The SPAC boom may have cooled off, and the IPO market, in general, seems to be far less active than it was just a few months ago. But that doesn't mean there aren't new investment opportunities coming to the market.
One interesting mortgage REIT (real estate investment trust) recently filed IPO paperwork. Angel Oak Mortgage is seeking to raise $150 million in an initial offering in the near future. Here's a rundown of the business and the important points investors should know about it.
What does Angel Oak Mortgage do?
Angel Oak Mortgage is a REIT managed by alternative credit management firm Angel Oak, whose primary focus is investing in mortgages and mortgage-related assets. Specifically, Angel Oak invests in first lien "non-QM" loans. This is a mortgage industry term for loans that don't meet certain requirements, including the "ability to repay," or ATR, rules of the Consumer Finance Protection Bureau.
This is a broad category of mortgage loans and includes investment property loans and other "alternative" loan programs. For example, Angel Oak owns mortgages called the "1099 Income Loan" for self-employed borrowers whose tax returns don't reflect their true income. The company also has an "Investor Cash Flow" loan that allows investors to finance properties based on the property's cash flow, not their personal income.
The biggest portion of the portfolio (64%) is mortgages made to borrowers who verified their income using bank statements, as opposed to traditional methods such as tax returns or W-2s.
At the end of the first quarter of 2021, Angel Oak had about $535 million in assets, which included $481 million in non-QM mortgage loans and other similar assets.
One interesting feature of the business is that Angel Oak doesn't really shop for loans to invest in -- the bulk of its portfolio consists of loans originated and underwritten by its affiliated Angel Oak Mortgage Lending business (that's where the unique loan types mentioned earlier come from). While the loans in the portfolio don't meet certain standards that most residential purchase mortgages must conform to, it's worth noting that the loans are pretty high quality. Angel Oak's average borrower has a FICO credit score of 715, makes a down payment of more than $100,000, and has a loan-to-value (LTV) ratio of 76.4%. In 2020, Angel Oak Mortgage Lending originated about $1.5 billion in non-QM loans, so it's fair to say that the mortgage REIT side of the business has no lack of opportunity to invest.
How risky is it?
For starters, non-QM mortgage loans are inherently riskier than qualified loans for the simple reason that if borrowers stop paying, there isn't a government guarantee that ensures the mortgage owner gets made whole, and there were some "alternative" means of documenting the borrower's ability to repay, which might not be as reliable as the standard method of evaluating tax returns and W-2 documentation. To be sure, Angel Oak invests in high-quality non-QM loans, but this is still a riskier approach than investing in agency-backed loans like many mREITs do.
On the other hand, because non-QM loans tend to have significantly higher interest rates than QM or agency loans, Angel Oak uses significantly more leverage than the average mortgage REIT. The company's pre-IPO leverage ratio of 0.7x debt to equity is deceptively low, and the company acknowledges it will likely increase, but Angel Oak anticipates that its leverage ratio will remain below 3:1.
Meanwhile, other mortgage REITs (especially those with agency loans), regularly use leverage ratios well in excess of 5:1, which makes them more vulnerable to interest rate fluctuations.
The Millionacres bottom line
Angel Oak Mortgage is certainly a unique mortgage REIT, and it will be interesting to see how its alternative mortgage loan investments and reduced leverage translate into income for investors. Before you consider investing, however, it's important to familiarize yourself with the basics of mortgage REIT investing, as there are some major risk factors that should be taken into consideration before buying shares.