Angel Oak Mortgage REIT (AOMR) has been painting a rosy picture of growth and resilience in its recent earnings calls, emphasizing expanding net interest income and a fortified balance sheet. Superficially, the narrative appears convincing. Following a strategic deleveraging phase in 2022, AOMR has embarked on an aggressive acquisition spree of high-coupon non-QM loans, capitalizing on favorable securitization markets to curtail financing costs and bolster earnings. The company even boasts a recourse debt-to-equity ratio of just 0.5 times post-securitization, projecting an image of prudent financial management.

But is this the complete picture? A meticulous examination of AOMR's securitization strategy unveils a potentially deceptive portrayal of the REIT's actual leverage position. While recourse leverage, which factors in only debt with direct claims on the company's assets, remains low, its reliance on non-recourse securitizations might be obscuring a more aggressive risk profile than initially apparent.

The Securitization Shell Game

The crux of the matter lies in AOMR's securitization strategy, which involves pooling loans into trusts and subsequently issuing mortgage-backed securities (MBS) against these loans. Although these securitizations are technically non-recourse, implying AOMR is not directly liable for the debt, the company frequently retains a substantial portion of the issued MBS, notably the lower-rated, riskier tranches.

This retention strategy, while promising higher returns, exposes AOMR to considerable indirect leverage. Take AOMT 2024-4, the company's recent $300 million securitization, as an example. While this transaction aided AOMR in reducing its recourse debt and achieving a headline-grabbing leverage ratio, the company likely holds a significant portion of the issued MBS. These retained bonds, though not categorized as recourse debt, still constitute a substantial financial obligation linked to the performance of the underlying loans.

Essentially, AOMR is utilizing non-recourse securitizations as a mechanism to leverage its balance sheet without explicitly inflating its reported leverage metrics. This tactic, while not inherently detrimental, raises concerns regarding the transparency of AOMR's financial reporting and its true risk appetite.

Amplifying the Risk

Adding to the apprehensions, AOMR has signaled intentions to tap capital markets for supplementary funding, potentially through debt issuances. While management asserts any capital raising will be accretive, the convergence of increased debt with the already considerable indirect leverage from retained MBS could exacerbate AOMR's susceptibility to interest rate volatility and credit deterioration.

Quantifying the Potential Impact

To illustrate the potential ramifications, let's explore some hypothetical scenarios. Presuming AOMR retained 20% of the MBS issued in AOMT 2024-4, this translates to a $60 million exposure linked to the deal's underlying loans. If the company were to procure an additional $100 million in debt, its total leverage, encompassing both recourse and non-recourse obligations, could surpass 2.5 times its equity. This leverage level, while still manageable, could expose AOMR to significant losses if interest rates were to surge unexpectedly or if delinquencies within its non-QM loan portfolio were to escalate.

The Analyst Blind Spot

The preoccupation with recourse leverage seems to be a blind spot in most analyst coverage of AOMR. Current reports predominantly underscore the company's low recourse debt-to-equity ratio, neglecting the potential risk embedded in its securitization-driven leverage.

Digging Deeper

Further investigation is imperative to fully evaluate AOMR's true leverage and risk profile. Crucial questions for investors and analysts to ponder include:

What percentage of MBS issued in recent securitizations has AOMR retained?

What is the credit quality and duration of these retained bonds?

How would an interest rate hike or a surge in loan delinquencies affect the value of AOMR's retained MBS portfolio?

Net Interest Income Growth

AOMR's net interest income has shown consistent growth for the past three quarters. Let's visualize this growth using data from their earnings transcripts:

The Bottom Line

While AOMR's growth narrative is alluring, investors should look beyond superficial leverage metrics and critically examine the company's securitization strategy. The reliance on non-recourse securitizations, compounded by the retention of riskier MBS tranches, could be masking a greater level of risk than initially perceived. Further analysis is essential to ascertain whether AOMR's seemingly low leverage accurately reflects its financial standing or is a cleverly orchestrated financial illusion.

"Fun Fact: Angel Oak's non-QM loans often target self-employed borrowers and individuals with non-traditional income streams. This niche focus, while potentially lucrative, inherently carries a higher credit risk than conventional prime mortgages."