Q3 2022 Western Asset Mortgage Capital Corp Earnings Call

Good day and welcome to the Western asset mortgage Capital Corporation third 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, now I'd like to turn the call over to Mr. Larry Clark Investor Relations. Please go ahead Mr. Clark.

Thank you Chuck I want to thank everyone for joining us today to discuss western asset mortgage capital Corporation's financial results for the third quarter of 2022.

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 and.

In addition, the company has included a slide presentation on the website that you can refer to during this call.

With us today from our management team are Bonnie want are cool Chief Executive Officer.

Robert Lehman, Chief Financial Officer, Greg Handler, Chief Investment Officer, and Sean Johnson, Deputy Chief Investment Officer.

Before we begin I'd like to remind you that in August the company announced its board of directors authorized a review of strategic alternatives aimed at enhancing shareholder value, which may include a sale or merger of the company.

No assurance can be given that the review being undertaken will result in a sale merger or other transaction involving the company.

The company has not set a timetable for completion of the review process.

The company intends to refrain from making comments related to the strategic review process until a definitive agreement has been reached or until the process of exploring strategic alternatives has ended therefore as a result of the ongoing status of this process. We will limit this call through our prepared remarks and will not be conducting a question and answer session.

During the call.

I'll now 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 forecast due to the impact of many factors beyond the control of the company.

Forward looking statements, including in this presentation are made only after 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 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 Bob I want to call body.

Thanks, Larry and welcome everyone.

Before I discuss our third quarter financial results I would like to say a few words about our ongoing review of strategic alternatives.

As I discussed on last quarter's call. The COVID-19 pandemic negatively impacted a number around that.

But then our commercial.

As you are well aware, we have experienced a significant decline in the value of our portfolio and our stock price. Therefore.

Therefore over the past two years, our overarching goal has been to improve and stabilize our future earnings power.

Over this period, we have made significant progress by taking actions to improve our liquidity and balance sheet and by shifting our investment focus toward residential real estate.

Nonetheless, we have not seen all these actions reflected in our stock price and therefore, we decided to embark on a strategic review of our alternatives with the goal of unlocking shareholder value.

We continue to move forward in this process and to analyze alternatives that may involve a sale merger or other transactions involving the company.

We are focused on completing the strategic review process as quickly as possible and we'll provide update as appropriate.

In the meantime, we will continue to run the company in a manner that is consistent with our goal of optimizing the value of our assets and maintaining stable.

Which will ensure support our ability to pay an attractive dividend.

We truly appreciate our shareholders, who have remained with us through this challenging period.

With that I will now turn to our quarterly results.

Our third quarter results continued to reflect the ongoing challenges of interest rate volatility and fluctuating asset value.

Again translated into credit spread widening across our whole.

This market volatility combined with an additional write down of our nonperforming commercial then put pressure on our GAAP book value per share, which declined 32% from the prior quarter well economic book value per share declined 21, 7%.

We generated stable net interest income during the quarter after adjusting for income from our interest rate hedges due to lower prepayments from our residential portfolio.

However, this was offset by moderately higher operating expenses.

Consequently, our distributable earnings of $2 $3 million or <unk> 37 cents per share in the third quarter were down approximately $400000 in the second quarter.

Well, our distributable earnings were less than our 45 per share dividend for the quarter. Our philosophy remains to pay dividends that are supported by the long term earnings power of the portfolio.

During the third quarter, we did not acquire any target and instead, that's primarily on strengthening our balance sheet and increasing our liquidity.

We received approximately $75 million from the sale repayment or pay down debt.

And use these proceeds to build our cash balances you have to further reduce debt, including the full retirement of our 2022 notes which occurred on October three.

We remain confident that we have sufficient liquidity to retire additional recourse debt and execute our investment strategy and we continue to monetize our non core commercial asset in an orderly manner.

We also remain confident in the overall credit quality of our portfolio.

The residential loans that we have been diligently underwritten and are supported by significant homeowner equity on our residential portfolio is performing as expected.

In summary, we continue to take steps to further strengthen our balance sheet and stabilize the earnings power of the portfolio.

As always we remain committed to building value for our shareholders now.

Now I'll hand, it over to John and Gregg. So you go into more detail about the investment portfolio.

John Thanks.

Thanks, Bonnie during the third quarter rates rose dramatically and spreads widened largely across our residential whole loan portfolio.

Does this put pressure on our book value because the vast majority of our residential whole loans are held within our securitization.

On our two most recent transactions also rose, which partially mitigated the impact on our book value.

However, our first two securitizations did not have this gap offset due to the accounting method.

We did not acquire any non QM loans during the during the quarter as our focus was on maintaining sufficient liquidity to address the maturity of our 2022 notes.

During the quarter origination rates on non QM loans rose alongside conventional mortgage rates and as expected the higher rate environment caused prepayment rates to meaningfully slow.

Third quarter non QM prepayments for the portfolio were $12 four CPR compared to $15 six CPR in the second quarter and 30 CPR in the first quarter as a result premium amortization from loan prepayments in the quarter was $945000 down from an average of $2 2 million for the <unk>.

First few quarters of the year.

Anticipate that higher mortgage rates will continue to cause refinancing activity in our portfolio to remain relatively low.

Our non QM portfolio continues to perform well with approximately 0.23% of our total loans more than 60 days delinquent at quarter end.

This underscores the effectiveness of our credit underwriting standards, which focus on high quality borrowers that have meaningful equity in their homes.

At origination our weighted average loan to value ratio was 66% and the average FICO score for our borrowers was 748.

Now a word on our view on our view of the overall housing market.

After booming during the pandemic home prices have begun to stall and even decline in certain markets under the pressure of higher mortgage rates and a lack of affordability.

Housing market surged during the pandemic was primarily due to inadequate supply relative to increase in that.

Supply chain issues continued to delay new home construction, but as supply comes online over the next six to 12 months in the face of waning demand. We anticipate that there will be continued downward pressure on home prices.

Speed and magnitude of the Paas will likely be determined by the broader economic growth levels and the absolute level of mortgage rates.

While housing well housing is expected to cool, we do not see the significant risk of default of home price correction that current market pricing implied mainly due to our approach of targeting targeting high quality.

Credit non QM borrowers as well as disciplined lender underwriting standards that have been a hallmark of this sector since the great financial crisis 14 years ago. Additionally.

Additionally, we expect volatility in interest rates and spreads to decline as we get more clarity on the pace and timing of the fed tightening cycle.

Therefore, we believe that spread normalization combined with high Carrie will provide upside value to our residential holdings.

With that I'll turn the call over to Greg handler to discuss our commercial holdings Gregg Thanks, Sean.

Now turning to our commercial portfolio.

During the third quarter spreads continued to widen across the commercial mortgage credit sector, but our commercial holdings were only modestly impacted with the exception of the nonperforming commercial loans that I will address later.

At quarter end, we held six commercial whole loans at a fair value of $91 million.

All but one of these loans have performed in line with expectations.

During the quarter, we received full repayment from one month and a partial paydown from another for a total of just over $20 million.

The five remaining performing loans represent $82 million of principal balance and are currently being marked at just over $81 million.

Negligible discount to cost.

We expect these loans to pay off over the next several quarters as properties are either sold or refinanced. However.

However, the ultimate timing and realization of loan payoff 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 U S northeast.

We reduced the fair value of this loan as in late October the senior mezzanine lender consummated a port closure of its equity interest in the property.

Which also serve as the primary collateral for a loan.

As a result, our loan remains outstanding but without the benefit of the primary collateral supporting alone.

We are currently exploring all available measures to maximize our recovery envelope.

But there are no assurances that any of those measures will be successful in which case, we could experience a total loss of our investment.

At September 30, the loan was marked down to a value of $8 8 million compared with approximately $27 million at the end of the second quarter.

Within non agency commercial mortgage backed securities.

Our single asset single borrower credit portfolio valued at $78 3 million down from $82 3 million in the prior quarter. This portfolio consists mainly of our class a retail and hotel properties that cater to leisure travelers and.

And we are continuing to see positive operating momentum and a number of these properties.

This portion of our portfolio had approximately 65% original loan to value.

And all but one of these loans representing less than $1 million of the $78 million portfolio remained current.

These properties are generally high quality assets with strong equity sponsors. So we believe that their collateral values have not been materially or permanently impaired.

Our commercial mortgage backed.

Conduit exposure is valued at $10 5 million down slightly from the second quarter.

We remain focused on optimizing the recovery values in our commercial portfolio and.

And intend to use those proceeds to pay down our recourse debt level and to opportunistically reinvest into new target assets that continue to offer attractive risk adjusted return.

I'll now turn the call over to Bob Leamon, our CFO Bob.

Thank you Greg.

We provided great detail regarding our portfolio and our third quarter press release, and our earnings presentation. So I'm going to focus here only on items that warrant additional attention.

And as we've noted in the earnings release all per share amounts have been adjusted to reflect the one for 10 reverse stock split that was implemented on July 11th.

We reported distributable earnings of $2 $3 million or <unk> 37 per share for the third quarter down from the second quarter's level of $2 $7 million or <unk> 44 cents per share.

We received $41.3 million from the sale and repayment of residential whole loans during the quarter down from $68 4 million in the second quarter. This resulted in $945000.

Premium amortization, which was down from $1 8 million in the second quarter.

Our higher core operating expenses in the quarter were primarily result of increases in compensation costs related to our new CFO controller that began in June 2022, and increases in professional fees that were offset by a slightly lower management fee.

We remain focused on disciplined expense management, while recognizing that we will continue to support the strategic review process and we will likely incur some additional some associated transaction expenses as a result.

Well of distributable earnings in the quarter fell short of our dividend of <unk> 40 per share. We will continue to evaluate the level of the dividend every quarter based on several factors, including our outlook for the long term sustainable earnings power of the portfolio and our taxable income.

GAAP book value for the quarter was $16.22 per share a decrease of $7 in one sense or 30% to 32% from the second quarter.

The decline was driven by two factors first the further increase the unrealized loss of the junior mezzanine loan that Greg noted negatively input packed at book value by $3.01 per share and second spread widening across our holdings, but mainly a residential whole loans due to.

Their relative size in the overall portfolio.

Economic book value, which reflects the value of our retained interest in the consolidated securitization trust, rather and the associated gross assets and liabilities decreased by 21, 7% for the quarter to $19.25 per share.

Turning to leverage our recourse leverage ratio at quarter end was three three times up from the 2.4 times in early July after the completion of our fourth securitization at that time.

Our leverage ratio was further reduced to three one times after the retirement of our 2022 notes that occurred on October 3rd.

Turning to liquidity, we ended the quarter with unrestricted cash of $55 $4 million after retiring the remaining 20.

26 million of our 2022 notes, our unrestricted cash was $28 $6 million.

Subsequent to quarter end, we extended the maturity date of our commercial whole loan facility to November 3rd 2023.

It was scheduled to mature on November 4th of this year.

In addition, we extended the maturity date of our residential whole loan facility to October 25 2023.

In summary.

We remain focused on actions that will solidify our capital structure and maintain our liquidity.

With a significant portion of our assets now financed by attractive long term financing, we feel that we are well positioned to generate consistent distributable earnings with the objective of supporting our dividend in the quarters ahead.

With that I'll turn the call back to Bonnie for closing remarks Bonnie.

Thank you Bob and thank all of you again for joining us for today's call. We appreciate your continued interest in WMC have a good day and we look forward to keeping you apprised of our progress in the months ahead.

The conference has now concluded. Thank you for attending today's presentation you may now disconnect.

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