Western Asset Mortgage Capital Corporation Q1 2023 Earnings Call

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Welcome to the Western asset mortgage Capital Corporation first quarter 2023 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 would like to turn the call over to Mr. Larry Clark Investor Relations. Please go ahead Mr. Clark.

Thank you Sarah.

Thank you everyone for joining us today to discuss western asset mortgage capital Corporation's financial results for the first quarter of 2023.

The company issued its earnings press release yesterday afternoon, and it's available on the Investor 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 this call.

With us today from our management team are Bonnie logical Chief Executive Officer, Robert Leven, Chief Financial Officer.

Rig handler, Chief investment Officer, and Sean Johnson, Deputy Chief Investment Officer.

Before we begin I'd like to remind you that last August the company's 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.

To avoid speculation 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.

I will 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 $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 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 Bonnie logical.

Got it.

Thank you Larry and welcome everyone.

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

Last August we embarked upon a process to review strategic alternatives for the company as the best path forward toward unlocking shareholder value.

The market environment for mortgage rates over the last several quarters has been remarkably challenge with record levels of interest rate volatility and increasing risks economic Brett.

This is added to our exploration of strategic partners.

Fellow shareholders, we are committed to concluding this process as quickly and.

And responsibly as we can and we will provide an update at the appropriate time.

Meanwhile, we continue to run the company in a manner that is consistent with our goal of optimizing the value of our assets and maintaining stable earnings which in turn should 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.

During the first quarter, we remain focused on strengthening our balance sheet and increasing our liquidity as volatility in equity and fixed income market and with further concentrated by the news of two hybrid I don't think failures.

Despite this our first quarter results improved sequentially from the fourth quarter, driven by higher earnings and improved Apple prices across most of our portfolio.

We also received approximately $67 million from the sale repayments for Paydowns of investment and use these proceeds to further reduce our recourse debt.

Our GAAP book value per share increased four 8% from the prior quarter, well economic book value per share increased one 8%.

We generated higher net interest income during the quarter driven by a higher net interest margin and higher income from our interest rate swap positions, while our operating expenses declined from the prior quarter.

Consequently, our distributable earnings of $2.2 million or 36 cents per share in the first quarter were up $200000 or seven 7% from the fourth quarter and exceeded the 35 cents per share dividend that we declared for the quarter.

In March we made a decision to reset our quarterly dividend to better reflect our earnings power as we continue to reposition the portfolio.

Consistent with our dividend philosophy, we will reassess the level of the dividend based on a number of factors, including the future earnings power of the portfolio and the level of any taxable income that we anticipate for the calendar year.

During the first quarter with the exception of a small amount of rotation within our non agency residential security told them, we did not acquire any target asset and instead focus primarily on strengthening our balance sheet further debt reduction and increasing our liquidity.

We remain confident that we have sufficient liquidity to execute our investment strategy and we continue to monetize our noncore commercial assets 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 in our residential portfolio is performing as expected.

In summary, we can be continued to take steps to further and further strengthen our balance sheet and maintain the earnings power of the portfolio with the overarching goal of building value for our shareholders.

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

Sean Thank.

Thank you Bonnie during the first quarter interest rates remain volatile against the backdrop of the market's changing sentiment about future fed actions in February the 10 year Treasury yield rapidly increased by 60 basis points topping 4%.

Only the completely reversed course after events in the banking sector dropping back to three 4%.

Against this volatility credit spreads widened across most risk assets with some asset classes being impacted more than others. For example, residential credit spreads fared much better than commercial real estate spreads.

The vast majority of our residential whole loans are held within our four securitizations and those portfolios continue to perform in line with our expectations.

Of the nearly 3000 mortgages that are securitized.

Fewer than 1% of them were more than 30 days delinquent at quarter and underscoring the effectiveness of our credit underwriting standards, which focus on high quality borrowers who have meaningful equity in their homes.

At origination our weighted average loan to value ratio of the pool.

Mortgages was 66% and the average FICO score for our borrowers was $7 49.

Nearly half.

Our non QM loan portfolio consists of adjustable rate mortgages during the fourth quarter during the first quarter approximately $11 million worth of loans reset to higher floating rates.

More than $75 million of current non QM loan holdings are scheduled to reset over the remainder of 2023 with more than $330 million resetting in the next four years.

Our NIM should benefit as these loans are almost entirely funded with fixed rate securitized debt.

First quarter non QM prepayments were seven five CPR compared to $6 two CPR in the fourth quarter.

And $12 four CPR in the third quarter of last year.

As a result premium amortization from loan prepayments in the quarter was $721000 relatively consistent with $677000 in the fourth quarter.

We continue to believe that higher mortgage rates will weigh on refinance refinancing activity and our portfolio keeping it relatively well.

We did not acquire any non QM loans during the quarter as our focus was paying.

Our focus is on paying down recourse debt and maintaining sufficient liquidity on our balance sheet.

Now a few words on the overall housing market.

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

The housing market search during 2020 in 2020, one was primarily due to inadequate supply.

Relative to increased demand more recently, new supply has come online.

NAND is cooled in response to higher rates.

Creating a more balanced market.

Given the potential for a recession, we believe that there will be continued modest downward pressure on home prices.

While housing is expected to cool, we do not see a significant risk of widespread defaults or home price correction, particularly as it relates to our portfolio.

This assessment is mainly due to underwriting standards remaining disciplined during the cycle and our approach of targeting high quality borrowers.

In addition, we do not see the risk of higher rates impacting borrowers who have already locked in ultra low mortgage rates.

We expect the volatility in interest rates and spreads to decline as we get more clarity on the conclusion of the fed's tightening cycle.

Therefore, we believe that spread normalization combined with high carry should 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.

The overall market sentiment for commercial real estate credit remains challenged we see three primary reasons for this.

First the fed rate hike have resulted in higher mortgage coupons.

Negatively impacting cap rates and collateral valuation.

Equity investors adjust to the higher capital call.

Second the recent banking industry stresses has impacted credit spreads broadly and overtime are expected to drive further reduction in real estate credit availability and the tightening of underwriting standards.

And lastly, the fundamental concerns over office values have escalated.

Some notable high profile defaults have recently occurred.

The office market faces a highly uncertain future with significant question about long term viability of lower quality properties.

Our exposure to office buildings is minimal across our commercial.

We do not see as many fundamental concern in the non office CRE sector.

Notably the multifamily housing industrial hospitality and retail sectors, where operating income and rents have predominantly recovered too and in many cases are now outperforming pre COVID-19 level.

We believe that our commercial mortgage portfolio, while not immune to the negative market sentiment is unique and well positioned to withstand the deteriorating economic environment.

Now turning to our commercial portfolio.

During the first quarter spreads continued to widen across the commercial mortgage credit sector, but our commercial holdings were only modestly impacted.

At quarter end, we held five commercial whole loans with a combined fair value of $79 million.

A slight discount to the $81 million par value.

All of these loans have performed in line with expectations.

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

However, the ultimate timing and realization of loading out depends on the specific factors.

Each property.

And there can be no assurance as to whether or when these payoffs will occur.

During the during the quarter, we received a partial repayment from one loan in exchange for a modest maturity extension.

We also received a 50 basis point extension fee on this one.

This $13 $5 million loan is backed by a skilled nursing facility and had an LTV of 49% at origination.

Within the non agency commercial mortgage backed securities our single asset single borrower credit portfolio is valued at $53 million.

During the first quarter, we received a $20 million.

Full repayment at par on one loan in this portfolio, which was backed by our hotel.

This reduces our exposure.

Which was $75 million at the beginning of the year.

The remaining portfolio consists of eight loans, which are primarily backed by class a retail and hotel properties.

Later to leisure travelers.

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

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.

However, given the current negative sentiment for commercial real estate.

This portfolio is currently marked at 71% of the combined principal balance.

The fact that these loans had an approximate 65% original loan to value and all but one of them representing less than $1 million of the $53 million portfolio remains current.

Our Cvs condo exposure is valued at $10 million down modestly from the fourth quarter Mark of $10 $5 million.

We remain focused on optimizing the recovery values in our commercial portfolio and intend to use those proceeds to pay down our recourse debt level.

To opportunistically reinvest into new target assets that continue to offer attractive risk adjusted return.

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

Thank you Greg.

We have provided you with great detail on our portfolio in both our first quarter press release and our earnings presentation.

I'm going to focus here only on items that warrant additional attention.

We reported distributable earnings of $2 $2 million or 36 cents per share for the first quarter.

Up from the fourth quarter's level of $2 million or <unk> 33 per share.

<unk> per share improvement in the first quarter distributable earnings was primarily driven by an increase in net swap interest income and lower core operating expenses.

Partially offset by a reduced net interest margin.

With respect to our core expenses, we expect to benefit from additional operating efficiency improvements in the future with offsets for courts, we may incur with respect to our strategic review process.

GAAP book value for the quarter was $16 46 per share an increase of 76 cents or four 8% from the fourth quarter.

The increase was driven by the increased valuation of our residential whole loan portfolio par.

Partially offset by spread widening across our commercial holdings.

Economic book value, which reflects the value of our retained interest in the consolidated securitization trust, rather and the associated gross assets and liabilities increased by one 8% for the quarter to $17 54 per share.

Turning to leverage our recourse leverage ratio at quarter end was two six times down from the two nine times at year end.

The lower leverage ratio was primarily due to the paydown of $28 $1 million of recourse borrowings as a result of the maturity and pay off of commercial security.

And asset sales during the quarter.

Our GAAP book value also contributed modestly to the lower leverage ratio.

Turning to liquidity, we ended the quarter with unrestricted cash of $16 $1 million and approximately $17 million of unencumbered unencumbered asset.

Subsequent to quarter end, we entered into a new repo financing facility.

Non agency MBS and <unk> portfolios as it was scheduled to mature on may 2nd of this year.

New facility matures in May 2024, with an initial amount outstanding of $60 million.

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 longer 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 we are happy to take your questions.

Operator, you May now open the call for questions.

Okay.

Thank you.

We will now begin the question and answer session.

I ask a question you May press Star then one on your telephone keypad.

If youre using a speakerphone please pick up your handset before pressing the keys.

John Your question. Please press Star then two.

At this time, we will pause momentarily to assemble our roster.

Our first question comes from Matthew.

Gardner with Jones trading. Please go ahead.

Hey, guys. This is Matthew on for Jason Thanks for open it up for questions today I appreciate it.

Correct me, if I'm wrong here, but you said you had $330 million in adjustable rates.

Could you tell me a little bit about the rate of origination and what it will reset at and if there's any concerns on credit deterioration there.

Yeah. So the 330 is what scheduled in the next four years.

But it is roughly 49% of the total.

Non QM loans are adjustable most of those are.

Note rates.

Sure.

That is the either the start rate or the margin and then theres interim caps involved.

And whatnot, but.

What we've been seeing in the resets is that the new note rate is just slightly below what market rates are right now.

And so that continues to look comparatively lower than going out and trying to refinance into a new note.

You know I can get into some of the details but essentially.

The margins are between $3 50.

And 500 over so for your sofa rate generally.

Okay. Thanks, and then you mentioned continuing to reposition it.

Portfolio, what do you think is the best allocation of capital going forward are you guys looking to stay in commercial get out of commercial increase in non agency non QM whats the plan there.

Sure Greg.

I think obviously we're committed to.

Uh huh.

Sure.

So just sort of Disney and the portfolio is still towards the residential side, that's been our focus as well.

Prudently managing liquidity and leverage so.

Yes, I think valuations are still pretty compelling across the board.

We see obviously the.

At todays low rates.

There's not a lot of supply of new mortgages being created but we do think that theres a lot of value.

Okay.

No rate today in the 7% to 9% range.

And then in.

The securities market, we still see spreads at elevated levels.

So still focusing on optimizing the.

Our value.

But we do hold and I think opportunistically looking to rotate into residential focus.

Gotcha, and then following up on that.

In terms of opportunistic investments. It's good to see you guys are paying down some of the recourse debt, but how are you valuing that versus.

M B a R.

<unk> so the current spreads.

Okay.

Yeah.

It does.

We did do some reinvestment in the quarter, so we've been rotating a bit within our within our position as well.

You're trying to take advantage of some of the opportunities as we see them.

But obviously the cost of financing continues to be elevated as well.

So it's a balancing act in terms of where we really see.

Liquidity management relative to.

We believe are attractive.

That's an opportunity.

Thanks, guys.

Okay.

Thank you.

Thank goodness you'd like to ask a question. Please press star one at this time.

Showing no further questions. This concludes our question and answer session.

To turn the conference back over to management for any closing remarks.

Thank you all again for joining us for today's call. We appreciate your continued interest in WMC. We hope you all 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.