Q4 2021 Western Asset Mortgage Capital Corp Earnings Call
Okay.
Welcome to the Western asset mortgage capital Corporation's fourth quarter and full year 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.
The 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 Tom I want to thank everyone for joining us today to discuss western asset mortgage capital Corporation's financial results for the fourth quarter and full year 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 management are Bonnie walked you cool Chief Executive Officer, Lisa Meyer, President and Chief Financial Officer, Greg 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 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 this 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 SEC.
Same any obligation to update our forward looking statements unless required by law.
With that I'll now turn the call over to Bonnie one to cool Bonnie.
Thank you Larry and welcome everyone.
As you know we announced last December that going forward, we plan to focus on residential real estate related investments and to transition out of the commercial investments in our portfolio.
We expect this transition to occur over the next 12 to 18 months.
We believe this focus will allow us to address attractive market opportunities, while maintaining alignment with western assets core competencies.
Investing in residential non QM whole loans is an area, where we have deep experience and a solid track record.
Western has been investing in this sector since 2014, and WMC has not experienced any cumulative losses over this timeframe.
During the fourth quarter, we continued to implement our strategic shift by acquiring approximately $185 million of residential whole loans.
Studying the maturity of our residential whole loan facility and exiting 'twenty $7.5 million of our non agency MBS investments.
In addition, we repurchased an additional $8 million of our 2022 convertible notes and bought back approximately 480000 shares of our common stock at a significant discount to book value.
In February we completed our third securitization of approximately $400 million stock by $432 million of residential whole loans.
This securitization enabled us to lock in long term fixed rate financing at attractive weighted average interest rate of three 1%, which we believe was the right move given the market expectations for short term interest rates to rise in 2022.
In addition in February we reached a successful resolution on one of our challenged investments specifically, we sold the unencumbered hotel property, we foreclosed on in 2020 one.
We received $36 million in net proceeds and estimate we will record a $6 $7 million gain on sale of the property.
We are in the process of redeploying the proceeds which we anticipate will be a combination of investing in our target assets retiring a portion of the remaining outstanding principal amount of our 2022 convertible notes and repurchasing our common stock.
We anticipated that as we transition and repositioned our portfolio there could be timing issues that would impact the near term earnings power of our portfolio. This was the case in the fourth quarter as our earnings were negatively impacted by several factors.
First relating to the transition we had lower net interest income for the quarter as we exited $157 million of commercial real estate investments in the third quarter, we incurred incremental expenses associated with the ownership and sale of the hotel property and we placed one investment in our non agency MBS portfolio.
Non accrual status.
Second we experienced elevated prepayment activity on our residential whole loan portfolio and third market conditions in the fourth quarter were challenging due to a higher interest rate volatility and fluctuating asset values.
The combination of these factors resulted in a GAAP net loss of $12 $1 million or 20 cents per share.
Distributable earnings of $908000 or one cent per share and a decrease in our GAAP book value per share of seven 2% from the third quarter.
Well this was clearly a challenging quarter, we remain committed to growing our portfolio and protecting shareholder value. We are confident that we are taking the necessary steps to resolve our challenge investments strengthen our balance sheet and improve the earnings power of the portfolio in order to generate sustainable earnings that support an attractive.
Dividend.
Now I'll hand, it over to John and Gregg to go into more detail about the investment portfolio Sean.
Thanks, Bonnie our residential investments continue to perform well in the fourth quarter benefiting from the strong housing market supported by historically low mortgage rates tight supply healthy consumer balance sheets, and rising incomes fourth quarter National home price indices again rose at double digit annual rates.
While we expect home price appreciation to moderate we believe the housing market will remain well supported given the favorable supply and demand dynamics.
Disciplined lender underwriting standards.
Mortgage underwriting today is performed much more responsibly than it was in prior periods and when combined with the fundamental strength of today's housing market consumers are generally less burdened with mortgage our mortgage payments that have more equity in their homes. This provides a cushion to withstand home price fluctuations and swings in economic conditions.
When they occur.
With respect to our portfolio loans in a forbearance plan decline dropping to just four loans at year end from 149 loans at the beginning of the year and at year end. These four loans were in their repayment period.
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 that obligation.
Mortgage rates remained low during the fourth quarter, but prepayments prepayments in our non QM portfolio declined to $28 two CPR from the third quarter's level of 34 CPR.
Non QM origination volumes continue to grow as originators refocus on non QM production, we continue to engage with existing and new non QM originators and acquired $185 million of residential whole loans during the fourth quarter, bringing the year's total to two sorry $428 million.
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 that 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 securitization as Bonnie mentioned.
In February we successfully executed our third residential whole loan securitization continuing our strategy of securing permanent financing on our holdings.
In addition, during the fourth quarter, we amended our residential whole loan facility obtaining approved terms and extended maturity lethal will provide additional details of the new terms during her comments.
And with that I'll turn the call over to Greg handler to discuss our commercial holdings Gregg.
Sean.
In regards to our commercial loan portfolio in the fourth quarter, we sold approximately $28 million of non agency commercial mortgage backed securities and subsequent to year end, we sold the hotel that we acquired last year through foreclosure.
As Bonnie mentioned, we plan on exiting the majority of our commercial holdings over the next 12 to 18 months.
Organic pay downs and opportunistic dispositions.
At year end, we held $130 million.
Commercial whole loans at fair value.
Representing seven months with all but one performing in line with expectations.
These six loans are expected to pay off over the next 18 months as we believe the refinance market and will remain a viable alternative for the borrowers, particularly for those properties with post COVID-19 stabilized cash flows.
However, the ultimate timing of loan payoffs remains uncertain as it depends on the specific factors pertaining to each property.
With respect to the junior mezzanine loan backed by our retail and entertainment complex located in the northeast U S. We continue to engage in discussions with the borrower and certain other lenders regarding potential alternatives to address the situation.
We believe the lenders and borrowers are looking to strike a balance by avoiding as you're just judicial process.
And granting the project time and a path to recovery.
Given the ongoing uncertainty regarding possible outcomes. Our loan is currently marked at a value of 29 spot 1 million up slightly from the third quarter based on the ongoing development.
As we have noted previously there are remain a risk of further impairment under certain scenarios.
Within non agency commercial mortgage backed securities are large loan credit portfolio, which is valued at $84 million from may.
Mainly of a class a class a retail and hotel properties that cater to leisure travelers and we are continuing to see positive operating momentum at a number of these properties.
This portion of our portfolio had an approximate 65% original loan value in all but one of these loans representing $2 million of the $84 million portfolio remains current.
Our properties are generally high quality assets with strong equity sponsors. So we believe that their collateral values have not been material materially or permanently impaired.
Our <unk> conduit exposure is valued at $21 million and while credit trends are improving on some loans others remained challenged.
We continue to believe that many of these near term challenges. We will eventually recede as COVID-19 restrictions continued to be lifted and the economy moves towards a full reopening.
As I mentioned during the quarter, we exited three see MBS credit positions.
Approximately $28 million at fair value.
These sales consisted of two conduit in one single asset single borrower securitization.
We believed that the upside relative to the downside for these investments what skus and that there were better alternatives for the capital in our target assets.
We will continue to evaluate future potential sale of our investments in this space as we seek to optimize our recovery values.
In summary, we remain focused on positioning our existing commercial portfolio for potential future appreciation and growing our residential portfolio in a disciplined manner with new investments that offer attractive risk adjusted returns.
I'll now turn the call over to Lisa Meyer, our president and CFO Lisa.
Thank you Greg before reviewing our fourth quarter results I want to highlight some of the measures. We have recently taken to further improve our balance sheet.
WMC continues to benefit from the broader western asset platform to <unk>.
Militating, our ability to work with our strategic partners to improve liquidity and secure attractive longer term financing.
In November we amended our residential whole loan facility the.
The amended facility has a 12 month term a stated capacity of $500 million and bears an interest rate of LIBOR, plus 2% with a LIBOR floor of 25 basis points.
At December 31st we had approximately $396 million outstanding on this facility.
In February of 2022, we completed our third securitization of non QM loans, which provided long term financing for $432 million of loans, which were previously financed under our residential whole loan facility.
Completing the securitization the outstanding balance on our residential whole loan facility was reduced to approximately $30 million.
Leaving $470 million of borrowing capacity under the facility, which will be utilized to continue growing our residential whole loan portfolio.
In the fourth quarter, we repurchased an additional $8 million aggregate principal amount of our existing 6.75 convertible senior notes due on October <unk>.
First 2022.
At a weighted average premium to par of approximately 1%.
At year end, we had a remaining outstanding balance of $37 $7 million on the 2022 notes.
Our goal is to continue repurchasing and retiring the 2022 notes prior to their maturity.
Provided accretive repurchase opportunities exist over the next seven months.
Okay.
We believe that we have ample liquidity to address the maturity of about 2022 notes and execute on our investment strategy with the February securitization and the sale of the hotel asset as of February 28, 2022, we had approximately.
$70 million of cash and cash equivalents as well as unused borrowing capacity under both our residential and securities financing facilities.
Now turning to our financial results.
We have provided great detail regarding our portfolio and our fourth quarter results in our press release and our earnings presentation. So I am only going to focus on items that warrant additional discussion.
We reported distributable earnings of $908000 or one cent per share for the fourth quarter.
Down from the third quarters level of $3 $8 million or six cents per share three primary factors drove the decline.
First we recorded $1 $2 million lower net interest income from an accounting change to a distress conduit non agency <unk> see MBS security to the cost recovery method.
Second we experienced an elevated level of prepayments in our residential whole loan portfolio that led to an increase of $400000 in premium amortization in the fourth quarter.
For the fourth quarter, we recorded a total of $2 5 million of premium amortization.
Third we experienced lower net interest income for the quarter from payoffs of $157 million of commercial real estate assets and $90 million of residential whole loans.
While the capital was redeployed into new residential investments, we did not get the full quarter benefit of either the additional income or the improved cost of funds under the amended residential whole loan facility.
Also the residential investments are generally lower yielding than the commercial investments that paid off.
The aggregate decline in net interest income was approximately $1.1 million.
We believe our earnings will improve as prepayments speeds decline and as we deploy the $36 million of capital. We received from the hotel sale into both income producing assets and repurchases about 2022 notes.
In addition, our <unk>.
Earnings will benefit from the 25% reduction in the management fee for 2022 paid to our manager.
Okay.
Well all distributable earnings for the fourth quarter were lower than our dividend of six cents per share. It is important to note that we evaluate the level of our dividend every quarter based on several factors. These factors include our outlook for the long term sustainable earnings power.
Of the portfolio.
And our taxable income.
GAAP book value for the quarter was $3.20 per share a decrease of 25 cents per share from the third quarter.
The majority of the decline or <unk> 18 per share was mainly driven by modest spread widening in our residential whole loan portfolio.
Lower net interest margin on the portfolio of $2 2 million or four cents per share.
And nonrecurring transaction costs of $1 $3 million or two cents per share associated with the hotel asset that was sold in February of 2022.
Economic book value, which reflects the value above our retained interest in the consolidated securitization trust rather than the associated gross assets and liabilities.
Kris by six 2% for the quarter to $3.03 per share.
Now turning to our leverage our recourse leverage ratio at year end was three eight times up from two nine times at September 30th 2021.
This was primarily due to financing new investments of residential whole loans under our residential whole loan facility.
As we completed the securitization in February which is non recourse a recourse leverage ratio has declined as expected.
Our recourse leverage ratio will fluctuate as we continue to grow the portfolio with the goal of executing additional securitization.
In summary, we continue to focus on actions that will solidify our capital structure and maintain our liquidity, while positioning WMC to benefit from the improving economic conditions and the ongoing recovery of certain commercial real estate sectors that were most impacted by.
The pandemic.
With a significant portion of assets now financed by attractive longer term financing, we feel that we are well positioned to continue to grow our portfolio through select investment opportunities with the objective of improved financial results in the quarters ahead.
With that we will now open up the call to your questions. Operator. Please go ahead.
Thank you we will now begin the question and answer session.
You'd like to join the question queue Press Star then one.
If you're using a speaker phone please pick up your handset before pressing the keys to withdraw yourself from the question queue Press Star then two.
We will pause momentarily to assemble our roster.
Okay.
The first question comes from Trevor Cranston with JMP Securities. Please go ahead.
Alright, thanks, good morning.
You guys referenced the spread widening.
Our residential loan portfolio.
Which I believe has continued into the first quarter.
In light of that can you talk about what you've seen in terms of the loan origination market in terms of changes in pricing on newly acquired loans. So far this year.
And can you also talk about.
Kind of what the expected return would be on the new.
Sort of loan purchase and securitization today relative to what it was in the last couple of quarters. Thanks.
Sure Trevor it's Sean I'll I'll take that one.
We have seen prices come down we've seen.
Primary rates the rates to borrowers move up.
And I would say that you know where are.
Target.
Note rates were in.
Call it right around 4% very low 4% area. There now are just slightly above 5%. So primary rates have moved up roughly 100 basis points.
I think the yields on that stuff are you know in the mid fours and I think the securitization execution as you know in the low to mid 3%. So the NIM is still there it's still roughly.
Roughly.
You know unchanged after the sort of adjustment in rates.
There's certainly a large number of loans out there right now that are.
Sitting on originator and bank balance sheets with.
Note rates that are that are pretty low so we've seen.
Dollar prices that you know call. It we're in the I don't know mid to high one O fours for the type of stuff that we like to buy.
Now 101 and below dollar prices, so there's definitely been a move there.
But but the I'm all in business plan is still in.
Intact and the NIM is still roughly around that kind of a 100 basis point area.
Okay got it that's helpful.
And you also talked about the impact of the fast prepayment speeds on our fourth quarter results.
I guess in light of the increase in rates and the increase in mortgage rates in the first quarter.
Can you talk about how much you expect that to impact sort of the go forward prepay speeds and an amortization rate on the loan portfolio.
You know we saw January speeds come in and they were pretty consistent with the with the fourth quarter speeds.
So not much relief there, but I think as you said note rates are up higher a lot of the refi opportunities are sort of disappearing, but for a lot of the borrowers, especially the ones that are that are in the you know our target borrower.
Area. So we do expect speeds to decline.
You know by how much.
We can't necessarily predict but if.
If we see over the next couple of.
You know that the next couple of months rates stay where they are right now we should see that.
Amortization costs, I think was last quarter or two and a half million bucks roughly close to $10 million on a year ago, those numbers should potentially come down a little bit that said, we are trying to buy more loans.
So you know that that you.
You know that dollar amount may increase, but so will be so the income as well you know I think we we see speeds over the next couple of months declining I don't know 10, 10 to 15, maybe 20% even from.
From where they are right now in agency space and I don't I don't think the non QM space is going to be immune to those declines as well.
Okay that makes sense.
Can you comment on how book value has trended since the end of the year given all the volatility we've seen in the markets.
Okay.
Yeah, Hi.
Hi, Trevor Unfortunately, I can't give any guidance on book value.
We're still finalizing you know closing our books after the year end audit. So you know we would expect to see book value slightly trend upward, but I can't give the specifics on that.
Okay Fair enough I appreciate the comments thank you.
Yeah.
The next question comes from Jason Stewart with Jones trading. Please go ahead.
Hey, good morning. Thanks.
Want to start with a more global question, what what's the appetite to Keith WMC is a public vehicle versus taking it private you know when you think of it in context of waiving fees et cetera.
Where is the mindset of the management team there.
Yeah sure I'll take that Jason. Thanks for the question you know as you do now and you noted our manager did waived management fee 20, <unk> 25 per cent for the calendar year 2022 and remains absolutely committed to.
To WMC I wish we do benefit from that relationship when we were looking to expand our financing diversify diversify originator partners and such and so none of that has changed the range remains supportive in terms of our.
Plans going forward, our near term focus is really to execute on this transition and to grow organically. We're always open to other ways to increase shareholder value, but for now our focus does remain on on the portfolio and making a successful transition.
Okay. Thanks, and I appreciate the color on the New Jersey Mall is there any preclusion to buying stock back as it relates to the negotiations.
G with the the debt work out there.
You said you want to take that one.
Sure so as far as buying back stock.
We did buy back stock in the fourth quarter and we continue to look back to look at buying it.
Stock because we're trading at significant discounts to book value.
But I think you know as Bonnie mentioned, our priority is to continue to organically grow the company. So we have we have to look at capital and determine what's the best use of that capital is that capital.
Better use to put into income producing assets in which we continue to grow the earnings power of the portfolio. We also have to keep into consideration. Our 2022 notes for $37 $7 million that we have outstanding.
Trying to buy those back to.
To also improve the earnings power of the portfolio. So I think the company you know ways all of those things when determining determining what's the best use of the capital that we have and that's how we will deploy it going forward.
Right. Thanks, Lisa.
I guess my question was more a legal oriented is there any preclusion that prohibits you.
As you negotiate the workout from buying stock back.
Things like the answers now Oh no no. There is no we wouldn't be in a black I don't know if something materially.
There's going to be disclosed so no we wouldn't be blacked out from buying back stock my apologies.
Got it Okay I appreciate that and then last one for me when you look at some of the other work outs, how should we from a modeling perspective take forward the workout costs from nonperforming loans going forward. So we use the fourth quarter in nonaccrual as a benchmark or was that sort of an anomaly on the high side.
I don't think you should use that for a benchmark I think that was specific to that particular asset. So I think that was probably a little on the high side.
You know I think the other asset that nonperforming I don't think the intention is to foreclose on that asset, which would bring a lot of cost on balance sheet as I did with the hotel asset.
Alright, alright, thanks for taking the question appreciate it.
The next question comes from Derek Hewett with Bank of America. Please go ahead.
Good morning, everyone. So how should we think about financial leverage longer term given there is more structural leverage with the securitization strategy.
Yeah.
Yeah, Hi, Derik I'll start and others can add in if they want it. Thanks for the question, yes. So in terms of leverage we would expect just given where we are and depending on where we are in the securitization cycle that would be you know somewhere between two two and a half in four times going up and down with the cycle.
Does that answer your question.
Yes, yes, it does and then.
My next question is it seems like there was at least two or three.
Kind of unusual items during the fourth quarter.
And I'm trying to just kind of.
Get a sense of what.
Uh huh.
Distributable earnings would've been kind of ex those items I thought you had mentioned that there was like $1 2 million was related to.
Non accrual and another 400000 was.
It was related to.
Some other event, so you kind of adding back another kind of <unk>.
For the quarter were there other items.
Now that we're kind of maybe just one time in nature that affected fourth quarter results.
No I think I think you've captured a number of them I think it was also like a timing lag in a weak appointed enough capital because we had a significant amount of assets that paid off at the end of the third quarter and assets are paid off in the fourth quarter.
And it was just timing and redeploying that capital into income producing assets I do think it's important to note that you know that hotel asset that we foreclosed on has not been income producing for several months.
Now with that $36 million of capital that the company received.
We can re deploy that asset now into income producing asset, which will definitely help distributable earnings going forward.
Okay and then my last question is just the dividend I realize that its kind of thought about kind of more of a longer term basis, but the stock is trading at a level.
That would suggest that there would be a at least a dividend cut in at least in the short term. So I guess given this transition period over the next 12 to 18 months.
Is there any additional color that you can provide in terms of how youre thinking about the dividend just maybe on kind of a shorter term basis.
Yeah, so when we have.
Go ahead, Bonnie can go.
I was just going to say Lee said that with respect to the dividend and you know we are looking at this from a long term perspective is as Lisa described in her comments. So we're looking at the long term earnings power and for US today that is the steady state in our newer business model with with post transition. So that is a consideration.
As she mentioned taxable income considerations. So we're all looking at that not from a quarter to quarter basis and not based on you know what might happen.
Yeah, just it's event driven but rather longer term and so that is a decision that is made by the board we make a recommendation based upon.
This modeling and we'll be meeting with them in three weeks.
Okay. Thank you.
Yeah.
This concludes our question and answer session I'll turn the conference back over to Bonnie Wang for any closing remarks.
Thank you operator, and thank all of you again for joining us for today's call. We appreciate your continued interest in WMC and hope everyone remains healthy and safe and have a good 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.
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