Q3 2021 Western Asset Mortgage Capital Corp Earnings Call
Welcome to Western asset mortgage capital Corporation's third quarter of 2021 earnings conference 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 a listen only mode.
It will be open for 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 Matt.
Want to thank everyone for joining us today to discuss western asset mortgage capital Corporation's financial results for the third quarter of 2021.
The company issued its earnings press release yesterday afternoon, 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, 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 Bonnie Wang to cool Chief Executive Officer.
Lisa Meyer, President and Chief Financial Officer.
Craig 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 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 factors section of the company's reports filed with the S. E C.
We disclaim any obligation to update our forward looking statements unless required by law.
With that.
I'll now turn the call over to Bonnie walked through cool Bonnie.
Thank you Larry and welcome everyone I.
I'm pleased to be joining WMC recently appointed CEO and look forward to meeting.
Thanks.
I'm just saying.
Alright.
Great.
Mike.
However, many of you may not know me I thought it appropriate to provide you some background on my tenure.
Yeah.
I joined Western asset.
And have more then.
That's it.
I was a member at western asset mortgage and consumer credit.
Great.
That is a portfolio manager and managing the firm.
Yeah. Thank you good morning.
My more recent.
The increase being a member of the firm.
Got it.
As well as chairman of the ESG strategic.
With respect to WMC I have enjoyed partnering with the right handler and Sean Johnson over the year and look forward to working with them and work Firstly again, alright at the senior management.
I also want to congratulate Lisa Meyer Stanislaw President and CFO.
Pete.
Lisa has served as CFO and treasurer since 2016 and brings more than 23 years.
To the role.
He has been a principal contributor to the company's financial and operating strategy, particularly as we continue to strengthen.
Our balance sheet.
At this time I want to take a step back and review the proactive steps we have taken over the last 18 months.
The impact of the pandemic.
While our portfolio.
Following the onset endemic in the spring of last year, resulting in volatility in the equity and fixed income markets adversely impacted portions of our portfolio, which led us to take Swift action to protect the portfolio strengthen our balance sheet and reduce overall risk.
Our early actions involved significantly reducing our leverage securing longer term fixed rate financing at attractive level, reducing our reliance on short term repurchase agreements, increasing our liquidity and bolstering our common equity by selling new shares at a premium to book value.
Over the course of 2020 and throughout this year, we have focused on strengthening our balance sheet, Laura recourse leverage refinancing and extending our funding agreements and improving the earnings power of the portfolio.
To be specific we have number one be here longer term financing for our commercial and residential whole loans.
Aggregate street, including a $356 million securitization of a large portion of our residential non QM, but.
Number two recalibrated, our dividends to better reflect the earnings profile of our portfolio.
Number three repurchased or retired approximately one $159 million.
Of our 2020 due to temporary quite our convertible senior notes at an average discount of three 5% and number four issued $86 million of new convertible notes that mature in 2024.
The combination of our new note issuance and the repurchase of our existing debt during the quarter enabled us to reduce our convertible debt by $36 million, which improves our ability to further execute on our investment strategy.
These actions were driven by our commitment to protecting shareholder value and improving our earnings power.
Turning to our investment activity. This year, we have focused on residential non QM origination and area, where we have deep experience and a solid track record.
Western asset had been investing in this sector since 2014, and WMC has not experienced any cumulative losses over the whole time frame.
We continue to view non QM, if an attractive value proposition and as of September 32021 have acquired more than $240 million of residential and non QM loans.
Our residential portfolio has performed well this year as the housing market and consumer balance sheets remain strong.
We expect housing price appreciation to moderate we believe that housing market will remain well supported given favorable supply and demand dynamic and disciplined lender underwriting standards.
Our commercial portfolio is also benefiting from the economic recovery and a more vibrant sale and refinance markets.
Aside from the two special situations that we have discussed in the past and have been diligently working through most of our commercial investments continue to perform in line with our expectations for continued economic recovery.
This year, we have received approximately $162 million in proceeds from payoffs in our commercial portfolio, including both hold on and non agency MBS investment.
In the third quarter alone we had five of these investments fully pay off the balance.
And nearly a $150 million in proceeds.
We have used those proceeds to make new investments in non QM loans and to pay down debt.
Both Greg and Todd will discuss our portfolio strategy in more detail, but I will say that under current market conditions going forward, we expect that our core investments will focus on high quality residential non QM investments complemented by select commercial investments that are backed by solid properties and seasoned sponsors.
We believe that this portfolio mix will enable us to maintain our current relatively low leverage and enhance our ability to return to generating sustainable earnings that support an attractive dividend with the overall goal of protecting and improving value for the benefit of our shareholders.
Now I'll hand, it over to John and Gregg to go into more detail about the investment portfolio Don.
Thanks Bonnie.
Residential investments continue to perform well in the third quarter benefiting from a strong housing market fueled by historically low mortgage rates tight supply favorable consumer sentiment and rising income third quarter National home price indices again, ROE rose at double digit annual rates.
We remain constructive on the U S mortgage credit mortgage underwriting today's perform much more responsibly than it was in prior periods.
And when combined with our fundamental strengths in today's housing market consumers are generally less burdened with mortgage payments and have more equity in their home.
This provides a cushion to withstand home price fluctuations and swings in economic conditions when they occur.
The percentage of loans that were part of a forbearance plan decline dropping to 0.6% at quarter end from 6% at the beginning of the year.
But one of the loans in forbearance are now in their repayment period we.
We see this as a confirmation of the effectiveness of our credit underwriting where we focus on high quality borrowers that have meaningful equity in their homes as we believe it creates a strong incentive for them to prioritize their mortgage payments and remain current on their obligations.
Prepayments in our non QM portfolio remained somewhat elevated.
LOE for the second quarter was $44 seven CPR to 34 CPR in the third quarter.
Non QM origination volumes continue to grow as originators focus on non QM production.
We continue to engage with existing and new non QM originators and acquired $233 million of.
Residential whole loans during the third quarter as Bonnie mentioned, we expect that for now this will remain a core focus for us given our solid track record in this space and its favorable risk return profile.
As we have discussed in the past we have developed strategic relationships with residential mortgage loan originators, who understand our specification as well and are able to provide us with attractive opportunities to meet our disciplined criteria.
Our approach to residential whole loans has always been to focus on high quality borrowers with lower ltvs were able to demonstrate a strong desire and ability to repay.
We plan to continue to grow this portion of our portfolio in the near term with the goal of financing these investments through another securitization securitization.
Securitization with that I'll turn the call over to Greg handler discuss our commercial holdings right.
Thank you Sean.
In regards to our commercial loan portfolio. This quarter, we received full payoffs on three of our commercial loans, representing $101 million. We are encouraged by the improving trend.
Loan activity and we believe this more favorable financing environment will benefit our fix or remaining loans, representing a $100 million.
Particularly for properties with post Covid stabilized cash flows. However, there can be no assurances this will be the case.
Similarly, similarly, the commercial securities portfolio also saw a significant pay down during the quarter. We received a full payoff of $11 million on a non agency MBS investment that was valued on our books at an approximate 5% discount or reversing an unrealized loss on that investment.
We also received $45 $3 million from the repayment of our subordinated interest.
Our AGM 2019 securitization.
Which was fully paid off during the quarter.
You may recall that this securitization originally consisted of over $900 million.
Combined bond tranches and was backed by a diverse portfolio of primarily retail power centers located across North America.
Most of which were sold over the last two years by the REIT sponsor.
Let me now provide a brief update on our two special situations.
As to the $30 million of hotel loan that we had previously discussed.
After dismissal of the borrower's bankruptcy proceedings.
And the other holders of alone foreclosed on the property for the purpose of Sterling.
Marketing the property and begun but continuing litigation is delayed a resolution.
We believe that based on preliminary indications there is a reasonable likelihood that the outstanding principal balance of $30 million and interest payments will be recovered we.
We hope to have final resolution in the near future. Although there is no guarantee that we will realize a full recovery.
With respect to the junior mezzanine loan backed by our retail and entertainment complex located in the northeast.
We continue to be in discussions with the borrower and certain other lenders regarding potential alternatives to address the situation.
Given given the ongoing uncertainty regarding possible outcome, we recorded an additional $5 $2 million write down on this loan during the quarter.
The loan is currently marked at a value of $27 5 million and there is a risk of further impairment under certain outcome.
We continue to work diligently on reaching positive resolutions for these two challenged investment as well as positioning the remainder of our commercial portfolio for potential future appreciation.
Outside of Nonqualified mortgages, we may reinvest some of the proceeds from our commercial sale into our other core strategies.
Within the MBS in CRE, we are looking to supplement our residential holdings with select high quality commercial investments, particularly in the new issue non agency MBS market.
While we are seeing attractive opportunities and newly underwritten post COVID-19 stabilized properties.
Targeting transactions that have solid credit fundamentals and strong covenants that protect us as lenders. We like these loans because we are able to get involved in the deals early and can often collaborate on key aspects of the structure.
We are encouraged by the continued momentum in the U S economy, and the signs of improvement in many of the commercial real estate markets.
The resurgence of consumer spending has led to higher retail sales.
Which has been strong the beginning of the year.
As a result retail occupancy rates and rental collections are improving in many markets.
We have also seen a healthy rebound in leisure travel, which has led to improved hotel operating metrics across the country.
Particularly in the resort and limited service.
The segments in the market.
In summary, we remain focused on positioning our existing portfolio for potential future appreciation and growing in a disciplined manner with new investments that offer attractive risk adjusted return.
I'll now turn the call over to Lisa Meyer, our president and CFO.
Uh huh.
Thank you Greg before.
Before I review, our third quarter results I want to discuss further improvements we have proactively made to our financing arrangements to improve our balance sheet.
As Bonnie mentioned in August, we repurchased $22 $3 million.
Have you get principal amount of our 675 convertible senior notes due October one 2022.
At a weighted average discount to par value of two 8% in September we issued $86 million of new $6 75 convertible senior notes due in September of 2024 and used the net proceeds together with approximately $20 million of cash on hand.
To repurchase an additional $100 about 2022 notes.
This resulted in a remaining balance of only $46 million in our existing 2022 notes at quarter end.
These transactions have enabled us to not only extend the maturity for two years on two thirds of our remaining convertible debt, but also lowered the overall convertible debt by $36 million, we have ample liquidity liquidity to address both our 2022 note maturities and to X.
On our investment strategy.
We continue to focus on improving and diversifying our other sources of recourse financing.
Now turning to our financial results.
During the quarter, our residential portfolio continued to perform well as did a number of our conversion commercial investments.
The repeatable earnings for the quarter were $3 $8 million or six cents per share an improvement of $1 million from the second quarter.
At the same time, our financial results during the quarter were negatively impacted by the further decline in fair value of a noncontrolling performing commercial loan.
As well as spread widening on certain non agency MBS holdings.
This resulted in a GAAP net loss of $4 $2 million or seven cents per share and a decrease in our GAAP book value to $3 45 pence per share down two 8% from the second quarter.
In addition, we've experienced elevated levels of prepayments in our non QM portfolio during the quarter that led to $2 1 million in loan premium amortization.
Economic book value, which reflects the value of our retained interest in the consolidated securitization trust rather than the gross assets and liabilities decreased by two 4% for the quarter to $3.20 per share.
Economic return on GAAP book value was a negative one 1% for the quarter and included a six cent per share dividend.
Oh dividend of six cents per share six cents per share has been consistent for the last four quarters.
We evaluate the level of our dividend every quarter based on a number of factors, including our outlook for the sustainable earnings power of the portfolio and our taxable income.
Our recourse leverage was two nine times at September 30th up from two five times at June 30.
Modest increase was primarily due to the additions we made to our non QM holdings, which occurred later in the quarter.
In summary, we continue to focus on actions that will solidify our capital structure and maintain our liquidity, while positioning W and seek to benefit from the growing economy and any ongoing recovery of certain commercial state commercial real estate sectors that were most impacted by the pandemic.
With a significant portion of our assets and now financed by attractive long term financing. We feel we are well positioned to grow our portfolio through selective investment opportunities with the objective of improved financial results in the quarters ahead.
That we will open up the call to your questions.
Operator, Please go ahead.
We will now begin the question and answer session.
Ask a question you May press Star then one on your Touchtone phone.
If you are using a speakerphone please pick up your handset before pressing the keys.
If at any time your question that's been addressed and we would like to withdraw your question. Please press Star then two.
At this time, we will pause momentarily to assemble our way.
Our first question will come from Trevor Cranston with JMP Securities. Please go ahead.
Hey, Thanks, good morning.
A question on.
Capital available for new investments.
They're obviously in the third quarter.
Significant amount of payoffs from the commercial portfolio.
And we're able to acquire some new residential loans.
Looking at the remaining commercial loan portfolio. It looks like the pay ups are kind of skewed towards the back half of 2022.
I guess as you look out over the next couple of quarters do you feel like you have enough capital available to continue acquiring new loans sort of roughly at the pace you were growing in <unk> or <unk>.
Going forward, they're going to be somewhat dependent on.
Continued payoffs from the commercial loan portfolio in particular.
Hey, Trevor.
Thanks for the question.
We feel great.
Very strongly on our capital position right now.
We've continued to book.
Acquire new assets, but also pay down existing debt.
We feel that way.
We're in a position to continue to grow the balance sheet.
And we will look to.
Potentially.
Great additional capital through terming out additional financing.
It would be a securitization as well.
So I think we're a good position.
To.
To redeploy capital as well as to pay.
Pay down debt.
In terms of the payoffs scheduled.
Yeah, you're right the commercial portfolio.
There's a little bit into 2022, although we.
We may see pay downs ahead of that as well.
<unk>.
Oh, I'm sorry, yes.
Yeah, I think thats pretty accurate we've got.
Proved advance rates, you know small air cuts on R. R.
Warehouse financing.
And then you know.
Our projected securitization will also generate some free cash to do some some interesting things with it so.
We don't really feel like we're capital constrained.
You know anytime in the near term here.
Okay got it.
And on the non agency MBS portfolio in particular.
You mentioned a couple of payoffs this quarter.
Is there any sort of where you can help us think about.
You know your projection for.
Continued payoffs within that portfolio and whether.
Whether it's through refinancings or maturity of those loans.
Sure Yes.
Amidst the market had been pretty much the last.
You know fashion to recover.
We've seen a tremendous amount of.
Activity in the second half.
Starting in second half of this year.
New issue non agency commercial mortgage origination volume.
It has.
Been nothing short of spectacular in the last couple of months I think October was the strongest issuance month on record post GST. So that trend. We do think is very positive.
Yeah.
The confidence of lenders and no just the ability to obviously see through COVID-19 and even to re underwrite loans due to COVID-19 levels with cash flows.
Clearly the parts of the market that's at the basket during Covid things like apartments, and industrial distribution logistics.
The properties had been the first to recover but we've been encouraged seeing things they still have COVID-19 related questions.
Things like offices, and hotels, and even high quality retail.
Getting financed in refinancing.
And then just overall transaction volume.
<unk> been pointing to the amount of money raised by distressed.
Investors looking to capitalize on the opportunities.
And do you think theres a lot of dry powder, so CRE transaction volumes also.
It picked up significantly in the third quarter well.
Well on pace to being the highest levels.
CRE transaction volume post the post GST as well so.
So we do think that.
That should help shore up liquidity in some of the legacy non agency positions and.
And we do feel like the resolutions on some of these question.
<unk> assets are.
With or without <unk>.
Dressed under Covid does feel like the trend is that they're breaking towards more positive resolutions.
Generally we think that that should benefit our holdings as well.
Okay. That's helpful.
And then on the non QM side could you give us a sense roughly kind of where you're projecting returns on doing a new securitization today.
Given where loan prices are and the sort.
So where the execution is on new securitization.
Sure.
New Securitizations are the ones that are pretty you know in the last week or two have been have been lighter than they were you know say in September.
So it makes it makes our handicapping the returns a little bit tough, but I'd say it.
If it was mid teens yield before it might be low teens now.
Okay Gotcha.
Then last question on the.
The Mezz loan, which there was a small write down on this quarter.
Can you just help me understand is that was there any sort of change in the status alone, which led to that write down or is it sort of a situation where.
The more time that progresses without a positive resolution.
The value of the lenders.
Deteriorates overtime.
Sure so.
So yes.
On a quarter, but I wouldn't say there was any material.
Event that led to that.
The ongoing negotiations obviously, we're getting.
Somewhat of a sense of what the potential outcomes may be and we are communicating those.
Ongoing discussions with the third party pricing service, whose value adding the.
With the final valuation.
So.
Yeah, I would say.
Yeah.
Some ways I think.
Time is actually our friend and that's the longer it takes.
Along the longer.
The property has.
The ability to stabilize and our values.
Values, we see tremendous value in the assets over the long term.
We're looking to position to capitalize.
And recover as much of that.
Over time so.
I think we.
We're still working diligently to protect our position there and.
I think just the.
Clearly you see the range of outcomes, it's still very broad.
And.
Factoring in several different.
The potential is there and also just a very high discount rate given the high level of uncertainty.
The main drivers.
Okay that makes sense appreciate the color. Thank you guys.
Okay.
Our next question will come from Jason Stewart with Jones trading. Please go ahead.
Alright. Thanks, Thanks for taking the questions just to follow up on the the Mezz loan and the northeast and the advent of an adverse outcome does it look more like an equity participation instead of alone how do you think about that sort of tail distribution.
That's certainly part of the.
The analysis.
I think.
Yeah.
Would it be appetite to be converted.
Preferred equity.
To add some sort of a split between loan and preferred as well.
So again I think we want to see is the stabilized cash capital structure that allows a property with two to four.
Holy Open and give everyone in the capital stack time to recognize the full value.
So that's really our NGO.
But obviously the adverse there's even more adverse scenarios.
Which we're also backing you beyond that.
Okay and then.
Let's just take the assumption that it's worth less.
The lesson you have it marked at now are those some of your comfortable with the fair value of it how do you look at repurchasing stock and your comfort level with the way you allocate capital.
For new investments versus something like a stock repurchase today.
Yeah.
Hi, it's Lisa So we you know we have to balance the two where do we want to repurchase stock or whether we want to.
Allocate that to the two investments in and we review both scenarios.
We are we are small and so actually buying back stock, we will actually make a smaller and one of our goals is to really try to grow the company and we think in order to grow the company.
Capital will be at a better allocated to new investments.
Okay.
Those investments generate a higher R O E than repurchasing the stock.
Some discount to book value.
Yes, or how do you.
And then how do you think about the cost structure of the company as you've talked to that into the equation.
Okay.
I think we are comfortable with the cost structure of the company I think with the refinancing of our convertible notes and also overall, reducing our convertible note debt and you know we're going to look to continue to do that.
Yeah, I would just add that that certainly on the cost structure. We do recognize that scale is very important in this business.
We are looking to at least at that organically grow that's our first priority to grow the portfolio through our investment strategy.
We believe we can do that we see good opportunities and we'll do it in a very disciplined manner that we think it's going to be accretive to shareholders.
Alright, thanks for taking the questions appreciate it.
Okay.
Again, if you have a question. Please press Star then one.
Is there no more questions. This concludes our question and answer session I would like to turn the conference back over to Bonnie Wang Trickle, Chief Executive Officer for any closing remarks.
Thank you operator, and thank you all again for joining us for today's call. We appreciate your continued interest in WMC and hope everyone remains healthy and they have a great day and I look forward to personally connecting with you in the weeks ahead.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.