Q2 2023 Western Asset Mortgage Capital Corporation Earnings Call

Welcome to the Western asset mortgage capital Corporation's second 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'd like to turn the call over to Mr. Jeff Haas of financial profiles. Please go ahead Mr.

Yes.

Thank you Alan want to thank everyone for joining us today, because it's got to western asset mortgage capital Corporation's financial results for the second quarter of 2023 yesterday. The company issued its earnings press release, which is available in the Investor Relations section of the company's website at www dot western half that MCC.

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

In addition, the company yesterday jointly announced with AG mortgage investment trust that they have entered into a definitive merger agreement under which AG mortgage investment Trust, we will acquire the company and its stock and cash transaction details of the proposed transaction are contained in the joint press release, which is posted on the investor.

Relations section of the company's website and filed with the SEC.

With us today from our management team are Bonnie Walter <unk>, Chief Executive Officer, Robert Lehman, Chief Financial Officer, Greg Handler, Chief Investment Officer, and Sean Johnson, Deputy Chief Investment Officer, as a result of yesterday's announcement regarding the transaction with M. ITT, we will limit this called swipe.

<unk> remarks, and will not be conducting a question and answer session. During the call 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 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 four.

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.

<unk> section of the company's report filed with the Securities and Exchange Commission, we disclaim any obligation to update our forward looking statements unless required by law with that I will now turn the call over to Bonnie wonderful Bonnie.

Thank you, Jeff and welcome everyone.

Before I discuss our second quarter financial results I would like to say a few words about yesterday's announcement that WMC has entered into an agreement to merge with AG mortgage investment Trust also known as M. I T T.

The joint press release, which is available on our website discusses the details of the proposed transaction and its benefits to our shareholders as well as M. I T T.

I will now touch on the key highlights of why we have entered into the transaction.

Firstly WMC shareholders well received cash consideration in addition to M. I T T stop.

The cash payment will be made by M. I T teeth external manager Angelo Gordon and will comprise just under 10% of aggregate merger consideration to shareholders.

Based on this past Monday's closing stock price that's M. I T. Six common stock for each share and W. M C or a shareholder would receive $10, an 11th N and M. I T T Star plus $1 12 in cash for a total consideration of $11.23 per share.

This represents a 34% premium to WMC closing price on July 12, 2023.

Second the combined company will have a reduced general and administrative expense ratio and a more optimized capital structure.

As a result, we expect the combination of our businesses to be accretive within one year of closing and to support an attractive growth profile for the combined company.

Third the combined company will be backed by strong commitment and resources from Angelo Gordon M. I T T. Its external manager, which is a leading global alternative asset manager with extensive expertise in residential credit and a proprietary best in class securitization platform that will support future growth of the residential mortgage portfolio.

Furthermore, Angelo Gordon has agreed to wave $2 4 million of management fees during the first year after closing.

Fourth WMC and M. I T T have complementary investment strategy is both focused on residential mortgage credit.

The company will have an investment portfolio valued at $5 7 billion.

Consisting of approximately 86% of non agency residential market is one 5% of agency residential mortgage backed securities and 6% and other residential investment.

WMC at legacy commercial investment will represent approximately 3% of the total investment portfolio on a pro forma basis.

Given the increased scale of the combined company, we expect the investor base to expand which should lead to enhanced trading liquidity and volume.

Finally in light of the synergies between the two companies, we expect significant operating efficiencies and the amount of $5 million to $7 million on an annual basis.

This is before taking into account the effect of resetting of Wmc's management fee and Angelo Gordon management fee waiver, which I previously noted.

A joint proxy statement and prospectus is expected to be filed in the coming weeks that will include additional details regarding the transaction and we encourage you to join US our fellow shareholders in voting to approve the proposed transaction.

With that I will now turn to our quarterly results.

During the second quarter, we did not acquire any target up and instead focus primarily on strengthening our balance sheet and increasing our liquidity.

Specifically, we've reduced our recourse debt by approximately $24 $3 million using the proceeds from the sale repayment or paydowns.

The investment.

Our GAAP book value per share decreased 10, 8% from the prior quarter, well economic book value per share increased five 7%.

We generated more net interest income during the quarter driven by a lower net interest margin and lower income from our interest rate swap positions, while our operating expenses increased sequentially from the prior quarter, primarily due to one time expenses related to our strategic process.

Consequently, our distributable earnings at $1.3 million or 22 10 per share in the second quarter were down 88 $846000 in the first quarter.

We maintained our quarterly dividend to be consistent with the first quarter level at 35 cents per share.

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

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

Now I'll hand, it over to Sean and Greg to go into more detail about the investment portfolio Sean.

Thank you Bonnie during the second quarter interest rates remain volatile against the backdrop of changing expectations regarding future Federal reserve actions.

10 year Treasury rate resumed its upward trajectory as events in the banking sector calmed down and the bond market. We focus his attention on inflation measures that while improved remained somewhat elevated relative to the fed's longer term target levels.

Against higher rates credit spreads generally widened across many risk assets with some asset classes impacted more than others similar to last quarter residential credit spreads fared better than commercial.

Real estate spreads.

Our residential whole loans continue to perform in line with our expectations.

With nearly 3000 mortgages fewer than 1% where more than 90 days delinquent at quarter end, reflecting 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 this pool of mortgages was just under 66% and the average FICO score for our borrowers was 749.

Nearly half our non QM loan portfolio consists of adjustable rate mortgages or the $90 million of current non QM loan holdings are scheduled to reset over the next year with more than 318 million scheduled to reset.

Oh.

The next four years.

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

Second quarter non QM prepayments were seven seven CPR compared to $7 five CPR in the first quarter and $6 two CPR in the fourth quarter of last year as a result premium amortization from loan prepayments.

In the quarter was $736000 consistent with $721000 in the first quarter.

We continue to believe that higher mortgage rates will weigh on refinance refinancing activity our portfolio keeping prepayments relatively low.

We did not acquire non QM or non QM loans during the quarter as our focus is on paying down recourse debt and maintaining sufficient liquidity on our balance sheet.

We did monetize $8 7 million of non agency CRT securities during the quarter using the proceeds to pay down recourse debt.

Now a few words on our view of the overall housing market, which remains favorable well.

While overall demand has cooled in response to higher rates. It's also created a more balanced market home prices are showing modest growth in recent months.

Given the strong labor market across the country, we do not see a significant risk of widespread defaults, particularly as it relates to our lower LCD portfolio.

With that I'll turn the call over to Greg handlers.

To discuss our commercial it's Greg.

Thanks, Sean.

As we noted last quarter, the overall market sentiment for commercial real estate credit remains challenged.

The fed rate hikes have resulted in higher mortgage coupons negatively impacting cap rates in property valuations as equity investors adjust to the higher capital costs.

Additionally, the fundamental concerns over office values have remained at the forefront of investors' minds, particularly given some recent notable high profile people.

The office market continues to face an uncertain future with significant questions about the long term viability of lower quality properties.

Our exposure to office building is minimal across our commercial investment.

We do not see as much fundamental concerns in the non office CRE sectors.

Notably multifamily housing industrial hospitality and retail sectors, where operating cash flows have generally recovered too and in many cases are now exceeding pre COVID-19 level.

Now turning to our commercial portfolio.

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

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

A slight discount to their 80 million par value.

All of these loans have performed in line with expectation.

We received a small partial pay down on one of these ones during the quarter and expect all of these loans to pay off at par over the next several quarters as <unk>.

These are either sold or refinanced.

Within the non agency commercial mortgage backed securities.

Our single asset single borrower credit portfolio is valued at $49 million down from $53 million at the beginning of the quarter.

Rates rose and spreads widen.

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

Catered to leisure travelers.

We continued to see positive operating momentum at a number of these properties.

These properties are generally high quality assets with strong equity sponsors. So we believe 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 67% of the combined principal balance despite.

Despite the fact that the loads had an approximate 66% of original loan to value at all but one of them representing less than $1 million of the $49 million portfolio remained Kurt.

We remain focused on optimizing the recovery value in our commercial portfolio and intend to use those proceeds to pay down our recourse debt level and to opportunistically reinvest into new target out there.

<unk> continues to offer attractive risk adjusted returns.

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

Thank you Greg.

We've provided you with great detail on our portfolio in both our second quarter press release and our earnings presentation.

Going to focus only on items that warrant additional attention.

We reported distributable earnings of $1 $3 million or 22 cents per share for the second quarter as compared to $2 $2 million with 36 cents in the first quarter.

The decline in distributable earnings with problem from the first quarter was primarily driven by lower net interest income and lower income from our interest rate swap positions.

Our core operating expenses increased modestly from quarter to quarter, primarily due to higher professional fees.

GAAP book value for the quarter was $14 69 per share a decrease of $1 77, or 10, 8% from the first quarter.

The decrease was primarily driven by spread widening across our residential and commercial holdings.

Economic book value, which reflects the value of our retained interest in the consolidated securitization trusts.

And the associated gross assets and liabilities increased by five 7% for the quarter to $18 54 per share.

Turning to leverage our recourse leverage ratio at quarter end was two six times consistent with the prior quarter.

Turning to liquidity, we ended the quarter with unrestricted cash of $17 4 million.

Subsequent to quarter end, we replaced an existing repo facility.

With a new longer term 65 million fixed rate non mark to market securitized funding vehicles.

As a result, we no longer have any financing arrangements with credit Suisse as a counterparty.

In summary, we remain focused on actions that will solidify our capital structure and maintain our liquidity.

With that I will now turn the call over to Bonnie.

Bonnie.

Thank you Bob and thank all of you again for joining us for today's call. We appreciate your continued interest in WMC and we'll be providing you more details on the merger with M. I T. T. In the weeks ahead, we encourage you to vote.

Actions have a great day.

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

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