Q1 2020 Earnings Call
Today's call is being recorded and will be available for replay beginning at five P.M. Eastern standard time.
At this time, all participants have been placed in listen only mode and the floor will be open for your questions. Following the presentation.
Now first I'd like to turn the call over to Mr., Larry Clark Investor Relations. Please go ahead Mr. Clark.
Thank you Debbie.
Thank you everyone for joining us today to discuss western asset mortgage capital Corporation's financial results for the first quarter 2020.
The company issued its earnings press release yesterday, and it's available in the Investor Relations section of the company's website at Www dot western asset M.C.C. Dot com.
In addition.
Companies, including a slide presentation that you can refer to during the call and you can also access these slides on the web site.
With us today for management or Jennifer Murphy, Chief Executive Officer, Lisa Meyer, Chief Financial Officer, and airstrip on Chief Investment Officer.
For begin I'd like to review the Safe Harbor statement.
This conference call will contain statements that constitute forward looking statements within the meaning of the private Securities Litigation Reform Act of 1995 Oh.
All such forward looking statements are intended to be subject to the safe Harbor protection provided by the Reform Act.
Actual outcomes and results could differ materially from those forecast due due to the impact of many factors beyond the control the company.
All forward looking statements included in this presentation are made only as of the data. This presentation and are subject to change without notice.
Certain factors that could cause actual results to differ materially from those contained in the forward. Looking statements are included in the risk factor section of the company's reports filed with the FCC.
Copies are available on the Fccs web site.
We disclaim any obligation to update or forward looking statements unless required by law.
With that I'll now turn the call over to Jennifer Murphy Jennifer.
[music].
Thank you Larry welcome everyone.
The March quarter wasn't extremely challenging in difficult environment for global markets and the economic impact at the pandemic created unprecedented market condition severe liquidity volatility and uncertainty.
In the beginning of 2020, we were anticipating continued moderate economic expansion in the United States.
That time, our investment strategy combined primarily agency CMBS interest rate investments with residential and commercial credit holding.
Our residential credit investments focused on whole loans to nonqm borrowers with strong credit profiles and lower loan to values.
Commercial credit investments focused on higher quality single asset single borrower loans, where we can play a significant role in shaping covenants and structure.
By mid to late March virtually all asset classes agency and non agency residential and commercial.
Suffered an acute lack of liquidity and forced selling in the marketplace, leading to swift and dramatic price decline.
Agency CMBS debt spreads widened from 50 to 60 basis points in January and February two 225 basis points at one point during the week of March 16th.
Closing the weak at 135 basis point spread.
One standard deviation change.
Spreads widen even more dramatically in non agency CMBS with AAA CMBS widening from approximately 60 basis points spreads.
Over 300 basis points, and Triple B CMBS widening from 300 basis points to 1200 basis points.
Over 50 standard deviation live.
These dramatic price declines reflected the uncertainty surrounding the economic impact of unprecedented action taken by government business and individual to enforce social distancing, including widespread business closures and other locked down restrictions.
The price declines also reflect the anticipated cost of some of the actions taken by federal state and local authorities to mitigate the impact on individuals and business owners, such as prohibitions on addiction, and the ability to obtain deferrals of mortgage and rent payments for those affected by the pandemic.
The fed acted quickly and decisively to stabilize agency mortgage markets and they seem to be largely successful and spreads an agency CMBS DUS bonds. For example are almost back to pre crisis levels of about 60 basis points.
And non agency markets. However, spreads have recovered only somewhat in senior AAA CMBS.
While non agency RMBS and triple by the CMBS spreads have not recovered much at all you can find its data on page five of our earnings presentation.
As a result of these unprecedented economic and market disruption the extreme uncertainty around how long and how negatively mortgage assets would be effective.
Acted combined with our portfolio positioning at the hybrid read and our exposure to margin calls related to our repo borrowing we experienced a significant declines and the fair value of our assets during the quarter.
Book value declined, 68% and we recorded a GAAP net loss of $382 million.
As a management team focused on book value stability, we're very disappointed with this result.
However, as the environment normalizes and the real impact on mortgage assets in general and our portfolio in particular become more clear we're keenly focused on preserving the opportunity for our shareholders to benefit from price recovery in our portfolio.
Well, we generated core earnings plus drop income of 29 cents per share during the first quarter relatively consistent with previous quarter. We made the decision to retain those earning and suspend the first quarter dividend to maintain additional liquidity to help protect the value of shareholder assets in these distress and disrupted market.
We've taken a number of other actions designed to help protect the portfolio during the price the crisis, including sold assets and repaid the associated repo borrowing to significantly reduce market exposures.
Entered into an 18 month term facility for a non QM loan portfolio, removing its exposure to mark to market margin calls.
Entered into a 12 month term facility for non agency CMBS and RMBS securities significantly mitigating their exposure to mark to market margin call.
Reduced short term repo financing to 10% of overall financing.
And consolidated orphaned and financing relationships with collaborative well financed counterparties, who we believe take a long term view of our relationship and mortgage rates generally.
We believe the assets we've retained in the portfolio are supported by the underlying value with the properties that serve as collateral for these investments.
Well, the terms and covenant designed to protect their value.
Well it will likely take time to assess the actual impact of the pandemic on our assets. We believe current prices of non agency residential and commercial assets reflect an overly pessimistic view with little differentiation amongst security.
And while the trajectory of the economic downturn in recovery, it's still very uncertain, we believe that asset prices they too much weight on the most bearish scenario.
As we get more clarity, we expect the underlying values to be more fully reflected in prices.
Therefore, we see the potential for significant recovery in our book value as a result.
2020, it's been a huge challenge for W.M.C. and the entire mortgage riet industry.
We are committed to taking the necessary steps to protect the portfolio and preserve the opportunity for our shareholders benefit meaningfully as acidize recover.
We believe our focus on high quality borrowers and assets as well as our diversified approach will provide the opportunity for our assets to recover significantly at the economy recovers.
It's fellow shareholders, we're extraordinarily focused on acting to protect shareholder interests.
We appreciate your patience as we seek to protect book value enable shareholders to benefit from recovery and repositioned the company to resume delivering on our long term objective.
With that I'll turn the call over to our CFO Lisa Meyer. Thank you Jennifer.
Jennifer mentioned March was a challenging them for many mortgage.
The unprecedented market condition in terms of magnitude and seen resulted in a significant decline in our asset values.
We were severely impacted by this market volatility, resulting in a GAAP net loss $381.9 million or $7.
Then a share.
Our core earnings plus drop income was $15.8 million or 29 cents per share.
We have taken certain measures keeping her to preserve the long term value about equity, including selective asset sale unwinding interest rate swap positions that were deemed no longer affected and <unk> financing arrangement that reduced our exposure to short term purchase agreement borrowing.
Daily margin requirements.
More specifically, we took the Boeing action to achieve these objectives.
During the quarter, primarily in March we sold just over 1.7 billion in security.
The vast majority consisted of agency CMBS and RMBS.
We do think purchase agreement borrowing by $1.6 billion.
We terminated our entire interest rate swap position consisting of $3.1 billion in notional value of Hey, Bob and $1.9 billion a variable pay swap.
<unk> interest rate swaps will no longer affected [laughter] due to the decline in short term interest rate and worry source of margin call.
We suspended I'll first quarter's dividends to preserve liquidity and subsequent to quarter end, we entered into some facility.
Counterparties that share a long term strategic view, which significantly reduces our exposure to margin call.
The combined facilities have an aggregate balance of $485 million and further when do you I would purchase agreement bar.
At March 31st a leverage with 9.5 times.
Higher leverage was the result of unsettled trades over quarter and any significant decrease in stockholders' equity, which in part was the result of the $209 million unrealized loss losses recognized during the quarter.
This quarter and we continue to selectively sell assets to reduce leverage.
One of approximately 454 million security mainly agency MBS.
149 million hold on.
We expect but we expect that by the end of second quarter, a leverage will be in line with pre crisis levels.
The current composition about financing arrangement of approximately $1.5 billion is as follows a.
Approximately 48% non recourse securitized debt from our Lloyd's securitization approximately 30% in the near term facility approximately 10% in warehouse line and approximately 10%, England purchase agreement finance.
We have met all margin requirement.
And our significantly.
Sure you haven't bought more financing any more stable market environment for mortgage credit related assets, we anticipate continuing to do so.
At March 31st while we were not in compliance with certain covenants some about a lender.
We have obtained a waiver.
Modification of those covenants will have to pay off the outstanding borrowings missile blender.
As Jennifer mentioned, we believe the remaining here we hold in the portfolio, how the fundamental value in excess of their current prices, while it may take some time to gap.
For that gets you know we estimate that there is a potential for significant upside to be realized.
Which would lead to a partial recovery of book value per share with that I will now turn the call over the Harris <unk> Harris.
Thanks Lisa.
While the broader market volatility, resulting from the cold that 19 pandemic led to an extreme close declines on our assets in March we have experienced some recovery in their passes through the end of April.
We believe that current prices in the credit sector of the U.S. residential and commercial real estate mortgage market and they did.
Your economic scenarios that were laughing during the global financial crisis.
While assessing the longer term economic damage of this crisis remains challenging given its unique nature and unprecedented scale. Our view is the extraordinary amount of fiscal and monetary support that the U.S. government is providing our financial system and the broader economy will dampen the economic impact.
Of the quarantine period and support liquidity conditions in fixed income markets.
We believe valuations in mortgage credit assets are particularly favorable relative to fundamentals, even given the increased uncertainty in the near term.
We also believe that the current recession will eventually path and give way to an economic recovery, although the timing and strength of the recovery will be dependent on the spread of the virus and the availability of therapeutics and a potential vaccine.
The magnitude of the price and liquidity dislocation in mortgage market over the last few months resulted in the most challenging environment in my career.
In response to the paradigm shift we significantly reduced the size of our portfolio in order to lower debt and increased liquidity.
In March we primarily sold agency MBS holdings with most of the self coming after the federal reserve announced by programs for first the RMBS market and then the CMBS market.
During the current quarter. We have also sold some of our residential and commercial credit investments as these markets began to stabilize and prices rose modestly from the late March lows.
Our current portfolio holdings remain diversified across a number of sub sectors of the mortgage market, but the majority of our holdings are now in residential whole loans.
Commercial whole loans and both non government guaranteed residential and commercial mortgage backed securities.
Our residential whole loan portfolio consists of mortgages mid to high quality borrowers will have substantial equity in their home.
The average LTV at origination of this pool of loans was 62%.
Loans are being serviced by our loan origination partners, mainly community banks and while we expect that some of the borrowers may require some form of bond payment deferral. We don't believe that there will be any ball term material credit losses from the portfolio, nor do we expect a meaningful amount of payments disruption due to forbearance requests.
Our long term view on residential real estate remains favorable.
Right before the crisis, the U.S. housing market with healthy driven by improved affordability rising income at historically low consumer debt level.
It was overlaid against the backdrop of limited supply and tight credit standards.
The shutdown and economic uncertainty will slow down housing activity significantly in the near term.
We are expecting lower prepayment as origination volume slow an extension of mortgage timeline and home prices to decline by up to 5% in our base case.
But we don't believe that there will be significant and permanent declines in residential real estate values in this country.
Our single our commercial whole loan portfolio, primarily consists of a number of single asset single borrower mortgages well, we have focused on short term loan secured by properties with solid credit fundamentals and strong covenants that protect our interest as lenders.
Our 320 million dollar portfolio at quarter end at a weighted average loan to value at origination of 65%.
However, we are mindful about some areas of the market will be more exposed to covert 19 risks, most notably hotel and retail properties.
That being said, we believe that I'll focus on high quality properties with well capitalized sponsors capable of withstanding short term disruption should enable our assets to emerge from the crisis without significant impairment.
Looking ahead, we believe mortgage is secured by real estate assets with meaningful equity in the properties and higher quality credit well continue to perform well over the long term.
Well many sectors of the mortgage market currently offer historically attractive valuations or primary focus is on maintaining sufficient liquidity and reducing our overall debt while consolidating our financing relationships in order to protect against further book value erosion and positioning the portfolio for potential future.
Our appreciation.
Entire WMC team as well as the broader western off the team has worked tirelessly during what has been an extremely difficult environment and whats confronted with a variety of challenges over the last two months and I'm proud of our team's effort navigating these unprecedented market conditions.
Well the decline in book value was large and unexpected we feel that our current stance is the best way to put us back on course towards our long term objectives of generating sustainable core earnings that can support and attractive dividend with the overall goal of enhancing stockholder value.
With that we will open the call up to your questions. Operator. Please go ahead.
We will now begin the question and answer session to ask a question you May Press Star then one on your telephone keypad.
If you are using the speakerphone, please pick up your handset before pressing the keys.
To withdraw your question. Please press Star then too.
This time, we will pause momentarily to assemble our roster.
The first question comes from Eric Hagen.
With KBW. Please go ahead.
Hey, Hey, Thanks, Good morning, and I Hope you guys are doing well a couple of questions on the or the new funding arrangements. What's the what's the funding cost someone's facilities and are you able to reinvest in the pay downs or does all the p. and I effectively go towards paying down the facilities and then.
What's the pay downs and you already on the on the cash flow from the portfolio. It is the convert ranked ahead of the the repo in terms of the priority of payments or does the.
Collateralize funding ranked first.
Okay, I think all inclusive of comment on that Eric. Thanks for your question, we there's two different facility.
So maybe we should start by commenting on the non QM loans facility for.
Sure. The then non QM facility on the way. It works is that the cash flows from the underlying loan value goes to pay a coupon which is which is based upon the whack.
And then any additional proceeds of piano I, then actually pay down the facility.
And then the second facility maybe comment on the EM.
The second facility.
It looks a little differently what happens is.
The cash flows go directly to the the counterparty. The interest is taking out and then the net proceeds come back to the company.
That is based upon a LIBOR plus 500 basis points.
And in addition to bad you know I payments I mean, no payments sorry go to reduce the facility a 50% I and then comes with when are we should certain level.
How about the <unk> that was helpful. Thank you I missed seniority of payments the convertible.
No.
It's a secure financing so it would be for those assets that are financing it they would have per claim on it.
Understood.
Great. Thanks, and then what's your book value and leverage after having completed the sales in the portfolio in April what percentage of your sea area Nonqm portfolio has asked for forbearance.
So far.
Thanks.
It's a little difficult right now to provide a book that book value of the April only because [laughter] significant portion about portfolio now it's been a whole loan products and those build one part of don't get more if they get moved on a monthly basis.
The process of just getting in value for those loan. So it's kind of difficult for me to say exactly at this point in time with any clarity what what book values.
How about having having said that it's improved and the with the parts of the portfolio than a mark to market every day, there's improvement and just to be clear those the loans at least dimensions that are on March monthly are marked by a third party provider an independent provider.
Got it.
Okay, Great and then can you just maybe guide us a little bit towards the.
Kind of core earnings that we should expect.
Yeah, just over the I guess kind of near term.
Thanks.
Yeah, I don't I think.
Our core earnings my expectation given the change in the portfolio they'll be lower so maybe we see you might want to comment is there range, we can offer or.
Some sense is that yes, we're estimating the range to be around between six to seven cents.
Mhm.
Got it. Thank you guys very much you still.
Thank you to think there.
The next question comes from Trevor Cranston with JMP Securities. Please go ahead.
Alright. Thanks.
A couple of follow up questions I guess first.
You know with the portfolio yields you guys would mean April as you look at what remains in the book.
Yeah. So are you continuing to Opportunistically look to sell assets or you know with what remains is that sort of things you're comfortable with that you'd like to try and capture upside on those markets recover.
No I wish I Wonder we think about.
The balance of the portfolio going forward from there.
Sure [noise] Trevor Terrace, I can I can take that one.
I think generally speaking, where we always try to be as opportunistic as possible, particularly in this environment, where our program of de risking and Delevering. The the portfolio you know the market conditions, while improved relative to where they were in March.
You know continued to be very fluid.
So the opportunity set in terms of selling.
Assets in the portfolio remains fluid as well.
I would say also that the execution of the longer term facilities for [noise].
The majority of our securities portfolio as well as our residential loan portfolio. You know certainly goes a long way and and giving us more time and flexibility and taking advantage of the liquidity conditions on <unk> on a day to day basis.
What our entire team is always focused on you know evaluating where we think we can move every single line item in the portfolio and we're constantly weighing the attractiveness of selling burst keeping given the overall goal a you know trying to preserve is.
Much optionality in the portfolio to recover as much book value is as possible.
Okay Gotcha.
No no a couple of a detailed questions on the portfolio.
First on the non agency CMBS and you cover a breakdown of.
The ratings your own and the remaining portfolio there.
I don't I don't have that in front of mean, Trevor but I I would say that most of the ratings are below investment grade.
[noise].
Ever I would I would also note that.
It's all long standing you that rating, particularly for mortgage credit assets have been overly conservative over the over the course of of the last number of years and we don't think necessarily reflects the inherent credit quality of the various classes.
Okay got true and then on the commercial loan portfolio I think you briefly mentioned in or potential issues with.
Hotel on and retail loans.
The prepared remarks.
Can you provide any additional color on you know whether or not or any of those borrowers.
Asked for payment deferrals or what's the status as oppose wolves, and how you're thinking about the roster.
Sure. Those conversations are are still ongoing there's one exposure that we have in the portfolio, where and put the April payment the borrower asked for forbearance.
That was ultimately not granted in in full.
And the most of the exposures that we have.
Most of the bone exposures, we have our structured with.
Various reserve.
And in many cases mean that service an interest reserves as well.
So you know those reserves are are being drawn down, particularly on a per assets, which are not operational at a car point in time.
Okay Gotcha.
And then.
So looking at the details you guys provided on the new financing facilities.
You know it looks like there's a provision for your counterparties to potentially sure and some books Lloyd price improvement in the assets.
When we think about.
Your book value going forward to the extent.
Prices do recover in spreads tighten.
Will there be you know some sort of offset to the improvement in asset values to account for the potential sharing or how should we just brought all those facilities are going to work.
That's correct.
So just just to be clear Trevor the.
Only the residential loan facility has that provision in it the security facility. There is no there's no sharing of a potential upside.
And on the but the bone facility you know there that there is that participation you should think about it largely in terms on monetization event of the underlying assets or in other words.
When and if we sell the loan I'm in a portfolio basis or we securitized loan.
And cheap financing that way the delta between the adjusted basis, the London now and in that facility at that point in time relative to the proceeds that that are generated as a result of one of those two event would be shared on the share.
He is heavily in the company's favor, but that was a concession that that we needed to make to achieve some of the structural features that were very important to us an early non mark to market as well as determined that facility itself.
Okay, and whatever German could I, just add to that that that opportunity for sharing with that partner is a very small would represent a very small part of the potential for a recovery in the portfolio.
Right, Okay got it.
And then last question for me.
Looking at slide 12 in the Duck I guess.
Are you showed some positions in TV news and credit default swaps or just wondering if you could provide some color on you know what those positions are and if those are things you continue to Oh I'm in the portfolio. Thanks.
The [noise].
TB a the TV a is no longer in the portfolio the credit default swaps Oh, we're part of a credit hedge that we had in place in the portfolio and that's what's reflected on the table you're referencing.
Okay and you do you still have that hedge in place or is that.
Recalls we then no we still have a we thought part of it we'd been adjusting it as you know as market conditions allow but we still we still do have a position there yes.
Okay got it thank you guys.
Thanks Trevor.
[laughter].
Again, if you have a question. Please press Star then one.
The next question comes from Derek Hewett with Bank of America. Please go ahead.
Good morning, and and I hope everyone is well Muslim most of my questions were already asked and answered but in terms of the fee waivers what will that continue until the dividend. It's just turned back on.
Hi, dark its Jennifer we've been making that determination on a month by month basis. So it's in part to assist the company WMC and keeping liquidity and helping to manage our expenses as well so well.
We'll make that determination again later this month, but we haven't set any particular rule like you just suggested its more of a month to month determination.
Okay.
That's it somebody thank you.
Thank you.
This concludes our question and answer session I.
I would like to turn the conference back over to Jennifer Murphy for any closing remarks.
Thank you thanks, everyone for joining us today, we appreciate your interest in your questions and hope everyone remain safe and healthy during this challenging time and we look forward to speaking with you again soon.
Thank you.
The conference has now concluded.
Q4 attending today's presentation you may now disconnect.