy crisis and economic restrictions imposed by Western countries to punish Russia's aggression against Ukraine pushed inflation to record highs and forced the US Federal Reserve to take an aggressive stance on raising interest rates.

Higher borrowing costs sent recession signals first to consumers and businesses, whose concerns are affecting the performance of US-listed equities through lower demand for goods, services and inputs.

The real estate industry has been hit hard by recession fears, as illustrated in the chart below, which compares a nearly 23% decline in the benchmark First Trust S&P REIT Index Fund ( FRI ) index with a 16.4% decline in the SPDR S&P 500 Trust ETF ( SPY ).

Real estate companies are suffering from lower demand for home loans due to higher interest rates and because inflation and a gloomy outlook could dramatically affect households' plans for new homes if incomes are not adjusted accordingly.

However, it is also true that there are quality stocks in the real estate sector that could be traded at significantly more attractive market prices within a few weeks if the headwind persists, which generally justifies a hold rating for these stocks at the moment.

Angel Oak Mortgage, Inc. May Surprise Following Fed’s Policy Change

Then, investors should open or add to real estate stocks in anticipation of the turnaround in Fed monetary policy. If the Fed steps in the first half of 2023, when the US economy is expected to be in recession, a possible recovery may follow in 2024, which will also benefit the real estate market.

Stocks that seem well positioned to benefit from the scenario just outlined include those in the mortgage REIT subsectors, and among these, Angel Oak Mortgage, Inc. ( AOMR ) may surprise.

Angel Oak Mortgage’s Stock Price Amid Current Headwinds

The stock is caught between certain financial tensions, but at the same time poised to skyrocket once economic system players step in to ease certain capital market conditions that are preventing the company from smoothly running its non-qualified mortgage lending business.

Due to the above financial stresses that come with the financial markets operating under strained conditions, Angel Oak Mortgage, Inc. stock price has faced downward pressure.

The strong near-term headwinds impacted the stock price, which plunged over the past year to levels well below the long-term trend of the 200-day moving average of $12.90.

About the Headwinds and their Impact on Angel Oak Mortgage

As the future became very uncertain after the Fed signaled recession to all market participants, investors developed an aversion to riskier assets in the financial markets. Fearing for the value of their assets, investors flocked to investment vehicles that offer protection, such as safe-haven assets.

In addition to traditional safe-haven assets such as gold and US currencies, investors have favored securities representing government bonds over corporate bonds. The development of this situation has provided a strong basis for a significant widening in the credit spread between the yields of the two classes of bonds with the same maturity.

Securities representing non-qualified mortgage loans were not immune to the headwind either, as the underlying home loans to applicants with irregular incomes or previous insolvency problems were also seen as too risky by bond investors.

These assets form the core of Angel Oak Mortgage's business as the Atlanta, Georgia-based mortgage REIT acquires and invests in these types of home loans.

Angel Oak Mortgage went public in June 2021. Meanwhile, conditions in the fixed-income and securitization markets have become very difficult due to tight liquidity and asset mispricing, leading to a decline in securitized non-qualified mortgage loans.

These were valued at $184.7 million in the third quarter of 2022, a significant decrease from $316.6 million in the third quarter of 2021.

The securitization market currently has limited access to funding, Bank of America analyst Derek Hewett said in a Dec. 5 note, downgrading the US mortgage REIT from a buy to an underperform rating. Such a situation does not allow for the liquidity that Angel Oak Mortgage and other operators would otherwise need and recycle by funding additional non-qualified mortgage loan purchases.

The company acquired $62.4 million of non-qualified residential mortgage loans in the third quarter of 2022 compared to $543 million in the third quarter of 2021.

So, Angel Oak Mortgage moved fewer non-qualified mortgage loans into the securitized portfolio, reducing its ability to acquire additional loans and leaving more liability on the balance sheet.

Higher liability coupled with an $83.3 million in Q3 2022 GAAP net loss (or -$3.40 per diluted common share), primarily due to net unrealized losses on mortgage loans (a lower fair value of home loans was due to higher interest rates in the market) led to a decrease in book value, dragging down the stock price.

The book value was $10.63 as of the end of Q3 2022 versus $19.72 as of the end of Q3 2021.

The Strategy to Restore Value to Shareholders

The third quarter was not a positive one for the company and managers sought cover. The board decided to cut its quarterly dividend to $0.32 per common share as a step to strengthen its balance sheet and make it more resilient to the next market headwind. The dividend leads to a TTM Yield of 34.86% as of this writing. The dividend cut was also decided to bring the dividend yield back in line with book value.

Where Angel Oak Mortgage Shares Are Headed

Shares of Angel Oak Mortgage were trading at $5.17 apiece for a market cap of $119.39 million and a 52-week range of $4.47 to $17.93 as of this writing.

In the near term, the headwinds will likely continue to weigh on Angel Oak Mortgage’s shares.

The 14-day Angel Oak Mortgage RSI of 21.04 could be pointing to a possible recovery as shares have touched near oversold levels.

However, recovery has no real chance now as the market conditions affected by the macroeconomic conditions will be such that the company could continue to face the same problems as in the third quarter compared to the corresponding year 2021.

Additionally, a 24-month beta of 1.19 means Angel Oak Mortgage is unlikely to be in an uptrend when the market reports the economic downturn.

For now, a Hold rating on this stock should be appropriate, but the company stands to benefit from significantly more favorable market conditions in the short term.

The catalysts will be the following:

• A strong rebound in the demand for mortgage loans following the Fed's return to accommodative interest rate policy to support the post-recession cycle.
• In particular, the recovery in demand for non-qualified mortgage loans should benefit from a likely increase in applicants with precarious jobs or unstable incomes due to the economic downturn.
• In addition, government fiscal policies are expected to foster a favorable environment for businesses, leading to a renewed investor interest in corporate bonds other than government bonds. As headwinds from widening credit spreads ease, market conditions for bonds and securitizations should improve in favor of Angel Oak Mortgage.

Conclusion

Strong near-term headwinds due to economic uncertainty and the aggressive stance of the Fed have impacted non-qualified mortgage securitization markets, causing Angel Oak Mortgage shares to fall significantly.

Under the influence of the same factors, Angel Oak Mortgage could fall further, hence a Hold rating is appropriate for now.

Then, a turning point in Fed policy should encourage the return of favorable conditions for a recovery in Angel Oak Mortgage shares.

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