Rising Competition and Market Risks May Weigh on Non-QM Loans but Opportunities Remain

Catalysts

About Angel Oak Mortgage REIT

Angel Oak Mortgage REIT is a real estate investment trust focused on originating, purchasing, and securitizing residential mortgage loans, primarily within the non-QM and HELOC segments.

What are the underlying business or industry changes driving this perspective?

• Although Angel Oak continues to demonstrate disciplined loan origination and active capital recycling, the overall pace of loan purchases remains at risk if competition for high-quality non-QM and HELOC loans increases further. This could put pressure on revenue growth.
• While securitization market conditions are currently favorable and spreads are tightening, sustained improvement in valuation could moderate as credit cycles progress. This may potentially constrain gains in net margins and earnings.
• Despite ongoing cost rationalization and reductions in operating expenses, continued investment in technology and compliance could eventually slow the pace of efficiency improvements. This may impact future net margins.
• Although recent capital releases from retired legacy deals have driven asset reinvestment and portfolio expansion, the ability to consistently identify high-yield accretive opportunities could diminish as market saturation and regulatory burdens rise. This may affect income growth over the longer term.
• While the company benefits from robust relationships with loan originators and an established platform, increasing competition and shifting borrower profiles in the residential lending space raise the risk of tighter spreads and lower risk-adjusted returns. This leads to uncertainty around future earnings stability.

Assumptions

This narrative explores a more pessimistic perspective on Angel Oak Mortgage REIT compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts. How have these above catalysts been quantified?

• The bearish analysts are assuming Angel Oak Mortgage REIT's revenue will grow by 16.6% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 50.4% today to 65.6% in 3 years time.
• The bearish analysts expect earnings to reach $36.0 million (and earnings per share of $1.39) by about December 2028, up from $17.5 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 10.5x on those 2028 earnings, down from 12.5x today. This future PE is lower than the current PE for the US Mortgage REITs industry at 12.8x.
• The bearish analysts expect the number of shares outstanding to grow by 6.02% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 9.2%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• The intense and rising competition in the non-QM and HELOC loan markets may lead to lower available yield opportunities, resulting in compressed revenue and diminished net margins for Angel Oak Mortgage REIT in the future.
• If the positive trend in securitization market spreads reverses or funding costs increase, the company could face reduced profitability, directly impacting future earnings growth.
• Sustained low prepayment speeds in the loan portfolio may hinder the ability to recycle and redeploy capital into higher-yielding assets. This would slow growth in both revenue and earnings over the long term.
• Any disruption in the credit performance of the loan portfolio, such as a deterioration in borrower credit or higher delinquencies, could drive higher credit losses and impair both income and net margins as the credit cycle advances.
• Overreliance on the ability to programmatically access securitization markets or consistently source high-quality loans may expose the company to market or liquidity risks. This could result in unpredictable fluctuations in earnings and threaten long-term revenue stability.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bearish price target for Angel Oak Mortgage REIT is $9.75, which represents up to two standard deviations below the consensus price target of $11.55. This valuation is based on what can be assumed as the expectations of Angel Oak Mortgage REIT's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $13.5, and the most bearish reporting a price target of just $9.75.
  
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2028, revenues will be $55.0 million, earnings will come to $36.0 million, and it would be trading on a PE ratio of 10.5x, assuming you use a discount rate of 9.2%.
  
• Given the current share price of $8.75, the analyst price target of $9.75 is 10.3% higher.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.