Q3 2020 Western Asset Mortgage Capital Corp Earnings Call

You can also also accessed the slides on the website.

With us today from management are Jennifer Murphy, Chief Executive Officer Lisa.

Lisa Meyer, Chief Financial Officer, and Harris, <unk>, Chief Investment Officer.

Before we 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 1995.

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 forecasts due to the impact of many factors beyond the control of the company.

All forward looking statements included in this presentation are made only as of the date of 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 Companys reports filed with the Securities and Exchange Commission.

Reserve bailed out on the Fccs website.

We disclaim any obligation to update our forward looking statements unless required by law.

With that I'll now turn the call over to Jennifer Murphy Jennifer.

Thanks, Laurie welcome everyone.

Mortgage credit markets rallied in the third quarter valuations on western asset mortgage is residential and commercial credit assets benefited meaningfully.

W.M.C. GAAP book value increased 29.2% in the quarter to $4.07 per share.

GAAP net income was 59.8 million or 98 cents per share in core earnings were 6.4 million or 10 cents per share in the quarter.

Our net interest margin improved to 2.27%, which together with the underlying performance of the portfolio contributed to solid core earnings. Despite a significant reduction in recourse leverage from three times as of June Thirtyth to 2.2 times as of September Thirtyth.

The last two quarters, we fortified the company's balance sheet improved funding terms increased liquidity and equity and reduced recourse leverage to ensure that our shareholders could benefit from the performance of the underlying assets of our portfolio.

In light of our results this quarter, including the strengthening of our balance sheet improved liquidity and solid core earnings the company declared a cash dividend of five cents in the quarter.

The payment of an attractive dividend as an important priority for our shareholders and the resumption of the dividend was a key milestone for the company.

The recovery in asset prices across the portfolio and the resumption of our dividend contributed to an economic return on book value of 30.8% for shareholders. This quarter.

We remain highly focused on our long term objective of generating sustainable core earnings that support an attractive dividend with relative stability in our book value.

We believe our portfolios earnings power is likely to provide a solid underpinning for future dividends and while we have seen substantial recovery in asset values across our portfolio. This quarter. We believe there's the potential for additional improvement, particularly in our commercial mortgage investments much of this will be dependent on the path of the virus.

Both the pace of recovery in economic activity.

In our view, our diversified investment strategy focused on high quality commercial and residential borrowers is well positioned for the uncertainties of this environment.

To talk more about our investment strategy and outlook I will turn the call over to our Chief investment Officer Harris Teeter fallen.

The third quarter of 2020, so the equity and credit markets continue to rebound driven by improved liquidity conditions across financial markets and the ongoing reopening of the economy, which translated into higher valuations for a number of our portfolio holdings the.

The recovery of our residential portfolio combined with improvement in our commercial holdings translated into a significant improvement in our GAAP book value.

As the market in our portfolio have improved so has our liquidity position, which contributed to our decision to reinstate our dividend for the third quarter.

Over the course of the quarter, we saw continued improvement in the credit performance from both our residential and commercial holdings.

Our non QM residential loan portfolio is performing well and experienced a decline in the percentage of loans that were part of a forbearance plant dropping to 10% at September 30 from 16% at the end of the second quarter.

We see this is a strong indication that borrowers with meaningful equity in their homes will prioritize their mortgage payment in order to remain current on that obligation.

We believe that this trend will continue given the positive data coming out of the U.S. housing sector, including robust purchase and refinance the man and ongoing home price appreciation in many major markets across the country.

Our commercial loan and non agency MBS portfolios are performing in line with expectations, even though those expectations have shifted as a result of the pandemic.

Commercial whole loan portfolio carries an approximate 65% original LTV and had and all but one of the loans remains current.

As we mentioned last quarter. The delinquent loan has a principal balance of $30 million, which is secured by a hotel.

We are currently exploring various workout strategies and believe that there is a reasonable likelihood that the majority of the principal and interest payments will be recovered. Although there is no guarantee that will be the case.

Our large low non agency CMBS portfolio has an original LTV of 60% and despite exposures to some retail and hotel assets over 82% of the loans by principal balance remained current compared with 70% at June 30, we.

We are in forbearance and modification discussions with the delinquent borrowers in this portfolio.

In fact, we have been active with many of our commercial real estate borrowers monitoring their situations and working with them to help preserve the value of the underlying properties in order to protect our collateral and increase the probability of an eventual recovery in asset values.

That being said, we believe that our focus on high quality properties with well capitalized sponsors capable of withstanding short term disruptions should enable our commercial real estate portfolio to emerge from the crisis without significant overall impairment.

We have spent a significant amount of time and effort over the last two quarters to improve the terms of our financing arrangements and the company's risk profile.

These ongoing efforts continued in the third quarter as we amended our existing residential whole loan facility to convert it to a limited mark to market facility with more attractive terms.

With respect to our outlook going forward, what the U.S. economy rebounded during the quarter, most economic measures remain well below where they started the year.

We believe that the recovery will continue to be dependent on the future trajectory of COVID-19, the availability of improved therapeutics and vaccines and continued fiscal and monetary support.

We also expect that the federal reserve will follow through on its commitment to keep interest rates at or near zero for an extended period of time.

We continue to believe mortgages secured by real estate assets with meaningful equity in the property and higher quality credit well continue to perform well over the long term well.

While many sectors of the mortgage market currently offer historically attractive valuations our primary focus remains on maintaining sufficient liquidity protecting the value of our assets and positioning the portfolio for continued future appreciation with that I will turn the call over to our CFO Lisa Meyer.

Thank you Harris.

We have provided a great amount of detail regarding our portfolio and our third quarter results in both our press release <unk> earnings presentation.

So I'm only going to focus on the items that warrant some additional explanation.

During the quarter, we continued to focus on optimizing our portfolio financing, increasing liquidity and improving shareholders' equity.

In July we retired 5 million about convertible senior notes at a 25% discount to par value.

In exchange for the issuance of 1.4 million shares about common stock.

We were once again acted in improving the financing of our assets during the third quarter, we amended our existing residential whole loan facility in October to convert it to a limited mark to market facility with more attractive term.

No.

The amended facility has a 12 month term and bears interest at one month LIBOR plus 2.75%.

We reported core earnings of $6.4 million or 10 cents per share for the third quarter.

Core earnings came in higher than the $4.3 million generated in the second quarter.

Primarily driven by higher net interest margin and a full quarter benefit of the lower financing costs associated with last quarter's a royalty securitization, which allowed us to reduce the income drag experienced under the original residential hold on facility.

Economic book value for the quarter increased 2.2% to $4.11 per share as mentioned last quarter. We believe that this non-GAAP financial metric provides investors with a useful supplemental measure to evaluate our financial position it.

Reflects our actual financial interest in all of our investments and eliminates the accounting mismatch that arises from our earliest securitization, where we fair valued alone, but not the debt.

This quarter the difference between our GAAP book value and economic book value narrow only four cents.

Due to the sharp rebound in asset values, mainly in the residential whole loan portfolio, which reduced this accounting mismatch.

In summary, we believe these steps solidify our capital structure increased liquidity and will need us to participate meaningfully in the economic recovery.

A recourse leverage was 2.2 times at September Thirtyth significantly lower than the 9.5 times level at the end of March and 5.4 times at the beginning of the year net.

Net interest margin remains healthy and with a significant portion about assets now finance with attractive longer term financing. We believe that we are well positioned for another quarter.

Positive financial results in the fourth quarter.

With that we will now open up the call to your questions. Operator. Please go ahead.

I'll begin the question and answer session.

That's a good question you May Press Star then one on your Touchtone phone.

Using a speakerphone please pick up your handset before pressing the keys.

To withdraw your question. Please press Star then too.

At this time, we'll pause momentarily to assemble the roster.

First question comes from Macau.

JMP Securities. Please go ahead.

Thank you very much good morning, everybody everybody is doing well.

Could you potentially give an update on a book value thus far in the fourth quarter.

Hi, This is Lee.

Hi.

How are you [laughter].

Good so <unk> book value, we haven't seen a substantial move either up or down as far as valuations go and so our book value I think it's pretty stable from from from the end of the third quarter.

Hi, Jay.

And.

The securitization market going forward could you.

Perhaps I'm opine a little bit on what you guys are seeing and if its continuing to you know to look I'm, a little bit better than it did about two quarters ago.

Sure. This is Harris I'll take that one.

As as we discussed during our opening remarks, we've seen a continued improvement in mortgage credit markets over the last two quarters.

Certainly has remained true so far in the fourth quarter. So you know I think the viability of an underlying strength of securitization for mortgage credit assets, particularly residential assets.

It's going to remain robust over the next over the foreseeable future.

Okay in terms of adding to the portfolio at the margin on.

Are you.

Leaning towards investing in commercial loans versus.

More more commercial loans versus residential whole loans or.

Is there a.

I guess my question is which way are you really going forward.

Sure well I think it's it's beyond argument that there are a lot stronger outlook for housing and commercial real estate at the moment just given the impact that this pandemic has had on commercial real estate, particularly the use of space and potential churn.

Change in behaviors.

As I mentioned earlier the data that we've seen on housing really only every metric you look at is been exceptionally strong and has really continued to get better quite frankly over the last few months.

So I think with that in mind in conjunction with the amount of commercial risk that we have in the portfolio already.

You know I think incremental investments certainly we would be more heavily focused on the residential side than the commercial side.

That all being said as we've always said, we could look at all investments regardless of what sector asset class. They come from you know through our relative value lens and and of course, our underwriting analysis and that'll continue to remain the case.

Got you. Thank you for that and if I may one more.

Kind of a more of a macro fed related question given the events of this week in the election seemingly if it is true that we're gonna have political gridlock and that would decrease the chances of a bigger stimulus package and maybe even delay the passenger was stimulus bill for a little while longer.

What are your thoughts on how that will play out in terms of the credit market and.

I'm sort of a second part to that question do you think that that will increase pressure on the fed to do more and.

And if so how do you see that playing out.

Sure.

I'm I'm not going to comment on the election and the potential outcome of it although I will say this you know Mitch Mcconnell was on the tape earlier this week talking about the need for more fiscal stimulus sure Paolo.

During his comments yesterday.

You know also reiterated the need for the combination of both monetary and fiscal support and so you know I think that remains certainly our base case that we will see.

Additional stimulus from the government what form it comes in how much and when that are obviously all open questions, but we do expect that we will continue to see additional fiscal stimulus in the weeks and months ahead I.

I think in terms of monetary support again Ceri Powell was was very clear during his remarks. This week and you know there's absolutely no.

No gray in his desire to continue with the programs that they have in place and continuing to support.

The economy and financial markets.

Okay. Thank you.

It for me. Thank you very much everybody.

Next question comes from Derek Hewett Bank of America. Please go ahead.

Good morning, everyone. My first question is I think that the portfolio is almost exclusively credit at at this point versus kind of a more balanced approach between rate and credit sensitive investments precursor bid is a is a more balanced portfolio a pro.

Priority in the recent the intermediate or longer term at this point or will the portfolio remained exclusively credit.

Thanks for the question to.

I think in the in the foreseeable future, we anticipate that the portfolio composition is going to remain largely focused on credit sensitive investments.

Yeah as I mentioned earlier, you know, we continue to evaluate relative value opportunities across both are rate sensitive as well as credit sensitive investments.

Given the degree of the dislocation in markets earlier, this year and even with the improvements many assets in mortgage credit markets are still trading at very attractive valuations you know conjunction with.

The convexity risk and rate ball that we've seen recently you know I would expect our focus is going to remain on the credit sensitive side of the market. However, you know things change and clearly we've seen you've seen that over the course of this year certainly.

And you know as market conditions change and as the economic environment changes and evolve as you know we will continue to assess the investment opportunity set within the agency market.

Okay, Great and then looking at.

Some commercial near term maturities I think it's on slide 10.

Could you provide any additional color on the that that hotel alone in the nursing home loans that mature mid next year.

I'm not going to provide any specific color on on those assets other than just to say that we continue to monitor Oh.

Upcoming maturities, particularly on the nursing asset that you referenced.

We feel good about the performance that we've seen over the course of this year and then in regards to the hotel asset as I mentioned during the opening remarks, you know we continue to evaluate various worked out strategies in regards to that specific asset and remain comfortable that way.

We should see a.

Near or full recovery in principle and missed interest, but you know obviously there is no guarantee that ultimately that will be the outcome.

Okay, and then last one for me was a was.

Was there anything kind of more onetime in nature with with.

The 10 cents of core earnings and if not should that be the the new baseline for trying to determine a growth in the dividend at this point.

Hey, Derik, it's Lisa so illiquid acquiring is pretty much in line with our expectations on I think that we spent a lot of time in.

Restructuring our financing facilities into more getting more attractive terms. So we are comfortable with the earnings power of our portfolio given our current leverage as far as the dividend anytime we look at the dividend you know we.

We look at it as a team and we assess the long term earnings power of the portfolio. So every quarter, we will revisit that along with.

Discussion with our board of directors.

Okay.

Actually what one additional one you had mentioned that book value was a pretty much kind of flat quarter to date is there any sort of estimate in terms of.

If we did a vaccine sometime next year in <unk>.

When we get more of a normalized.

Economy. He asked how much of unrealized losses still kind of embedded in book value at this point.

But what I can do is I can direct you to our 10-Q, we have a schedule on there that summarizes our unrealized losses.

For the nine mine and that can give you a range of what the potential recovery is I would focus on looking at the cumulative unrealized losses related to our non agency CMBS the residential whole loans that can that commercial loan as well as other securities which are our G.S.C.. So that kind of give you a range and of course.

As you mentioned the recovery of these assets the timing and the amounts will be contingent on what happens in the market then it doesn't it.

Okay, if the <unk>.

The dollar amount of the range of <unk> of the categories. You. Just mentioned is about $100 million is that about right.

That is correct Jennifer yes.

Yes is there that you know 60 or 67 million shares.

The dollar 50 ish or so sure yeah. Okay.

Okay. So very sizeable okay, great. Thank you very much.

Thank you.

Thank you next question is from Jason Stewart of Jones trading. Please go ahead.

Thanks, Good morning are there any incremental opportunities to execute on the convertible debt for equity exchange or is that opportunity largely pass.

Hi, Phil.

We continue to look for opportunities for that I mean, we did do 5 million during the quarter and we continue to look for opportunities to do that which would which would be accretive to our shareholders. So that's something that we're we're continuing to look at and if if there are opportunities out there you know.

We will consider them.

Okay, Great and Harris I think I heard you say, you're not going to update us on any assets, but specifically.

Specifically on the 30 million hotel loan do you have any sense of a timeline of what investors can expect on that work out.

Sure you know as I said, we're in the process of evaluating.

A number of different strategies in terms of resolving that asset I'm hopeful that we will be able to move forward with the path and see resolution over the next couple of months.

You know of course, it's contingent on you know all the macro issues that weve talked about but you know I think over the next call. It one to two quarters.

You know, we hopefully should be in a position, where we can resolve that asset.

Got it Okay, and then one more on the on the residential side. It sounds like that's going to be the investment focus for at least the near term are there opportunities to cook to trade out of securities that have appreciated.

And move around perhaps within capital structure to take advantage of your view there.

Yes is the short answer again.

Myself, Sean and the team are constantly evaluating opportunities in the market and obviously mining them up with what we think the value proposition is for each of the holdings in the portfolio. Currently so you know that's something that we're going to continue to.

Do.

The market environment has has been positive overall as we've discussed but it also remains fluid and so yes, I do expect that.

There will be more opportunities as we continue to see the recovery in end markets and our assets within WMC.

Okay. Thanks for taking the questions.

Thank you.

Again, if you have a question. Please press Star then one on your Touchtone phone.

This time, we have no further questions.

I'm going to turn the conference over Mr.

Ms. Jennifer Murphy for closing remarks. Please go ahead.

I just want to thank you all for joining us and we look forward to talking with you next quarter.

Have a great day.

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