Q2 2021 Western Asset Mortgage Capital Corp Earnings Call
Welcome to Western asset mortgage capital Corporation's second quarter of 2021 earnings Conference call. Today's call is being recorded and will be available for replay beginning at 5 P. M. Eastern standard time.
At this time, all participants have been placed in a listen only mode and the floor will be opened 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 Tom I want to thank everyone for joining us today to discuss western asset mortgage capital Corporation's financial results for the second quarter of 2021.
The company issued its earnings press release yesterday afternoon, and it's available on the Investor Relations section of the company's website.
Additionally, the company has included a slide presentation on the website that you can refer to during the call.
With us today from our management team are Jennifer Murphy, Chief Executive Officer, Lisa Meyer, Chief Financial Officer, Rick Handler, Chief Investment Officer, and Sean Johnson, Deputy 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 of $19.95.
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 to the impact of many factors beyond the control of the company.
All forward looking statements included in this presentation for <unk>.
As of the date of this presentation and are subject to change without notice certain.
Certain factors that could cause actual results to differ materially from those contained in the forward. Looking statements are included in the risks risk factors section of the company's reports filed with the SEC.
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.
Larry welcome everyone.
As you know from our previous quarterly updates our expectation for the last several quarters has been that the U S economy continues to recover and that our portfolio's credit oriented holdings were likely to benefit.
That was broadly the case in the second quarter as narrowing credit spreads resulted in improving prices across a number of our portfolio holdings, but with 1 very notable exception a commercial junior mezzanine whole loan in our portfolio was very negatively impacted as it specific operational challenges resulted in it becoming.
Forming among other issues contributing to a significant decline in its fair value.
This in turn negatively affected the company's book value and earnings as our GAAP book value fell 16, 9% from the first quarter to $3.55 per share and we reported a GAAP net loss of $40 million $42 million for 66 cents per share.
This commercial junior mezzanine loan, it's a very meaningful exposure for the company.
Our management team is devoting significant time and resources to it with support from the broader western asset platform.
We are focused on doing everything we can to improve the potential outcome of this situation for WMC shareholders and continue to make it a very high priority.
Jack will discuss more of the details of this situation later in the call.
W. M sees distributable earnings, which we used to call core for the second quarter were $2.8 million or 5 cents per share and were also impacted by this commercial junior mezzanine loans moved to nonaccrual status during the quarter.
In addition, we experienced an increased level of prepayments in our residential whole loan portfolio, which resulted in higher loan premium amortization during the quarter also impacting earnings.
Aside from the challenged junior mezzanine loan Ive discussed already the value of our portfolio holdings have continued to steadily improve as the underlying properties are benefiting from the reopening of the economy, which Greg and Sean will discuss.
During the quarter, we amended 2 key financing facilities under more favorable terms and conditions and also extended their maturities Lisa will have more details on this.
Last week, our board of directors appointed Greg handler to serve as Chief investment Officer of the company and Sean Johnson, Deputy Chief Investment Officer.
As you know, both Greg and Sean had been serving as interim co chief investment officers since being appointed to those roles last December.
I guess ahead of the mortgage and consumer credit team at Western asset he's been in investing in the mortgage sector for more than 18 years and he's also a member of Western asset U S broad strategy Committee he.
He has played a key role in shaping investment strategy at both WMC and at Western and we look forward to his continued leadership in the CIO role.
You all know Sean S. He's been an integral part of the company's investment team and strategy since our initial public offering in 2012.
Sean has more than 31 years of investment experience and has critical roles at WMC and at Western asset and we look forward to his continued contributions as deputy CIO.
In June we declared a cash dividend of 6 cents per share for the second quarter in line with the previous 2 quarters, we remain committed to paying sustainable and attractive dividends.
While our second quarter results were significantly affected by the decline in fair value of the commercial junior mezzanine whole loan. We are encouraged by the progress we see in the economy and that WMC. We continue to focus on delivering on our long term objective of generating sustainable core earnings that support an attractive dividend, while enhancing shareholder value.
Now I'll hand, it over to Greg and Sean to go into more detail about the investment portfolio Greg.
Thank you Jennifer.
Our commercial mortgage portfolio, which carries an approximate 65% original loan to value is generally performing according to our expectations and all but 2 of these loans remain current as Jennifer mentioned it was the junior mezzanine loan backed by a high quality retail and entertainment complex located in the northeast U S that drove the decline.
And our book value during the quarter.
Pandemic has adversely impacted the operating performance of this asset while the majority of the entertainment complex is operating and seeing good activity. The retail portion has been delayed.
As a result of the uncertainty around the potential outcomes. The fair value of the loan was marked down by $49 million to $32.7 million, which reflects the new facts and circumstances.
We are currently in discussions with the borrower and certain other senior lenders regarding a variety of options.
Towards reaching a resolution.
These could potentially include modifications of loan terms deferral of payments for the funding of new advances.
As Jennifer noted we are spending significant amounts of time and resources in order to optimize the recovery of our investment. However, there are no assurances that a resolution will be reached with the borrower or with the senior lenders. So there is a risk of further impairment of this 1.
The second nonperforming loan of $30 million hotel loan that we have previously discussed we are still in bankruptcy proceedings and we are actively monitoring the process.
That was listed for sale and there is significant interest in the asset based on the value of those offers that had been received we feel there's a reasonable likelihood that the majority of the principal and missed interest payments will be recovered and as a result. This 1 was written back up to par during the quarter.
We hope to have final resolution on this situation in the near future. Although there's no guarantee that we will real debt, we will realize a full or partial recovery on the asset.
Taking a step back we are encouraged by the improvement in the fundamentals of the remainder of the of our commercial real estate loan portfolio.
In July we received a full repayment of a $45 million loan.
Cured by 2 skilled nursing facilities and we also expect to have another loan pay offs in this portfolio in the near future.
As the economy has continued to gain momentum we have seen signs of improvement in many of the commercial real estate markets across the country.
The resurgence of consumer spending has led to higher retail sales, which had been strong since the beginning of the year.
Sales have picked up again this summer after briefly pausing in late spring.
As a result retail occupancy rates and rental collections are improving in many markets.
We've also seen a healthy rebound in leisure travel, which has fueled a recovery in the hotel sector.
Total operating metrics have nearly recover to pre pandemic levels, particularly in the resort and limited service segments of the market.
Given this backdrop, we are seeing increased activity and favorable trends in the large loan commercial securitization market June was the biggest securitization month post COVID-19 and we see lending activity is coming back for the space.
There were some major hotel and office transactions that God securitized and saw a significant demand.
We are pleased to see this market reopening again as we believe that it will ultimately benefit our non agency commercial mortgage backed holdings.
Within non agency commercial mortgage backed securities are large loan credit portfolio consists mainly of class 8 retail and hotels that cater to the leisure traveler and we are starting to see positive operating momentum at a number of these properties.
This portion of our portfolio had approximate 66% in original loan to value and all but 1 of these loans remains current representing less than $2 million or dollar investments in this bucket.
These properties are generally high quality asset with strong sponsors. So we believe that their collateral values have not been materially for permanently impaired.
And our C N BS conduit exposure delinquency trends are improving and some loans have become current through a mix of improved cash flows and equity infusions.
We continue to believe that these near term challenges will eventually be overcome as COVID-19 restrictions are lifted and the economy moves towards a full reopening.
In the meantime, we remain focused on maintaining sufficient liquidity and positioning our portfolio for future appreciation, which we expect to occur as the economy continues to strengthen.
Now turn the call over to Sean to discuss our residential whole Sean. Thanks, Greg as we have noted the U S. Economic recovery continued to build momentum in the second quarter consumer spending was the biggest contributor to growth boosted by the loosening of COVID-19 restrictions and more businesses fully reopening as a rig.
Equity and credit markets responded positively continuing the trend that began last year. This generally translated into higher valuations across our portfolio.
Our residential whole loan portfolio continue to depreciate during this quarter benefiting from a strong housing market fueled by historically low mortgage rates very tight supply.
And favorable consumer sentiment second.
Second quarter National home price indices again rose at double digit annual rates.
Nomura research notes that the average non QM borrower has seen an increase in home equity of 9% in the last 12 months well credit availability that loosened from the tightness seen during the Covid period.
New loans still.
Still continue to have lower ltvs and higher FICO than those made in the months before COVID-19.
Residential credit performance continues to improve as a result from lower overall delinquency and forbearance metrics for the universe of non agency mortgages.
Our residential loans continue to perform well the percentage of loans that were part of a forbearance plan declined to 2 for 2.4% at quarter end from 6% at year end and a high of 19% in may of last year.
Nearly all the loans in forbearance are now in their repayment period, and those that arent represent less than 1 half of 1% of the total residential loan portfolio.
We see this good performance is a confirmation of the effectiveness of our credit underwriting as we focus on borrowers have meaningful equity in their homes. This equity creates a strong incentive for borrowers to remain current on their mortgage payments.
Given the long given the strong refinish refinancing market and pent up refi demand, we did experience an elevated level of prepayments during the second quarter and our non QM portfolio now.
Non QM origination volumes continue to grow as originators refocus on non QM production and agency refinancing slows.
We continue to engage with existing and new non QM originators closing a small purchase with a new originator during the second quarter.
With that I'll turn the call over to our CFO Lisa Meyer Lisa.
Thank you Sean before reviewing our second quarter results I want to highlight some of the recent improvements. We have proactively made are now financing arrangements, we continue to benefit from the broader western asset platform for.
Celebrating our ability to work with our strategic partners to improve liquidity and secure attractive longer term financing.
We amended our primary securities repurchase facility during the second quarter, which financed is mainly non agency MBS and RMB S asset.
The term of the facility was extended by 1 year, we obtained improved advance rates and secured more attractive pricing significantly lowering our borrowing costs from LIBOR, plus 500 to LIBOR plus 200.
At June 30, we had outstanding borrowings on this facility of $117.5 million secured by assets with a fair value of $204 million.
In addition, we amended our commercial hold on facility during the quarter converting it from a facility that automatically rolled every 30 days to now having a 1 year maturity.
At June 30th we had outstanding borrowings on this facility at the $115.3 million secured by commercial loans with a fair value of $165.8 million.
Moving to earnings we have provided great detail regarding our portfolio and our second quarter results in our press release and our earnings presentation. So I am only focusing on items that warrant additional explanation as Jennifer mentioned, we decided to renamed core earnings to distributable.
Earnings during the second quarter to address FCC comment letters recently received by some of our mortgage REIT peers.
For no changes to the calculation.
We reported distributable earnings of $2.8 million or 5 cents per share for the second quarter down from the first quarter's level of $6.1 million or 10 cents per share.
2 primary factors drove the decline for.
First we recorded $2 million of lower net interest income from our investment in the junior mezzanine loan that became non performing in May of 2021 that was put on non accrual status.
We experienced an elevated level of prepayments in our non QM portfolio that led to an increase of $2.4 million in loan premium amortization.
Our distributable earnings were 1 cent less than a quarter dividend of 6 cents per share. However, we evaluate the level of our dividend every quarter based on several faxing factors, including among other things our outlook for the sustainable earnings power of the portfolio and are taxed.
Book income.
GAAP book value for the quarter was $3.55 a decrease of 72 cents per share.
80 cents per share of the decline was driven by the lower valuation of the junior mezzanine loan discussed earlier.
However, generally we saw crude valuations across the remainder of our portfolio, which partially offset this decline.
Economic book value, which reflects the value of our retained interest in the consolidated securitization trust rather than the gross asset and liabilities decreased by $18.4 per cent for the quarter to $3.28 per share.
The decrease was mainly driven by the lower valuation of the junior mezzanine loan and a slightly lower value of the retained interest in our Arroyo securitization due to pay downs in the securitization.
Our recourse leverage was 2.5 times at June 30th up from 2 times at March 31st.
The modest increase was primarily due to a decrease in book value and slightly higher leverage from purchase of $10 million in non QM loans combined with an improved advance rate on our securities repurchase facility.
In summary, we continue to focus on actions that will solidify our capital structure and increased our liquidity and position us to benefit from the rebounding economy and the recovery of certain commercial real estate sectors that were most impacted by the pandemic with a significant portion of that asset now financed by debt.
Trap for longer term financing, we intend to focus on selectively growing our portfolio with the objective of improved financial results in the quarters ahead.
With that we will open up the call for your questions. Operator. Please go ahead.
We will now begin the question and answer session to asking question Press Star then 1 on a test handset.
You are using a speakerphone please pick up your handset before pressing the keys.
To withdraw your question Press Star then 2.
And the first question comes from Trevor Cranston with JMP Securities. Please go ahead.
Hey, Thanks, good morning.
I guess my first question on the.
Junior Mezz loan.
In the prepared remarks, you got it.
You said youre working on some resolutions with respect to that loan, but obviously nothing could be for sure.
Can you help us understand what kind of scenarios exactly are factored into the current valuation of the loan.
Where it's where it stood as of June 30th then you know what type of scenarios would potentially lead to further breakdown of that value right.
Okay.
Hi, Trevor this is Greg.
So yeah, there's a lot of scenarios being priced and you can see by the markdown.
That there's a lot of uncertainty around the around those scenarios.
So the discount rate that's being applied is quite high.
You know I think.
As negotiations continue we will get more clarity on those resolutions.
But for the time being we have to factor in.
You know several potential outcomes, including you know for the write down from the physician either through.
Through foreclosure on the asset or through bankruptcy.
Potentially and we also need to factor in the extension of the maturity date.
Potential decline in income.
Oracle accrual rates.
And so given the.
For the wide range of scenarios potentially that could that could affect us this outcome.
You know we have a meaningful.
Distribution across the process right.
Okay that makes sense and is there any sort of comment or for context, you could provide around sort of how long do you think.
Negotiations are likely to be ongoing for that loan and wouldn't be Mike.
Might see some sort of agreement or a resolution.
Okay.
I would say that the timing is still very uncertain.
<unk> situation.
But the negotiations are ongoing.
Yeah.
We believe it's a very valuable property and it's a tremendous traction we think that the lenders have an incentive to work together on this 1.
You know, we think that there is progress being made towards that but are.
Uncertainty still around the timing.
Okay fair enough.
And other on the rest of the commercial loan portfolio. I think you mentioned that 1 of the loans that paid off in July.
And it looks like several others are set to mature over the second half of this year.
I guess can you maybe.
At this point as you're thinking about those upcoming maturities is the expectation that you do you believe most of those loans are likely to pay off where do you think there could be.
Some loans that end up extending.
And then I guess the second part of that question is you do get some payoffs of these loans can you talk about sort of your prioritization of book.
Redeploying that capital into a different investment opportunities. Thanks.
Yes sure.
So so yeah, we're seeing a mix of loans paying off at maturity or prior to maturity.
Or what are their earliest maturity that is.
We have a couple of loans that are gonna have moderate extensions, but we feel very strongly that debt.
These losses are still.
Very well on track to pay off.
And cash flows continue to improve on the underlying assets and as noted in the comments.
Money market continues to open them up for you know across all property types.
So we are.
But for those that progress in terms of deployment.
The appointment of a.
Paydowns.
We're always looking for the best risk adjusted per ton.
Yes.
Return.
Possibly for the portfolio.
We do believe that the opportunities as I mentioned is lending is opening back up that we will continue to see more deal flow, whether that's from non qualified mortgage originations.
Other residential whole loan opportunities that were reviewing as well as.
Commercial real estate opportunities as well.
Okay got it.
On the other non QM portfolio, you mentioned, the increased prepayment speeds and <unk>.
It sounded like that was attributable.
Hopefully to just increased origination activity in that space.
I guess as you look forward in that portfolio it seems like.
The non QM origination of our Korean and focus from lenders is there for anything increasing or how are you thinking about the outlook for for prepay speeds within the Nokia on book do you think.
They're kind of going to remain around 2 P levels or is there some chance that they could.
Elevate further it's.
More lenders for Prada.
In that market.
Hi, it's Sean.
We've already seen the most recent prepayment print.
The lower than than the peaks that we saw earlier in the quarter or in the <unk>.
Second quarter. So we do think some of that prepayment activity was pent up demand during the Covid period when you.
Prepayment speeds for a little artificially low.
So.
We do think that just naturally the prepayment speed should should decline a little bit due to that.
But.
Interest rates do remain you know near the all time lows.
On mortgages and as you said the activity and focus of originators.
Is increasing in the space and the competition to create these things so you.
You know, we do think it'll be higher than it was during the COVID-19 period, but but probably not as high as we saw last quarter.
You know our portfolio is generally a little bit lower and note rate on average than than most and our prepayment speeds have been slower than many of the other non QM you know our competitors. So we do think we're positioned pretty well for for these rates we've Ava.
<unk> paying extremely high premiums on the loans that we did buy so despite the amortization that we saw this last quarter.
You know it isn't as bad as it is it could have been had we paid much much higher premiums were going to continue to focus on that strategy.
And you know the increased activity in non QM space is an opportunity for us that we intend to other chip.
Chip.
Okay. That's helpful. I appreciate the common cigarettes.
Yeah.
The next.
Next question comes from Derek Hewett from Bank of America. Please go ahead.
Good morning, everyone. How should we think about portfolio growth over the next year or so have been kind of debt those non QM opportunities plus other.
Other residential credit opportunities, while the portfolio remained relatively flat as a commercial.
So payoffs.
And that will just be replaced by Firefly residential credit or should or will we actually see portfolio growth over the next say 12 to 18 months and then.
What are your thoughts in terms of taking leverage a little bit higher at this point.
Oh sure.
Yeah, obviously.
We're evaluating the opportunity set in real time, so that's subject to change but.
I think the encouraging signs in terms of the lending market.
Great positive, although I would say.
On the commercial real estate side, you really are still seeing most of the lending you know really being targeted towards the COVID-19 winters.
And so what you're seeing.
Cap rates declined meaningfully so.
I would say somewhat priced to perfection.
On some of the higher quality, COVID-19, winning type asset and still more uncertainty and risk premium surrounding the.
Things like offices.
And hotels, so I think in terms of the opportunity set.
You know, we do believe right now it's more focused on the residential side clearly the fundamental backdrop there is quite strong.
And we do see some of the GSE limits being triggered in pushing some product back into the non agency space, where there's pretty much no non non agency mortgage origination in 2020.
That is encouraging.
But we are we are evaluating the landscape and we do believe that.
Given the.
The relative tightness for the credit box that still remains that we have.
The ability to really select the best quality asset.
And you know.
Priced appropriately.
Yes, we've seen some interesting products coming out of some of our non QM.
Originators, including <unk>.
15 year product, which really fits into our more conservative.
Our focus in the non QM space so.
We're encouraged by that we've.
We've had discussions with the our current originators and ones that are new to us as well that had been that had been very productive. So we do think that we'll see.
Some growth in our in the in the non QM area and as Greg had mentioned potentially some of those.
You know loans targeted towards agency, where the the limits are from the FHFA of have.
Pushed some of that product into the into the private label space. So we're looking at those opportunities right now and making progress there.
And just 1 more point on leverage we do think that we're pretty conservatively levered at this point.
Depending on opportunities you could look to to grow that.
And reduce some of our cash drag on the portfolio.
And we do have we believe you know a fair amount of room still on the lines that we have in place.
And as Lisa mentioned.
These lines are much more conservatively structured now with.
Longer term less less rollover risk, so we feel comfortable increasing the leverage.
Should we find the appropriate opportunity.
Okay, Great and then I believe it was roughly there was a 2 million drag in terms of prepayments.
Higher prepayment speeds since this quarter has that normalized.
And in.
And in Q3, so far.
We've seen only 1.1 prepayment print so far that you know that it's really the speeds from collections in.
In in June so.
And then that was lower so we have seen prepayments speeds declined slightly but it's only 1 observation so far so it remains to be seen what.
What what the prepayment speeds will be say over the next couple of months, but but it does make sense for us to see them come down.
Okay, and then lastly for me did you provide any sort of.
Timeline in terms of the resolution of that hotel loan that is in bankruptcy.
It's still uncertain. So I don't believe we gave any definitive timeline, but there's definitely the bankruptcy proceedings.
You know continue.
And.
Yeah, I think it's.
I mean, just given the quarter.
Given given the write up.
Could it be resolved by the end of this year or.
Are there certain technical issues, where it could drag out a little bit longer.
I think there's definitely a good chance that it could get resolved by the end of the year.
Okay.
Thank you for taking my questions.
Thank you.
Okay.
As a reminder, if you have a question press Star then wanted to join the queue.
The next question comes from Jason Stewart of Jones trading. Please go ahead.
Hey, thanks for taking the questions.
First I think everybody appreciates investors certainly do western commitment to <unk>.
This junior Mezz loans. So thank you for putting all the resources behind that I guess, a technical question on it what factors have led to the senior lenders extending this assignment for the third time or maybe if you could give us an update if they've done it again since July 15th.
Yeah, So the way to go.
<unk>, which started in earnest I would say in may of.
Of this.
This year.
You know has definitely brought all of the parties to the table.
We've seen you know.
A good amount of.
Back and forth and I would say.
Progress towards.
The resolution, but I'm still very uncertain in terms of the timing and the eventual.
Right.
Eventual.
Shape thereof, but there.
There has not been.
1 second.
Yeah.
Yeah.
Okay.
Apologies for that.
Again, it's a fluid situation and those negotiations are ongoing.
Okay.
And I guess technically there, though you do have the right as a junior Mezz fund or to force the entity into bankruptcy.
Okay.
I think it's a it's a much more complicated.
Yeah.
That side would be very it would be a complicated resolution I don't think that that's.
The high probability.
Okay, Okay, I'll leave that part there.
And then on the convert any plans to I mean for 14 months out to 160, plus ish million something like that what are the plans for the retirement of the convert.
Hey, Jason its free cash flow.
We're very mindful of the maturity in 2022, so we continue to evaluate opportunities to refinance that convert them, which would include us continually buying back more notes in the open market as well as outright financing a smaller portion of what's outstanding.
Okay.
It trades at a 9% yield to call. So we're at a yield to maturity at this point would.
Would you think that you could refinance it at a tighter spread I mean or where are you looking at this more holistically and I guess Jennifer. This question goes to you I mean, when we pull all this together regardless of how you resolve these challenged credit Suisse seemed like some go 1 way or the other what is WMC look like in 2023 when should this converged on challenge credits.
It's a little bit less skilled or a platform.
What does it looked like for you going forward from that point.
Okay.
Yeah. Thank you.
Youre right I think we're I mean at this point I think with as Greg and Sean If you know come into their new roles and really and sort of a day and the broader team at western asset have engaged in you know helping to sort through the issues in the portfolio, mostly stemming obviously from the pandemic I think.
We're really encouraged by the whole things beyond the 2 travel once we've talked about the hotel are holding as Greg said I think when we think it's likely to get resolved in the near term and the other you know where for sort of actively very actively working on so I think you know looking ahead, a year or 2 there.
I think we're optimistic about our ability to construct the portfolio in a way that will allow it to perform again again, there. There's a lot of good assets and performance in their Sean highlighted that I think certainly our non QM strategy as a highlight of the portfolio. So I would expect us to continue to focus on.
On that also at Western we've added to our our commercial team and some additional professional and I think we're Greg it's and Sean for very optimistic about our ability also to out there. So I think we're looking towards a REIT.
We are building you know our high quality portfolio and that will allow us to access capital markets and also as you know in the past we've considered M&A, yes for a small we have some oh some of our fellow peers are also a small we've we've.
Centered M&A in the past I would expect us to do that again, and so I think it'll be a combination of performance, which will allow us to access capital markets and looking for a potential M&A opportunities that could be beneficial to WMC shareholders.
Got it okay. Thank you I appreciate the color.
Okay.
This concludes our question and answer session.
Now, let's turn the conference back over to Jennifer Murphy for any closing remarks.
I just wanted to thank you all for joining us today, and we'll look forward to talking with you soon thank you.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.
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