Q1 2022 Western Asset Mortgage Capital Corp Earnings Call
Welcome to Western asset mortgage capital Corporation's first quarter 2022 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 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 of Investor Relations. Please go ahead Mr. Clark.
Thank you Jason I want to thank everyone for joining us today to discuss western asset mortgage capital Corporation's financial results for the first quarter of 2022.
The company issued its earnings press release yesterday afternoon, and it's available.
Mr Relations section of the company's website.
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 body wash or cool Chief Executive Officer.
Lisa Meyer, President and Chief Financial Officer.
Rig 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 that.
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 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 Securities and Exchange Commission.
We disclaim any obligation to update our forward looking statements unless required by law.
I'll now turn the call over to Bonnie want to go Bonnie.
Thank you Larry and welcome everyone.
As you May recall, we announced last December I plan to focus on residential real estate related investment as it transitioned out of the commercial investments in our portfolio.
We'll be making this transition over the course of the coming quarters by seeking to maximize the value of our commercial assets and strategically focusing our resources on the residential market we.
We believe that the strategic steps will allow us to address attractive market opportunity and will ultimately result in a more stable and improved earnings profile.
During the first quarter, we continued to implement the strategic portfolio shifts, while working proactively to strengthen our balance sheet.
As we just got our last quarter's call. We saw the unencumbered hotel property that we foreclosed on in 2021 and received $36 million in that country, well recording an $8 $7 million gain on the sale of the property we.
We used the proceeds from this sale along with cash on hand to reinvest approximately $160 million of our target asset and to repurchase an additional $3 $4 million about 2022 convertible notes.
We also reduced our recourse leverage and increase our interest rate hedges during the quarter to protect the portfolio in light of the ongoing interest rate and spread volatility.
We are confident that we have sufficient liquidity in this market environment to continue executing on our investment strategy.
In February we completed our third securitization, that's approximately $400 million backed by $432 million of Brexit, that's a whole lot.
Securitization enabled us to secure a long term fixed rate financing at a weighted average interest rate of three 1% with review at a favorable level given the rising interest rate environment.
We were able to lock in an attractive net interest spread on this pool of residential mortgages through this financing.
However, the quarter was not without its challenges in particular, the rapid rise in interest rates and concrete spread widening across all fixed income sectors.
Our portfolio was not immune to these pressures and our GAAP book value per share declined 14, 7% from the prior quarter well economic book value per share declined seven 3%.
We have previously expected that transitioning and repositioning our portfolio could create timing issues that would impact our near term, earning power and this was the case again in the first quarter.
Our financial results were negatively impacted by the combination of lower net interest income and elevated prepayments on our residential whole loan portfolio.
Consequently, our distributable earnings were $379000 for one cents per share in the first quarter down $529000 from the fourth quarter.
While the first quarter with no doubt a difficult one we are confident that we are taking the right steps to resolve our talented investment strengthen our balance sheet and improve the earnings power of the portfolio.
I believe our progress on these steps will be reflected in our stock price over time and remain committed to building value for shareholders.
Before turning the call to John and Gregg I want to highlight that we recently published our 2021 annual report to shareholders and we encourage you to visit our Investor relations website to read through it.
In addition, we recently filed our Parker team either in the process of mailing out the materials to shareholders.
And finally, we will be holding our virtual annual meeting on Friday June 24, and welcome your participation.
Now I'll hand, it over to John and Gregg to go into more detail about the investment portfolio Sean.
Thanks Bonnie.
He noted were active again this quarter in repositioning the portfolio, adding bolt nonqualified residential mortgages and security start holding the spreads widened in.
In February we successfully executed our third residential whole loan securitization continuing our strategy.
Securing permanent financing on our non QM holdings.
We plan to continue our strategy of purchasing non QM loans.
Financing them via securitization. So this should allow us to lock in favorable long term funding rates and reduced mark to market volatility during.
During the first quarter, we across the acquired $117 million worth of newly originated non QM loans, we were able to purchase these assets at attractive levels.
The spread on non QM loans widened due between 275 and 295 basis points during the quarter.
Characterizations widened during the quarter as well with AAA pricing in the 170 to 180 basis point range.
The speed the transition of our portfolio. In addition to purchasing loans, we added $40 million in non QM, our MBS securities.
We've got the opportunity to make these purchases at attractive spreads as well, especially.
Especially at these wider spreads our residential investments continue to present attractive fundamental value benefiting from a strong housing market low unemployment levels and solid consumer balance sheet well.
We expect home price appreciation to moderate from the very strong recent performance. We believe the housing market will remain well supported given the favorable supply and demand dynamics as well as disciplined lender underwriting standards.
Our non QM portfolio continues to perform well with less than 1% of our total loans by dollar value being more than 30 days delinquent at quarter end.
This underscores the effectiveness of our credit underwriting standards.
On high quality borrowers that have meaningful equity in their homes.
Portfolio weighted average loan to value is 59% and the average FICO score for our borrowers at origination is 747.
Much of the quarter raised our non QM mortgage loans lagged the rise in conventional mortgage rates and many non QM borrowers were able to refinance at relatively attractive rates.
As a result, our portfolio continued to experience an elevated level of prepayments.
First quarter non QM prepayments were 37, CPR compared to $28 two CPR in the previous quarter.
We anticipate that the substantial rise in mortgage rates over the last quarter will cause refinancing activity and our portfolio to moderate.
More than half our non QM loan portfolio consists of adjustable rate mortgages with approximately 15% of that is scheduled to have rate reset in the next 12 months.
This reduces portfolio duration that leads to higher interest income as interest rates rise.
Going forward, we remain positive on overall residential credit fundamentals.
While securitizations are trading currently at wider levels than they were pre COVID-19 new loan pricing already reflects this with that I'll turn the call over to Greg handler discuss our commercial holdings Gregg.
Shaun during the first quarter spreads generally widened across the commercial mortgage credit sector, but our commercial holding in aggregate were only modestly impacted by the market move.
At quarter end, we held seven commercial whole loans at a fair value of $128 million.
All but one of these loans have performed in line with expectations.
Six performing loans represent hundreds of million of principal balance.
And are currently marked at $101 million, a negligible discount to cost.
We expect these loans to pay off over the next several quarters as properties are either sold or refinanced.
However, the ultimate timing and realization of loan payoffs it depends on the specific factors pertaining to each property and there can be no assurance as to whether or when these payoffs will occur.
With respect to the junior mezzanine loan backed by our retail and entertainment complex located in the northeast we continue to engage in discussions with the borrower and certain other lenders.
Guarding potential alternatives to a judicial process.
We believe the property has significant upside and are seeing encouraging growth in sales and dependent.
As well as positive momentum in leasing activity.
As we have noted previously there remains a risk of further impairment under certain scenarios.
Given the ongoing uncertainty regarding possible outcomes. Our loan is currently marked at a value of $27 million.
Slightly from the fourth quarter, primarily due to changes in the assumptions around the estimated timing of resolution to the situation.
Within non agency commercial mortgage backed securities.
Our single asset single borrower credit portfolio is valued at $83 $4 million down slightly from the prior quarter.
This portfolio consists mainly of class a retail and hotel properties that cater to leisure travelers and we are continuing to see positive operating momentum and a number of these properties.
This portion of our portfolio had an approximate 65% original loan to value and all but one of these loans representing less than $1 million of the $83 million portfolio.
Uh huh.
Property, they're generally high quality assets with strong equity sponsors, we believe that the collateral values have not been materially or permanently impaired.
Oh excuse me a conduit exposure is valued at $22 million up slightly from the prior quarter and while credit trends are improving on some loan others remain challenged as a result, we placed two investments on non accrual status during the first quarter.
The operating performance of the underlying properties is taking longer than anticipated to recover.
We remain focused on optimizing our recovery values and Alex in your disposition and continue to believe our positions will benefit as more COVID-19 restrictions are lifted and the economy moves towards a full meal.
If you did not exit any see MBS positions during the first quarter, but we will continue to evaluate potential sale of our investment in this space with a view to redeploying proceeds from the sales and payoffs.
And into new target assets 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 first quarter results I want to highlight some of the measures. We have recently taken to further improve our balance sheet.
W. M. C continues to benefit from the support of the broader western asset platform.
Facilitating our ability to work with our strategic financing partners to improve liquidity and secure attractive long term financing.
Earlier this month, we executed a one year extension on our non agency MBS and non agency MBS financing facility.
In February as previously noted we completed our third securitization of non QM loans, which provided long term fixed rate financing for $432 million of loans previous financed under our residential whole loan facility.
We also repurchased an additional $3 $4 million a barrel existing 675% convertible senior notes due October 1st of 2022 at a weighted average premium to par of approximately 8%.
At quarter end, we had a remaining outstanding balance of $34 $3 million on the 2022 notes.
We believe we have ample liquidity to continue repurchasing and retiring the 2022 notes prior to their maturity provided accretive or purchase opportunities do exist over the next six months and then address remaining bonds at maturity.
Now turning to our financial results, we have provided great detail regarding our portfolio and our first quarter results press release and earnings presentation. So I am going to focus here only on items that warrant additional discussion.
We reported distributable earnings of $379000 or one seven per share for the first quarter down from fourth quarters level of <unk>.
$908000 three primary factors drove the decline.
First we recorded approximately $350000 lower net interest income on our non agency MBS portfolio, primarily due to an accounting change.
Distress conduit bonds that were put on nonaccrual during the quarter.
Second we experienced an elevated level of prepayments in our residential whole loan portfolio in the first quarter there.
There were $95 $6 million of loan pay downs during the quarter, which led to know what lowered net interest income of approximately $268000.
In addition, the Paydowns resulted in $2 $5 million of premium amortization, which was similar to last quarters that amortization on roughly the same level of prepayments.
Third we experienced higher professional fees of $203000 as a result of higher accounting internal audit and external audit fees related to our year end reporting.
These items were partially offset by $368000 in lower management fees as the 25% reduction in fees paid to our manager went into effect in January we also recorded an $88000 reduction in compensation expense.
Well, our distributable earnings for the first quarter were lower than our dividend four cents per share. It is important to note that we evaluate the level of the dividend every quarter based on several factors. These factors include our outlook for the long term sustainable earnings power of the portfolio and <unk>.
Taxable income.
Well it did not impact distributable earnings we did incur a one time expense that impacted our GAAP earnings and our book value, we incurred transaction costs of approximately $2 $9 million related to our residential whole loan securitization that was completed in February two.
And in 'twenty, two we were required to expense these costs because of our decision to elect the fair value option for the securitized debt.
We elected the fair value option for the debt in order to reduce the accounting mismatch caused by fair value in the assets and not the debt.
GAAP book value for the quarter was $2.73 per share a decrease of 47 cents per share from the fourth quarter.
The decline was driven mainly by spread widening across our holdings.
Mainly from our residential whole loans due to their relative size in the overall portfolio.
The wider spreads led to a net unreal.
Realized losses of $38 $9 million or 64 cents per share.
This was partially offset by consolidated realized gains of $12 $1 million or 20 cents per share from the sale of the hotel as well as $6 $9 million or 11 cents per share of gains on derivatives due to interest rate hedging activity during the quarter.
Economic book value, which reflects the value of the retained interest in the consolidated securitization trust rather than the associated gross assets and liabilities decreased by seven 3% for the quarter to $2.81 per share.
Turning to leverage our recourse leverage ratio at quarter end was two eight times down from three eight times at December 31st 2021, as we completed the securitization in February which is non recourse a recourse leverage ratio declined as expected.
Recourse leverage ratio will fluctuate as we continue to grow the portfolio with the goal of executing additional securitization.
In summary, we remain focused on actions that will solidify our capital structure and maintain our liquidity, while positioning WMC to benefit from 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 that actually.
Now financed by attractive long 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 open up the call to your questions. Operator. Please go ahead.
We will now begin the question and answer session.
To ask a question you May Press Star then one on your Touchtone phone.
If youre using a speakerphone please pick up your handset before pressing the keys to withdraw your question. Please press Star then two.
At this time, we will pause momentarily to assemble our roster.
Our first question comes from Jason Stewart from Jones trading. Please go ahead.
Alright, thank you.
Well, let's start with margin on the residential side you know obviously, there was a little bit of dislocation in the securitization markets and in <unk> I guess, one could you address that and if there was any impact that we should expect to see in terms of a drag on margin going forward and then if you could sort of bifurcate that and say on a go forward basis.
Based on new loan yields what you expect margin on the residential side to be that'd be helpful.
Yeah sure John I can I can answer that question.
I think you know towards the end of March and early April was sort of the wide in the securitization market.
We've seen a little bit of improvement since then.
Oh loan pricing has widened out as I had mentioned and so so the NIM is you know still feel pretty good.
There's.
A couple of deals that are printed in the last week.
Cost of funds were in the you know.
For.
60 to 475 range.
Yields on non QM around 6%. So we're still seeing you know all in you know.
A NIM of over 100 basis points.
So the securitization market is still pretty accretive given given given those numbers.
Okay. That's helpful.
And then switching gears to CRE three are.
Under what scenario I mean, thank you for the disclosure first of all this is much appreciate it.
Under what scenario do you envision having to advance additional funds and a restructuring.
I think the decided just Greg I just.
Or that you know for that.
And that's going to supersede, obviously you would need.
Significant.
Hum.
We would need to expect significant recovery.
Any such investment.
Either require additional collateral or something.
We felt very very strongly about and isolation.
But you know I think.
It's something that given our already outsized exposure.
We would obviously need very significant support from them.
But for me, that's a committee to make any additional investment.
I would say.
It's not something that we're planning on doing at this point.
Okay.
Since you could update us on what's your as you've gone through this process. Our current L. T V looks like.
Yeah.
I think a lot of it will depend on sort of the final stage of a modification for this property you know in terms of the cash flow performance. You know obviously, there's continued as you mentioned there's continued.
But in terms of what the final a long term run rate for the property will look like that's still.
Highly variable at this point.
So we haven't done.
You know we struck the L. T D at this point, but obviously.
We're looking for are finalized structure that gives the property enough time to fully recover as well as giving it.
So the ability to refinance.
And the time, we definitely feel the time has been beneficial for this project and we did we did see some progress.
Within the negotiations towards a resolution we do feel that the.
The lenders are working.
Together in this in this instance, and so we do see some progress there.
We're hoping that we'll have a more stabilized.
Final capital structure too.
To present in the coming quarter or two.
Great. Thanks for taking the questions I appreciate it.
The next question comes from Trevor Cranston from JMP Securities. Please go ahead.
Hey, thanks.
Another question on the non QM strategy.
Can you talk about what did you guys were seeing in terms of and supply of loans coming out from originators given how much.
Rates have moved back up.
Hum.
And then in terms of the prepayment speed on the existing portfolio you mentioned that you expect that to.
Decline can you maybe give us a sense as to kind of where where you fix them you know speeds on that portfolio will stabilize over the next couple of quarters. Thanks.
Sure I think supply.
You don't have he talked to the originators that we've been buying from.
Sort of ground to a halt for a couple of weeks as rates jumped up.
And then and then recently we've seen origination pick back up again I think you know we were expecting a record year of non QM production.
I think right now.
Originations are down probably by a third from where they were.
Before rates began to rise.
So early early first quarter pace.
<unk> is a third lower right now, but I do expect quite a bit of supply I think it's gonna be.
A.
You know a shift in the market, where we will see more originators focusing in non QM is agency.
Prepays that.
That agency, sorry, refinance opportunity decline, so I'm not expecting.
Supply to be created by that much.
Uh huh.
Over the next few quarters, we're already seeing a strong recovery in originations.
As far as Prepays, we saw.
Fannie 30 year prepaid.
Prepays declined by 20 basis, 20% sorry.
In the last prepay report and the.
The refi index, the mortgage bankers refi index.
Extremely low level right now so we do its like expect Prepays to decline I'm not sure exactly to what extent, but it you know it should slow.
You know pretty well.
The non QM sort.
A borrower has a little bit more.
Turnover and an incentive to prepay then than you know than the average borrower, but but you know we do expect prepayments to decline I'm you know like I said, if agencies down 20% and you know given the time to originate in the non QM loan as you know.
Maybe.
30% to 45 days versus you know a couple of weeks for for agency, we should see declines happen pretty soon.
Okay Gotcha.
You guys mentioned that you also made about 40 million of investments in non QM M. B S.
Can you say where in the capital stack.
Those investments were in and sort of how are you how do you view the returns available in the.
Secondary market M B S purchases versus according willing to do at your own securitization.
Yeah.
Sure Yeah, Trevor we've definitely seen the you know the spreads in that new issue and secondary markets widen in concert.
So you can just take advantage of that.
Targeting I'd say similar credit risk profiles to the ones that we've originated historically.
And and it is attractive I think we did the majority of the purchases. We made we're investment grade rated barely short duration.
Yeah.
Less extension risk maybe than some of the lower rated subordinated tranches. So you know obviously Michael.
Uh huh.
I'm staying staying liquid being higher in the capital structure, and we do see attractive levered returns on those assets, but I still think.
Our goal is still to have you.
The long term financing via securitization. So yeah, we view the securities investment is more of an opportunistic rotation as we as we see opportunities in real time.
But it's still committed to that.
The.
Acquisition and securitization.
Sure.
Makes sense appreciate the time thank you.
The next question comes from Dan Holtzclaw from D. I a management services. Please go ahead.
Yes. Good morning, Thanks for taking my call.
I think I have a question about.
The recent.
A recent proposal.
The reverse split.
I'm just wondering if you could please explain your rationale schools and what the plan is as investors feel too.
The reverse split.
Sure Dan This is Bonnie thanks for that question.
Yeah, one of the factors that we consider and recommending to the board and Theyre, putting it at the diversifying the investor base. So there are some constraints that institutional investors have them based upon the level of stock price and so we felt that it was very soft but.
Lament it could expand the potential base of investors that could buy definitely see that so that is part of it it.
If it does not pass you know we are we are obviously operating in situation at our current levels and so we'll just continue to focus on our strategy of.
Focusing on the transition and building shareholder value, that's our status quo plan.
Look forward to the results.
No.
Current price of the stock.
If trends continue.
I mean, it's getting.
The areas enrichment.
What would be.
Do you see western asset stepping in as the manager and supporting the company. If the company continues trending towards this level of reverse split what didn't happen.
So western asset as the external manager you know fully does support WMC. They do believe in the fundamental value of WMC and as you know.
And granted hasn't labor for 2022 and we fully expect that they will continue to.
Wonderful managerial support to the entity.
Thank you.
Again, if you have a question. Please press Star then one.
There are no more questions in the queue. This concludes our question and answer session I'd like to turn the conference back over to Bonnie walked her cool 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 we look forward to personally connecting with you in the weeks ahead.
We hope that everyone has a good rest of the day and remains healthy and safe.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.
Okay.
Hum.
Okay.
[music].
Yeah.
[music].